Parent Corporations and Their Subsidiaries' Liabilities: Guidelines

Both courts limited the reach of their opinions by making explicit the common law principle that corporate shareholders are not generally liable for the acts and omissions of their subsidiaries in the absence of active involvement of the parent in those acts or omissions. 'It is a general principle of corporate law 'deeply ingrained in our economic and legal systems' that a parent corporation ' is not liable for the acts of its subsidiaries ' Thus it is hornbook law that the exercise of control which stock ownership gives to the stockholders ' will not create liability beyond the assets of the subsidiary. That 'control' includes the election of directors, the making of by-laws and the doing of all other acts incident to the legal status of shareholders. Nor will a duplication of some or all of the directors or executive officers be fatal.' Bestfoods at 61, citing Douglas & Shanks, Insulation from Liability Through Subsidiary Corporations, 39 Yale L.J. 193, (1929) (internal citations omitted).

Both decisions rejected the alternative theory of piercing the veil of the subsidiary to reach the parent because the elements of that cause of action were not present.

The Illinois Supreme Court ruled that the plaintiffs presented sufficient evidence of the existence of factual issues to reverse the trial court's grant of the parent's motion for summary judgment. The Bestfoods case was also referred back to the trial court for factual determinations. Both opinions described the facts as reflected in the record on appeal as the basis for their opinions, thus providing guidelines for avoiding parental liability. Similarly, the opinions provide a discovery checklist for plaintiffs' lawyers and governmental officials to use to add and retain parent corporations in their cases.

Facts in the Case

The facts in the Illinois case were straightforward. Clark USA, Inc. is the parent of Clark Refining and Marketing, Inc., which owned and operated a refinery where it employed two men killed by an explosion. The Clark subsidiary paid decedents' estates amounts due under the Illinois Workers' Compensation Act. The estates then brought suit against the parent corporation and others; the latter parties settled leaving only Clark USA as a party to the appeal. The Illinois Supreme Court also held that it would not permit the parent to pierce its own corporate veil and treat the decedents as its employees in order to take advantage of the Workers' Compensation Act.

The plaintiffs alleged that the refinery was negligently maintained and staffed by untrained mechanics as a result of budgetary restrictions, including capital expenditures, imposed by Clark USA on the operation of its subsidiary. The two corporations had overlapping, but not identical, boards which often held joint meetings, and Paul Melnuk was the president and CEO of Clark USA and president, CEO and chief operating officer of the subsidiary. In Bestfoods, the defendant parent and its subsidiary also shared some common directors and managers.

The Illinois court, quoting from Bestfoods, articulated a truth that every corporate officer and director relies on when she or he has roles in two or more related entities: there is a 'well established principle [of corporate law] that directors and officers holding positions with a parent and its subsidiary can and do 'change hats' to represent the two corporations separately, despite their common ownership, [and] it should be presumed that directors are wearing their 'subsidiary hats' rather than their parent hats when acting for the subsidiary' (at 239, internal citations omitted).

Among the facts relied upon by the Illinois court, the concurring opinion noted that when the parent corporation 'ordered the budget cuts at the [subsidiary's] refinery, it knew that safety, training, staffing, education and maintenance would all be compromised, and accordingly, it was foreseeable that injury would occur as a result. Plaintiffs further contend that the record reflects that the subsidiary had no decision in this reduction' (at 248).

The court focused on the roles of Mr. Melnuk, the senior officer of both the parent and subsidiary corporations. The concurring opinion also noted that there were documents prepared by or under the direction of Melnuk entitled 'Clark USA, Inc. 1995 Imperatives April 1995' and 'Clark USA, Inc. Scorecard First Quarter, 1995,' among others, which bore the parent company's name. At his deposition, Melnuk testified that these titles were 'incorrect' and that they were really imperatives and a scorecard for Clark Refining and Marketing, Inc., the subsidiary. The Court held that '[a]t the very least, there is a genuine issue of material fact as to whose hat Melnuk was wearing when he completed the 1995 memorandum. If the fact-finder concludes that Melnuk was acting on behalf of defendant and thus wearing his Clark USA 'hat,' there is some evidence that he was directing or authorizing the manner in which [the subsidiary's] budget was implemented such that he had a duty, under the direct participant theory of liability to do so with reasonable care ' ' (at 240.)

