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Nerox Power Systems, Inc. v. M-B Contracting Co., Inc. (9/13/2002) sp-5628
Nerox Power Systems, Inc. v. M-B Contracting Co., Inc. (9/13/2002) sp-5628
Notice: This opinion is subject to correction before
publication in the Pacific Reporter. Readers are
requested to bring errors to the attention of the Clerk
of the Appellate Courts, 303 K Street, Anchorage,
Alaska 99501, phone (907) 264-0608, fax (907) 264-0878,
e-mail corrections@appellate.courts.state.ak.us.
THE SUPREME COURT OF THE STATE OF ALASKA
NEROX POWER SYSTEMS, INC.; )
NEROX ENERGY CORPORATION, ) Supreme Court No. S-9922
a/k/a E*TWO MEDIA.COM; )
WILLIAM D. ARTUS; COAL ) Superior Court No.
FACTORS, INC.; THE LKL TRUST; ) 3AN-98-10356 CI
JOHN WALLACE, TRUSTEE FOR )
THE WALLACE M.D. FAMILY ) O P I N I O N
TRUST; GRETCHEN A. ROSS, )
TRUSTEE FOR THE G.A.R. ) [No. 5628 - September 13,
2002]
TRUST; and NICHOLAS E. ROSS, )
)
Appellants, )
)
v. )
)
M-B CONTRACTING COMPANY, )
INC.; TOPE EQUIPMENT )
COMPANY; ALASKA LAW )
OFFICES, INC.; and STEVEN )
JONES, )
)
Appellees. )
________________________________)
Appeal from the Superior Court of the State
of Alaska, Third Judicial District,
Anchorage, Karen L. Hunt, Judge.
Appearances: William L. Choquette, Choquette
& Farleigh, LLC, Anchorage, for Appellants.
Gary Spraker, Bundy & Christianson,
Anchorage, for Appellee Tope Equipment
Company.
Before: Fabe, Chief Justice, Eastaugh,
Bryner, and Carpeneti, Justices. [Matthews,
Justice, not participating.]
FABE, Chief Justice.
I. INTRODUCTION
In April 1997 Nerox Power Systems, Inc. recorded two
deeds of trust encumbering mining rights to the Jonesville coal
mine in Sutton, for the purpose of securing repayment of debts to
certain alleged creditors. At issue in this appeal is the
superior courts decision to give other creditors lien priority
over the deeds of trust under the doctrine of equitable
subordination. A second issue concerning the legal relationship
between Nerox Power, its parent company, and the major
shareholder in the parent company is which of these should assume
liability for the debts of Nerox Power. The superior court
pierced the corporate veil of the parent company to make its
major shareholder liable for the debts of Nerox Power. We affirm
the decision of the superior court in all respects.
II. FACTS AND PROCEEDINGS
Gemini Capital Corporation was incorporated in Nevada
in 1985, and its stock was publicly traded. The corporation held
interests in various gas and oil wells and based its profits on
royalties from its holdings. By April 1991 Gemini Capital
Corporation had run into financial difficulties, and its stock
was de-listed due to valuation uncertainties. The company
remained dormant for the next several months and in 1992 changed
its name to Gemini Energy Corporation. Gemini Operating Company,
a subsidiary of Gemini Capital Corporation (later Gemini Energy
Corporation), was incorporated in 1990.
In November 1992 Nicholas E. Ross obtained a
controlling interest in Gemini Energy Corporation; the
corporation changed its name to Nerox Energy Corporation in 1994.
Ross served as the president and chief executive officer of Nerox
Energy from the time of purchase until November 1997. In 1994
Ross sought to acquire a five percent interest in a Cook Inlet
oil field owned by Stewart Petroleum. In order to raise the
necessary capital, Ross issued 108,394 shares of common stock in
Nerox Energy. Because Nerox Energy was facing financial
difficulties at the time, Ross attracted investors by promising
that by 1996 Nerox Energys stock would reach $35.71, for a total
valuation of $3.87 million, and that any difference would be paid
either in cash or additional stock if this goal was not reached.1
Stewart Petroleum went bankrupt in 1996, depriving Nerox Energy
of its expected profit.
In 1995 Ross decided to expand into coal mining through
the subsidiary Gemini Operating Company, which he renamed Nerox
Power Systems, Inc. Nerox Power acquired the Jonesville coal
mine in Sutton, which was not operational at the time of
acquisition. The mining rights were previously owned by Hobbs
Industries, Inc. under a sublease with Placer Dome U.S., Inc.
Hobbs assigned its rights to Nerox Power on August 10, 1995 in
exchange for stock in Nerox Power and other consideration. In
late October 1995 Nerox Power purchased the mining rights from
Placer Dome for $1 million, $800,000 of which was paid in cash
and the balance executed in a promissory note. Of the $800,000
paid in cash, $400,000 was contributed by the GAR Trust and the
Ross Family Trust, while the other $400,000 was raised by the
sale of preferred stock to a set of investors.2 The mining
rights to the Jonesville mine were the only asset Nerox Power
ever owned.
The Jonesville mine was not successful, and Nerox Power
never generated any revenue from the sale of coal. Ross himself
personally loaned approximately $1.8 million to Nerox Power and
Nerox Energy to cover operating and development costs for the
mine. In September 1996 Nerox Power leased heavy equipment from
both M-B Contracting, Inc. and Tope Equipment Company for use at
the mine. Out of frustration over Nerox Powers financial
difficulties, Ross fired its existing president in December 1996
and replaced him with William Artus, who had been serving as
legal counsel for Nerox Energy. Shortly after being hired, Artus
loaned $79,500 to Nerox Power to cover operating expenses and a
portion of the remaining $200,000 it owed to Placer Dome. Artus
was also owed a little over $68,000 for legal services he
provided to Nerox Energy prior to becoming president of Nerox
Power. Nerox Energy issued Artus 151,016 shares of stock in 1997
but did not specify for which debt the stock was issued or how
much of the debt was relieved by the issuance. Nerox Power
recorded a deed of trust against the Jonesville mine on April 11,
1997 to secure a payment of $191,576 to Artus and Coal Factors,
Inc., which had supplied plans, materials, and equipment for a
coal washing plant.
