The Parent and The Subsidiary. When is The Former Liable for The Actions of the Latter?

• Posted on: Apr 5 2021

Corporations are legal entities distinct from their managers. As such, like any shareholder or investor, a corporation can buy shares in another corporation. When a corporation buys enough voting shares of another corporation to control that company, a parent – subsidiary relationship is created. 

Specifically, when a corporation buys less than 100%, but more than 50%, of another company, the latter company becomes a regular subsidiary of the former. If the corporation acquires 100% of the voting shares of another company, then the acquired company becomes a wholly owned subsidiary of the other. The difference between a subsidiary and a wholly owned subsidiary, therefore, is the amount of voting control held by the parent company. 

As a general matter, the corporate identities of the parent and its regular subsidiaries cannot be disregarded. However, the courts will look beyond the corporate form where necessary to prevent fraud or to achieve equity. Thus, for example, a parent corporation may become a party to its subsidiary’s contract if the parent’s conduct manifests an intent to be bound by the contract. Such intent will be inferred from the circumstances surrounding the transaction, including whether the parent participated in the negotiation of the contract. Indeed, a parent corporation that negotiates a contract but has its subsidiary sign it can be held liable as a party to the contract, if the subsidiary “is a dummy for the parent corporation.” A.W. Fiur Co. v. Ataka & Co., 71 A.D.2d 370 (1st Dept. 1979).

Moreover, a parent corporation may be liable on a contract signed by its subsidiary if the subsidiary is shown to be a mere shell dominated and controlled by the parent for the parent’s own purposes. In In re Sbarro Holding, Inc., 91 A.D.2d 613 (2d Dept. 1982), a holding company sought to stay an arbitration proceeding against it and other related corporations on the ground that the agreement that called for arbitration was between a franchisee and its subsidiary. The court held that all the related corporations could be compelled to participate in the arbitration proceeding, although they were not signatories of the contract. The court explained that:

The corporate veil will be pierced (1) to achieve equity, even absent fraud, where the officers and employees of a parent corporation exercise control over the daily operations of a subsidiary corporation and act as the true prime movers behind the subsidiary’s actions, and/or (2) where a parent corporation conducts business through a subsidiary which exists solely to serve the parent.

Sbarro, 91 A.D.2d at 614 (citations omitted). 

Additionally, where a shareholder uses a corporation for the transaction of the shareholder’s personal business, as distinct from the corporate business, the courts have held the shareholder liable for acts of the corporation. See Rapid Tr. Subway Constr. Co. v. City of N.Y., 259 N.Y. 472 (1932). The determinative factor is whether “the corporation is a ‘dummy’ for its individual stockholders who are in reality carrying on the business in their personal capacities for purely personal rather than corporate ends.” Walkovszky v. Carlton, 18 N.Y.2d 414, 418 (1966).

Apart from the foregoing rules, a parent corporation can be held liable for the actions of its subsidiary under veil piercing or alter ego liability principles. 

The alter ego doctrine has been applied to pierce the veil between corporations when subsidiary corporations are used by a dominating parent corporation to engage in fraudulent or wrongful conduct. Under New York law, a corporation is considered to be a “mere alter ego when it ‘has been so dominated by . . . another corporation . . . and its separate identity so disregarded, that it primarily transacted the dominator’s business rather than its own.’” Trabucco v. Intesa Sanpaolo, S.p.A, 695 F. Supp. 2d 98, 107 (S.D.N.Y. 2010). When that occurs, “the dominating corporation will be held liable for the actions of its subsidiary ….” Id.

Courts consider a wide array of factors in assessing the degree of domination and control exercised by the parent company. Such factors include: overlap in ownership, officers, directors, and personnel; common office space, address and telephone numbers of the corporate entities; whether the related corporations deal with the dominated corporation at arm’s length; and whether the corporation in question had property that was used by other of the corporations as if it were its own. Shisgal v. Brown, 21 A.D.3d 845, 848 (1st Dept. 2005) (internal citation omitted). Because the decision whether to pierce the corporate veil depends “on the attendant facts and equities” (Matter of Morris v. N.Y. State Dep’t of Taxation & Fin., 82 N.Y.2d 135, 141 (1993)), and because said facts can apply to an “infinite variety of situations” (Wm. Wrigley Jr. Co. v. Waters, 890 F.2d 594, 601 (2d Cir. 1989)), no one factor controls the consideration. N.Y. Dist. Council of Carpenters Pension Fund v. Perimeter Interiors, Inc., 657 F. Supp. 2d 410, 421 (S.D.N.Y. 2009). Courts recognize, however, “that with respect to small, privately-held corporations, ‘the trappings of sophisticated corporate life are rarely present,’” and, therefore, they “must avoid an over-rigid ‘preoccupation with questions of structure, financial and accounting sophistication or dividend policy or history.’” Bridgestone/Firestone, Inc. v. Recovery Credit Servs., Inc., 98 F.3d 13, 18 (2d Cir. 1996) (quoting Wrigley, 890 F.2d at 601).

