We recently posted about the risks associated with veil-piercing claims and the ways in which fund managers can protect themselves from exposure to these claims. Our first post on veil-piercing focused on Delaware standards, while this post discusses California law.

California law differs in several important respects from Delaware law on this topic. If a company is subject to suit in California, there are increased risks even if the company is incorporated elsewhere.  Courts may assert that California law should apply when the plaintiff is a California resident or when the company operates in California.

And where California law applies, courts may aggressively set aside corporate distinctions, leading to unanticipated results. For example, a Santa Clara Superior Court held in recent years held that a private fund limited partnership entity could be held responsible for the fund GP’s obligations to its former employees.

Because the alter ego inquiries are so fact-driven, if an underlying California cause of action against the portfolio company survives, it is likely the alter ego claim may survive too—beyond the dismissal stage, leading to costly litigation involving the fund. That means that a liability of the fund or even its GPs could well become entirely dependent, on a derivative basis, on that of the portfolio company.

What Law Applies?

Most states follow the internal affairs doctrine and apply the law of the state of incorporation to piercing the corporate veil claims. However, no California case has done this.  To the contrary, statements made in California cases strongly suggest that the “internal affairs doctrine” would not apply to a veil piercing claim. See, e.g., Lidow v. Superior Court, 206 Cal. App. 4th 351, 362 (2012).  And a federal district court in the Northern District of California, interpreting California law in a diversity case, concluded that the “internal affairs doctrine” does not apply to choice-of-law questions involving the alter ego/veil piercing doctrine. Oncology Therapeutics Network Connection v. Virginia Hematology Oncology PLLC, No. C 05-3033 WDB, 2006 WL 334532, at *17 (N.D. Cal. Feb. 10, 2006).

Instead, California applies the choice-of-law test it traditionally uses for all other claims: the “governmental interest” test. California’s “governmental interest” test is complicated and costly to litigate.  It involves three basic steps:

  1. First, do the competing states’ laws differ?
  • In other words, is the substantive law of alter ego/veil piercing different in state X than in state Y California?
  • If the laws of the competing states do not differ, then either state’s law produce the same result, and it doesn’t matter which law you apply, you’ll get the same result.
  1. If the laws of the competing states do differ, the court then identifies which interests of each state, if any, could be impaired if the court does not apply that state’s laws.
  2. If both states have interests that would be impaired if its their laws are not applied, the California court conducts an analysis of “comparative impairment” to determine which state has the greater interest in having its laws applied.
  • When the plaintiff is a California resident who claims to have been injured by the defendant, or when the defendant is doing business in California and subject to suit there, California courts tend to find that California has the greater interest.
  • In either scenario, the court is validating California’s interest in policing (California defendant) or giving redress to its own citizens (California plaintiff).

In short, if a plaintiff can bring the suit in California, there is good chance California law will apply to any veil-piercing claims – even if the company and the fund are located elsewhere.

General Standards in California

California law typically does not require a plaintiff to come forward with evidence of fraud in order to apply the veil piercing doctrine.  Rather, a California plaintiff only needs to show that honoring the corporate form would “promote injustice” or “bring about inequitable results.”

California utilizes a non-exclusive, multi-factor test to make veil-piercing determinations. This long list of almost twenty factors (including one factor that points to the existence of additional factors as yet unarticulated by the courts) includes the following:

  1. commingling of funds and other assets;
  2. the holding out by an individual that he is personally liable for the debts of the corporation
  3. failure to maintain adequate corporate records;
  4. identical equitable ownership in the two entities;
  5. identification of the directors and officers of the two entities in the responsible supervision and management;
  6. sole ownership of all of the stock in a corporation by one individual or the members of a family;
  7. the use of the same office or business location;
  8. the employment of the same employees and/or attorney; and
  9. failure to maintain arm’s length relationships among related entities.

Morrison Knudsen Corp. v. Hancock, Rothert & Bunshoft, LLP, 69 Cal. App. 4th 223, 249–50 (Cal. Ct. App. 1999).  California courts have made it clear that summary judgment is rarely appropriate for veil-piercing determinations.  All a plaintiff likely needs to survive summary judgment is a genuine dispute of material fact over some of these factors.

Takeaways:

What You Can Do

So, what can you do to protect a fund from piercing claims? Our prior post outlined a list of dos and don’ts to help minimize exposure to alter ego claims.  If the portfolio company is potentially subject to claims in California, these concerns are even more heightened.  A fund manager might evaluate the structure with the view of a California court:  would recognizing the corporate limitation of liability “promote injustice” or “bring about inequitable results?”  If so, the manager may want to take steps to further extend its arm’s length relationship with the investment.