Ross purchased Nerox Power in 1998 for $10,000 and the
assumption of all corporate debt. Ross also transferred control
of Nerox Energy to outside investors as part of the same
transaction. Nerox Energy was renamed E*two Media.com.
M-B recorded a lien against Nerox Power and Nerox
Energy on May 14, 1997 and a lien extension on October 27, 1998.
Tope recorded a similar lien on May 22, 1997 and a lien extension
on November 19, 1997. Nerox Energy stipulated to a judgment of
$47,500 in outstanding legal expenses to Alaska Law Offices and
Steven Jones on August 28, 1997 for services rendered with regard
to continuing litigation between Nerox Power and Hobbs
Industries.
On April 10, 1998, M-B filed to foreclose on its
mechanics lien and hold Nerox Energy liable for Nerox Powers
debt. Tope cross-claimed and counter-claimed to foreclose on its
mechanics lien, and Alaska Law Offices and Steven Jones later
moved to foreclose on its judgment lien. As a sanction for
failing to comply with a discovery order, the superior court held
that Nerox Energy was the alter ego of Nerox Power. Following a
May 2000 trial, Superior Court Judge Karen L. Hunt concluded,
based on extensive factual findings: that M-B and Tope could
foreclose on their mechanics liens and that Alaska Law Offices
and Steven Jones could foreclose on their judgment lien; that the
two April 1997 deeds of trust were subordinated to the mechanics
and judgment liens; and that both Nerox Power and Nerox Energy
were instrumentalities of Ross, thus piercing the corporate veil
and making Ross liable for their debts. Ross, Artus, Nerox
Power, Nerox Energy, and other investors in Nerox Energy appeal
this decision.
III. DISCUSSION
There are two main issues in this case: (1) whether
the two April 1997 deeds of trust can be equitably subordinated
to the liens of M-B, Tope, and Alaska Law Offices;3 and (2)
whether Ross is personally liable for the debts of Nerox Power
and Nerox Energy. The primary factual question raised by both
issues is whether Ross and Artus acted fraudulently in their
handling of the financial affairs for Nerox Energy and Nerox
Power. Judge Hunt found sufficient evidence to conclude that
fraud existed. To this finding we apply the clearly erroneous
standard of review.4 A finding of fact is clearly erroneous if
it leaves this court with a definite and firm conviction on the
entire record that a mistake has been made. 5 This standard,
therefore, requires us to give great deference to the findings of
the superior court.6 Judge Hunt further concluded that the
deeds of trust should be subordinated to the liens and that Ross
was personally liable for the debts of Nerox Power. These are
questions of law to which we apply our independent judgment.7
A. The Superior Court Did Not Err by Subordinating the Two
April 1997 Deeds of Trust to the Liens of M-B, Tope,
and Alaska Law Offices.
The Alaska Supreme Court has recognized that the
doctrine of equitable subordination, whereby the court may undo
or offset any inequity in the claim position of a creditor that
would produce injustice or unfairness to other creditors in terms
of bankruptcy results,8 can exist outside of the standard
bankruptcy context.9 A need for equitable subordination arises
in situations of [f]raud, unfairness, or breach of the rules of
fair play. 10 It is also the case, however, that an insolvent
debtor may convey property to one creditor, even if it means that
the debtors assets will thereby be depleted, and that the claims
of other creditors will be defeated.11 In the absence of
inequitable conduct on the part of a debtor, a court cannot alter
the pre-existing priorities among creditors.12 It is also
important to note that we have held both that directors of
insolvent corporations have a fiduciary duty to preserve the
assets of the corporation for its creditors13 and that attorneys
who represent insolvent corporations and have control over their
assets must also protect those assets for the creditors where
they know[ ] or should know that the director or officer intends
to interfere with creditors claims through an improper
distribution of those assets.14
1. The April 11, 1997 deed of trust
a. The debt to William Artus
On April 11, 1997, Nerox Power recorded a deed of trust
against the Jonesville mine and listed as beneficiaries William
Artus and Coal Factors, Inc. Artus himself signed the deed in
his role as president of Nerox Power. Debt amounts to Artus and
Coal Factors were not separately listed in the deed of trust
itself. The 1997 10-K report that Nerox Energy was required to
file with the Securities and Exchange Commission lists debts to
Artus of: (1) $68,196 for legal services in 1996 and 1997
combined, and (2) $85,432 for a loan that Artus made to Nerox
Energy in late 1996 or early 1997. However, Artus testified at
trial that he was owed $79,500 for the loan. This amounts to a
total debt to Artus of either $153,628 or $147,696. Nerox Energy
issued 151,016 shares of stock to Artus in conversion of debt
sometime in 1997.
The 1997 10-K report does not explain to what extent
the debts owed to Artus, both from his loan and for his legal
services, were satisfied by the 151,016 shares issued to him.
There is no monetary value attached to the shares, although one
could reasonably infer that the entire debt was satisfied by the
issuance of stock. The 1997 10-K report states that Nerox Energy
converted $568,168 in debt to shares of common stock in 1997 at
$1.00 per share. There is nothing definitive to say that the
issuance of stock to Artus was included in this debt conversion,
although converting debt at a dollar per share for the 151,016
shares issued to Artus would closely approximate the combined
debt owed to Artus for his loan and for legal services. Judge
Hunt concluded that Artuss debt was satisfied by the issuing of
the stock. She further found that the loan to Nerox Power by
Artus was a capital contribution for which he received the shares
of common stock in Nerox Energy. Judge Hunt found that fraud
existed in these transactions:
Mr. Artus breached his fiduciary duty to the
creditors by attempting to place the
interests of William D. Artus and Coal
Factors, Inc., shareholders in the
corporation, over the interests of third-
party creditors. The execution of the deed
of trust was done at a time when both
corporations were grossly undercapitalized.
Such conduct constituted a fraudulent
conveyance, hindered creditors and was
inequitable conduct.
