Alter Ego in Federal Court

by Daniel T. McCloskey

For many years, plaintiffs enjoyed wide latitude when stating claims in federal court. But in recent years, that has changed as the U.S. Supreme Court has clarified the pleading standards, effectively raising the bar for avoiding dismissal. Two of the Court's decisions in particular have affected the pleading of all manner of claims in federal court, requiring plaintiffs to include more detail to show their entitlement to relief. (See Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 561 (2007) and Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949-50 (2009).) At the same time, these cases offer defendants an enhanced opportunity to obtain dismissals if claims are facially deficient.

These decisions have had notable consequences for pleading alter ego claims designed to "pierce the corporate veil" as plaintiffs now must allege more detail before courts will allow these claims to proceed. Since Twombly and Iqbal, federal courts have required more than the conclusory allegations of alter ego elements that often sufficed in the past. As a result, defendants facing alter ego claims now have a potent tool for winning dismissal or forcing the plaintiff to file an amended pleading that contains a facially plausible claim. This development has not been lost on corporate defendants and their parent companies, affiliates, and shareholders--each of whom is a potential alter ego defendant. Plaintiffs are paying attention too, for they are anxious to get their cases moving past the pleading stage.

Rule 8
In federal court, the general pleading requirements are contained in Rule 8 of the Federal Rules of Civil Procedure. It provides that a complaint must contain "a short and plain statement of the claim showing that the pleader is entitled to relief." (Fed. R. Civ. P., Rule 8(a)(2).)

Though simply stated, this rule is important. Under Rule 12(b)(6) a court may dismiss a claim if the complaint fails to "state a claim upon which relief can be granted." (Fed. R. Civ. P. 12(b)(6).) Dismissal may be based on the lack of a cognizable legal theory or on insufficient factual allegations (Johnson v. Riverside Healthcare Sys., 534 F.3d 1116, 1121 (9th Cir. 2008)).

For years, the U.S. Supreme Court set a low threshold for satisfying Rule 8, and consequently, for surviving a motion to dismiss under Rule 12(b)(6). Before Twombly and Iqbal, dismissal was improper "unless it appears beyond doubt that the plaintiff can prove no set of facts" that would entitle the plaintiff to relief (Conley v. Gibson, 355 U.S. 41, 45-46 (1957)).

Under this standard, stating an alter ego claim was not difficult. Plaintiffs would simply include a paragraph alleging that defendants were alter egos, and stating baldly that there was such a unity of interest that to consider the defendants to be separate entities would result in an injustice. These bare allegations tended to be devoid of facts.

A case involving the Federal Reserve Bank exemplifies the conclusory pleading that courts considered sufficient to state a claim for alter ego. In that case, the plaintiff alleged that the parent "dominated and controlled" its subsidiary "to such an extent that the individuality and separateness of the subsidiary had ceased," that the parent "disregarded [the subsidiary's] corporate form," that the subsidiary "was so inadequately capitalized that ... its capitalization was illusory," and that allowing the two entities to remain distinct would result in inequity.

The court found that these allegations "implicated a variety of the factors" relevant to alter ego, so that the court "cannot say that the [plaintiff] can prove no set of facts that would entitle it to relief." (Federal Reserve Bank of San Francisco v. HK Systems, 1997 WL 227955 at *6 (N.D. Cal.).) The plaintiff was allowed, in essence, to recite buzzwords showing the claim elements, rather than to allege underlying facts that would plausibly support alter ego.

Impact of Twombly and Iqbal
Twombly was the antitrust case that opened the door for a reassessment of the pleading standards that were laid down half a century earlier in Conley. In giving Rule 8 a fresh look, the Supreme Court stated that the pleadings "must allege facts suggestive of illegal conduct." "[W]holly conclusory" allegations are insufficient (Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 561 (2007)).

Whether Twombly applied outside of the antitrust context was not definitively answered until two years later, when the high court decided a case involving a Pakistani Muslim who had been arrested after 9/11 and contended he was mistreated.