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Photo of Joshua M. Newville Joshua M. Newville

Joshua M. Newville is a partner in the Litigation Department and a member of Proskauer’s White Collar Defense & Investigations Group and the Asset Management Litigation team.

Josh handles securities litigation, enforcement and regulatory matters, representing corporations and senior executives in civil and…

Joshua M. Newville is a partner in the Litigation Department and a member of Proskauer’s White Collar Defense & Investigations Group and the Asset Management Litigation team.

Josh handles securities litigation, enforcement and regulatory matters, representing corporations and senior executives in civil and criminal investigations. In addition, Josh advises registered investment advisers and private fund managers on regulatory compliance, SEC exams, MNPI/insider trading and related risks.

Before joining Proskauer, Josh was senior counsel in the U.S. Securities and Exchange Commission’s Division of Enforcement, where he investigated and prosecuted violations of the federal securities laws. Josh served in the Enforcement Division’s Asset Management Unit, a specialized unit focusing on investment advisers and the asset management industry. His prior experience with the SEC provides a unique perspective to help asset managers manage risk and handle regulatory issues.

Photo of Lee Popkin Lee Popkin

Lee Popkin is a trial lawyer in Proskauer’s Commercial Litigation, Product Liability, and Intellectual Property groups. Lee represents clients in a wide range of industries in high-stakes trials in state and federal courts throughout the country. Lee’s experience includes developing case themes, preparing…

Lee Popkin is a trial lawyer in Proskauer’s Commercial Litigation, Product Liability, and Intellectual Property groups. Lee represents clients in a wide range of industries in high-stakes trials in state and federal courts throughout the country. Lee’s experience includes developing case themes, preparing key witnesses for deposition and trial, taking and defending expert depositions, and drafting and arguing case-dispositive motions.

Lee was recently named to the Best Lawyers in America inaugural “Ones to Watch” list.

Lee’s notable representations and victories include:

  • Universal Standard Inc. v. Target. Counsel to Target in successful defense of Lanham Act trademark infringement action related to its Universal Thread clothing line.
  • Echeverria v. Johnson & Johnson. Trial counsel to Johnson & Johnson in a widely publicized product liability trial relating to the company’s talc-based products and their alleged link to ovarian cancer. After trial, the court entered judgment notwithstanding the jury verdict for the J&J defendants, and, in the alternative, granted J&J’s motion for a new trial.
  • Bed Bath & Beyond Inc. v. 1-800-Flowers.com, Inc. Successfully represented Bed, Bath & Beyond in action to enforce agreement by 1‑800-Flowers to purchase PersonalizationMall.com.
  • Global Holdings v. Church & Dwight, Co., Inc. Secured dismissal of state and federal dilution claims in Lanham Act action regarding a consumer product. The court’s decision made new law in the Second Circuit on the issue of whether a valid registration preempts state law claims of dilution.  Daniels v. Johnson & Johnson. Trial counsel to J&J in product liability trial related to the company’s talc-based products in St. Louis. The jury returned a complete defense verdict on all claims and awarded zero damages.
  • Daniels v. Johnson & Johnson. Trial counsel to J&J in product liability trial related to the company’s talc-based products in St. Louis. The jury returned a complete defense verdict on all claims and awarded zero damages.Daniels v. Johnson & Johnson. Trial counsel to J&J in product liability trial related to the company’s talc-based products in St. Louis. The jury returned a complete defense verdict on all claims and awarded zero damages.
  • Allied Lomar, Inc. v. Diageo North America, Inc. Counsel to Diageo in successful defense of Lanham Act trademark infringement action concerning Blade & Bow Whiskies and the Stitzel-Weller Distillery.
  • Diageo North America, Inc. v. Mexcor. Trial counsel to plaintiff Diageo in a Lanham Act trade dress infringement and dilution action against competitor involving Crown Royal whisky. Obtained a jury verdict and permanent injunction in favor of our client following a two‑week trial.

In addition to her active practice, Lee regularly contributes to the Firm’s false advertising blog, Watch This Space: Proskauer on Advertising Law. Lee also devotes significant time to pro bono matters, and was recognized by KIND for her work representing two sisters from El Salvador fleeing gang violence.

Before joining Proskauer, Lee served as law clerk to the Honorable Sarah S. Vance of the United States District Court for the Eastern District of Louisiana. She received her J.D. cum laude from Harvard Law School.