Some Thoughts on the Alter Ego Ruling in Crystallex

I have had a bit of time to digest the district court’s ruling that PDVSA is Venezuela’s alter ego, and here are some preliminary thoughts. The opinion is 75 pages and covers a lot of ground, but I’ll focus on perhaps the most important and least technical question: Is the case a one-off or a harbinger? Put differently, assuming the ruling stands after appeal and further proceedings in the district court, does it definitively establish that PDVSA is Venezuela’s alter ego? If so, the ruling could have important consequences for a future attempt to restructure the debts of both entities.

The answer isn’t clear. Or rather, it depends whether one wants a formal or a functional answer. Formally, the decision is a one-off; it need not have implications for future alter ego determinations. Functionally, however, the decision creates real risks for PDVSA and the government.

Before elaborating, here’s a quick overview of what the district court held on the alter ego question. The Supreme Court’s Bancec case allows courts to disregard the legal status of a state-owned corporation in at least two cases. First, when the government so extensively controls day-to-day operations that a “relationship of principal and agent is created.” Second, when respecting the corporate form would result in a fraud or injustice. The first test (control-only) is perplexing. Despite the reference to agency law, no actual agency relationship is required so long as the government’s involvement “exceeds the normal supervisory control exercised by any corporate parent.” As I have written here on Credit Slips and elsewhere, the law of sovereign immunity draws important distinctions between governments and their agencies and instrumentalities. It isn’t obvious why extensive control—without more—should cause us to disregard these distinctions in any particular case.*

Notably, the district court based its alter ego decision entirely on Bancec’s control test. The court ruled that Crystallex had not even alleged that “Venezuela used PDVSA as an instrument to defraud Crystallex” (p. 34). And despite acknowledging (in a footnote, p. 23) that “some level of unfairness” is usually required in addition to control, the court did not explain what would be unfair about respecting the corporate form in this case. Instead, the opinion includes detailed findings describing how the government has dominated PDVSA over the years (pp. 38+). I don’t take issue with these findings, and it seems to me that the result can be justified as consistent with the law of sovereign immunity. But the relationship between control and the FSIA remains a bit opaque.

Now, for the long-term implications of the ruling: Here is the argument for why the district court’s decision will have limited effect. Crystallex did not ask the court to rule that PDVSA is generally liable for government debts. It asked only for an order determining that the government in fact owns specific property—shares in PDV Holding—ostensibly belonging to PDVSA. That is a very narrow question, and the court correctly notes that the ruling does not automatically entitle Crystallex or any other creditor to attach any other PDVSA asset or to generally impose Venezuela’s liabilities on the company.

Functionally, however, the problem is issue preclusion. When a party has had a full and fair opportunity to litigate a question, and loses, it is often precluded from re-litigating that question. In subsequent lawsuits, you can be sure that Crystallex and other creditors will rely on this doctrine to argue that the alter ego question has been settled. They won’t necessarily win. For example, the classic case for issue preclusion involves findings of fact or legal rulings made at a trial, with all of the procedural formalities that entails, not those made during a relatively informal, post-judgment proceeding like this one. Likewise, courts sometimes hesitate to let non-parties, such as creditors other than Crystallex, benefit from issue preclusion. But these are not firm exceptions. There is a clear risk of issue preclusion in future cases alleging that PDVSA is the government’s alter ego. And of course there is an independent risk that other judges will find the district judge’s reasoning persuasive and follow it even if not required to do so.

The issue preclusion question is further complicated by the fact that other creditors may assert slightly different alter ego arguments. As noted, the district judge premised his ruling entirely on the extensive control the Venezuelan government has until now wielded over PDVSA’s operations. But if a future government were to restore operational independence to PDVSA, the time frame relevant to the alter ego determination would shift, and the district judge’s opinion might not dispose of the alter ego question.** So: it’s complicated. The best we can say is that, if this decision stands, there is a significantly increased risk that PDVSA will be treated as the government’s alter ego for other purposes as well.

*Here is one example of the interplay between Bancec and the law of foreign sovereign immunity. The FSIA, in 28 U.S.C. 1610(a), confers a broad immunity from execution on the property of a foreign state. 28 U.S.C. 1610(b) confers a much narrower immunity on the property of an agency or instrumentality like PDVSA. One question before the court, then, was whether to apply the standard in subsection (a) or subsection (b) to PDVSA, assuming it was an alter ego. The court decided (correctly, I think) to apply the broader protection in subsection (a). Note that a contrary ruling would allow a creditor to attach almost any PDVSA asset, even if the same creditor could not attach the same asset if held by the government. It seems to me impossible to justify such a result by reference to the government’s level of control over the instrumentality.

**It depends on the alter ego theory. For example, assume that a creditor of PDVSA seeks to impose liability on the government, claiming that the government stripped PDVSA of assets and thereby elevated itself in priority over corporate creditors. As I have discussed previously, the government should not be able to defeat such a claim by restoring operational independence to PDVSA. On the other hand, some alter ego theories are based only on the level of control wielded by the government. For such a theory, what is most important is the level of control the government wields now.

Comments

[Roland Pettersson]

Thanks for the clear and straightforward analysis. Certainly, the gut feeling from the perspective of the non-US observer is that this opinion increases the litigation-related risks (from either alter ego, piercing of corporate veil, or any other exception to the FSIA) and, thus, has a potential to set off different debtholder strategies (which in general seem to be be at a very precarious / unstable equilibrium).