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Piercing the Corporate Veil - Asking the Right Questions (Part II)

Kurt A. Strasser


III. PIERCING THE VEIL IN CORPORATE GROUPS- ASKING THE WRONG QUESTIONS

These contracts cases illustrate how courts are able to use the flexibility and abstraction of veil piercing law to reach results in individual cases that make good sense as contract policy. However, these courts do so in spite of the structure of veil piercing law, rather than because of it. Consider the first factor in traditional veil piercing, the extent to which the subsidiary is separate from the parent, either as a matter of form or in business reality, or both. Yet, determining the extent of separation is not a very good way of evaluating whether veil piercing is appropriate in either of these kinds of contracts cases. With the misrepresentation cases, the extent of formal separation is established by the trappings of corporate existence and formal structure that have no apparent relationship to likelihood of misrepresentation or confusion. The extent of real business operational separation might make confusion less likely, if business locations, assets, personnel, etc., are not shared. However, it does not address the chances of misrepresentation by the parent. Similarly, with the asset manipulation cases, the extent of real business separation is at most tangentially related to the likelihood of manipulation. Again, formal separation appears to be simply beside the point. When the parent and the subsidiary conduct separate businesses operations with separate financial and operating structures, they will have to use overt transactions to manipulate assets, and these are perhaps more likely to leave a paper trail which provides proof for later use. However, it does not seem to correlate at all with the chance that manipulation will in fact take place.

The second factor emphasized in traditional veil piercing, wrongful conduct, aligns obliquely with the good results in these cases, although doing so requires a fine tuned and precisely focused concept of wrongfulness. 75 Veil piercing embraces a broad concept of wrongfulness here, so that it will not limit the exercise of judicial discretion in individual fact patterns. Unfortunately, in expanding judicial discretion, this broad concept fails to guide it. In these contracts cases, one can find misrepresentation, deliberately induced confusion, and asset manipulation that certainly qualify as "wrongful" under this broad criteria. Yet, what makes this conduct "wrongful" in these contract cases, from a policy perspective, is not the intrinsic nastiness of the behavior, but rather its effect in disrupting the deal that the parties made. Thus, in contracts cases, we need to identify what is appropriately "wrongful" conduct by contracts policy, not by an idealized notion of the merits of the conduct in the abstract.

The idea that "wrongful" conduct in contracts cases should be defined by contracts policy is implicitly supported by the contract cases that do not pierce the veil even when there is conduct that general veil piercing policy would consider wrongful. Thus, the courts have refused to pierce the veil in contracts cases where the parties got the deal they made, even when other traditional indicia of veil piercing factors are present. In Norhawk Investments, discussed above, the subsidiary was undercapitalized, and had no assets or employees.76 Yet, there had been no misrepresentation in the lease agreement; the lessor knew it was only getting the promise of a subsidiary for which it had been denied financial information it had sought. The lessor willing to make such a non-recourse transaction, as many are in real estate settings, should not be given a better deal via veil piercing than the one it bargained for. Thus, there was no wrongfulness in the parent's use of such a thin, if not evanescent, subsidiary because it was a contracts case and contracts policy was not violated. Yet, to reach this correct contracts result, the court had to be quite selective in its use of the precedent from the traditional doctrine.

These contracts cases illustrate the fundamental problem with traditional veil piercing doctrine—it asks the wrong questions. As already noted, in contracts cases, veil piercing doctrine focuses on abstract, generalized ideas of entity separateness, and of "wrongful" conduct. In doing so, it does not direct the court's attention to the requirements of contracts policy, although this should certainly be a significant part of the decision to respect or ignore the separate corporate entities—the decision whether to "pierce the corporate veil"—in these contracts cases.

Traditional veil piercing asks abstract, generalized questions as a matter of corporate law, questions that then are to guide the results in all the substantive areas of law in which veil piercing issues arise. The core problem with this approach in corporate groups cases is that the questions it asks do not relate well to the reasons for respecting or ignoring separate corporate identities in different areas of law. No doctrine can be applied indiscriminately through the full spectrum of the many discrete legal areas of procedure, jurisdiction, tax, and substantive law, not to mention statutory law of general application. The only transcendental principle universally applicable is that the decision to respect or ignore separate corporate identities in corporate groups cases in different substantive legal areas should be guided by the policies of those areas, not by the abstract and generalized ideas at the core of the traditional doctrine.