In Ashcroft v. Iqbal, the Court made clear that the basic requirements discussed in Twombly apply to all cases in federal court, confirming that while "well-pled facts" would be presumed true, "legal conclusions" would not. Thus, "[t]hreadbare recitals of elements of a cause of action, supported by mere conclusory statements, do not suffice." As a result, to avoid a Rule 12(b)(6) dismissal, "a complaint must contain sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face." The Court explained that "[a] claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." (Iqbal, 129 S. Ct. at 1949.)

Alter Ego Requirements
Under California law as applied in federal court, a plaintiff must meet two requirements to establish alter ego. The plaintiff must show "(1) that there is such a unity of interest and ownership that the separate personalities [of the two entities] no longer exist, and (2) that failure to disregard [their separate identities] would result in fraud or injustice." (Halo Elecs. Inc. v. Bel Fuse Inc., 2010 WL 2605195 at *5 (N.D. Cal.) (citations omitted).)

Since Iqbal, district courts in California have issued a number of decisions dealing with the adequacy of alter ego pleadings, showing they will dismiss claims that lack the required factual detail.

In one case, the court dismissed an alter ego claim that was based on allegations that at all relevant times "there existed a unity of interest in the ownership" between defendant Jerome Kowalski and the defendant corporations, "such that any individuality and separateness between him and the corporations ceased to exist, rendering his corporations his alter ego." The complaint went on to allege that "adherence to the fiction of the separate existence" of the defendant corporations as distinct from Kowalski "would permit an abuse of the corporate privilege and would sanction fraud, inequity and promote injustice by his ability to avoid and prevent attachment and execution by creditors," thereby rendering the defendant corporations insolvent and unable to meet their obligations (Legal Additions LLC v. Kowalski, 2010 WL 335789 at *6 (N.D. Cal.)).

The court held that these allegations did not satisfy Rule 8, finding instead that the complaint contained "only conclusory factual content." The court dismissed the alter ego claim with leave to amend, provided that the plaintiff could do so consistent with Federal Rule 11 (2010 WL 3355789 at *6-7).

District courts have rejected similar allegations in other cases. (See Eclectic Properties East LLC v. Marcus & Milli- chap Co., 2010 WL 384736 at *4 (N.D. Cal.) (dismissing claim and stating that "plaintiffs must allege facts from which a plausible inference could be drawn that a defendant is the alter ego of another"); and Hammond v. Monarch Investors LLC, 2010 WL 2674401 at *5 (S.D. Cal.) (dismissing "conclusory" alter ego claim and stating that "[p]laintiffs must point to specific facts demonstrating that Defendants have failed to observe the corporate separateness.")

To plead alter ego, plaintiffs now must allege facts plausibly showing entitlement to relief. Some have been able to do so. For instance, in a wage and hour case, the court denied a motion to dismiss an alter ego claim. The court in Laguna v. Coverall North America Inc. (2009 WL 5125606 (S.D. Cal.)) held that the plaintiff had alleged specific facts to show alter ego, including that one of the defendants "is the sole shareholder [in the defendant and another corporate entity]; regularly removed cash and other assets from Coverall to minimize the ability of creditors to attach funds[; and] failed to keep corporate minutes and/or backdated such minutes. ..." The plaintiff further alleged "failure to contribute capital, issue stock, [or] otherwise complete formation" and cited deposition testimony showing that the defendants had not received pertinent corporate data and reports. The court found these allegations sufficient to "raise the right to relief beyond a mere speculative level." (See 2009 WL 5125606 at * 3.)

In another case, the court denied a motion to dismiss a complaint alleging wage and labor code violations and other claims against Noteware Development and its alleged alter ego. The court affirmed that "conclusory allegations" of alter ego are inadequate to establish facial plausibility, but held that the plaintiff's allegations were sufficient because they included "specific allegations as to why there was such a unity of interest and ownership that the separate personalities ... do not in reality exist." (See Rimes v. Noteware Development LLC (2010 WL 1644693 at *3 (N.D. Cal.).)