Artus contends15 that because the amount of debt
compensated by the 151,016 shares is unclear, the conveyance of
the deed of trust cannot be fraudulent. However, we cannot say
that the superior court was clearly erroneous in concluding that
Nerox Power satisfied any debts Nerox Power owed to Artus. Based
on the 1997 10-K statement that certain unspecified debts were
converted to common stock at a price of $1.00 per share in 1997,
Judge Hunt found that the stock issued in satisfaction of debt in
1997 was issued for a dollar a share. Because the 151,016 shares
issued to Artus are roughly equal to the amount of money owed to
Artus by Nerox Power ($153,628 based on the figures in the 1997
10-K), there is evidentiary support for the superior courts
conclusion that all of Artuss debts had been satisfied, and we
cannot say that this factual determination is clearly erroneous.
Furthermore, Judge Hunt could have effected the
subordination of Artuss interest in the deed of trust
independently of whether or not she believed that his debt had
been satisfied by the issuance of stock. Appellees M-B, Tope,
and Alaska Law Offices focus on Artuss position as an insider in
Nerox Power and argue that this status supports a finding of a
fraudulent conveyance to Artuss own benefit. Appellees argue
that this is sufficient to support equitable subordination of the
deed of trust. The law supports this conclusion. Federal courts
have recognized three types of misconduct that constitute
inequitable conduct: (1) fraud, illegality, or breach of
fiduciary duties; (2) undercapitalization; and (3) claimants use
of the debtor as a mere instrumentality or alter ego.16 Judge
Hunt found the first two of these to exist, and her conclusions
were not clearly erroneous.
The prohibition against fraudulent conveyances has been
codified in Alaska law.17 The intent to defraud through a
conveyance is a question of fact usually to be proved by
circumstantial evidence.18 Many circumstantial factors can
indicate the existence of fraud.19 Badges of fraud must be viewed
within the context of each particular case.20 Judge Hunt found
that Artus either knew or should have known that many creditors
had not been paid at the time the deed of trust was recorded and
that these creditors would likely claim a lien against the mining
rights. In his role as a director of the company, and in his
former role as a lawyer for Nerox Energy, Artus had an obligation
to protect the rights and assets of the corporation for its
creditors.21 Judge Hunt further found that by naming himself as a
beneficiary of a deed of trust encumbering Nerox Powers only
asset for the purpose of repaying a loan and reimbursing the
costs of legal services he provided, Artus ignored his fiduciary
duty and engaged in inequitable conduct.22
We have recognized inadequate consideration, the
insolvency of the debtor/transferor, and a transfer of assets in
anticipation of a pending suit to be among the badges of fraud.23
All of these existed in the present case. Judge Hunt found that
Nerox Power was insolvent; that there was inadequate
consideration for the deed of trust; and that Artus knew Nerox
Power was likely to be burdened by mechanics liens in light of
its insolvency. These factual findings are not clearly erroneous
and satisfy the fraud category of inequitable conduct.
Judge Hunt also found that both Nerox Power and Nerox
Energy were grossly undercapitalized and that this constituted
inequitable conduct.24 The only asset of Nerox Power was the
right to mine coal at the Jonesville mine, which never went into
production. Judge Hunt found that Nerox Power had neither the
expertise nor the equipment to run a coal mine, hence the need to
hire M-B and Tope. All the funding for the expenses of Nerox
Power came either directly from Ross or indirectly from Ross via
Nerox Energy. Given these facts, it was not clearly erroneous to
find that Nerox Power was undercapitalized and that the deed of
trust for Artus could thus be equitably subordinated to the liens
of M-B, Tope, and Alaska Law Offices.
b. The debt to Coal Factors, Inc.
Judge Hunt found that Coal Factors was a consultant to
Nerox Power and had advanced them funds for use in developing the
mine, making them either an investor or an unsecured creditor.
Because Nerox Energy satisfied its debts to consultants by
issuing stock, Judge Hunt found that the debts owed to Coal
Factors had been satisfied. Coal Factors thus could not be
preferred over bona fide creditors.25 Yet, the evidence Judge
Hunt cites to show that Coal Factors was a consultant actually
suggests that Coal Factors was a standard contractor rather than
a consultant. Furthermore, the billing statements in the record
demonstrate that a substantial amount of Coal Factorss billing
was for material goods provided to Nerox Power for use in
developing the mine. There is also very little testimony at
trial to support the conclusion that Coal Factors served as a
consultant. However, M-B argues an alternative ground on which
to affirm the equitable subordination ordered by Judge Hunt.
It is unclear exactly how much was owed to Coal
Factors. There are no specific debt figures contained in the
1997 10-K report. Artus testified conflictingly that Coal
Factors was owed $115,000 and that it was owed $130,000. Nerox
Power and Coal Factors do not provide in their combined briefs
any clarification of the amount owed other than to rely on Artuss
testimony.26 Because the deed of trust was drafted for payment of
$191,576, subtracting the $151,016 that Artus received leaves
$40,560 for Coal Factors. However, the timing between the debts
incurred, the payments made, and the April 11, 1997 recording of
the deed confuses matters further.
The largest expense incurred by Coal Factors $80,000
for structural steel for a coal wash plant was invoiced on
September 8, 1997, several months after the deed of trust was
recorded on April 11, 1997. It is conceivable that some or
perhaps all of this expense was incurred prior to the recording
of the deed of trust.27 Certain other expenses apparently were
incurred prior to April 11, 1997, even though they were not
invoiced until several months later. M-B alleges that Coal
Factors was only owed $27,541.44 on April 11, 1997, when the deed
of trust was recorded. Ultimately, it is impossible to get a
clear accounting from the record of the expenses Coal Factors
incurred before April 11, 1997.
Based upon the evidence in the record, there is
insufficient justification for the amount of the Coal Factors
deed of trust.28 The record shows that prior to April 11, 1997,
Coal Factors had incurred costs of $33,394.4629 for work done and
materials provided to Nerox Power30 and been paid $17,794.90 for
these costs, leaving indebtedness of only $15,599.56. The deed
of trust, as far as the record goes, provides collateral to Coal
Factors for a debt of only $40,560. There is no indication in
the deed of trust as to what the deed is securing and no
indication of what consideration, if any, Coal Factors gave to
Nerox Power to justify any amount in excess of its existing debt.