For example, consider a tort claimant seeking to pierce the veil in the fact patterns of the contracts cases discussed above.77 Whether the parent misrepresented itself as the contracting party does not seem to be important in deciding whether the veil should be pierced and the parent held liable to the subsidiary's third-party tort claimant.78Whether the parent manipulated the subsidiary's assets to remove them from the reach of the tort creditor is obliquely relevant to the veil piercing claim, to the extent that it may affect whether a meaningful remedy is available. However, the relevance is only oblique; tort policies should be important in determining whether there is tort liability of the parent and such manipulation is important only as it relates to them. Similarly, the fact that there was no misrepresentation or manipulation of assets, while important for contract claims, has less relevance in a tort case.

For the tort claimant, the core tort policies of compensating injured parties, allocating costs to the activities that cause them, and discouraging negligent or intentionally harmful conduct are key.79 In corporate groups cases, whether the parent company should be liable to the subsidiary's tort claimant should be based on the extent to which such liability furthers these policies. Yet, this is the question that traditional veil piercing law addresses only obliquely, and in a way that is different from the way it addresses contract law.

Neither of the questions that are central to traditional veil piercing directs the inquiry to matters of concern to tort policy. The first question in traditional veil piercing asks whether the subsidiary is a separate entity, either formally or in operating business reality. Yet, this does not direct attention to the facts relevant to the core tort policies of securing compensation or discouraging harmful conduct. In one respect, this first question's concern with corporate separateness can overlap somewhat with tort policy's concern to distribute losses to the activities that cause them. If the parent and subsidiary are in reality not conducting parts of the same business enterprise, then the liability should stop at the boundary of the enterprise. While it is possible that the parent and subsidiary are not jointly conducting one business enterprise, the working assumption of corporate groups is that the whole group is conducting one enterprise. In these typical cases, then, the separation question will again not further the pursuit of this tort policy, although the tort policy could potentially question the justification for parent company liability in the unusual case in which parent and subsidiary corporations are not part of the same enterprise.

What of the "wrongful conduct" consideration that is the second part of traditional veil piercing? The contracts cases concerned with asset manipulation, discussed above, were able to reach good veil piercing results there. Yet asset manipulation is important in torts cases only to the extent it leaves a tort claimant with no meaningful remedy. While this is certainly a foreseeable result of such manipulation, the absence of a meaningful remedy could also arise in other ways, particularly if the tort claim is large and the subsidiary is not. This would be even more true if the "wrongful conduct" took a form that did not so clearly implicate the subsidiary's ability to respond in damages. A focus on the availability of a meaningful remedy, rather than the manipulation of the assets, is more likely to reach good results that achieve tort policies in these veil piercing cases.

There is general recognition that tort cases and contract cases call for different analysis when piercing the veil.80 Some cases and many academic commentators develop this theme.81 There are serious, well developed proposals for limiting or abolishing veil piercing in tort cases.82 Although the case has been well made in the academic literature, there seems to be little response by the courts. Courts (and commentators) do frequently say that veil piercing should be more generally available in tort than contract, although the empirical evidence does not find this to be the result in the decided cases.83 For better or worse, veil piercing has a sufficiently strong hold on our legal culture and our legal conceptual framework that wholesale or even partial abolition of the doctrine does not appear to be a realistic prospect.

Yet substantial reform is needed. I have argued that veil piercing asks the wrong questions. It is concerned with abstract, generalized questions of corporate separateness and wrongful conduct, rather than with the policies of the body of law under consideration. Thus, it does not directly consider contracts policy for contracts cases, or torts policy for torts cases. Good results are possible because the doctrine is sufficiently imprecise and vague that courts have much freedom of movement under it. But the veil piercing doctrine does not guide the courts toward these good results because it asks the wrong questions. As a consequence, good results are much less likely, and they will often require a very selective application of the principles of the traditional doctrine. The next section will consider how the doctrine can be reformed to ask the right questions.

