When Do Courts Pierce the Corporate Veil COVERSTORY

When Do Courts Pierce the Corporate Veil?



Just how responsible are parent corporations for their subsidiaries' acts? Well, it depends . . .

by Lindsey Martin-Bowen
NPR Editor


About three years ago, a Missouri motorist learned parent firms need not always pay for their errant children's misdeeds. He gained this wisdom after he sued Telecom Corporation, Contrux's parent, when one of the subsidiary's drivers collided with him and his motorcycle. The trial court excused Telecom, and the appellate court affirmed the trial court's decision. See Radaszewski v. Telecom Corporation, 981 F.2d 305 (8th Cir. 1992).

At the other end of the parent-firm liability spectrum, a seller, Hystro Products, Inc., sued a corporate parent for its subsidiary's debts owed on goods received and won. See Hystro Products, Inc. v. MNP Corporation, 18 F.3d 1384 (7th Cir. 1994). There, the Hystro court applied Illinois law to pierce the corporate veil between MNP and its subsidiary. Hystro, 18 F.3d at 1388-91.

Piercing the Corporate Veil

When a corporation begets another corporation, in line with state law, it creates another entity. But many times, the subsidiary is financially dependent upon the parent firm. In fact, sometimes the subsidiary functions merely as a shell or "alter ego" for the parent. Consequently, if a person with a grievance against a company discovers the firm's parent holds the subsidiary's purse strings, the claimant will sue the parent company. In other cases, a subsidiary may be fiscally independent, but not truly a separate entity, because the parent firm exerts a strong influence over the subsidiary's operations. So a court must determine if the parent is to blame for the subsidiary's acts by "piercing the corporate veil" that would otherwise shield the parent from liability for its subsidiary's errors.

To pierce or not to pierce is a question perplexing courts as much as the question of existence perplexed Prince Hamlet. Certainly, courts don't arbitrarily hold parent firms liable for their subsidiaries' crimes. Instead, to do so, courts apply various tests to discern whether they can pierce the corporate veil. Along with these tests, courts, including federal courts, rely on state laws to decide if a case warrants piercing the corporate shield between a parent company and its subsidiary-or between stockholders and a corporation.

To complicate the issue even moreso, especially in diversity cases, these laws and tests vary from circuit-to-circuit and state-to-state.

For example, when applying Missouri law, the U.S. Eighth Circuit Court uses a tripartite test to decide whether to pierce a corporate veil. This test shows if the parent completely controls or dominates its subsidiary, if such control forced the subsidiary to commit fraud or commit an illegal act, and if that control caused the injury "or loss complained of." Radaszewski, 981 F.2d at 306, citing Collet v. American National Stores, Inc., 708 S.W.2d 273, 284 (Mo.App. 1986). The Second Circuit Court applying New York law uses a similar test. See American Protein Corporation v. AB Volvo, 844 F.2d 56, 60 (2d Cir. 1988).

To pierce the corporate veil under Illinois law, however, requires meeting only two situations: when "unity of interest" and ownership between the parent and subsidiary exist and when "adherence to the fiction of separate corporate existence would sanction a fraud" Van Dorn Co. v. Future Chemical and Oil Corp., 753 F. 2d 565, 569-70 (7th Cir. 1985) cited in Hystro, 18 F.3d at 1388-89.

The Tenth Circuit recognizes four tests to determine a parent firm's liability. Eichenwald v. Krigel's, Inc., 908 F.Supp. 1531 (D.Kan.1995), citing Spicer v. Arbor Nall Nursery, Inc., Civ.A. No. 93-2537-EEO, 1995 WL 42660 at *3 (D.Kan. 1995). That court applies one of these four tests-the agency test, alter ego test, instrumentality test, and integrated enterprise test-depending upon the case at bar. Id. See also Frank v. U.S. West, Inc., 3 F.3d 1357, 1362 (10th Cir. 1993). Although these tests vary slightly, they were all designed to reveal whether or not the parent controls a subsidiary's purse strings and management decisions.