In Fund Raising v. Alaskans for Clean Water (2009 WL 36725 (C.D. Cal.)), the plaintiff sought to compel arbitration against a nonsignatory to a contract on grounds that the nonsignatory was the alter ego of a signatory. The alleged alter ego defendant moved to dismiss, arguing that the allegations were insufficient to state a claim under Iqbal. The court found sufficient the plaintiff's allegations that the alter ego dominated and controlled the others and comingled assets, and that the separateness of the entities had ceased to exist. Despite this, the court granted the motion to dismiss because the complaint's allegations failed to satisfy the second alter ego element, that is, that recognizing the corporate status would sanction an inequitable result. It should be noted that the petitioner had pled that "[a]dherence to the fiction of separate existence ... would permit an abuse of the corporate privilege, sanction fraud and promote injustice. [Respondents] have insufficient assets to respond to the an [sic] award of compensatory damages, costs, attorney's fees and punitive damages sought in this case." The court held that these allegations were "conclusory," and that "the insufficiency of assets is not enough to establish inequity under the alter ego test." (2009 WL 36725 at *4.)

These cases demonstrate that successful alter ego claims should specifically allege the presence of one or more of the factors that prove alter ego relationships. Further, courts will require facts to show inequity beyond a simple failure to recover. To merely parrot legal conclusions about unity of interest and inequity is not enough after Iqbal.

California Courts
Given the U.S. Supreme Court's adjustment of federal pleading, it is worth reviewing how alter ego claims fare in California state courts.

Section 425.10 of the California Code of Civil Procedure governs the general pleading standards for claims in state courts. This section provides, in pertinent part, that a complaint shall contain a demand for judgment and "a statement of the facts constituting the cause of action, in ordinary and concise language." (See Cal. Code Civ. Proc. § 425.10(a)(1) and (2).) If a party fails to meet this standard, the claim is subject to dismissal via demurrer for failure "to state facts sufficient to constitute a cause of action." (Cal. Code Civ. Proc. 430.10(e).)

As with the evolving federal cases, it is important to understand the scrutiny courts will apply in determining whether a complaint states "facts sufficient" to state a cause of action. While bare legal conclusions are insufficient, California courts typically require complaints to plead "ultimate, rather than evidentiary facts." A complaint is sufficient if it sets forth the essential facts with reasonable precision and with particularity sufficient to acquaint a defendant with the nature, source, and extent of the cause of action. Moreover, a plaintiff may allege on information and belief any matters that are not within his personal knowledge if he has information leading him to believe that the allegations are true. The latter statement refers to the "less particularity doctrine," which the state supreme court has endorsed for cases in which the defendant has more "particularized knowledge." (See Doe v. City of Los Angeles, 42 Cal. 4th 531, 550 (2007).)

Under the "ultimate facts" standard, alter ego claims (which are sometimes considered a remedy not subject to demurrer) are not subject to a plausibility requirement. As a consequence, alter ego claims receive significantly less scrutiny in California state courts at the pleading stage than they do in federal court, a situation analogous to the federal approach before Iqbal.

A related issue is whether a heightened pleading standard should be applied to alter ego claims in state court, given that they may trigger intrusive financial discovery under the state's punitive damages statute. (See Cal. Civ. Code, § 3295(c).) In a recent unpublished decision granting a writ on a discovery issue, the appellate court declined to rule on this question because the sufficiency of the alter ego allegations had not been tested in the trial court via motion to strike or demurrer (RP Communities LLC v. Superior Court, 2010 WL 2125212 at *15 (Cal. Ct. App.)).

A New Day
The U.S. Supreme Court has raised the bar for pleading all claims, with clear consequences for alter ego plaintiffs and defendants. After Iqbal, federal courts no longer accept claims that consist of a bare recital of conclusory labels and the elements for alter ego. To overcome a motion to dismiss, plaintiffs must now plead sufficient factual detail to show a facially plausible entitlement to relief. Defendants now have a powerful tool for testing the sufficiency of alter ego claims, and have a clear path for obtaining dismissals that did not exist before Iqbal.

The more liberal pleading standard operative in California state courts is an additional reason alter ego defendants may seek removal to federal court: Their ability to dismiss or otherwise limit alter ego claims is significantly improved in federal court after Iqbal. And in light of the RP Communities decision, a defendant in state court should at a minimum test the sufficiency of conclusory alter ego allegations via a motion to strike; failing to do so may prohibit consideration of the question in a higher court.

Daniel T. McCloskey is of counsel in the Silicon Valley office of Greenberg Traurig, where he litigates complex business and intellectual property disputes.

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