Case No.: 1-13-CV-254777

Demurrer by Defendant Surpass, Inc. to Plaintiffs’ First Amended Complaint

This action arises from the alleged breach of a commercial lease agreement. Plaintiffs Michael Mansfield and Theresa Mansfield, as trustees of the Mansfield Family Trust (collectively “Plaintiffs”), are the owners of commercial real property located in the City of Mountain View. (First Amended Complaint (“FAC”), ¶ 1.) In August of 2009, Plaintiffs leased the property to Defendant Lychron, LLC. (Id., ¶¶ 9-10.) Under the terms of the original lease agreement, Plaintiffs agreed to lease the 9,984 square foot premises and surrounding land in return for monthly base rent payment of $14,300. (Id., ¶¶ 9, 12.) In September of 2011, Plaintiffs and Lychron agreed to amend the lease agreement whereby Plaintiffs would provide Lychron with a $500,000 loan for tenant improvements and Lychron would repay the loan in monthly installments. (Id., ¶¶ 13, 14.) The monthly loan payments were to be made in addition to the monthly rent payments. (Id., ¶ 14.) In September of 2012, Plaintiffs deposited $500,000 into an escrow account and, per the parties’ escrow agreement, Lychron was authorized to withdraw funds to pay for construction, acquisition, and installation of tenant improvements. (Id., ¶ 15.)

Plaintiffs allege that Lychron withdrew $445,836.10 from the escrow account but, contrary Lychron’s representation that the money was for tenant improvements, much of the money was utilized for paying off existing loans and debts that Lychron had incurred prior to Plaintiffs’ making the tenant improvement loan. (FAC, ¶¶ 17-18.)

In January of 2013, Lychron was acquired by Surpass-Silicon Valley, LLC (“SSV”). (FAC, ¶ 20.) SSV is a subsidiary of Surpass, Inc. (“Surpass”). (Id., ¶ 4.) According to Plaintiffs, Surpass desired to purchase Lychron, but not in its own name. (Id., ¶ 28.) Surpass therefore created SSV for the purpose of purchasing Lychron. (Id.) To avoid liability to Lychron’s creditors (such as Plaintiffs), Surpass provided SSV with enough capital to purchase Lychron, but not to cover Lychron’s debts. (Id., ¶¶ 30-31.)

As part of the asset contribution agreement between Lychron and SSV, Lychron assigned its lease with Plaintiffs, including all of Lychron’s contractual obligations, to SSV. (Id.) In August of 2013, SSV stopped making monthly rental payments and payments on the tenant improvement loan. (Id., ¶ 22.) By the end of August 2013, SSV had vacated the premises. (Id.)

On October 18, 2013, Plaintiffs initiated this action against Lychron and SSV, asserting claims for breach of the lease agreement, conversion, misrepresentation, successor liability, and declaratory relief. Default was entered against Lychron in December of 2013. Plaintiffs thereafter sought leave to amend their complaint to add Surpass as a named defendant. The court granted the motion for leave to amend on February 5, 2015.

Plaintiffs filed the operative FAC on February 18, 2015, asserting eight causes of action: (1) breach of the lease agreement (against Lychron, SSV, and Surpass); (2) conversion (against SSV and Surpass); (3) conversion (against Lychron); (4) misrepresentation (against Lychron); (5) successor liability (against SSV and Surpass); (6) breach of contract (against Kinderhook Industries, LLC (“Kinderhook”), which is a general partner and managing member of both SSV and Surpass); (7) misrepresentation (against Kinderhook); and (8) declaratory relief against all defendants.

Discussion

Surpass demurs to each of the causes of action asserted against it (the first, second, fifth, and eighth causes of action) on the ground that Plaintiffs have failed to state facts sufficient to constitute a cause of action under Code of Civil Procedure section 430.10, subdivision (e). More specifically, Surpass points out that Plaintiffs’ claims are dependent upon the theory that Surpass is the alter ego of SSV. According to Surpass, Plaintiffs have not pled facts sufficient to support their alter ego theory of liability.

