The U.S. Bankruptcy Code does not address or govern the requirements for formation of a corporate entity in California.
As noted above, it therefore California law that will govern a creditor’s action to determine whether an individual debtor or a parent or subsidiary entity is a mere alter ego.
Although a bankruptcy judge will render a decision regarding a creditor’s attempt to pierce the corporate veil in a bankruptcy proceeding, California state law provides the relevant analysis.
This is the alter ego or unity of interests test described above.
However, the extent to which creditors can litigate this issue in a bankruptcy case varies depending upon what Chapter bankruptcy has been filed.
In a Chapter 7 bankruptcy proceeding, the Chapter 7 Trustee assigned to the case is the sole actor empowered to recover any assets of the bankruptcy estate created with the filing of the case. Likewise, the Chapter 7 Trustee is solely empowered to unwind or avoid fraudulent transfers or so-called preference payments.
Creditors of a Chapter 7 debtor are limited to filing motions denying the debtor’s discharge entirely or denying the dischargeability of the specific debt held.
A creditor may also provide information to the Chapter 7 Trustee regarding possible fraudulent transfers or other “bad faith” debtor activity for the Trustee’s consideration as to his or her own next steps in the case.
However, any alter ego allegations against the debtor initiated by a creditor would occur within the context of a motion or adversary proceeding seeking denial of discharge or non-dischargeability of the specific debt in question.
A piercing of the corporate veil in a Chapter 7 bankruptcy, in short, would be attempted attendant to a claim that the debt owed by the bankruptcy debtor is one that arose fraudulently.
Debts incurred fraudulently are not dischargeable in bankruptcy.
In Chapter 13 individual and Chapter 11 corporate reorganization bankruptcies, on the other hand, the debtor filing the bankruptcy case remains in possession of the assets of the bankruptcy estate.
Creditors retain standing to file motions for turnover of assets as well as motions or adversary proceedings to deny discharge or for non-dischargeability orders in Chapter 13 and 11 bankruptcies.
A motion for an order of non-dischargeability is the course of action in a bankruptcy proceeding most likely to succeed.
The effect of such an action will essentially be to remove the creditor’s collection efforts from Federal bankruptcy court back to state court, where the Bankruptcy Code’s mandated presumption in favor of the dischargeability of debt is not an issue.
If the matter has not already been adjudicated in California state court and the question of alter ego remains pertinent, the Bankruptcy Court’s order will estop the debtor’s arguments against a unity of interests in that forum.
If the matter is post-judgment in state court, the creditor will be able to resume execution of its state court judgment once the bankruptcy case is dismissed or administratively closed by the Bankruptcy Court.
In any instance, the assistance of a collection attorney experienced in state and Federal Bankruptcy Courts will be invaluable.
Contact collection attorney Ronald P. Slates today to discuss your collection matter.