COURT EASES LIABILITY FOR
PARENT-SUBSIDIARY CORPORATIONS

by Bob Gregg

Many small business operations consist of a parent corporation with separate incorporated subsidiaries. Often an individual entrepreneur or family will operate several separate businesses, each as a separate corporation. These may be “overseen” from a central office.

Small businesses have received some good news from the Seventh Circuit Court of Appeals (covering Wisconsin, Illinois and Indiana). The Court has adopted a new standard making it more difficult to aggregate “affiliated corporations” for purposes of creating sufficient employee numbers for jurisdiction or increased liability in employment cases.

This is important for many small businesses since “threshold” numbers mean the difference between coverage under federal laws or not (15 for Title VII and ADA, 20 for ADEA and COBRA, 50 for FMLA, etc.). Federal discrimination laws also base punitive damage awards on the size of the employer, so lumping parent and subsidiaries together can mean hundreds of thousands of dollars in extra damage awards.

In Papa v. Katy Industries, Inc., and Walsh Press Co., Inc., (7th Cir., 1999) (an age discrimination case) and U.S. Equal Employment Opportunity Commission v. GJHSRT, Inc., et al. (known as “The Frederick Group of Companies”) (7th Cir., 1999) (Americans with Disabilities case) the Court held that “affiliated” subsidiaries and parent corporations should not be lumped together unless there are special circumstances.

The Old Standard

Until now courts have used the “National Labor Relations Board Standard” which is used for deciding union representation and “affiliate liability” under the National Labor Relations Act. The NLRB uses a Four Factor Test, each being of equal weight:

1. common ownership,
2. common management,
3. interrelated operations,
4. centralized control of labor and personnel.

Enough of the factors will cause an aggregation of the separate corporations into one unit. Under this standard a lot of small businesses would be aggregated. Often there is a central office where the entrepreneur or family is located and oversees several operations. There is one bookkeeper or accountant who does records for each subsidiary. There is use of one legal counsel or law firm for the needs of all the business ventures. There may be a pooling of pension plans or health insurance.

The Seventh Circuit Court determined that the NLRA is not a relevant law, and the Four Factor Test makes little sense in an employment discrimination situation.

The New Standard: “Whether the Parent Corporation Itself Committed the Wrongful Act”

The Seventh Circuit recognized that the nature of small business is often “common ownership” of separate operations. The fact that there is an oversight office, one bookkeeping and accounting function, one legal counsel, and pooled insurance does not create a “unity” of corporations. As long as there are truly separate corporate entities, the court will presume each is acting as a separate business, and the employment decisions of each corporation are the acts of separate employers.

So, the sins of the children are not automatically attributed to the parent. If the affiliate and corporation itself is under the “threshold” number of employees, there is no federal law jurisdiction and there is a much more limited liability.

Three Exceptions: Where There Will Be Aggregation

The court’s opinion listed three situations where there should be a lumping together of parent and subsidiary.

1. “Piercing the Corporate Veil” This is an old term used in standard commercial law for erasing the standard liability protection normally associated with incorporated status. It is usually used to chase down individual shareholders and make them liable for corporate debts. It results from not operating the business truly as a corporation. Among the factors that lend to “piercing the corporate veil” are intermingling funds, sloppy corporate record keeping, neglect of the corporate formalities and filings.
   
   Often to get contracts, make a sale, or enhance a loan application, the parent will hold itself out as the real “party in interest,” to overcome the smaller size or assets of the subsidiary. In that case, the parent cannot depend on the subsidiary corporate status to shield itself from any liability.

2. Creating Subsidiaries Expressly for the Purpose of Avoiding Legal Coverage. Anyone who reads this article and then runs out to create small corporations for the very purpose of avoiding the “threshold numbers” is wasting time and money. It is a sham and will not work.
   
   Splitting off a separate corporation each time a subsidiary gets close to a “threshold number” of employees will be seen as pretextual and will not work as a shield. Setting up small corporations for functional reasons, though, will be fine. In one of the Seventh Circuit cases, the subsidiary had been purchased at its small size, so clearly no claim could be made that the parent had set up a small organization for the purpose of evading the law.

3. The Parent Company Made the Wrongful Decision and Directed the Policy and Practice to the Subsidiary. The parent did or dictated the action at issue. Under this exception, it is the parent or management company which is the primary actor, and the subsidiary is simply a direct extension and should be aggregated. A good example involved a Wisconsin corporation, subsidiary to a Delaware parent company. A Wisconsin employee was told she had to go back to working directly with the manager who had physically sexually harassed her, and the Human Resources Director told her, “Corporate out East told us we have to get back to normal here.” In that case, “Corporate out East” meant the parent corporation, which was dictating the decision to the Wisconsin corporation.
   
   This is perhaps the most dangerous of the exceptions. If officers and owners of several corporations are centrally located, it is normal for managers in each corporate business to refer to the central location as “central,” or “corporate,” or “control,” or “they,” and thereby dilute the corporate separateness. It certainly makes it seem that the parent management corporation is dictating decisions. Often the words loosely used by managers become crucial evidence in litigation. It is very important for managers to be aware of the corporate separateness. Though the president, CEO or bookkeeper may be sitting in a central location, they are in their separate corporate role as CEO or bookkeeper for each specific corporation when communicating and deciding for that specific corporation. That important distinction should be emphasized and fostered in all communications with subsidiaries.
   
   Common policies or practices dictated by “central” to all “branches” may create an issue. If each operation is different enough to warrant separate corporate status, it may not be wise to have a “lock step” carbon copy approach for all. It is normal that subsidiaries will have a number of commonalities, but managers of each should at least be consulted about the difference in their operations before simply dictating uniform employee handbooks, policies and practices to all subsidiaries. Certainly, each employment decision involving individual employees should be considered on its own merits before applying a “blanket corporate policy” or practice. Those “blanket” policies or practices may result in all subsidiaries being aggregated together instead of just the parent and the one subsidiary at issue.

Conclusion

The Seventh Circuit Court of Appeals has ruled in favor of small business. There is now more flexibility to effectively manage separate subsidiary corporations with less fear of overwhelming legal liability.

There are situations where the separateness can be challenged, and you can get the greater liability. Be aware, and be careful to avoid those situations.

This is not the final answer. The Seventh Circuit is just one of the several federal circuits. Several others still use the NLRB Four Factor Test. So, if you operate outside Wisconsin, Illinois or Indiana, it would be wise to check the recent decisions in those areas. When there is a dispute of decisions among the different federal appeals courts, the U.S. Supreme Court will ultimately resolve the issue. These current cases may be appealed to the Supreme Court. So, sooner or later the standard could change, again. In the meantime, the Seventh Circuit has given some guidance and flexibility in the three states under its jurisdiction.

Bob Gregg is a partner at Boardman Law Firm of Madison, Wisconsin. He has over 30 years of experience in employment relations and has conducted over 2,000 seminars on employment law. Bob’s career has encompassed canoe guide, carpenter, laborer, Army Sergeant, social worker, educator, business owner and EEO officer. Bob’s emphasis is to help employers identify and resolve problems before they generate legal action. He has designed pay and absence policies, and solved salaried position issues, for numerous private and public employers.

Copyright © 2005 by Robert E. Gregg. All rights reserved.