In applying these and other factors, the cases “reveal[] common characteristics” that necessitated piercing the corporate veil. Wrigley, 890 F.2d at 601. “In each case, the evidence demonstrated an abuse of that form either through on-going fraudulent activities of a principal, or a pronounced and intimate commingling of identities of the corporation and its principal or principals, which prompted the reviewing courts, driven by equity, to disregard the corporate form.” Id.

In World Wide Packaging, LLC v. Cargo Cosmetics, LLC, 2021 N.Y. Slip Op. 02088 (1st Dept. Apr. 1, 2021) (here), the Appellate Division, First Department had the opportunity to consider the foregoing principles in reversing the order of the motion court, which allowed World Wide Packaging, LLC (“World Wide Packaging”) to amend its complaint to assert a claim of alter ego liability against defendant TPR Holdings, LLC (“TPR”).

World Wide Packaging involved claims against the affiliates of TPR (“Subsidiary Defendants”) for breaching their payment obligations with regard to certain cosmetic supply transactions conducted on credit accounts. 

As alleged, TPR had been conducting business with World Wide Packaging since 2012. The Subsidiary Defendants were operating subsidiaries of TPR. 

In 2016, TPR requested that Plaintiff establish “separate credit accounts” for each of its subsidiaries to transact their own individual business dealings with World Wide Packaging. Plaintiff agreed. From August 2016 through June 2018, World Wide Packaging had an established a course of dealing with each of the Subsidiary Defendants whereby Plaintiff had done business with the subsidiaries of TPR on their own separate credit accounts. 

In 2018, Plaintiff commenced the action against the Subsidiary Defendants, asserting contract claims against each of them for nonpayment on certain transactions conducted on their individual credit accounts. World Wide Packaging later sought leave to amend its complaint to add TPR as a defendant under, inter alia, alter ego liability/veil piercing theories of liability.

The motion court granted the motion. Defendants appealed. The First Department unanimously reversed, holding that there was no evidence that TPR was the real party in interest with regard to the separate transactions at issue in the litigation or dominated and controlled the Subsidiary Defendants beyond the incident of ownership.

The Court explained that “the complaint [was] silent” as to TPR’s involvement in the negotiation of the credit accounts Plaintiff created with the Subsidiary Defendants. Slip op. at *1. Indeed, said the Court, although “[i]t appear[ed] that TPR Holdings initially approached plaintiff about three separate credit accounts for its three subsidiaries. … there [was] no allegation about who negotiated the pricing or the general terms of each transaction.” Id. And, noted the Court, “Plaintiff acknowledged that the purchase orders were issued separately by the subsidiary defendants.”

In short, concluded the Court, “[w]hile it appears that TPR Holdings’ employees were frequently, but not always, involved in the creative aspect of the transactions by approving the order designs, there is no allegation that TPR Holdings directly participated or micro-managed each transaction underlying the purchase orders or acknowledged that it was the actual party in interest.” Id.

The Court also held that Plaintiff’s claim for piercing the corporate veil was insufficient. The Court noted that “[e]ven if TPR Holdings exercised complete domination of the subsidiary defendants, plaintiff failed to allege that the abuse of the corporate form was for the purpose of defrauding plaintiff and causing it an injury.” Id. The Court explained that “plaintiff did not allege that the subsidiary defendants were not legitimate businesses or that they were created for an improper purpose of cutting off plaintiff’s ability to collect on the contract, or that corporate funds were purposefully diverted to make any of the three companies judgment proof.” Id. (citing Tap Holdings, LLC v. Orix Fin. Corp., 109 A.D.3d 167, 174-177 (1st Dept. 2013); Fantazia Intl. Corp. v. CPL Furs N.Y., Inc., 67 A.D.3d 511, 512 (1st Dept. 2009)). Merely alleging that “TPR Holdings caused the subsidiary defendants to breach a contract,” concluded the Court, was “insufficient to show the requisite wrongdoing.” Id. at *1-*2 (citing Skanska USA Bldg. Inc. v. Atlantic Yards B2 Owner, LLC, 146 A.D.3d 1, 12 (1st Dept. 2016), aff’d, 31 N.Y.3d 1002 (2018)).

Takeaway

Under New York law (and elsewhere), a parent corporation may be held liable for its subsidiaries’ acts when the “alleged wrong can seemingly be traced to the parent through the conduit of its own personnel and management,” and the parent has interfered with the subsidiaries’ operations in a way that surpasses the control exercised by a parent as an incident of ownership. See, e.g., United States v. Bestfoods, 524 U.S. 51, 64 (1998) (quotation omitted). As noted by the Court in World Wide Packaging, there was no allegation or evidence that TPR interfered with the actions of its subsidiaries. 

Moreover, there was no allegation or evidence in World Wide Packaging to support the imposition of veil piercing or alter ego liability. As the Court in World Wide Packaging recognized, allegations of domination and control without any allegation or evidence of fraud, inequity or other misconduct is insufficient to support a claim for alter-ego/veil-piercing liability against a parent corporation.