In reaching its conclusions, the Illinois court cited the Bestfoods holding that 'the presumption that an act is taken on behalf of the corporation for whom the officer claims to act is strongest when the act is perfectly consistent with the norms of corporate behavior, but wanes as the distance from those accepted norms approaches the point of action by a dual officer plainly contrary to the interests of the subsidiary yet nonetheless advantageous to the parent' (at 239, quoting Bestfoods at 70, note 13). The Illinois court noted that the documentation prepared by the parent company referred to its survival and the restoration of its cash reserves by cutting maintenance and safety programs and taking other steps at the subsidiary's facility which put the employees of the latter at risk.

The Supreme Court Ruling

In the Bestfoods case, the U.S. Supreme Court did not rely on specific language in CERCLA, particularly the meaning of 'operating' to which it gave its common meaning, but rather the Court examined the common law of corporations. Justice Souter, writing for a unanimous Court, phrased the issue as 'whether a parent corporation that actively participated in, and exercised control over, the operations of a subsidiary may, without more, be liable as an operator of a polluting facility owned or operated by the subsidiary. We answer no, unless the corporate veil may be pierced. But a corporate parent that actively participated in, and exercised control over, the operations of the facility itself may be directly liable in its own right as the operator of the facility' (at 55, emphasis added).

The trial court in a bench trial held that the two parent corporations were directly liable for clean-up costs because they 'exerted power ' over [their respective subsidiaries] by actively participating in and exercising control over the [subsidiaries'] business during a period of disposal of hazardous waste' (at 58). With respect to one of the parents, the District Court found it particularly telling that the parent selected the subsidiary's board of directors and populated its executive ranks with the parent's officials and that one of these officials 'played a significant role in shaping the subsidiary's environmental compliance policy' (at 59).

In rejecting the reasoning of the District Court, Justice Souter identified the crux of the source of a parent's direct liability (thus providing guidance for corporations and their counsel) when he wrote, 'The well-taken objection to the actual control test, however, is its fusion of direct and indirect liability; the test is administered by asking a question about the relationship between the two corporations (an issue going to indirect liability) instead of a question about the parent's interaction with the subsidiary's facility (the source of any direct liability) ' The question is not whether the parent operates the subsidiary, but rather whether it operates the facility, and that operation is evidenced by participation in the activities of the facility, and not the subsidiary' (emphasis added, at 67).

Thus, the Supreme Court directed the District Court to focus its analysis on the relationship of the parent corporation to the facility and not the relationship between the parent and its subsidiary corporation. The test is whether, when the human actors participated in the acts that resulted in injury, they were wearing their parent's or subsidiary's hats.

The Illinois Court Holding

Using this analysis, the Illinois Supreme Court held that while '[p]arent companies are free to craft overall business and budgetary strategies; such companies simply must not interfere directly in the manner their subsidiaries undertake certain activities such that the subsidiaries are no longer free to utilize their own expertise. Alternatively, if parent companies do interfere directly in the manner their subsidiaries undertake certain activities, they must do so with reasonable care' (at 238). The court emphasized throughout its opinion the incriminating effect when parent corporations determine the manner in which their subsidiaries undertake an activity, even though the parents are free to decide business and budgetary strategies. Thus the court, citing authority from California and Texas courts, determined that even budgetary mismanagement alone will not give rise to parental liability; however; if it is 'accompanied by negligent direction or authorization of the manner in which the subsidiary accomplishes that budget, it can lead to a valid cause of action under the direct participant theory of liability' (at 237).

