When is a Parent Company Liable for the Acts of a Subsidiary?
Imagine you went out of your way to create a corporate structure that would minimize risk. You divided up your corporate assets into different subsidiary entities so that they could not all be reached by a single creditor. Now, one of your subsidiaries is being sued, your parent entity has also been named in the lawsuit, and you’re wondering to what extent the parent entity’s assets–including its ownership of all the other subsidiaries–are at risk.
The Basic Rule–Parent Corporation not Liable for Acts of Subsidiaries
The basic rule is that parent corporations will not be liable for acts of their subsidiaries. This default rule is the reason so many conglomerates are structured as a hierarchy of parent and subsidiary corporations. The Supreme Court of the United States emphasized this basic rule in United States v Best Foods:
“It is a general principle of corporate law deeply ingrained in our economic and legal systems that a parent corporation (so-called because of control through ownership of another corporation’s stock) is not liable for the acts of its subsidiaries.”
Returning to the hypothetical, you’re probably thinking you’re okay since the general rule is that your parent corporation will not be liable to your subsidiary’s creditors. Well, unfortunately it isn’t that simple. After all, it wouldn’t be a rule worth discussing unless there was an exception or two…
Exceptions to the Basic Rule–“Piercing the Corporate Veil”
Washington Corporate Law
A parent corporation may be liable for its subsidiaries’ obligations when state law supports “piercing the corporate veil”–a legal term of art that means disregarding the liability protection afforded by a limited liability entity such as a corporation or limited liability company. To pierce the corporate veil and find a parent corporation liable for a subsidiary’s debts, the plaintiff suing the parent entity must show that there is an overt intention by the corporation to disregard the corporate entity in order to avoid a duty owed to that plaintiff.
What does it mean to “disregard the corporate entity in order to avoid a duty?” This is where the Washington case law gets a little fuzzy. Generally, the entities have to be some part of a fraud. What exactly constitutes a fraud in this context is not entirely clear. One general definition of fraud is “wrongful deception intended to result in financial gain.”
While more recent cases trend toward defining fraud in this parent-subsidiary liability context more narrowly, older cases in Washington that haven’t been directly overruled embrace principles like:
“A corporation may not be used as a cloak or disguise to escape corporate liability, and corporate veil may be pierced when necessary to do justice in particular cases.”
This position laid out by the Supreme Court of Washington in 1966 is difficult to reconcile with the fact that limited liability entities are created to limit liability. If a corporation can be disregarded any time it limits liability, it would not have much utility.
Also, compare these two quotes from the Supreme Court of Washington, the first from a 1966 case and the second from a case in 2002:
“Legal fiction of corporate existence may be disregarded where a corporation is so organized and controlled, and its affairs are so conducted, as to make it merely instrumentality or adjunct of other corporation.”
“Mere common ownership of stock, having the same officers, employees, etc., does not justify disregarding the separate corporate identities unless a fraud is being worked upon a third person.”
These two statements of law nearly conflict, leaving uncertainty as to the importance of common control in a parent-subsidiary liability analysis. What we can take away from these two statements is that common control is not a determining factor absent other facts, but when combined with other facts, it can be an important factor.
While Washington corporate law doesn’t have the number of cases necessary to develop a robust body of law to rely upon, we can gain some important insights by looking into the treatment of corporate law by other states, which is often persuasive in Washington courts.
Looking at Cases from Across the Country
When reviewing cases from across the country, some clear patterns begin to emerge. Most of the situations in which the parent entity can be found liable for a subsidiary’s liabilities fall into one of three categories:
- Single Business Enterprise
A parent may be liable for its subsidiary’s activities if the two entities are part of a single business enterprise. An example of common facts to this type of case: the subsidiary and parent have undocumented transfers of funds and the subsidiary does business under the name of the parent entity.
- Under Capitalization
If a subsidiary is under capitalized–if it is insolvent from its inception and has no assets whatsoever, that may be grounds for piercing the corporate veil. For example in Garden City Co. v Burden, a corporation owned an irrigation canal and its subsidiary that had no assets was responsible for operating and maintaining the canal. When the canal flooded, plaintiffs successfully sued the parent corporation. The Court held that because the operating company had no assets and owned no property it would be inequitable to allow the parent company to escape liability under the pretext of the separate identity of two corporations.
- Fraudulent Transfer of Assets
If a subsidiary transfers assets to the parent corporation after incurring liability and does not receive equal value in return, the parent company may be sued to at least recover the assets that were fraudulently transferred.
Returning one more time to our hypothetical, what does all this mean for your parent entity that is being attacked by a creditor of a subsidiary? Each case is unique, and the outcome of your particular case will depend on the facts and circumstances of your case, but if your corporation doesn’t fall into one of the three categories above, there’s a good chance your parent entity will escape liability.
If you have questions about your corporation or limited liability companies and their parents or subsidiaries, you can contact us at (206) 745-5229 or email us at email@example.com.
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