Published in: General

Can Your Veil be Pierced?

Author Eric Proos

Published on: October 11, 2021

What do Audi, Porsche, Bentley, and Ducati all have in common? They are all subsidiary companies of Volkswagen Group. This means that Volkswagen owns a majority interest in the companies, but those brands operate independently. Does that mean that if you drive a Ducati and there is a manufacturing error you can sue Volkswagen? Well, that would depend on whether the corporate veil was pierced. I can tell you one thing, with corporations this big, complex, and well-known, piercing the corporate veil is not going to happen. However, it could happen to smaller companies.

What is a corporate veil? A corporate veil is a legal term that separates the parent company from its subsidiaries. The term can also be used to separate a corporation from its shareholders. The corporate veil protects a parent company from the liabilities of its subsidiary. So why would a plaintiff suing a subsidiary want to pierce the corporate veil? What must a plaintiff arguing to pierce the corporate veil prove? What proactive steps can a parent company and subsidiary take to protect themselves? Read on and you’ll find out.

Reasons why Plaintiffs Seek to Pierce the Corporate Veil, and Timing of the Claim

As with any lawsuit the main reason that a plaintiff may seek to pierce the corporate veil is to get after the bigger assets possessed by the parent company. Think about it, if you are suing a company that is worth $1 billion and that company is owned by another company that is worth $60 billion dollars, wouldn’t you want to involve the company with the bigger bank account? Of course.

Money is not the only reason to pierce the corporate veil. Another reason a plaintiff may seek to pierce the corporate veil is to obtain jurisdiction over a parent company that may not be present in the United States or does not do business in the US. This type of claim can also be used as a negotiation tactic. By incorporating a piercing claim to a lawsuit, or threatened lawsuit, it increases the burden and cost to defend the case because now the parent company is involved. This is especially true when it is a non-US company.

Ok, I get it Eric, but my parent company wasn’t sued, only the subsidiary. So, the parent company is good right? Not exactly. There are two times during the process that a piercing claim can be brought. The first is before a judgment against the subsidiary is issued. The timing of this claim is to expand the pool of assets that is available to the plaintiff to satisfy the claims. The second, which goes to the question at hand, is after a judgement is issued against the subsidiary that cannot be satisfied by the subsidiary’s assets alone.

Pleading a Piercing Claim

As with any cause of action, there are certain theories and elements that apply to the law. Piercing claims are no different. In order for a plaintiff to establish a piercing claim, they must show that the subsidiary is either the parent company’s alter ego or its agent.

Alter Ego

An alter ego claim is a claim that the parent company basically dominated and controlled the subsidiary company, the subsidiary’s separate identity was disregarded, AND an injustice or other wrong to the plaintiff will likely result if the corporate veil is not pierced.

Let’s start with the parent company dominating and controlling the subsidiary. How can a plaintiff show that a parent company did this? Courts have looked at the following factors when evaluating this element:

1. Corporate form and structure, which can include:
   1. The subsidiary’s corporate formalities are disregarded by the parent company;
   2. The subsidiary functions as a mere façade of the parent company;
   3. The parent company owns ALL of the subsidiary’s stock;
   4. The subsidiary is inadequately capitalized.
2. Operational and contractual arrangements, which can include:
   1. Sharing corporate officers and board of directors;
   2. Sharing offices, bank accounts, employees, and phone numbers;
   3. The parent company uses the subsidiary’s property as its own.
3. Financial arrangements with the parent company, which can include:
   1. The subsidiary makes undocumented loans to the parent company;
   2. The parent company pays the salaries of the subsidiary’s employees;
   3. The parent company makes all the human resources decisions for the subsidiary;
   4. The parent company siphons money out of the subsidiary.

The next element that must be evaluated under the alter ego theory is an injustice or other wrong. The easiest way to show this is the illustration of a fraudulent intent to avoid liability. This is different in California.

Each element is fact –dependent, and one fact is not determinative if the alter ego theory applies.

Agency

Under the agency theory, a plaintiff attempts to prove that the subsidiary was simply the agent of the parent company. To present a claim on this theory, the plaintiff must generally establish the following:

1. The parent company authorized the subsidiary to act on its behalf and the subsidiary agreed to act as the parent company’s agent.
   1. This can be actual or apparent. Showing that the agent is actual can be done through words, conduct, or other actions that manifest an intent to grant the authority on behalf of the parent company. Demonstrating that the agent is apparent requires proving that a third-party was given the impression that the subsidiary had the authority to act on the parent company’s behalf. This cannot be based solely on the subsidiary’s actions; there must be proof that the parent company influenced the subsidiary’s actions.
2. The parent company exercised total control over the subsidiary.
   1. This must be more than the level of control that a parent company is allowed to exercise. Because a parent company has some level of control as majority shareholder, something extra must be shown. Common examples that show a parent company has total control over the subsidiary include:
      1. Active participation in exercising control over the subsidiary;
      2. Affirmative direction for the subsidiary to act in a certain way;
      3. Agreement by the subsidiary to be bound by resolutions of the parent company; and
      4. Control over the subsidiary’s acceptance and rejection of client engagements by the parent company.

Steps Your Parent Company Should Take to Limit Liability

After reading the above, you may be worried that your parent company is piercing the corporate veil and may think nothing can be done. However, that is not true. Here is a list of some steps that your parent company can take to limit its liability if a subsidiary is sued.

1. Observe corporate formalities and structures:
   1. Make sure the subsidiary is properly capitalized;
   2. Document the reasons for the subsidiary’s capital structure and the level of capital used; and
   3. Properly file the subsidiary’s articles of incorporation (this is a no-brainer).
2. Ensure the subsidiary operates independently:
   1. Ensure that the parent company does not have too much control over day-to-day operations (ownership of stock in the subsidiary is not determinant of whether the subsidiary is independent)
   2. Avoid structuring the relationship between the parent company and subsidiary so that the parent company has final decision-making power;
   3. Create separate bank accounts for the parent and subsidiary companies;
   4. Maintain separate books and records; and
   5. Make sure the parent company’s board and the subsidiaries board are independent.

This list of safeguards is not exhaustive, but it provides a path that a parent company should take in order to prevent a piercing claim from being successful.