Newly Posted Article - "Parent Corporation's Liability for Subsidiary's Prior Actions"
[April 4, 2008]
Martin I. Estner, Senior Counsel

In Scott v. NG US 1, Inc., a case decided on March 7, 2008, by the Massachusetts Supreme Judicial Court, concepts of corporate law, real estate law and environmental law met at a crossroads.

The case presents the businessperson with certain key points. They deal with acquiring a subsidiary, acquiring real estate, or acquiring a subsidiary that has owned or does own real estate and also with respect to maintaining separation between stockholders and corporations, between parents and subsidiaries, and between brother/sister entities. In a broader sense, they deal with shareholder liability for prior actions of the corporation.

FACTS:

The facts present a confusing history of corporate mergers, acquisitions, dispositions, combinations, and liquidations that by my count number fifteen separate such transactions.

From 1850 to 1890, Salem Gas Light Company owned certain property in Salem, Massachusetts and during that time caused a release of hazardous material on it. Salem Gas sold that property in 1890.

Through the various corporate transactions mentioned, in 1973 Salem Gas became part of Boston Gas, which now does business as Keyspan. Boston Gas is at present a subsidiary of the defendant, NG US 1, Inc., which is also known as National Grid.
In 2002, some 112 years after Salem Gas sold its property, the plaintiff, Wayne Scott, Trustee of 12 Woodbury Court Trust, acquired other nearby property for development. He found hazardous waste on his property. The court assumed the waste to have migrated from the former Salem Gas property.

ISSUE:

The issue was whether a corporation that acquired ownership of a subsidiary corporation after that subsidiary had caused a release of hazardous materials may be indirectly liable for the consequences of that release.

DISCUSSION:

Under Massachusetts laws, the owner or operator of property on which there is a release of hazardous material is liable for the damages. It does not matter whether the release was intentional, negligent, or accidental. It also does not matter whether the release occurred before the enactment of this statute.

Therefore, assuming a release did occur on Salem Gas’s property, it would be liable. The plaintiff for reasons not made clear was unsatisfied suing only Boston Gas, the successor to Salem Gas. It sought to include National Grid, the parent corporation of Boston Gas, as an operator and to impose liability on it for the release.

Ordinarily, shareholders of corporations are not personally liable for actions of the corporation. A parent corporation is merely the sole shareholder of a subsidiary corporation. A shareholder’s liability is limited to the value of his or her investment in the corporation. This is the concept known as limited liability. In certain instances, a plaintiff may try to impose liability on shareholders and is said to be seeking to “pierce the corporate veil."

It is rare that an attempt to pierce the corporate veil is successful. It will not succeed unless one of two tests is met.

The first test, which we may call the “Pervasive Control” test, asks whether there has been pervasive control of the subsidiary by the parent and whether that pervasive control results in some injury or fraud. Mere pervasive control will not suffice; there must also be injury resulting.

The second test we may call the “Confusing Intermingling” test, which is a little more difficult. It asks whether (a) there has been confusing intermingling of activities of parent and subsidiary entities that (b) are engaging in common enterprises with (c) substantial disregard of the entities’ separate nature or serious ambiguity about the manner and capacity in which each entity or its representatives may be acting.

DECISION:

The court decided that National Grid was not liable for the release by Salem Gas some 100 plus years earlier.

REASONING:

In essence, the court believed that the Pervasive Control test was not met. Even if National Grid had maintained pervasive control, it had no ownership interest in Salem Gas at the time of the release. Therefore, the pervasive control could not have led to this injury. It also believed that that the Confusing Intermingling test was not met. Even if there had been such confusing intermingling, it had not transpired at the time of the release of the hazardous material and had no bearing on it.
In effect, the Court has said that stockholders of a corporation will not be liable for a corporate wrong even if (a) the shareholders have exercised pervasive control, and there has been an injury, if either (b) the injury predates the pervasive control or (c) the injury is not the result of that control. They also will not be liable even if (d) there has been confusing intermingling of the entities, if (e) the events giving rise to the liability have no relationship to the confusing intermingling.
In the Scott case, the release occurred long before National Grid became parent of Salem Gas. Even had the release occurred while Salem Gas was a subsidiary of National Grid, it would not mean necessarily that National Grid would have been liable. We would still need to look at the two tests. First, did pervasive control result in the injury? Second, did existing confusing intermingling have any bearing on the injury? It is possible that both answers would be no. It is clear that the timing of a particular event by a subsidiary will bear strongly on whether a court will impose liability on a parent entity in meeting the pervasive control and the confusing intermingling tests.

KEY TAKEAWAYS:

So what does the businessperson take from this case? One point worth mentioning is that in many instances involving small, privately owned corporations, the corporations do not own real estate. Rather, the owners of the corporation, for both tax and liability reasons, will form another entity, usually a limited liability company or a realty trust, to take ownership of the real estate, and that entity then leases it to the corporation. The two entities would not be parent/subsidiary entities. At best, they would be brother/sister entities. We do not yet know whether the same tests would apply. There may be good reason to think that they would apply.

A second question involves the timing issue. Was the existence of a 100-year gap so extensive that the court just sensed that imposing liability would be unjust? Suppose it had occurred merely five years earlier, would that make a difference?

A third question related to the second, might ask what responsibility does an acquiring corporation have in its investigation of the subsidiary before acquisition if it might have known of the release (or other injury) had reasonable investigation been made? If it should have known, will a court hold it liable?

Certain important things for a businessperson to learn from the Scott decision are:

(a) This decision, despite the result under these facts, does not grant carte blanche to any parent entity to disregard the prior acts of a target subsidiary,

(b) To undertake a thorough investigation or due diligence examination before acquiring another entity,

(c) To maintain a bright line between stockholders and their corporation, between a parent and its subsidiary entity, and between a brother and its sister entity,

(d) To maintain all appropriate formalities of separation among these parties, and

(e) To scrupulously avoid confusing intermingling between or among these parties that might cause a third party to be unable to distinguish who is engaging in what activities.

CONCLUSION:

This case does not forge new law but clarifies existing law. Nevertheless, it does so in a way that may make it broader than initially meets the eye. To an extent, like many complicated cases, it is noteworthy for the questions it does not answer.
The author welcomes questions or comments.

Copyright Martin I. Estner 2008

DISCLAIMER: The content of this article is not legal advice. It is intended to provide general information to the public and is not legal advice of the author or his law firm or any of its attorneys. Any opinions expressed are the opinions of the author only and may not reflect the opinions of his firm or any other attorney. The author has tried to ensure the accuracy of the content, but laws do change. It cannot be guaranteed that all of the content is complete, accurate, or current. You should not act or refrain from acting on the basis of any aspect of this article without consulting an attorney licensed to practice in your jurisdiction.

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