This court cannot act as the accountant for Coal Factors,
determining when its debts were incurred and which ones are valid
for the purpose of the deed of trust.31 Were the deed of trust
clearer or the record more complete, it is possible that Coal
Factors could demonstrate that it was error for Judge Hunt to
shift the priority of the liens of M-B, Tope, and Alaska Law
Offices.32 As the record stands before this court, however, a
sufficient implication of fraud exists with regard to the
dealings between Coal Factors and Nerox Power to support Judge
Hunts conclusion that Coal Factorss interest in the deed of trust
must be equitably subordinated to the claims of other creditors.
2. The April 21, 1997 deed of trust
On April 21, 1997, Nerox Power, with Artus as
president, recorded a deed of trust encumbering the Jonesville
mine and naming as beneficiaries ten entities or individuals:
Duane Albert, Mr. and Mrs. L.G. and C. Brotzman, George Peterson,
The Larson Family Trust, The LKL Trust, Paul F. Schroff, Robert
O. Jones, Sally L. Zutter, John Wallace for the Wallace Family
Trust, and Gretchen A. Ross for the Ross Family Trust and the GAR
Trust. The total debt owed to all of these beneficiaries was
$1,040,000. Judge Hunt found that those named as beneficiaries
had already had their debts satisfied by receiving preferred
shares for their capital contributions. As such, Judge Hunt
determined that the interests of these beneficiaries in the deed
of trust should be equitably subordinated to the claims of other
creditors.
The primary dispute lies in who lent money to Nerox
Energy to raise capital for the purchase of the Placer Dome
lease. Ross stated in his deposition33 that $800,000 was raised
for this purpose and that the investors received preferred shares
in exchange. He listed as lenders: Myself, or I should say my
family trust, my wifes family trust, that was the GAR trust.
Last names only, Brockman; Shiba . . . ; Peterson; Larson; Albert
. . . Schroff; . . . Zutter. The corresponding total amount for
these names on the deed of trust is $695,000, although no amount
can be found for the alleged investor Shiba.34 Nerox Power admits
in its brief that the GAR Trust received shares of preferred
stock in exchange for its loan of $400,000. Nerox Power further
admits that Peterson, Larson, Albert, Schroff, and Zutter also
received preferred stock.35 Nerox Power in its brief only
challenges the finding that Mr. and Mrs. L. G. and C. Brotzman,
the LKL Trust, Robert O. Jones, and the Wallace Family Trust
received preferred stock.
Rosss deposition confirms that those who supplied the
money for the Placer Dome lease received preferred stock for
their loans:
Q: Now the money that was paid to Placer
Dome, youve already told us that came
from these six or seven people you.....
A: Correct.
Q: Did you end up paying back those people
the amounts that they had lent?
A: They got preferred shares in Nerox
Energy Corporation.
Q: Were they ever paid back any money?
A: No, they had preferred shares.
Q: Are they still preferred shareholders
of.....
A: Theyre preferred shareholders, correct.
As such, these people would be investors and not creditors, which
would prevent them from having priority over the liens of M-B,
Tope, and Alaska Law Offices because they were already
compensated for the money they provided.
Artus in his testimony provides further evidence that
the investors who had provided money to acquire the coal mine
were listed as beneficiaries in the April 21 deed of trust to
compensate them with collateral for their payment used in the
acquisition of the Jonesville lease:
Q: . . . [W]ho directed you to record
either or both of these [deeds of
trust]?
A: Myself as a director and Mr. Ross as a
director.
Q: So other than yourself, Mr. Ross was the
other one who directed you to do this?
A: Yes.
Q: From what Mr. Ross told you[,] what was
his reasoning for reporting these two
deeds of trust?
A: These people were owed money by Nerox
Power Systems, Inc., and they provided
money to acquire the coal mine, or for
the development of the coal mine, and
they were owed money and he wanted them
to have some collateral for their
payment.
Q: And why was he or you taking this step
in recording this deed of trust at this
time?
A: Because the board of directors
determined it was an appropriate thing
to do.
Q: And why?
A: Because these people had loaned money
for the acquisition of the coal lease
and/or development of the coal mine and
we thought it was appropriate that they
have security for payment of the debts
that were owed.
By themselves, the statements of Ross and Artus are
inconclusive. However, when Artuss statement that those listed
on the deed of trust were the people who had provided money to
start the corporation is combined with Rosss statement that those
who loaned the money received preferred shares in return, one
could reasonably reach the conclusion that those listed in the
deed of trust received preferred shares for their investments.
Because the mine had never gone into operation, these investors
had not received any return on the money they provided to Ross
and thus still could have been viewed as creditors.
There is therefore evidence to support Judge Hunts
conclusion that the parties listed in the deed of trust were
investors who were compensated for their expenditures with
preferred stock.36 Nerox Power argues that no evidence was ever
provided showing that the beneficiaries engaged in any
inequitable conduct. This misses the point. The issue is not
whether those listed as beneficiaries in the deed of trust acted
inequitably but rather whether those who recorded the deed did.
The evidence in the record supports the conclusion that those who
provided money to Nerox Power for the coal mine simply made a bad
investment. This finding is not clearly erroneous. It was not
inappropriate to conclude that to compensate these investors over
the rights of bona fide creditors would be inequitable.
Consequently, the interests in the mining lease held by those
named in the deed of trust could be equitably subordinated to the
liens by M-B, Tope, and Alaska Law Offices.
3. The extent of the lien
In her final judgment, Judge Hunt recognized M-B and
Tope as having mechanics liens on the entire Jonesville coal mine
site. Nerox Power argues that mechanics liens only attach to the
specific location at which the hired machinery was used and that
because M-B and Tope did not identify the specific locations
where their machinery was used, their mechanics liens cannot
extend to the entire lease site. Nerox Power urges that this
interpretation is required by the language in AS 34.35.055(a).37
However, the statute does not require so narrow an
interpretation.