Conclusion

There are many reasons to insulate parent and sibling entities from known exposure to which a particular subsidiary is subject. These include, in addition to the tort and federal regulations at issue in the Forsythe and Bestfoods cases, vulnerability to the taxes, regulation and jurisdiction of a state or foreign nation. Protecting against such vulnerabilities are an important task for corporate counsel. Here are two suggestions.

Counsel are very aware that the time and attention of directors and senior management are precious. Joint meetings of the board, or committees of the board, of the parent and its subsidiaries can be efficient; there is a natural reluctance to impose a regime of formality upon what seems at the time to be routine. However, counsel should take steps to assure that only the appropriate board adopts resolutions or otherwise takes action pertaining to its activities. Separate minutes should accurately reflect the acts of each entity. For a guideline, imagine the deposition of the secretary of the meeting.

In addition, if a parent corporation is to be insulated from the activity of its subsidiary (or one subsidiary is to be insulated from the activity of another), and the officers or managers of the former are involved in the activities of the latter, the appropriate hats those individuals are wearing should be documented. Perhaps an employee leasing agreement or a less formal memorandum setting forth the relationship can be used. Whatever the form, the written statement of the relationship should set forth the fact that the individuals are carrying out duties as agents of the vulnerable subsidiary under the direction of and with reports to that subsidiary's personnel. The vulnerable subsidiary should pay fair consideration for use of another company's personnel, even if only by an intercompany book entry. Again, for guidance, counsel should project what the discovery process will be like.

Stanley R. Weinberger is of counsel in the Chicago office of Dykema Gossett PLLC in the Corporate Finance group. His practice focuses on counseling owners of closely held businesses in a variety of industries and providing legal services for planning, negotiating and documenting transactions and operating issues with which privately owned businesses are faced. Weinberger may be reached at 312-627-2261 or [email protected].

'[H]e might put on a hat ' and so escape.' Shakespeare, The Merry Wives of Windsor, IV, 2.

In February 2007 the Illinois Supreme Court in a unanimous decision held as a matter of first impression that a parent corporation could be directly liable for its negligence to the estates of two employees of its subsidiary corporation. Forsythe v. Clark USA , 864 N.E. 2 nd 227.

The Illinois Court relied extensively on the unanimous 1998 opinion of the U.S. Supreme Court in U S v. Bestfoods , 524 U.S. 51. The court there ruled that a parent corporation could be held directly liable for the clean up costs under the Comprehensive Environ-mental Response, Compensation and Liability Act caused by its subsidiary's operation of a chemical plant owned by the subsidiary.

Both courts limited the reach of their opinions by making explicit the common law principle that corporate shareholders are not generally liable for the acts and omissions of their subsidiaries in the absence of active involvement of the parent in those acts or omissions. 'It is a general principle of corporate law 'deeply ingrained in our economic and legal systems' that a parent corporation ' is not liable for the acts of its subsidiaries ' Thus it is hornbook law that the exercise of control which stock ownership gives to the stockholders ' will not create liability beyond the assets of the subsidiary. That 'control' includes the election of directors, the making of by-laws and the doing of all other acts incident to the legal status of shareholders. Nor will a duplication of some or all of the directors or executive officers be fatal.' Bestfoods at 61, citing Douglas & Shanks, Insulation from Liability Through Subsidiary Corporations, 39 Yale L.J. 193, (1929) (internal citations omitted).

Both decisions rejected the alternative theory of piercing the veil of the subsidiary to reach the parent because the elements of that cause of action were not present.

The Illinois Supreme Court ruled that the plaintiffs presented sufficient evidence of the existence of factual issues to reverse the trial court's grant of the parent's motion for summary judgment. The Bestfoods case was also referred back to the trial court for factual determinations. Both opinions described the facts as reflected in the record on appeal as the basis for their opinions, thus providing guidelines for avoiding parental liability. Similarly, the opinions provide a discovery checklist for plaintiffs' lawyers and governmental officials to use to add and retain parent corporations in their cases.

