Parent Subsidiary Liability: Everything You Need to Know
Parent subsidiary liability refers to when a parent corporation is liable for its subsidiaries actions. Determining liability, depends on a few considerations.3 min read
Parent subsidiary liability refers to when a parent corporation is liable for its subsidiaries actions. Determining liability, however, depends on a few considerations.
The Relationship Between a Company and Its Subsidiary
The relationship between a company and its subsidiary depends on a few important conditions:
- How much stock the parent company owns.
- Whether or not the corporation purchased a new company or bought existing shares in a company.
- The level of subsidiary independence involved. Although the parent company has a lot of influence on the company, the subsidiary remains the primary stockholder. This can affect the board members positions, voting, and any other major decisions involved in the business.
- The intentions of the parent company. They can ultimately control the board members and the processes for voting and changing regulations.
Despite the influence of the corporation, subsidiaries still have independence. They are still responsible for managing the day to day operations of the company and for making decisions that affect the subsidiary company, not the parent company.
Important Characteristics of a Parent-Subsidiary Relationship
There are three important characteristics to the parent-subsidiary relationship:
- Subsidiary independence: Although the subsidiary remains an independent business, the parent company has a significant amount of authority.
- Parental power: The parent company should attempt to maintain control while still holding up to the subsidiaries independence requirements. This can be accomplished by drafting the articles of incorporation with clear and concise bylaws and regulations.
- Liability: Having subsidiaries that are independent can eliminate the possibility of liability to the parent company. Parent companies can reduce liability by having separate board members and bylaws between businesses.
Is the Parent Company Liable When an LLC Is Sued?
There are many advantages to limiting liabilities when someone has invested interest in multiple businesses. Otherwise, a failing business can affect all of the other businesses. Filing for a parent-subsidiary relationship can protect business owners from legal claims against limited liability businesses.
The legal components are as follows:
- Independent legal status: Filing for an LLC ensures that the business is kept separate from each of its members. The LLC also prevents them from being sued personally.
- LLC subsidiaries: An LLC subsidiary is considered a company that is entirely or majority-owned by another parent company. The LLC can be owned either by another LLC or by a corporation.
- Suits against LLC subsidiaries: Although the parent company is responsible for ensuring that the day to day activities are properly performed, the subsidiary is considered an independent business.
Basic Legal Rule: Limited Liability
In most cases, the parent company is not liable for the subsidiaries' actions. This basic level of liability protection is what has led to so many companies establishing a parent-subsidiary relationship. It is important, however, to know that the parent company is not always separated in terms of liability from its subsidiaries.
Parent Liability Under Some Circumstances
Separating liability among subsidiaries and parent companies is not always possible. If one of the parent members is involved in illegal activities or if they fail to keep the businesses practices separate, the parent company can be liable too. This is known as piercing the veil. It refers to dipping into the parent company's assets to receive compensation for a legal dispute.
Piercing the Veil
Piercing the veil is the exception to the basic rule of reduced liability. In order for someone to pierce the veil, the person must prove that the parent company openly intended to get around the liability rule. This is present in cases of fraud. The exact definition of fraud is not clear, but often includes the establishment of a corporation to intentionally disguise liability.
There are three concepts to consider when establishing whether or not the parent company will be liable for its subsidiary liabilities.
- Single business enterprise: This occurs when two businesses are part of a single business enterprise.
- Undercapitalization: This occurs when the subsidiary does not have sufficient funds to cover a liability.
- Fraudulent transfer of assets: This occurs when assets are quickly transferred to the parent company without record following a suit of liability.
Because each case is complex and unique, there are many factors to consider when determining the liability of a parent company. If you need help with parent-subsidiary liability, you can post your legal job on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.