244 Cal. App. 4th 789
Cal. Ct. App.2016Background
- MF ’08 LLC (the Company) was controlled by two managers (Walter and Kelly Ng); Dennis Zentil was the Company’s lawyer.
- The managers allegedly formed the Company to siphon investor funds to entities they controlled; Zentil is alleged to have known of and assisted the concealment.
- The Company became insolvent; investors filed involuntary bankruptcy and Susan Uecker was appointed liquidating bankruptcy trustee (Trustee).
- Trustee sued Zentil for torts based on his alleged participation in the managers’ fraud; Zentil demurred arguing the claims are barred by the in pari delicto doctrine.
- The trial court sustained the demurrer without leave to amend; the Court of Appeal affirmed.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether in pari delicto bars trustee’s suit brought under 11 U.S.C. § 541 | Trustee: § 541 should not allow a trustee to be treated as the debtor for this defense; trustee is an innocent successor | Zentil: § 541 requires treating the trustee as standing in the debtor’s shoes; if debtor would be barred at commencement, trustee is too | Held: Affirmed — under § 541 trustee is subject to in pari delicto if the debtor would have been at case commencement (following federal authority) |
| Whether Civil Code § 2306 prevents imputing managers’ fraud to the Company (defeating in pari delicto) | Trustee: § 2306 bars imputation when an agent acts fraudulently; Company should not be charged with its managers’ fraud | Zentil: Sole-actor/alter-ego rule imputes agent knowledge where agent controls principal; § 2306 does not apply when agent and principal are effectively one | Held: Imputation proper here — managers were sole controllers so their fraud is imputed; § 2306 does not negate sole-actor doctrine |
| Whether leave to amend should have been granted | Trustee: Could plead that governing documents allowed removal of managers by innocent owners, negating sole-actor rule | Zentil: Complaint shows managers controlled the entity; Trustee hasn’t shown a viable amendment | Held: Denied — Trustee failed to show a reasonable possibility an amendment could cure the in pari delicto bar |
Key Cases Cited
- Schifando v. City of Los Angeles, 31 Cal.4th 1074 (Cal. 2003) (standard for reviewing demurrer with and without leave to amend)
- Peregrine Funding, Inc. v. Sheppard Mullin Richter & Hampton LLP, 133 Cal.App.4th 658 (Cal. Ct. App. 2005) (trustee stands in debtor’s shoes under § 541; in pari delicto can bar trustee)
- Official Committee v. R.F. Lafferty & Co., 267 F.3d 340 (3d Cir. 2001) (§ 541 prevents considering post-commencement events; trustee cannot invoke innocent-successor theory)
- Grassmueck v. American Shorthorn Ass’n, 402 F.3d 833 (8th Cir. 2005) (sole-actor/alter-ego doctrine imputes agent’s knowledge when agent controls the principal)
- F.D.I.C. v. O’Melveny & Myers, 61 F.3d 17 (9th Cir. 1995) (receiver vs. trustee distinction; receiver not necessarily bound by in pari delicto defenses)
- Travelers Casualty & Surety Co. v. Pacific Gas & Electric Co., 549 U.S. 443 (U.S. 2007) (federal law governs what property is in the bankruptcy estate; state law governs substantive rights)