Facts in the Case

The facts in the Illinois case were straightforward. Clark USA, Inc. is the parent of Clark Refining and Marketing, Inc., which owned and operated a refinery where it employed two men killed by an explosion. The Clark subsidiary paid decedents' estates amounts due under the Illinois Workers' Compensation Act. The estates then brought suit against the parent corporation and others; the latter parties settled leaving only Clark USA as a party to the appeal. The Illinois Supreme Court also held that it would not permit the parent to pierce its own corporate veil and treat the decedents as its employees in order to take advantage of the Workers' Compensation Act.

The plaintiffs alleged that the refinery was negligently maintained and staffed by untrained mechanics as a result of budgetary restrictions, including capital expenditures, imposed by Clark USA on the operation of its subsidiary. The two corporations had overlapping, but not identical, boards which often held joint meetings, and Paul Melnuk was the president and CEO of Clark USA and president, CEO and chief operating officer of the subsidiary. In Bestfoods, the defendant parent and its subsidiary also shared some common directors and managers.

The Illinois court, quoting from Bestfoods, articulated a truth that every corporate officer and director relies on when she or he has roles in two or more related entities: there is a 'well established principle [of corporate law] that directors and officers holding positions with a parent and its subsidiary can and do 'change hats' to represent the two corporations separately, despite their common ownership, [and] it should be presumed that directors are wearing their 'subsidiary hats' rather than their parent hats when acting for the subsidiary' (at 239, internal citations omitted).

Among the facts relied upon by the Illinois court, the concurring opinion noted that when the parent corporation 'ordered the budget cuts at the [subsidiary's] refinery, it knew that safety, training, staffing, education and maintenance would all be compromised, and accordingly, it was foreseeable that injury would occur as a result. Plaintiffs further contend that the record reflects that the subsidiary had no decision in this reduction' (at 248).

The court focused on the roles of Mr. Melnuk, the senior officer of both the parent and subsidiary corporations. The concurring opinion also noted that there were documents prepared by or under the direction of Melnuk entitled 'Clark USA, Inc. 1995 Imperatives April 1995' and 'Clark USA, Inc. Scorecard First Quarter, 1995,' among others, which bore the parent company's name. At his deposition, Melnuk testified that these titles were 'incorrect' and that they were really imperatives and a scorecard for Clark Refining and Marketing, Inc., the subsidiary. The Court held that '[a]t the very least, there is a genuine issue of material fact as to whose hat Melnuk was wearing when he completed the 1995 memorandum. If the fact-finder concludes that Melnuk was acting on behalf of defendant and thus wearing his Clark USA 'hat,' there is some evidence that he was directing or authorizing the manner in which [the subsidiary's] budget was implemented such that he had a duty, under the direct participant theory of liability to do so with reasonable care ' ' (at 240.)

In reaching its conclusions, the Illinois court cited the Bestfoods holding that 'the presumption that an act is taken on behalf of the corporation for whom the officer claims to act is strongest when the act is perfectly consistent with the norms of corporate behavior, but wanes as the distance from those accepted norms approaches the point of action by a dual officer plainly contrary to the interests of the subsidiary yet nonetheless advantageous to the parent' (at 239, quoting Bestfoods at 70, note 13). The Illinois court noted that the documentation prepared by the parent company referred to its survival and the restoration of its cash reserves by cutting maintenance and safety programs and taking other steps at the subsidiary's facility which put the employees of the latter at risk.

The Supreme Court Ruling

In the Bestfoods case, the U.S. Supreme Court did not rely on specific language in CERCLA, particularly the meaning of 'operating' to which it gave its common meaning, but rather the Court examined the common law of corporations. Justice Souter, writing for a unanimous Court, phrased the issue as 'whether a parent corporation that actively participated in, and exercised control over, the operations of a subsidiary may, without more, be liable as an operator of a polluting facility owned or operated by the subsidiary. We answer no, unless the corporate veil may be pierced. But a corporate parent that actively participated in, and exercised control over, the operations of the facility itself may be directly liable in its own right as the operator of the facility' (at 55, emphasis added).