The Ultimate "Laundry List"

Of all the circuits, the Fifth Circuit Court designated probably the most complete list of fiscal factors for deciding whether to pierce the corporate veil and discern if a subsidiary is its parent's alter ego. This "laundry list" includes

But regardless of fiscal factors, courts will sometimes overrule-or "reinterpret"-traditional state laws. For instance, Texas law traditionally had required courts to find "fraud, injustice or some form of bad-faith dealing" to pierce the corporate veil. Edwards Company, Inc. v. Monogram Industries, Inc., 700 F.2d 994, 995 (5th Cir. 1983). And so, the Edwards trial court ruled that Monogram, Inc. was not liable for its subsidiary Monotronics' $352,000 debt. But the Edwards appellate court reinterpreted the Texas statute as deeming parents of fiscally dependent subsidiaries responsible for their offspring's acts and thus, held Monogram, Inc. liable. Id.

But the Feds Beat All

If a court rules on a federal issue, such as income tax, liability under the Employee Retirement Income Security Act of 1974 (ERISA), or the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), the federal statutes supersede state law and common law rules for corporations.

Or, in the U.S. Supreme Court's words, "[N]o State may endow its corporate creatures with the power to place themselves above the Congress of the United States and defeat the federal policy . . . which Congress has announced." Anderson v. Abbot, et al., 321 U.S. 349, 365, rehearing denied, 321 U.S. 804 (1944).

But problems arise when Congress fails to distinguish corporate forms or specify parent corporations are liable parties, and state corporate laws attempt to fill in those gaps. Nonetheless, often a court's choice to pierce will depend not only upon the fiscal links between the parent and subsidiary, but also upon the issue at bar.

Contracts and Torts

In contracts and torts, piercing the corporate veil isn't a catch-all panacea. Sometimes plaintiffs rely on a subsidiary's word, lose a deal, then assume it can recover from the subsidiary's parent-or even its great-grandparent. But the law doesn't necessarily warrant such a recovery.

When American Protein Corporation sued AB Volvo, the great-grandparent of Beijer Industries, Inc. and Bo Lycke, the U.S. District Court for the Southern District of New York awarded the plaintiff $3 million for breach of contract, tortious interference of contract and negligent misrepresentation. American Protein Corporation v. AB Volvo, 844 F.2d 56 (2d Cir.1988). But Volvo appealed, and the appellate court reversed. Id.

Why? The appellate court found not only did the evidence fail to establish that the president of the original contracting party (Beijer, Inc.) guaranteed Volvo's performance (to buy dried cattle and pork blood from American Protein), the "existence of interlocking directorates was insufficient to pierce the corporate veil between Beijer, Inc. and its great-grandparent." Id. Here, Beijer, Inc.'s president showed interest in American Protein's idea of forming bovine blood into a bouillon-like food and purportedly said Beijer's Swedish parent would back a contract. Id. at 58. But before American's president signed, Beijer's president told him he could offer no guarantees about Volvo. Id. So, the court ruled that Volvo didn't control its subsidiary, and no evidence suggested the great-grandparent had used the subsidiary to commit fraud. Id. at 60. Thus, it excused Volvo.

Creditor-Debtor and Bankruptcy

On the other hand, when Hystro Products, Inc. sued MNP Corporation (in the onset of this feature) for its subsidiary's order, it won. Hystro, 18 F.3d at 1384. How so? After Hystro shipped MNP's offspring, American Hydraulics, $10,258.64 in goods, MNP shut down its subsidiary and refused to pay Hystro. Applying Illinois law, the court ruled, "If a corporation . . . carries on business without substantial capital in such a way that the corporation is likely to have no sufficient asset available to meet its debts, it is inequitable that shareholders set up such a flimsy organization to escape personal liability," and described such an act as "an abuse of the separate entity." Id. at 1391.

So parents with indigent offspring best beware. Courts generally won't excuse them from responsibility for those subsidiaries' debts.

But, of course, this isn't always so. Many times, stockholders create a corporation to limit their personal liability. This is "one of the principal purposes for which the law . . . created the corporation." Berger v. Columbia Broadcasting System, Inc., 453 F.2d 991, 994 (5th Cir.) cert. denied, 409 U.S. 848 (1972).

And courts don't always concur about which firm's liable in such cases. Thus, sometimes, a court will refuse to pierce the corporate veil to prohibit subsidiaries from going into involuntary bankruptcy. In fact, the Sims appellate court determined, "If the creditor wants to be able to hold the parent liable for the subsidiary's debts, it can contract for this." Matter of Sims, 994 F.2d 210, 218-19 (5th Cir.1993). Here, subsidiaries tried to coerce the court to hold the parent firm liable for debts they'd accrued. Although the bankruptcy court granted the creditors relief under the subsidiaries' "involuntary bankruptcy" petitions, the district court bought the subsidiaries' argument and reversed the decision But, then, the appellate court reversed and remanded the district court decision "with instructions to reinstate the judgments of the bankruptcy court." Id. at 222.

