When a company files for bankruptcy and receives a discharge of its debts, can creditors “pierce the corporate veil” and try to collect the company’s debts from the company’s owner?

That was the question presented to the United States Bankruptcy Appellate Panel of the Ninth Circuit by a recent case (RS Air v NetJets Aviation).

In 2001, Stephen Perlman founded RS Air, LLC, a Delaware limited liability company based in California, and was its sole managing member. RS Air purchased a 6.25% fractional interest in two aircraft from NetJets.

The relationship between RS Air and NetJets soured, and NetJets filed a lawsuit in Ohio alleging, among other things, breach of contract and nonpayment of fees.

Before trial in the Ohio lawsuit, RS Air filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. NetJets filed a claim in the bankruptcy case for over $2.1 million that it alleged RS Air owed.

It also objected to the bankruptcy filing and claimed that Mr. Perlman should be held liable as an alter ego of RS Air. There is no mention in the court documents of a personal guaranty by Mr. Perlman, which would have provided another avenue for NetJets to pursue.

One of the benefits of operating a business as a limited liability company or corporation is to protect its owners from the liabilities of the LLC or corporation.

Alter ego is a legal doctrine whereby a court finds that a corporation or limited liability company lacks a separate identity from its owner. The result is that the corporate veil is pierced and a shareholder can be held personally liable for the company’s debts.

The bankruptcy court rejected NetJet’s objections and issued a ruling discharging most of RS Air’s debts.

The bankruptcy court determined that NetJet didn’t have standing to raise the alter ego claims. Although the Bankruptcy Appellate Panel later vacated that part of the order, the court by then had confirmed the plan and the alter ego claims could not be brought in the bankruptcy case.

As a result, in a separate action in Ohio, NetJets sued Perlman (but did not sue RS Air) to collect RS Air’s debts from him, again claiming alter ego as the basis for Perlman’s liability.

In response, RS Air filed a motion for contempt in the bankruptcy court against NetJets for violating the discharge of debts granted by the bankruptcy court.

The bankruptcy court held NetJets was not in contempt, and RS Air appealed to the Bankruptcy Appellate Panel to determine whether NetJets had violated the discharge by maintaining its alter ego claim in the Ohio case.

Bankruptcy law, the appellate panel said, clearly states that a discharge of debt “only protects the debtor and not any other person who is liable with the debtor.”

The discharge granted to RS Air did not extinguish the debt; it merely released RS Air from its liability. The debt continued to exist and could be collected from any other entity that might be found liable to pay it, the panel noted.

The panel ruled that NetJets could bring the separate action in Ohio against Perlman under the alter ego theory, even though NetJets could not recover the obligation from RS Air because of the bankruptcy debt discharge.

Although we do not yet know whether NetJets’ alter ego claim will prevail, this case highlights the importance of taking steps to minimize the risk of alter ego claims.

(Rachelle Cohen will be speaking on a panel titled “Protecting or Piercing the Corporate Veil” at the California Lawyers Association Annual Meeting taking place in San Diego September 21-23.)

By Rachelle Cohen