The trial court in a bench trial held that the two parent corporations were directly liable for clean-up costs because they 'exerted power ' over [their respective subsidiaries] by actively participating in and exercising control over the [subsidiaries'] business during a period of disposal of hazardous waste' (at 58). With respect to one of the parents, the District Court found it particularly telling that the parent selected the subsidiary's board of directors and populated its executive ranks with the parent's officials and that one of these officials 'played a significant role in shaping the subsidiary's environmental compliance policy' (at 59).

In rejecting the reasoning of the District Court, Justice Souter identified the crux of the source of a parent's direct liability (thus providing guidance for corporations and their counsel) when he wrote, 'The well-taken objection to the actual control test, however, is its fusion of direct and indirect liability; the test is administered by asking a question about the relationship between the two corporations (an issue going to indirect liability) instead of a question about the parent's interaction with the subsidiary's facility (the source of any direct liability) ' The question is not whether the parent operates the subsidiary, but rather whether it operates the facility, and that operation is evidenced by participation in the activities of the facility, and not the subsidiary' (emphasis added, at 67).

Thus, the Supreme Court directed the District Court to focus its analysis on the relationship of the parent corporation to the facility and not the relationship between the parent and its subsidiary corporation. The test is whether, when the human actors participated in the acts that resulted in injury, they were wearing their parent's or subsidiary's hats.

The Illinois Court Holding

Using this analysis, the Illinois Supreme Court held that while '[p]arent companies are free to craft overall business and budgetary strategies; such companies simply must not interfere directly in the manner their subsidiaries undertake certain activities such that the subsidiaries are no longer free to utilize their own expertise. Alternatively, if parent companies do interfere directly in the manner their subsidiaries undertake certain activities, they must do so with reasonable care' (at 238). The court emphasized throughout its opinion the incriminating effect when parent corporations determine the manner in which their subsidiaries undertake an activity, even though the parents are free to decide business and budgetary strategies. Thus the court, citing authority from California and Texas courts, determined that even budgetary mismanagement alone will not give rise to parental liability; however; if it is 'accompanied by negligent direction or authorization of the manner in which the subsidiary accomplishes that budget, it can lead to a valid cause of action under the direct participant theory of liability' (at 237).

Conclusion

There are many reasons to insulate parent and sibling entities from known exposure to which a particular subsidiary is subject. These include, in addition to the tort and federal regulations at issue in the Forsythe and Bestfoods cases, vulnerability to the taxes, regulation and jurisdiction of a state or foreign nation. Protecting against such vulnerabilities are an important task for corporate counsel. Here are two suggestions.

Counsel are very aware that the time and attention of directors and senior management are precious. Joint meetings of the board, or committees of the board, of the parent and its subsidiaries can be efficient; there is a natural reluctance to impose a regime of formality upon what seems at the time to be routine. However, counsel should take steps to assure that only the appropriate board adopts resolutions or otherwise takes action pertaining to its activities. Separate minutes should accurately reflect the acts of each entity. For a guideline, imagine the deposition of the secretary of the meeting.

In addition, if a parent corporation is to be insulated from the activity of its subsidiary (or one subsidiary is to be insulated from the activity of another), and the officers or managers of the former are involved in the activities of the latter, the appropriate hats those individuals are wearing should be documented. Perhaps an employee leasing agreement or a less formal memorandum setting forth the relationship can be used. Whatever the form, the written statement of the relationship should set forth the fact that the individuals are carrying out duties as agents of the vulnerable subsidiary under the direction of and with reports to that subsidiary's personnel. The vulnerable subsidiary should pay fair consideration for use of another company's personnel, even if only by an intercompany book entry. Again, for guidance, counsel should project what the discovery process will be like.

Stanley R. Weinberger is of counsel in the Chicago office of Dykema Gossett PLLC in the Corporate Finance group. His practice focuses on counseling owners of closely held businesses in a variety of industries and providing legal services for planning, negotiating and documenting transactions and operating issues with which privately owned businesses are faced. Weinberger may be reached at 312-627-2261 or [email protected].