IV. PIERCING THE VEIL IN CORPORATE GROUPS— ASKING THE RIGHT QUESTIONS

In discussing a better policy for veil piercing within corporate groups, it is important to emphasize what is not at stake. This is not a proposal for changing the limited liability of individual investor shareholders, whether in the publicly held corporate groups that predominate in the modern economy, or in closely held corporations. This paper is concerned with the liability within corporate groups, that is, liability of parent companies for their wholly owned or controlled subsidiaries when both are involved in the collective pursuit of one common business enterprise under the direction of their parent companies. Within corporate groups, the traditional policy concerns supporting limited investor liability mostly do not apply.84 In the corporate group that is typical of modern large business enterprises, the corporate structure is not chosen in order to give non-manager investors protection from some of the risks of the business, even though those managing the enterprise may be quite happy to have this or any other shifting of the risks of the business. Rather, corporate structure in the modern corporate group is more often chosen for managerial, accounting, tax, personnel, or other strategic business considerations, including accommodation to local law and culture in multi-national enterprises. While the pursuit of limited liability may well be one of these considerations, it is not the reason for making a new investment, but rather an extra-strategic consideration to be evaluated with others in deciding the best mix for this enterprise at this time. For this reason, limited liability policy and its incentives for entrepreneurial investment are typically not implicated in decisions about veil piercing within the corporate group.

In this situation, whether to pierce the veil or respect the separate identities of the separate corporate entities making up the group should be determined by looking to the policies of the body of law under consideration. Thus, as I have argued above, contracts veil piercing cases within corporate groups should be decided with reference to the dictates of contracts policy. Therefore, the appropriate questions to ask are: first, was the contracting party misled as to the identity or assets of the corporate entity it actually contracted with? Or did the contracting party reasonably think that the parent or another more robust affiliate either agreed to the contract or agreed to stand behind the performance of this contract? Second, has the parent company substantially disabled the subsidiary from being able to perform or respond in damages after the contract was made? That is, have the assets been stripped from the subsidiary or otherwise manipulated so that the subsidiary is no longer able to render the performance that would reasonably have been expected of it, thus violating the policy of good faith and fair dealing in contract performance?

More broadly, in contracts cases, the veil piercing inquiry should focus on whether the contracting party got the deal to which it agreed. If so, contracts policy calls for no veil piercing if doing so would award a better deal than the one on which was agreed on. But if the structure of the group or the behavior of the different corporate entities in it have caused the contracting party not to get the deal it made, then veil piercing is appropriate to accomplish the core policies of contract law.85 This Article has discussed two groups of typical veil piercing cases which implicate these contracts policies; further inquiry may well identify other corporate groups veil piercing cases in which contracts policy is implicated and either supports or refutes the need for veil piercing in those situations. But the emphasis should remain on contracts policy for contracts veil piercing cases with corporate groups.

In much the same way, veil piercing in torts corporate groups cases should be based on an evaluation of the core concerns of torts policy. One of these is the need to provide adequate compensation for victims. Here the emphasis will be on whether piercing is necessary to supply a sufficiently large asset pool to compensate victims. Tort law also emphasizes the policy of imposing the costs generated by an activity on that activity, and the related goal of discouraging negligent or intentionally harmful conduct. Here the veil piercing emphasis will be whether this corporate group is appropriately seen as conducting one business enterprise. If so, as is typically the case, then that whole enterprise should bear the costs it generates, including paying for the injured tort claimants. This will also provide an incentive for the whole enterprise to exercise care to minimize the amount of tort injury it inflicts.

Such a reformulation of veil piercing appears to be a substantial doctrinal change, but it may in reality be less radical than first appearances indicate. Part II, above, shows that there is substantial case authority that reaches results consistent with this approach, even though these cases are nominally applying the traditional veil piercing law or the single factor variation. Indeed, as the contracts misrepresentation cases show, these cases have in fact been quite selective in their application of veil piercing conventional wisdom, overlooking undercapitalization, neglected corporate formalities, respect for subsidiary separateness, or substantial economic integration when necessary. These cases have been using the doctrine of traditional or single factor veil piercing, but stretching it to comfortably cover important contract policies. It is not a large rhetorical step to remove the cover and look directly to the contract policies for contract cases.

The idea that veil piercing should look to the policies of the underlying body of law implicated by the decision also finds unexpected support in various enterprise law doctrines embraced by many statutory and regulatory bodies of law. While veil piercing makes an occasional appearance here, these decisions are much more typically reasoned with reference to the public policy goals and objectives of the statutory regime.

Antitrust offers a useful example. One of its key goals is to prohibit combinations of economic actors for anticompetitive ends. Thus many antitrust offenses require a conspiracy between two or more economic actors, for it is the combination of their market power that creates the anticompetitive effect which is of such concern to antitrust law. Are separate corporate entities within the same corporate group capable of conspiring? The pure logic of corporate separateness would say yes—because parents, subsidiaries, and affiliates are separate corporations, they can conspire— and there was some older authority in accord. But in Copperweld Corp. v. Independence Tube Corp.,86 the Court looked to the policy of antitrust to reject this formalist view and hold that entities in the same corporate group were not capable of forming an antitrust conspiracy.