Although the determination of who qualifies as a
lienholder is strictly construed, the intent and purpose of lien
laws are to be liberally construed.38 In the present situation, M-
B and Tope supplied equipment for use on the mining site. Nerox
Power admits that the equipment was used on the mining site. The
granting of a lien contemplates not just the physical area in
which a contractor worked but also the monetary costs the
contractor incurred.39 M-B and Tope were contracted to provide
equipment for the purpose of developing the entire mine site, not
just a portion of it. As such, their liens should extend to the
entire mine site.40 The fact that construction was so incomplete
as to make it difficult or perhaps impossible to determine the
precise location or locations at which their equipment was used
does not deprive M-B and Tope of recovery.
B. Judge Hunt Did Not Err in Ruling that Nicholas Ross Was
Personally Liable for the Debts of Nerox Power and
Nerox Energy.
Judge Hunt found that Nerox Energy was the mere
instrumentality of Nicholas Ross. As part of a sanction for
failure to comply with a discovery order, Judge Hunt held Nerox
Energy to be liable for the debts of Nerox Power.41 At trial,
Judge Hunt also found Nerox Power to be a mere instrumentality of
Nicholas Ross. The finding that Nerox Power, both directly and
via its identity with Nerox Energy, is a mere instrumentality of
Ross allows M-B, Tope, and Alaska Law Offices to pierce the
corporate veil and hold Ross personally liable for the debts of
Nerox Power and Nerox Energy.42
Alaska law establishes six factors for determining if a
corporation is a mere instrumentality of one of its shareholders:
(1) whether the shareholder owns all or most of the stock; (2)
whether the shareholder subscribed to all of the capital stock or
caused the incorporation; (3) whether the corporation is grossly
undercapitalized; (4) whether the shareholder uses the property
of the corporation for his or her own benefit; (5) whether the
directors of the corporation act independently of the
shareholder; and (6) whether the formal legal requirements of the
corporation are observed.43 It is not necessary for all six
factors to be satisfied before instrumentality can be found.44
However, at least some evidence of five of the six factors can be
found in the present case. This evidence supports Judge Hunts
conclusion that both Nerox Energy and Nerox Power were mere
instrumentalities for Nicholas Ross and that Ross was thus liable
for their debts to M-B, Tope, and Alaska Law Offices. Judge
Hunts factual findings are not clearly erroneous; we therefore
affirm those findings.45
1. Ownership of stock
Ross admitted that he owned a controlling interest in
Nerox Energy. Through Ross Production Company, Inc., for which
Ross was the sole shareholder, Ross never owned less than twenty
percent of Nerox Energy. Nicholas Ross admitted that Ross
Production Company had no business and was just a shell
corporation. Ross Production Company owned eighty-one percent of
the shares of Nerox Power.46 As part of the conversion of Nerox
Energy into a shell corporation for purchase by outside
investors, Ross Production Company assumed all of the debts and
liabilities of Nerox Power. This evidence supports the finding
that Nicholas Ross was the dominant and controlling shareholder
of Nerox Energy Corporation from 1992 through the end of 1998 and
exercised exclusive control over Nerox Power Systems, Inc. This
finding is not clearly erroneous.
2. Cause of incorporation
Ross did not initially incorporate either of the
companies that became Nerox Energy or Nerox Power. However, at
the time Ross took control of the two companies under their
former names of Gemini Energy Corporation and Gemini Operating
Company, both were essentially dormant. Ross thus played a
crucial role in reactivating the two companies. Judge Hunt
concluded that this activation of Nerox Power was substantively
no different than originally incorporating the corporation.
Judge Hunt reached a similar conclusion with regard to Nerox
Energy, which would have gone out of existence but for the 1992
infusion of capital by Mr. Ross. When a corporation was
previously dormant and thus for practical purposes non-existent,
the difference between activation of the corporation and its
initial incorporation is, for the purposes of this factor,
minimal. We therefore affirm the superior courts finding.
3. Undercapitalization
The determination of whether the capitalization of a
corporation is sufficient is based on whether the corporation has
sufficient capital to satisfy its likely business obligations.47
This matter is assessed in relation to the corporations
operations.48 Judge Hunt found that the initial capitalization of
Nerox Energy was grossly inadequate and that Nerox Power was
grossly undercapitalized during all relevant times. Nerox Powers
only asset was the rights to the Jonesville mine, which never
went into production. All of the funding for the expenses of
Nerox Power came from Ross.
The finances of Nerox Power were never entirely clear,
even to those ostensibly in charge. The initial president of
Nerox Power testified that he could not assess whether the
company was undercapitalized because he never knew what funds
were in its accounts. He further testified that it was his
understanding that Nerox Power had none of its own funding, but
depended entirely on money from Nerox Energy. Nerox Energy,
which was dependent in large part on a bankrupt Stewart Petroleum
for its source of income, did not fare much better. To what
extent these circumstances were business transactions gone sour
and to what extent they were initial undercapitalization is hard
to determine definitively. However, there is enough evidence to
conclude that Judge Hunts finding of undercapitalization is not
clearly erroneous.
4. Shareholder use of corporate assets
Judge Hunt found that Nicholas Ross used the corporate
assets of Nerox Power and Nerox Energy for his personal benefit
by: naming his family trusts as beneficiaries in a deed of trust
encumbering the Jonesville coal mine lease, which was Nerox
Powers only asset; using Nerox Powers coal lease as collateral
for a $300,000 loan (increasing to $500,000 when interest is
included) that was used to pay the operating expenses of Nerox
Energy; and improving his own financial situation as the
principal shareholder in Nerox Energy, and by extension in Nerox
Power, through converting the debt of those two companies into
shares in what he knew to be an essentially insolvent
corporation. These actions alone do not clearly indicate that
Nerox Power was an instrumentality of Ross. Because not all
factors in the Uchitel test need to be satisfied to institute
equitable subordination, we decline to determine whether or not
the actions of Ross constitute the use of corporate assets for
ones own personal gain.
