You’ve just gotten off the phone with the CEO of one of your company’s subsidiary corporations—Sub A. Several thousand neighbors of Sub A’s main production facility have filed a lawsuit for personal injuries and property damage they attribute to groundwater and air contamination caused by the facility.
Worse, your company, Parent Inc., has also been named as a defendant. Although it never owned or operated Sub A’s facility, Parent has substantial in-house environmental expertise. When the contamination was first discovered several years ago, Parent’s in-house environmental engineers stepped in to lead the investigation and cleanup. These activities included hiring and supervising remediation experts, and editing reports they submitted to the state regulators overseeing the site.
Looking down the road, you know that Sub A probably has sufficient financial strength and independence to survive this litigation, but the plaintiffs seek to “pierce the corporate veil” and also hold Parent liable, including for punitive damages. Can Parent extricate itself from this lawsuit at an early stage, based on the argument that it is not liable for the acts of Sub A?
Given its involvement in Sub A’s activities, Parent is likely to have a difficult time achieving an early exit. Whether it succeeds will turn on the outcome of a careful examination of the degree to which Parent and Sub A have operated as separate corporations, particularly with respect to Sub A’s environmental contamination problem.
Putting aside issues relating to successor or “continuation of business” liability, and recognizing that substantial marketing and other benefits can accrue to an entity that is part of a corporate “family,” this article focuses on the importance of preserving the separate statuses of parent corporations and their subsidiaries, and recommends some best practices for maintaining such corporate distinctions.
When the activities that distinguish a parent from its subsidiary become blurred, the subsidiary’s liabilities may be imputed to the parent. Indeed, a primary goal of a plaintiff’s lawyer suing a corporate subsidiary is often to “pierce the corporate veil” and attempt to bring the larger, better known and “deep pocket” parent into the litigation as a defendant.
Courts are generally reticent to pierce the corporate veil, but the more a subsidiary can be characterized as merely a “conduit” for the parent’s activities, the more vulnerable the parent becomes to an “alter ego” attack. Although the applicable tests and burdens vary across jurisdictions, evaluating whether one company is the “alter ego” of its parent is a highly fact-intensive inquiry, and no single factor controls.
For example, in order to pierce the corporate veil in California, there must be such a “unity of interest and ownership” between the subsidiary and the parent corporation that the “separate personalities” of these entities cease to exist, and there must be an “inequitable result if the acts in question are treated as those of the [subsidiary] alone.” Sonora Diamond Corp. v. Superior Court, 83 Cal.App.4th 523, 538 (2000). In evaluating these criteria, California considers such factors as: the commingling of funds and other assets between parent and subsidiary, one entity holding itself out as being liable for the other’s debts, identical equitable ownership of the two entities, the “use of one as a mere shell or conduit for the affairs of the other,” inadequate capitalization, disregard of corporate formalities, lack of segregation of corporate records, the same offices and employees, and identical directors and officers.
In-house counsel for both parent and subsidiary corporations are uniquely positioned to promote and protect the vital distinctions among their related corporate entities. Day to day, the importance of maintaining these distinctions may not seem as critical as other near-term goals and deadlines. But if these distinctions are not carefully maintained and litigation rears its head, a successful effort to pierce the corporate veil can place the parent at substantial risk. While no bulletproof or uniform protocol exists, the following practices can assist in-house counsel in minimizing that risk:
1. Adhere to the Corporate Formalities Upon Formation/Acquisition
2. Maintain Corporate Distinctions During Operations
3. Maintain Corporate Distinctions in Interactions with Regulatory Agencies and During Litigation
Maintaining corporate separateness among related business entities is a challenging task that requires constant vigilance by in-house counsel. Following the guidelines listed above can help preserve the separateness of related entities and improve the likelihood that a parent can extricate itself from litigation arising from its subsidiary’s activities.
Stephen C. Lewis is a founding partner of, and Nicole M. Martin is an attorney with, the San Francisco-based environmental law firm Barg Coffin Lewis & Trapp. They can be reached at email@example.com and firstname.lastname@example.org, respectively.