Key Takeaways

  • A parent company subsidiary relationship typically shields the parent from liability, but exceptions exist.
  • Courts may hold parent companies liable if they exercise excessive control or commit fraud.
  • Piercing the corporate veil occurs when legal separateness is ignored, exposing the parent company to liability.
  • Subsidiaries must be properly capitalized and managed independently to maintain liability protection.
  • Parent companies can be liable under doctrines such as alter ego, agency, or direct participation.
  • Careful structuring, documentation, and governance help limit risk for parent companies.
  • Legal assistance is highly recommended when forming or managing subsidiaries.

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.

How Subsidiaries Are Formed

Subsidiaries are formed when a parent company purchases a controlling interest—usually more than 50%—in another company. This may occur through:

  • Direct acquisition of shares in an existing company.
  • Creating a new entity and registering it as a subsidiary.
  • Asset transfers from the parent to the new subsidiary.

To form a subsidiary:

  1. The parent company decides on the legal structure (LLC, C-Corp, etc.).
  2. It files formation documents with the relevant state.
  3. It drafts bylaws or an operating agreement.
  4. It capitalizes the subsidiary appropriately.
  5. It appoints a board of directors or managers.

The subsidiary then operates as a separate legal entity, though under the ownership umbrella of 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.

Common Uses of Parent-Subsidiary Structures

Parent company subsidiary relationships serve various strategic and legal purposes, such as:

  • Risk isolation: Liability for debts and lawsuits can be contained within the subsidiary.
  • Tax benefits: Some structures allow tax optimization or deferment.
  • Operational focus: Different subsidiaries can specialize in unique markets or industries.
  • Brand protection: Limiting risk to a specific brand under the corporate umbrella.
  • Mergers and acquisitions: Acquired companies are often made subsidiaries to retain their operations.

These benefits only materialize when the parent company carefully maintains the legal separation between entities.

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.

Alter Ego Doctrine and Its Impact

One key theory under which a parent company can be held liable for its subsidiary’s actions is the alter ego doctrine. This arises when the court finds that:

  • The parent and subsidiary do not have truly separate identities.
  • The parent exercises complete domination over the subsidiary.
  • The subsidiary was used to commit fraud or avoid obligations.

Under this theory, courts disregard the corporate form and treat the two as one entity. Indicators of alter ego status may include:

  • Shared management and personnel.
  • Commingled finances.
  • Lack of corporate formalities (e.g., no separate records).
  • Undercapitalization of the subsidiary.

Courts look at the totality of circumstances, and no single factor guarantees veil piercing.

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.

When Limited Liability Fails: Legal Theories of Liability

Besides piercing the corporate veil, courts have applied several other legal doctrines to hold parent companies accountable:

  • Agency theory: If the subsidiary acts as an agent for the parent, the parent may be liable for the subsidiary’s conduct.
  • Direct participation: A parent company that directly participates in the subsidiary’s wrongdoing (e.g., ordering illegal acts) can be held liable.
  • Joint venture liability: If the relationship resembles a partnership more than a traditional parent-subsidiary model, joint venture rules may apply.

These theories require specific facts and substantial evidence. Merely owning a subsidiary does not trigger liability.

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.

Best Practices to Limit Parent Company Liability

To maintain liability protection between a parent company and subsidiary, it is critical to observe legal separateness. Best practices include:

  • Maintain separate books and bank accounts.
  • Hold regular board meetings and document decisions independently.
  • Avoid commingling of funds or assets.
  • Ensure subsidiaries are adequately capitalized.
  • Clearly define roles and responsibilities of officers and directors.
  • Use separate branding and communications when possible.

Following these practices supports the legal independence of each entity, helping uphold the protections offered by the corporate structure.

Frequently Asked Questions

  1. Can a parent company be sued for the actions of its subsidiary?
    Yes, but typically only under specific circumstances such as fraud, undercapitalization, or if the parent exerts total control, justifying veil piercing.
  2. What does “piercing the corporate veil” mean in a parent-subsidiary context?
    It refers to a legal decision to treat the parent and subsidiary as one entity, allowing creditors or plaintiffs to reach the parent company’s assets.
  3. How can a parent company avoid liability for its subsidiary’s actions?
    By maintaining corporate formalities, keeping finances and operations separate, and ensuring the subsidiary is adequately funded and independently managed.
  4. What legal structure is best for forming a subsidiary?
    This depends on the business goals, but LLCs and C-Corporations are common due to their flexibility and liability protections.
  5. Is a parent company always in control of its subsidiary?
    While the parent company may hold a majority interest and influence major decisions, subsidiaries are expected to operate independently to maintain liability separation.

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