5. Independence of directors
Judge Hunt found that the various directors of Nerox
Power took their directions from Ross himself.49 This finding is
supported by trial testimony. Ross personally loaned $1.8
million for continuing the operations of Nerox Power, giving him
substantial control over the operations of the company. Ross
himself admitted that Nerox Power could not make any investments
without some sort of loan from him. This is confirmed by the
testimony of the two directors of Nerox Power. The first
director of Nerox Power testified that he had limited involvement
in the financial dealings of Nerox Power and did not even have
the authority to sign checks for the company. When asked who he
considered himself an employee of Nerox Power, Nerox Energy, or
Nick Ross the director answered Nick Ross. Artus, the second
director of Nerox Power, testified that as director he recorded
the deeds of trust at Rosss direction. Artus further testified
that it was Rosss responsibility to ensure that there was enough
money to pay the bills for Nerox Power. Given the financial
control that Ross exercised over Nerox Power, this finding is not
clearly erroneous.
6. Corporate formalities
Judge Hunts conclusions about the inadequate financial
records kept by Nerox Power and Nerox Energy are supported by the
record, or lack thereof. There was no documentation of the loans
to acquire the Jonesville lease. There was incomplete
documentation of loans from Nerox Energy to Nerox Power. The
financial reports are exceedingly vague as to who received shares
of stock and in compensation for what.50 Nerox Power points in its
defense to the fact that its corporate meeting minutes were
transcribed. While these minutes are helpful in building a
chronology of events, they do little to clarify the sources of
financing for Nerox Energy or Nerox Power. The lack of record
keeping by Nerox Power calls into question its existence as an
independent entity and justifies the finding by Judge Hunt that
Nerox Power was an instrumentality of Nicholas Ross.
IV. CONCLUSION
Judge Hunt did not err in her factual findings that
Nerox Power committed fraud in recording its deed of trust and
that Nerox Power was a mere instrumentality of Ross. Nor did
Judge Hunt err in applying the law to these findings. The
decision of the superior court is therefore AFFIRMED in all
respects.
_______________________________
1 An earlier financial statement also lists $3.87 million
of expected stock value but claims that the promised value of
each share was only one dollar, implying that 3.87 million shares
were issued. The number of shares issued is less important than
the amount of debt incurred by Nerox as a result.
2 The exact number of investors is disputed and will be
addressed in the later discussion of the April 21, 1997 deed of
trust.
3 References to Alaska Law Offices also implicate any
debts owed to or arguments made by Steven Jones, as Jones was an
attorney for Alaska Law Offices and the services rendered appear
to be the same. The two were treated as essentially the same
entity by Judge Hunt.
4 Gillum v. L & J Enterprises, Inc., 29 P.3d 266, 268
(Alaska 2001).
5 City of Hydaburg v. Hydaburg Coop. Assn, 858 P.2d 1131,
1135 (Alaska 1993) (quoting Parker v. Northern Mixing Co., 756
P.2d 881, 891 n.23 (Alaska 1988)).
6 Matanuska Elec. Assn, Inc. v. Rewire the Bd., 36 P.3d
685, 700-01 (Alaska 2001) (noting that the use of a clearly
erroneous standard of review for factual findings in contempt
proceedings is consistent with the deferential review used by
courts in other jurisdictions); Berry v. Berry, 978 P.2d 93, 97
(Alaska 1999) (referring to the clearly erroneous standard of
review as deferential); In re J.A., 962 P.2d 173, 175 (Alaska
1998) (also describing the clearly erroneous standard as
deferential).
7 Kinnard v. Kinnard, 43 P.3d 150, 153 (Alaska 2002)
(With respect to questions of law, we apply our independent
judgment and adopt the rule that is most persuasive in light of
precedent, reason, and policy.).
8 White v. State ex rel. Block, 597 P.2d 172, 176 n.13
(Alaska 1979) (quoting 6 Harold Remington, A Treatise on the
Bankruptcy Law of the United States 2874 (5th ed. 1952)); see
also Great Western Sav. Bank v. George W. Easley Co., 778 P.2d
569, 581 (Alaska 1989).
9 White, 597 P.2d at 175-76. The United States Supreme
Court held in Pepper v. Litton that bankruptcy courts are for
many purposes courts of equity and thus can exercise their
equitable powers to subordinate the debts of shareholders to
those of outside creditors. 308 U.S. 295, 307-08 (1939).
10 White, 597 P.2d at 176.
11 Blumenstein v. Phillips Ins. Ctr., Inc., 490 P.2d 1213,
1221 (Alaska 1971).
12 White, 597 P.2d at 176.
13 Willners Fuel Distributors, Inc. v. Noreen, 882 P.2d
399, 405 (Alaska 1994).
14 Id. at 406.
15 The same appellants brief is shared by Artus, Coal
Factors, Ross, Nerox Power, Nerox Energy, and various investors
in Nerox Energy.
16 In re Mobile Steel Co., 563 F.2d 692, 702-06 (5th Cir.
1977); rule summarized by In re Missionary Baptist Found. of
America, Inc., 712 F.2d 206, 212 (5th Cir. 1983); see also In re
604 Columbus Ave. Realty Trust, 968 F.2d 1332, 1353 (1st Cir.
1992); In re Toy King Distrib., 256 B.R. 1, 198-99 (Bankr. M.D.
Fla. 2000).
Once inequitable conduct is found, equitable
subordination can be employed as long as there is either an
injury to the creditor or an unfair advantage conferred to the
claimant and as long as the remedy does not violate bankruptcy
law. Mobile Steel, 563 F.2d at 700; Fabricators, 926 F.2d at
1464-65.
17 AS 34.40.010 states:
Except as provided in AS 34.40.110, a
conveyance or assignment, in writing or
otherwise, of an estate or interest in land,
or in goods, or things in action, or of rents
or profits issuing from them or a charge upon
land, goods, or things in action, or upon the
rents or profits from them, made with the
intent to hinder, delay, or defraud creditors
or other persons of their lawful suits,
damages, forfeitures, debts, or demands, or a
bond or other evidence of debt given, action
commenced, decree or judgment suffered, with
the like intent, as against the persons so
hindered, delayed, or defrauded is void.
18 First Natl Bank of Fairbanks v. Enzler, 537 P.2d 517,
521-22 (Alaska 1975).
