The following is a recent case update prepared by Gary Kaplan a partner at Farella, Braun + Martell LLP:
In MSY Trading Inc. v. Saleen Automotive, Inc., 51 Cal.App.5th 395 (2020), the California Court of Appeal held that a defendant is entitled to attorneys’ fees after successfully defending a claim to be held liable as the alter ego of a judgment debtor, when the underlying litigation involved a contract with an attorneys’ fees provision, even though the defendant was not a party to the underlying contract. A post-judgment action to add a party as an alter ego on a judgment is itself an action “on a contract” for purposes of Civil Code section 1717, entitling the business owner who defeated the alter ego claim to prevailing party attorneys’ fees. To view the opinion, click here.
In an earlier lawsuit, plaintiff MSY Trading obtained a judgment for breach of contract against certain entities (“Judgment Debtors”). Because the contract contained an attorneys’ fees provision, MSY Trading’s judgment also included an award of attorneys’ fees. MSY Trading then filed an action against Steve Saleen (among others), on the basis that Mr. Saleen, the CEO of one of the Judgment Debtors, should be held liable as its alter ego. Mr. Saleen successfully defeated the alter ego claim and then moved to recover his related attorneys’ fees based on the contract in the underlying action. The trial court awarded attorneys’ fees to Mr. Saleen and MSY Trading appealed.
Pursuant to California Civil Code section 1717, where a contract provides for an award of attorneys’ fees in a lawsuit to enforce the contract, the right to reasonable attorneys’ fees is reciprocal and they are awarded to whomever is the prevailing party. On appeal, MSY Trading asserted that the alter ego action was not an action “on a contract,” so that attorneys’ fees were not available to Mr. Saleen as the prevailing party.
The Court of Appeal rejected this argument. Even though the alter ego action was not directly an action on the underlying contract, the appellate court found that the lawsuit constituted a continuation of the original action on the contract. The Court of Appeal noted that MSY Trading could have included its alter ego allegations against Mr. Saleen in the underlying action, in which event, “undoubtedly [Mr. Saleen] would have been entitled to contractual attorney fees.” The appellate court reasoned that MSY Trading’s choice to sue him in a separate (post judgment) action should not insulate MSY Trading from a fee award under Civil Code section 1717. The Court of Appeal accordingly held that when a judgment creditor seeks to add a party to a contract-based judgment, the alter ego action is “on the contract” for purposes of an attorneys’ fees award under Section 1717, even if the alleged alter ego was not a party to the contract.
The Court of Appeal also rejected MSY Trading’s argument that attorney’s fees are unavailable to the defendant because the judgment extinguished all further contractual rights, including the attorney’s fees provision in the underlying contract. While the Court of Appeal noted that this rule—a judgment entered in a case involving a contract extinguishes all further contractual rights, including an attorney fees provision—is true in general, it does not apply to alter ego claims. When an alter ego is added to a judgment, it is because the alter ego is deemed a party to the original lawsuit. Therefore, an alter ego claim to establish liability for a judgment on a contract—regardless of the procedural method employed to raise the claim—is an “action on a contract” for purposes of Civil Code section 1717.
Although the appellate court’s opinion states that the case raised an apparent issue of first impression, a different panel of the Court of Appeal had previously ruled similarly in Burkhalter Kessler Clement & George LLP v. Hamilton, 19 Cal.App.5th 38 (2018). And another Court of Appeal decision recently followed the reasoning in MSY Trading Inc. v. Saleen Automotive in awarding attorneys’ fees under Civil Code section 1717 to two alter ego defendants who prevailed on the tort causes of action against them after plaintiff voluntarily dismissed its breach of contract claims. 347 Group, Inc. v. Philip Hawkins Architect, Inc., 2020 WL 7136870 (3d Dist., December 7, 2020) (ordered published). The appellate court in 347 Group, reversing the trial court, found that the alter ego action was an action “on the contract” because it sought to hold the individual liable (on fraudulent conveyance and conspiracy grounds) for the underlying judgment on a contract against their company. The appellate court observed that if the plaintiff had prevailed on its alter ego action to have the defendants deemed to be alter egos of the judgment debtor, then the individuals would have been liable for attorney fees pursuant to the attorneys’ fees provision in the underlying contract. The Court of Appeal ruled for defendants because section 1717 makes the right to fees reciprocal.
These cases illustrate the potential risks a plaintiff faces in pursuing alter ego claims related to a contract with an attorneys’ fees provision. Indeed, a plaintiff with a meritorious breach of contract claim may end up being liable for the defendant’s attorneys’ fees in pursuing an unsuccessful alter ego claim against the counterparty’s principal while being unable to collect a judgment obtained against the contracting party. This scenario—an effort to recover from the principals of an entity that cannot pay a judgment—frequently occurs in the real estate context where single purpose entities (typically LLCs or partnerships) are created to pursue development projects, while lacking funds to pay a judgment for contract breach if the project fails.
These materials were prepared by ILC member Gary M. Kaplan, a partner at Farella Braun + Martel LLP in San Francisco (email@example.com), with editorial contributions from ILC member Joseph Boufadel, a partner at Salvato Boufadel LLP in Los Angeles (Jboufadel@salvatoboufadel.com).