If an appellate court reverses a bankruptcy court that has denied recognition in a chapter 15 case, the automatic stay under Section 1520 does not become effective retroactively to the date when the bankruptcy court had denied recognition, the Ninth Circuit ruled.

In a second holding by Circuit Judge Carlos Bea, the appeals court ruled that a “general” alter ego claim may be asserted by a creditor even after invocation of the automatic stay.

The September 16 decision might fall into the category of “hard cases make bad law,” because the facts make a compelling case for equities to favor the beleaguered creditor.

Alter Ego

The creditor was a producer of lubricants. Headquartered in Monaco, the debtor was a distributor of lubricants for the debtor. Naturally, the agreement between the two contained nondisclosure and noncompetition agreements binding the debtor.

The debtor hired one of the producer’s chemists. They formed a business that produced lubricants identical to those made by the producer. Competition from the distributor drove the producer’s revenue to the vanishing point.

When the producer eventually learned about the theft of its intellectual property and violation of the nondisclosure and noncompetition agreements, the producer started an arbitration in California. The arbitrator gave the producer an award against the distributor for $1 million plus costs and attorneys’ fees. The producer had the award confirmed in federal district court in California.

According to Judge Bea, the debtor stonewalled the producer’s subsequent efforts in discovery aimed at collecting the judgment. While discovery was pending, the distributor declared bankruptcy in Monaco. The foreign representative filed a chapter 15 petition in California seeking foreign main recognition.

In chapter 15, there is no automatic stay before a grant of foreign main recognition. To halt the producer’s discovery and efforts to collect the judgment, the bankruptcy court entered a provisional stay before ruling on recognition.

Eventually, the bankruptcy court denied recognition, saying the petition was a sham to forestall recovery by the producer. Now a debtor, the distributor appealed the denial of recognition but did not seek a stay pending appeal.

Once the provisional stay evaporated, the producer turned up the heat in the district court where it had been attempting to collect the judgment. As a sanction for discovery abuses, the district court ruled that the owner of the debtor was the debtor’s alter ego. The district court added the debtor’s owner as a judgment debtor on the $1 million arbitration award.

The owner appealed the $1 million judgment to the Ninth Circuit.

While the appeal was pending in the Ninth Circuit, the Bankruptcy Appellate Panel reversed the bankruptcy court and decided that there should have been recognition under chapter 15. At that point, the automatic stay finally came into effect under Section 1520.

Effective Date of the Automatic Stay

In the appeal to the Ninth Circuit from the $1 million judgment, the owner argued that the judgment was invalid because the chapter 15 automatic stay should have been retroactive to the day when the bankruptcy court originally denied recognition. The owner also argued that the alter ego claim underlying the judgment belonged to the chapter 15 estate and should not have been asserted by the producer.

Judge Bea first dealt with the effective date of the chapter 15 automatic stay under Section 1520(a)(1). On recognition, the subsection says that “sections 361 and 362 apply with respect to the debtor and the property of the debtor that is within the territorial jurisdiction of the United States.”

The owner contended that the $1 million judgment was void because the proceedings in district court on the alter ego theory occurred after the date when recognition should have been entered in the first instance.

Judge Bea said that retroactive application of the chapter 15 stay was a question of first impression. Nonetheless, he said that “the answer is as straightforward as the question is novel.” He said that the “plain text” of Section 1520 means that a stay is triggered only when recognition is granted.

Judge Bea saw no reason to apply the court’s equitable power as a “workaround” to avoid “Section 1520’s clear language,” because the owner had not sought a stay pending appeal. Had the appeals court made the automatic stay retroactive, he said that the owner would have had the effect of a stay pending appeal without having sought one in the first place. The rules requiring a stay pending appeal “would no longer be ‘obligatory’” had he made the stay retroactive.

Judge Bea held that the district court’s enforcement action on the judgment did not violate the automatic stay because the stay was not retroactive and did not come into effect until after the producer was awarded a $1 million judgment against the owner.

Ownership of Alter Ego

The owner argued that the alter ego claim belonged to the bankrupt estate of the debtor-distributor.

Regarding choice of law, Judge Bea said that the owner made no proffer about the substance of Monegasque law on alter ego claims. He ruled that the alter ego law of California, the forum state, was presumptively controlling.

Judge Bea said that the Ninth Circuit had “already answered the question as to who owns an alter ego claim under California law.” In Ahcom, Ltd. v. Smeding, 623 F.3d 1248, 1250 (9th Cir. 2010), he said that the appeals court said that a “general” alter ego claim simply does not exist in California. Ahcom held that a trustee may bring an alter ego claim against a debtor’s owner if there is some evidence of injury to the debtor itself. In the absence of such proof, the creditor may assert the alter ego claim.

In the case on appeal, the producer’s claims for breach of contract and misappropriation alleged injury only to the producer and not to the chapter 15 debtor. “To the extent this purely procedural claim belongs to anyone,” Judge Bea said, “it belongs to [the producer].”

Judge Bea affirmed the district court. There was no automatic stay in effect when the district court entered judgment against the owner, and the alter ego claim was not property of the chapter 15 estate.