19 Id. at 522.
20 Blumenstein v. Phillips Ins. Ctr., Inc. 490 P.2d 1213,
1223 (Alaska 1971).
21 Willners Fuel Distributors, Inc. v. Noreen, 882 P.2d
399, 405-06 (Alaska 1994). Artus also had a fiduciary duty in
his role as an attorney for Nerox Energy. As we have stated,
attorneys face a duty to protect the assets of a company for its
creditors if they have control over those assets. Id. at 406.
Creditors can bring suit against attorneys for breaching this
fiduciary duty. Id. at 405. While there may be insufficient
evidence provided to conclude that Artus had control over the
assets of Nerox Power (or Nerox Energy) while he was providing
only legal representation, he certainly had this control over
assets, at least with regard to Nerox Power, while simultaneously
serving as president of Nerox Power and continuing to offer legal
representation for both Nerox Energy and Nerox Power. Artus
represented Nerox Power and Nerox Energy at trial. He thus had a
fiduciary duty to the creditors of Nerox Power under both prongs
of Willners Fuel Distributors, Inc. v. Noreen.
22 Judge Hunt considered the loan to be a capital
contribution that Artus made to Nerox Power. Placing a lien on
Nerox Powers assets to protect that loan would therefore be
inequitable conduct. See In re Fabricators, Inc., 926 F.2d 1458,
1467-68 (5th Cir. 1991) (holding that obtaining a lien on
corporate assets in order to secure capital contributions is
inequitable conduct). Artus cannot place himself on the same
level as other creditors. To allow someone who has just ascended
to the head of a company to relieve personal debts even debts
validly incurred mocks the equitable principle of protecting the
assets of a corporation for its creditors by giving one creditor
an unfair advantage in raiding those assets. Robson v. Smith
does allow directors who become secured creditors by making good
faith loans to their own corporation to repay their secured debt
ahead of unsecured creditors, but that is not the case here. 777
P.2d 659, 661-62 (Alaska 1989). The debts owed to M-B and Tope
were secured by a mechanics lien and the debts owed to Alaska Law
Offices by a judgment lien. This situation was not contemplated
in Robson. As Judge Hunt stated: A debtors conveyance to a bona
fide creditor is not fraudulent merely because it prefers one
creditor over another. But, a conveyance made with the actual
intent to hinder, delay or defraud is not cured by the mere fact
that the transferee is a creditor.
23 Enzler, 537 P.2d at 522.
24 See In re Fabricators, Inc., 926 F.2d 1458, 1467 (5th
Cir. 1991); In re Mobile Steel Co., 563 F.2d 692, 702-04 (5th
Cir. 1977).
25 Alaska law requires that the preference to a creditor
be a bona fide preference. Blumenstein v. Phillips Ins. Ctr.,
Inc., 490 P.2d 1213, 1222 (Alaska 1971).
26 Adding up the invoices found in the record, it appears
that Nerox Power owed $116,848.79 to Coal Factors, although even
this amount may have been reduced by payments of $17,794.90,
leaving $99,053.89 in debt.
27 At oral argument before this court, the attorney for
Coal Factors contended that the material for which the $80,000
was later billed was supplied before April 11, 1997. However,
this statement is unsubstantiated by the record.
28 See Miscovich v. Tryck, 875 P.2d 1293, 1304 (Alaska
1994) (It is well established that a partys failure to designate
portions of the record that are necessary to allow the
determination of a point on appeal will amount to a waiver or
abandonment of that point.); see also City of Whittier v.
Whittier Fuel & Marine Corp., 577 P.2d 216, 223 n.26 (Alaska
1978) (maintaining that this court will not examine on appeal
documents that are not part of the record on appeal).
29 Some of these expenses are for the full month of April
and impossible to break down further.
30 This generously assumes that all costs stretching over
the entire month of April were accrued before April 11.
31 Ketchikan Retail Liquor Dealers Assn v. State,
Alcoholic Beverage Control Bd., 602 P.2d 434, 438-39 (Alaska
1979) (holding that the failure of appellee to designate in the
record support for its factual claims justifies the courts
adoption of the factual description asserted by appellant).
32 See Walden v. Dept of Transp., 27 P.3d 297, 303 (Alaska
2001) (It is well-settled that it is an appellants responsibility
to present this court with a record sufficient to allow
meaningful review of his or her claims.).
33 Ross did not testify at trial; rather, his deposition
was read into the record. Ross was not asked specifically about
the financial relationship between Nerox Power and the LKL Trust,
Robert O. Jones, and the Wallace Family Trust.
34 Nerox Power implicitly argues in its brief that a
difference exists between Brockman and Brotzman by listing
Brotzman as among those listed in the deed of trust but not named
by Ross. Because Ross did not seem entirely clear in his
recollection, it was not unreasonable to assume that Brockman and
Brotzman are the same entities.
35 In 1995 Nerox Energy issued 70,709 shares of preferred
stock to raise $495,000; it is unclear if any of these shares
were paid to investors in Nerox Power, although both sides seem
to assume that this was the case.
36 Further circumstantial evidence supports Judge Hunts
conclusion. For one thing, Ross testified that the total amount
paid to acquire the Jonesville coal mine lease was $1,020,000:
the $800,000 payment to Placer Dome, the $200,000 promissory note
to Placer Dome, and a $20,000 fee to the State. This amount
roughly matches the $1,040,000 owed to those listed on the April
21, 1997 deed of trust. There is also the fact that the
investors seemed to have their dealings primarily with Nerox
Energy, not Nerox Power. Ross stated that the investors received
their preferred stock in Nerox Energy. Indeed, it appears that
the only parties who ever owned stock in Nerox Power were Nerox
Energy and Hobbs Industries. Absent evidence that the
beneficiaries made their loans directly to Nerox Power, it is
just as likely that their debts are properly owed by Nerox
Energy.
37 AS 34.35.055(a) provides:
The land upon which a building or other
improvement described in AS 34.35.050 is
constructed, together with a convenient space
about the building or other improvement or so
much as is required for the convenient use
and occupation of it (to be determined by the
judgment of the court at the time of the
foreclosure of the lien), and the mine on
which the work is performed or for which the
material is furnished is also subject to the
lien created by AS 34.35.050 34.35.120 if,
at the time the work is started or the
materials for the building or other
improvements are first furnished, the land
belongs to the person who causes the building
or other improvement to be constructed,
altered, or repaired.