Antitrust is concerned with maintaining competitive markets, and there is no realistic prospect that corporate entities within the same enterprise will actually compete with each other. Thus, when they act together, they are not combining separate bits of market power, so their acting together does not make a conspiracy that violates antitrust policy. The Court continued:

[T]heir general corporate actions are guided or determined not by two separate corporate consciousnesses, but one . . . . . [A] parent and a wholly owned subsidiary always have a "unity of purpose or a common design." They share a common purpose whether or not the parent keeps a tight rein over the subsidiary; the parent may assert full control at any moment if the subsidiary fails to act in the parent's best interests.87

Seen through the lens of antitrust policy, the corporate group is one business enterprise so its constituent parts cannot increase their anticompetitive market power by combining with each other in a conspiracy.

A second illustration is bankruptcy law's doctrine of substantive consolidation as it is applied to corporate groups.88 When some entities of a group are in bankruptcy, two questions arise in the law of substantive consolidation. First, should the debts and assets of all the entities in bankruptcy be combined in one consolidated determination? Second, should the debts and assets of other entities in the corporate group also be included in the grand reckoning even though those entities are not in bankruptcy? In determining these questions under the law of substantive consolidation, courts have looked to basic bankruptcy policy. One of the specific factors emphasized is the extent to which creditors have relied on the corporate group for repayment, and the specific facts noted here are familiar to veil piercing law.89 Yet the cases also emphasize the potential for successful reorganization of the business.90 This is a well-established bankruptcy policy goal and it should certainly be a central part of the analysis. However, considering the chances of successful reorganization has no counterpart in traditional veil piercing law; it is bankruptcy policy. Such an enterprise approach, emphasizing bankruptcy policy for bankruptcy corporate groups cases, offers another illuminating example for corporate groups law generally.

While this emphasis on the underlying policy of the body of law at issue will often look to the corporate group as one enterprise with the result being a decision not to recognize the separate corporate entities making it up, this result is not invariably the case. Consider, for example, an enterprise policy view of parent company liability for subsidiary workplace injuries to employees. As discussed above, when a parent company gets involved in its subsidiary's workplace safety issues, it may incur direct tort liability of its own.91 While this is understandable as part of a judicial search for deeper pockets to respond to the needs of a particular claim in a particular case, it is questionable as broader employee safety policy.92 The potential for such liability might well discourage enterprise-wide employee safety efforts conducted and supervised by the parent company, particularly efforts that seek to go beyond minimal compliance with existing legal commands. By emphasizing the statutory objective of workplace safety, the decision about whether to limit parent company liability becomes better informed and more sophisticated, although also more complex.

V. CONCLUSION

When should a parent company be responsible for the obligations of its subsidiaries? The traditional approach treats the shareholding parent company like an individual non-manager investor and supplements the investor's limited liability with a second level of limited liability by insulating the parent company from liability for its subsidiaries as well. Thus, parent companies are not liable unless the rules for piercing the veil are satisfied. Yet the reasons for limiting individual investors' liability are largely inapplicable to parent companies because their relationship to their subsidiaries is so different from an investor's relationship to a particular corporation. Thus, the conventional reasons for limiting shareholder liability do not apply.

Because limited liability policy is different within corporate groups, traditional veil piercing and the other doctrines that articulate the outer boundaries of that limited liability will need to be different also. This Article argues that a substantially reformulated version of traditional veil piercing law for corporate groups cases has been developing, although without general recognition. This newer formulation considers the policies and principles of the underlying body of law—contract or tort are the examples discussed in this paper—in deciding whether to pierce the veil. Contracts policy should determine veil piercing in corporate groups contracts cases, and torts policy in torts cases. Abstract corporate law ideas of "separateness" or "wrongful conduct" are the heart of traditional veil piercing, but they simply ask the wrong questions for corporate groups cases.