Tax Spats

What's there to say? We're talking about the IRS here. If a subsidiary owes the government, you can bet it will collect from Pop. The federal policy is-Pierce the veil to give the IRS its due! See Valley Fin., Inc. v. United States, 629 F.2d 162, 171-72 (D.C.Cir.1980), cert. denied, 451 U.S. 1018 (1981). Although some exceptions to this policy may exist, trying to evade liability for a subsidiary's debt to Uncle Sam hardly seems worth the risk.

Civil Rights Fights

Along with suing for racial discrimination, plaintiffs have urged courts to pierce the corporate veil for sexual harassment claims. And in this arena, court decisions sometimes seem as irrational as chemical urges.

Generally, courts concur that the key issues here are what type of sexual harassment occurred and whether the parent took steps to remedy the situation once it discovered the prohibited behavior. See Steele v. Offshore Shipbuilding, Inc., 867 F.2d 1311, 1315 (11th Cir. 1989) and Eichenwald v. Krigel's, Inc., 908 F.Supp. 1531 (D.Kan. 1995).

The Eichenwald court applied the integrated enterprise test to determine the parent firm's liability in this sexual harassment case. Interrelation of operations, common management, centralized control of labor relations, and common ownership or financial control constitute those test factors, and the court ruled, "The first three factors are weighed more heavily than the last." Eichenwald, 908 F.Supp at 1540. Consequently, the court held Krigel's liable for three former employees' claims and awarded the women damages under Title VII of the Civil Rights Act, based on the salaries they lost when they left the retailer because of the "hostile working environment." Id. at 1531 and 1564-70.

But in sexual harassment cases, piercing the corporate veil doesn't guarantee an aggrieved party success.

For example, a U.S. District Court in Florida denied an employee's claim against a parent firm for "intentional infliction of emotional distress" due to sexual harassment because the plaintiff "failed to state a [sufficient] cause of action." Howry v. NISUS, Inc., 910 F. Supp. 576 (M.D.Fla. 1995). Here, too, the court applied the integrated enterprise test to pierce the corporate veil, but it dismissed the claim on Florida case law precedents. Although the plaintiff alleged the employer "required employees to listen to personal and explicit telephone conversations, disrupted work by . . . specifically commenting to Plaintiff as to his likes/dislikes with regard to female attributes, contacted employees during . . . business [hours] to comment on the size of his penis, presented a suggestive doll to employees and required them to view it, used a bull whip in the office, used obscene language . . . physically touched employees and himself in a suggestive manner," the court ruled these allegations did not meet the state standard for "outrageousness." Id. at 580.

"According to Florida case law, this standard is very difficult to meet," the court held. Id.

That ruling seems to contradict the Eichenwald decision. But even though the Steele court excused the parent firm, this was because the parent had "taken prompt remedial action against the supervisor." Steele, 867 F.2d at 1315.

The Steele court also distinguished between a "quid pro quo case," where "the corporate defendant is strictly liable for the supervisor's harassment." Id. at 1316 and one about a "hostile environment." "When a supervisor requires sexual favors as quid pro quo for job benefits, the supervisor, by definition, acts as the company . . . the supervisor uses the means furnished to him by the employer to accomplish the prohibited purpose," the court explained. Id. at 1315. But the court added that a corporate parent is not strictly liable in a "pure hostile environment setting" where the supervisor acts outside "the scope of actual or apparent authority to hire, fire, discipline, or promote." Id. at 1316. In the latter case, the corporate parent or "employer can only be liable indirectly if it knew of . . . [the supervisor's] actions and failed to take prompt remedial action." Id., footnote 1.

CERCLA Crimes

Here lies what seems like another nest of inconsistencies. The Joslyn court concluded that because CERCLA does not specify parent corporations are liable parties, a court must pierce the corporate veil to deem a parent firm responsible for its subsidiary's toxic disposal. Joslyn Corporation v. T.L. James & Co., 893 F.2d 80 (5th Cir. 1990), cert. denied, 498 U.S. 1108 (1991). But usually courts that apply the alter ego theory and decide a parent is liable under CERCLA do so only to firms that maintain very parasitic subsidiaries.

