Legal Significance of the Corporate Structure
When conducting legal risk management audits, it is important for in house counsel as well as managers to consider the topic of corporate structure. For companies with subsidiaries it is increasingly important to review the corporate structure in place to determine whether or not the parent is shielded from liability. One of the major features of a corporate organization in the United States is that it insulates shareholders from personal liability for the debts of the corporation. Therefore, under normal conditions, a corporate parent will not be held liable for the obligations of its subsidiary. The court will not impose liability upon a parent for the obligations of its subsidiary in the absence of compelling legal reasons. However, under certain circumstances courts will hold the parent or stockholders of the company liable. It will, in other words, “pierce the corporate veil” and go past the subsidiary and hold the parent liable. Or in absence or a parent-subsidiary relationship, the court could hold the shareholders themselves liable for corporate debts. The major legal doctrine allowing the courts to do this are set forth below.
If a company is being used by its shareholders as a vehicle to perpetuate a crime or if a subsidiary is being used by the parent as a vehicle to perpetuate a fraud or crime.
If there is such a close relationship between the parent and the subsidiary that the former may be said to be the “alter ego” of the latter.
Though fraud is usually not a major concern of conglomerates, the alter ego doctrine can be. Courts will sometimes treat a wholly owned subsidiary as an instrumentality of the parent, hence alter ego if the parent fails to respect corporate formalities necessary for the proper formation and function of a subsidiary.
Therefore, if the parent exerts too much control over a subsidiary, and the subsidiary does not follow corporate formalities, an alter ego situation can exist. Or is a shareholder exerts too much influence over a company, an alter ego situation can exist.
To determine if an alter ego situation exists, courts will look at a number of factors indicating control, such as:
A court may be inclined to invoke the alter ego doctrine if it finds a subsidiary disregards minimum corporate formalities.
Specifically, corporations in the United States are required to hold annual stockholder meetings, elect officers, annually file a franchise tax return, maintain separate corporate minute books, and maintain separate accounting records. Failure to follow these processes can result in a court holding that the subsidiary is merely the alter ego of the parent.
Remember, when considering legal risk management isues for next year,it is important to confirm you are following all applicable corporate law regulations especially as it concerns corporate structure. If you are treating the corporation as an alter ego,or if the corporate parent is not following corporate formalites when it comes to subsidiares, it is possible you or the corporate parent will lose the right to be shielded from corporate debts and liabilites even though you are just a stockholder. While thinking about next year, make certain the parent corporation is following all corporate formalities. How do you do this?
To avoid this, the parent company or holding company needs to do the following:
Sometimes, those the parent company gets sloppy in adhering to corporate formalities that are legally required causing a potential alter ego issue. For those managing companies it is essential to maintain all minimum corporate formalities and comply with the general corporate requirements in the jurisdiction where the company is located. Remember, the corporate structure is just as important as general day to day corporate processes and procedures.