Such an approach is not really very radical and has, in fact, indirectly developed substantial support in the existing law. Indeed, there is a group of traditional veil piercing contract cases that reach results consistent with this approach. Part II discussed the substantial authority in contracts cases supporting the idea that veil piercing is appropriate where it will give the parties the deal or the performance they bargained for, and that the veil should not be pierced where it is not needed to do so. Sometimes courts do this by simply ignoring part of the traditional doctrine, and sometimes by stretching the doctrine with largely formal determinations that its requirements are satisfied.93

Beyond these veil piercing cases, several statutory areas offer substantial statutory, case law and regulatory authority for the idea that the goals of the statutory area involved should determine whether parent companies should be liable, and these give little or no attention to traditional veil piercing law. This is enterprise law. In common understanding, it is a vastly different legal inquiry from the traditional veil piercing tests. However, it is not so different in substance; it also must decide when the whole enterprise should be responsible, because its formally separate parts are collectively conducting a single integrated enterprise under the parent's control, and when the law should look to separate entities. This enterprise law approach makes this decision by considering policies relevant to the impact of the decision in the areas of law at issue. Veil piercing in corporate groups should too.

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75 Thus these cases can be described as examples of single factor piercing based on the wrongful conduct. See 2 BLUMBERG ON CORPORATE GROUPS, supra note 1, §§ 69.04, 69.05.

76 811 P.2d 221, 221–22 (Wash. Ct. App. 1991). There was some evidence that the subsidiary’s assets had been manipulated, although the court made no specific determination. This is potentially troubling in determining that the case is consistent with good contracts policy. However, the particular facts of the case explain that the parent has a particularly strong policy of not disclosing either its or the subsidiary’s financial information. Id. at 222. Thus, in this extreme factual situation, the lessor can be understood to have run the risk of such manipulation under the terms of the contract.

77 There is general agreement in the academic literature that torts cases should be treated differently than contracts cases for veil piercing purposes, as will be further discussed below.

78 Where the misrepresentation was made to the tort claimant, the court will have to consider whether the tort claimant, in making the contract, was in fact bargaining for the larger and presumably more familiar parent company as the ultimate bearer of the risk of tortious behavior. If so, then contract policy should give it the bargain it made. However, if not, tort policies should determine whether piercing is appropriate.

79 W. PAGE KEETON ET AL., PROSSER AND KEETON ON THE LAW OF TORTS § 4 (5th ed. 1984).

80 Contracts and torts, discussed here, illustrate the more general point that corporate groups veil piercing analysis in all legal areas should look to the policies of the body of law at issue, whether it is contract or tort, procedure, bankruptcy, or many areas of statutory and regulatory law. Discussion of these diverse areas is beyond the scope of this Article; they are treated in BLUMBERG ON CORPORATE GROUPS, supra note 1.

81 See, e.g., Edwards Co. v. Monogram Indus., Inc., 730 F.2d 977, 981–82 (5th Cir. 1984) (en banc); Gentry v. Credit Plan Corp. of Houston, 528 S.W.2d 571, 573 (Tex. 1975); Gevurtz, supra note 1, at 858–59; Hansmann & Kraakman, supra note 3, at 1925; Mendelson, supra note 1, at 1233–34 & n.122; Thompson, supra note 7, at 631.

82 See generally Hansmann & Kraakman, supra note 4. In a variation on this idea, Bainbridge, supra note 1, at 523–26 advocates abolishing veil piercing in all cases combined with other routes to shareholder liability in tort cases. These include robust shareholder liability for any participation in the corporation’s tortious conduct, as well as newly enacted legislative exceptions to limited liability in particular industry settings.

83 See Thompson, supra note 22, at 1058. This excellent study considers only the decided cases and cannot allow for settled cases and the role of insurance as factors in the overall success rates of veil piercing claims. This might explain the difference between the empirical results and the common assumption.

84 As noted in the introduction, there are some parent-subsidiary relationships in which the parents are non-manager investors, rather than single enterprise corporate groups, but I argue that these are not proportionately significant. Consideration of these corporate groups is beyond the scope of this paper.

85 In this situation, it is important to emphasize that the deal a party made includes the specific provisions negotiated and documented, but it also includes contract law’s policy of good faith and fair dealing in performance and enforcement.

86 467 U.S. 752, 777 (1984).

87 Id. at 771–72.

88 See generally 2 BLUMBERG ON CORPORATE GROUPS, supra note 1, at ch. 88.

89 Id. § 88.06[A].

90 Id. § 88.06[B].

91 See supra notes 46–47 and accompanying text.

92 The application of various labor standards and other employee protection statutes to corporate groups is discussed in 3 BLUMBERG ON CORPORATE GROUPS, supra note 1, at ch. 105.

93 Development of this point in procedural law is beyond the scope of this Article. See generally 1 BLUMBERG ON CORPORATE GROUPS, supra note 1, at chs. 25–30.