Of course, many courts disagree. They believe this thwarts the "polluter pays" principle that CERCLA was meant to uphold. Consequently, because the veil-piercing standard is so stringent, and thus, allows many parent firms to escape blame, many federal courts apply the "owner-operator" (or direct liability) theory. Taken from CERCLA's wording, the latter theory empowers a court to link the parent as an "owner" or "operator" to an environmental crime. Courts applying it simply decide if a parent firm actually "operated" or had the "capacity to control" its subsidiary's toxic waste disposal. See Riverside Market Development v. International Building Products, 931 F.2d 327 (5th Cir. 1991) and Lansford-Coaldale Joint Water Authority v. Tonolli Corporation, 4 F.3d 1209 (3d Cir. 1993).

Then, there's the Kayser-Roth case. Here, the trial court pierced the corporate veil, then applied the owner-operator theory to hold Kayser-Roth liable for its subsidiary, Stamina Mills' toxic disposal. United States v. Kayser-Roth Corp., Inc., 724 F. Supp. 15, 25 (D.R.I. 1989), aff'd., 910 F.2d 24 (1st Cir.1990). But when Kayser-Roth appealed on the ground "that the parent company of a dissolved subsidiary cannot, as a matter of law, be liable . . . ," 910 F.2d at 25-26, the Fifth Circuit court disregarded veil-piercing to rule, "Kayser misunderstands CERCLA. Under this strict liability statute, all that is necessary to prove is that Kayser was an operator at the time of the spill." Id. at 28.

ERISA Errors and Labor Disputes

One ERISA case reveals an interesting twist on the alter ego theory. When former employees of a division sued a successor employer's corporate parent for unpaid pension benefits under ERISA and Labor Management Relations Act, the parent firm attempted to defend itself by using the alter ego doctrine. See Lumpkin v. Envirodyne Industries, Inc., 933 F.2d 449 (7th Cir.1991). There, Envirodyne, the successor parent, argues that because its offspring, WSC and EDC, were specifically named in a settlement agreement, it (the parent firm) also "benefits from the release under the alter ego theory." Id. at 459.

But the appellate court said no go. "The alter ego theory is a sword, not a shield, the basis for a cause of action, not a defense," it ruled. Id. at 460. Consequently, because "ERISA protects workers from their employers' attempts to deny them pension benefits," and "ERISA . . . cannot be said to attach great weight to corporate form," Id., citing Alman v. Danin, 801 F.2d 1, 3 (1st Cir.1986), parent firms will save arduous hours and exorbitant litigation costs by not shirking their duties to employees.

Tip of the 'berg

Obviously, courts are ruling one way or another on myriads of such cases as you read these lines. So, then, what is a parent firm's responsibility? Although when a subsidiary is completely independent of its parent, the offspring is responsible for its acts, a parent cannot always rely on this principal to protect it from liability. Like a diligent parent of a teenager, it's best to play it safe. A parent will fare best by keeping a watchful eye on its offspring-especially when it may be tempted to violate federal laws. If it looks the other way, that parent best be prepared to take the heat.
NPR Editor Lindsey Martin-Bowen has served full-time as a legal editor for the U.S. Interior Department, a journalist/photographer for THE LOUISVILLE TIMES and THE SUN Newspapers, and as an associate editor for MODERN JEWELER Magazine. A Phi Kappa Phi member, she holds an M.A. Degree in English/writing, has taught writing and literature at Johnson County and Penn Valley community colleges, and is pursuing a J.D. at the University of Missouri-Kansas City School of Law. Each year since 1987, she has helped judge the international NEW LETTERS Literary Contest. Her biography appears in WHO'S WHO IN THE MIDWEST (22d, 23d, 24th, and 25th editions), WHO'S WHO IN THE WORLD (10th and 11th editions), and WHO'S WHO IN AMERICA (48th, 49th, and 50th editions).

Sources

Aronovsky, Ronald G., and Lynn D. Fuller. "Liability of Parent Corporations for Hazardous Substance Releases Under CERCLA." 24 U.S.F.L.Rev. 421 (Spring 1990).

Hamilton, Robert W. The Law of Corporations in a Nutshell. St. Paul, Minn.:West Publishing Co., 1991.

"Piercing the Corporate Law Veil: The Alter Ego Doctrine Under Federal Common Law." 95 Harv. L.Rev. 853 (1982).
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