38 H.A.M.S. Co. v. Elec. Contractors of Alaska, Inc., 563
P.2d 258, 262-63 (Alaska 1977); see also AS 34.35.930 (The intent
of this chapter is remedial and its provisions shall be liberally
construed.).
39 Cascaden v. Wimbish, 161 F. 241, 245 (9th Cir. 1908)
(It is the purpose of the lien law to secure priority of payment
of the price and value of work performed and materials furnished
in erecting and repairing a building or other structure. )
(quoting Van Stone v. Stillwell & Bierce Mfg. Co., 142 U.S. 136
(1891)).
40 See Dannemiller v. AMFAC Distrib. Corp., 566 P.2d 645,
651 (Alaska 1977) (The purposes of extending a statutory lien to
the land is because the value of the land is increased when a
materialperson provides labor or material for a structure which
is attached to the land. The lien should extend to the land,
which is benefited by the materialperson.); see also Mitford v.
Prior, 353 F.2d 550, 552-53 (9th Cir. 1965) (holding that an
entire subdivision was subject to a lien by a civil engineer who
worked on the water and sewer system because the entire
subdivision benefitted from the engineers efforts even though the
actual labor site was located outside the subdivision).
41 Ross did not challenge this order either at trial or on
appeal. Consequently, any objection to it is waived. B.B. v.
D.D, 18 P.3d 1210, 1214 (Alaska 2001) (Matters not made issues or
tried before the lower court will not be considered on appeal.).
42 Uchitel Co. v. Telephone Co., 646 P.2d 229, 233-34
(Alaska 1982); Jackson v. General Elec. Co., 514 P.2d 1170, 1173
(Alaska 1973) (The parent corporation may also be liable for the
wrongful conduct of its subsidiary when the subsidiary is the
mere instrumentality of the parent. Liability is imposed in such
instances simply because the two corporations are so closely
intertwined that they do not merit treatment as separate
entities.); see also Murat v. F/V Shelikof Strait, 793 P.2d 69,
76 (Alaska 1990) ([T]he primary consideration in determining
whether to pierce the corporate veil is whether the corporate
form has been abused by the person sought to be charged; that is,
whether the corporate entity was used to defeat public
convenience, justify wrong, commit fraud or defend crime. )
(citing and quoting Eagle Air, Inc. v. Corroon & Black/Dawson &
Co., Inc., 648 P.2d 1000, 1004 (Alaska 1982)).
43 Uchitel, 646 P.2d at 235 (citing Jackson, 514 P.2d at
1173); see also McCormick v. City of Dillingham, 16 P.3d 735, 744
(Alaska 2001) (affirming the applicability of the six-factor
Uchitel test for piercing the corporate veil and holding those
individuals in control of the corporation personally liable for
the misdeeds of the corporation). This test is an adaptation of
the earlier eleven-part test in Jackson v. General Electric for
determining if a subsidiary is a mere instrument of its parent
company. See Jackson, 514 P.2d at 1173. Uchitel also
establishes an alternate theory of personal liability whereby the
corporate veil cannot be pierced simply if one person controls
the activities of the corporation; rather the corporation must be
used to defeat public convenience, justify wrong, commit fraud,
or defend crime. Uchitel, 646 P.2d at 234 (citing Jackson, 514
P.2d at 1172-73).
44 Uchitel states only that these six factors should be
considered and does not even establish the exclusivity of the
factors. 646 P.2d at 235. See also McCormick, 13 P.3d at 744
(If other factors militate in favor of piercing the corporate
veil, a court may impose personal liability on the control person
even if he owns no stock.); Murat, 793 P.2d at 76-77 (considering
the possibility that instrumentality could be found on the basis
of only two of the six Uchitel factors, but ultimately rejecting
the finding on the grounds of an inadequate factual basis); cf.
McKibben v. Mohawk Oil Co., Ltd., 667 P.2d 1223, 1230 (Alaska
1983) (It is not necessary that all eleven of these factors [in
the Jackson test] be found in order to pierce the corporate
veil.).
45 Ross urges the application of Nevada law as opposed to
Alaska law in this case. Ross did not make this argument below
and in fact relied upon Alaska law both in his objections to the
proposed facts and conclusions and at trial. Arguments not made
at trial will not be considered on appeal. Sengupta v.
University of Alaska, 21 P.3d 1240, 1255 n.61 (Alaska 2001) (This
court will not consider arguments on appeal that were not raised
below unless the new issues either establish plain error or do
not depend on new or controverted facts, are closely related to
the appellants arguments at trial, and could have been gleaned
from the pleadings.). Furthermore, while Nevada law does not lay
out a six-factor test with quite the clarity contained in Alaska
law, it does list as factors in determining whether a company is
the alter ego of a person co-mingling of funds,
undercapitalization, unauthorized diversion of funds, treatment
of corporate assets as the individuals own, and failure to
observe corporate formalities. Lorenz v. Beltio, Ltd., 963 P.2d
488, 497 (Nevada 1998); Polaris Indus. Corp. v. Kaplan, 747 P.2d
884, 887 (Nevada 1987). These factors are substantially the same
as those listed in Uchitel. Where there is no material
difference between the competing laws of two states, the conflict
of laws issue can be ignored. Williams v. Stone, 109 F.3d 890,
893 (3d Cir. 1997); Angelini v. Delaney, 966 P.2d 223, 227 (Or.
App. 1998).
46 In June 1999 Ross Production Company sold its shares in
Nerox Power to outside investors.
47 Fiumetto v. Garrett Enters., Inc., 749 N.E.2d 992, 1005
(Ill. App. 2001).
48 Stirling-Wanner v. Pocket Novels, Inc., 879 P.2d 210,
213 (Or. App. 1994).
49 Ross was the director of Nerox Energy.
50 Indeed, Nerox Power frequently in its brief uses this
confusion as a defense for being unable to attach loans and
investments to compensation.