To recover on an alter ego theory of liability, a plaintiff must establish facts sufficient to show (1) a unity of interest and ownership between the corporation that allegedly engaged in the wrongful conduct and its equitable owner (which may be an individual shareholder or another business entity, such as a parent or sister corporation), and (2) an unjust result if the corporation is treated as the sole actor. (See Sonora Diamond Corp. v. Super. Ct. (2000) 83 Cal.App.4th 523, 538; see also Las Palmas Assocs. v. Las Palmas Ctr. Assocs. (1991) 235 Cal.App.3d 1220, 1249.)

Surpass contends that alter ego allegations must be pled with specificity. (Mem. of Ps & As in Support of Demurrer, p. 4.) This is incorrect. Under California law, alter ego allegations are not subject to any heightened degree of scrutiny at the pleading stage. (See Rutherford Holdings, LLC v. Plaza Del Rey (2014) 223 Cal.App.4th 221, 236.) A party is only required to allege ultimate rather than evidentiary facts in support of an alter ego theory. (First Western Bank & Trust Co. v. Bookasta (1968) 267 Cal.App.2d 910, 915.) Indeed, the plaintiff need not mention the words “alter ego” in his or her complaint. (Leek v. Cooper (2011) 194 Cal.App.4th 399, 415.) The complaint must simply set forth the facts with sufficient precision to put the defendant on notice about what the plaintiff is complaining of and hat remedies are being sought. (Id.)

The cases cited by Surpass indicating that a plaintiff carries a heavy burden to demonstrate liability based on the alter ego theory of liability are either (1) not in same procedural posture—such as Vasey v. California Dance Company (1970) 70 Cal.App.3d 742 (appeal from order denying motion to set aside default judgment after evidentiary hearing in unlawful detainer proceeding) and Pearl v. Shore (1971) 17 Cal.App.3d 608 (appeal from order granting motion for summary judgment)—or (2) federal cases not citing to California precedent—such as Neilson v. Union Bank of California, N.A. (C.D. Cal. 2003) 290 F. Supp. 2d 1101, 1116 (citing to federal case out of the Southern District of New York for the proposition that alter ego allegations must be pled specifically).

Concerning unity of interest, the Court of Appeal has found that forming a shell company for the sole purpose of undertaking the allegedly wrongful conduct, combined with inadequate capitalization and the diversion of assets to pay for personal expenses was sufficient to find a unity of interest between a corporation and the person sought to be held liable as an alter ego of the company. (Hub City Solid Waste Services, Inc. v. City of Compton (2010) 186 Cal.App.4th 1114, 1123-1124.) Plaintiffs have made similar allegations in this case. They allege that prior to its acquisition, Lychron was a profitable company and Surpass desired to acquire it. (FAC, ¶¶ 27-28.) They allege that Surpass created SSV as a subsidiary company for the purpose of acquiring Lychron. (Id., ¶ 28.) They allege that, at the time of Lychron’s acquisition, SSV and Surpass has the same CEO. (Id., ¶ 29.) They further allege that Surpass undercapitalized SSV, contributing enough capital so that SSV could acquire Lychron’s assets, but not enough for operating expenses or to cover Lychron’s liabilities. (Id., ¶ 30.) Finally, Plaintiffs allege that Surpass “has withdrawn funds from [SSV] and concealed and sold [SSV’s] assets, keeping [SSV] undercapitalized in order to avoid liability to creditors.” (Id., ¶ 31.) These allegations, taken as true for the purpose of evaluating Surpass’ demurrer, are sufficient to plead unity of interest.

As to the second prong, Plaintiffs are required to plead and prove that an unjust result will occur if the corporation is treated as the sole actor. (Sonora Diamond Corp., supra, 83 Cal.App.4th at p. 526.) The Court of Appeal has held that bad faith conduct by the individual or entity sought to be held liable satisfy this element. (Hub City Solid Waste Services, Inc., supra, 186 Cal.App.4th at p. 1123.) Bad faith may be found in situations involving (1) the manipulation of assets and liabilities between entities so as to concentrate the assets in one and the liabilities in the other, and (2) the diversion of assets from the corporate entity to another person or entity to the detriment of creditors. (Associated Vendors, Inc. v. Oakland Meat Co. (1962) 210 Cal.App.2d 825, 840.) Plaintiffs have made such allegations in this case. (FAC, ¶¶ 30-31.)

The demurrer of Surpass to the FAC is OVERRULED.