By Kevin Scura, ACLR Featured Blogger
Different areas of the law treat the relationship between a corporation and its wholly owned subsidiary differently. Corporate law (while varying from state to state) will generally treat the two entities separately, except under specific circumstances governed by the doctrine of “piercing the corporate veil.”[i] In interpreting the Sherman Act’s prohibition in collusive agreements, however, a corporation and its subsidiary are treated as a single entity.[ii] Thus, while one area of law presumes a corporation and its wholly owned subsidiary are distinct, another invariably treats them as inseparable.
Consider corporation A and its wholly owned subsidiary B. If a plaintiff sues B (for breach of contract or in tort) and wins the suit, but B has insufficient assets to satisfy the judgment, courts will generally not let plaintiffs collect from A, instead presuming that A and B are separate entities, and A is not responsible for B’s conduct.[iii] If the government, however, prosecutes A and B for conspiring in violation of the antitrust laws the suit will be dismissed because courts presume that the two entities act together for antitrust purposes.[iv]
II. Corporate Common Law Treatment
Whether a corporation and its subsidiary are treated separately or as a single entity is governed by a doctrine called “piercing the corporate veil.”[v] Courts generally treat a corporation and its wholly owned subsidiary as separate entities.[vi] The guiding principle is that of limited liability. The corporate form exists, at least in part, to connect capital to labor and innovation, thereby encouraging people to invest in potentially risky business ventures by allowing them to limit their liability.[vii] Stockholders in a corporation cannot lose more than their initial investment.[viii]
This state of affairs reflects a policy judgment. State legislatures and courts answering corporate law questions must weigh the interests of plaintiffs who are owed contract or tort damages by a failing corporation against the increased economic value created by incentivizing riskier business ventures through limiting liability.
Courts generally pierce the corporate veil for a limited set of reasons.[ix] First among them is the failure to observe the formalities of the corporate form.[x] A corporation and its wholly owned subsidiary will be treated as one, and the parent will be liable for the subsidiaries debts, when the subsidiary does not function as a separate corporation, but instead as an arm of the parent corporation.[xi] Courts will find a failure to observe the corporate form where there is a large amount of crossover between the officers and directors of the two corporations, subsidiary meetings are held in parent corporation facilities or not at all, and the parent corporation raiding the subsidiary’s assets for the parent corporation’s purposes.[xii]
Another of those reasons is an undercapitalization of the subsidiary.[xiii] Undercapitalization is found where the facts suggest that the parent corporation owning the subsidiary deliberately kept the amount of assets in the subsidiary low.[xiv]
Thus, corporate law treats a parent corporation and its subsidiary as two separate entities, unless those corporations undertake specific conduct that indicates otherwise.
III. Criminal Antitrust Treatment
Antitrust law, in contrast, treats a corporation and its wholly owned subsidiary as a single entity.[xv]Section one of the Sherman Act prohibits “Every contract, combination . . . or conspiracy, in restraint of trade or commerce.”[xvi] Agreements between a parent corporation and its subsidiary, however, are exempt from the Sherman Act’s prohibition.[xvii]
In Copperwood Corp. v. Independence Tube Corp.,[xviii] the Supreme Court decided that a parent corporation and its wholly owned subsidiary were incapable of conspiring for Sherman Act purposes.[xix] The case actually overruled several prior cases rejecting defenses predicated on common ownership.[xx] The shift had started in Sunkist Growers, Inc. v. Winckler & Smith Citrus Products Co.,[xxi] in which the Court stated that imposing liability on the basis of the defendant’s separate incorporation “would be to impose grave legal consequences upon organizational distinctions that are of de minimis meaning and effect.”[xxii]
The Supreme Court in Copperwood outlined its reasons for treating a corporation and its subsidiary as a single entity.[xxiii] It observed that a parent corporation and its subsidiary are both ultimately subject to a single corporate consciousness.[xxiv] That resulting unity of purpose – maximizing profits for the parent corporation – renders the two entities incapable of not cooperating.[xxv]
The Court reasoned that corporations are free to organize their subunits either as unincorporated divisions or incorporated subsidiaries.[xxvi] It did not see a compelling reason to punish the corporations for that choice in antitrust law, not wanting to deprive consumers of the benefits a separately incorporated subsidiary can provide.[xxvii]
Cogent considerations buttress the policies of both antitrust and corporate law. Corporate law’s position encourages entrepreneurship and innovation. Antitrust acknowledges economic realities and refuses to punish corporations for simply obeying their own profit-maximizing interests. The positions, however, are inconsistent.
Perhaps most jarring are the different assumptions made in different areas of the law. Antitrust presumes that parent corporation and its subsidiary are ultimately subject to a single decision maker. Corporate law presumes (indeed requires) that the management of the two be different. Antitrust presumes that the two corporations have a unity of purpose. Corporate law presumes separate purposes, and will pierce the corporate veil when the parent exploits the subsidiary for its own gain.
The current situation is perfect for corporations. It allows corporations to limit their liabilities in their subsidiaries while simultaneously shielding them from antitrust prosecution. The only drawbacks for the corporations are the potentially inefficient measures that have to be taken to maintain adequate legal separation between the parent and the subsidiary. Consumers, on the other hand receive only one advantage: the improved economy from encouraged innovation. Consumers cannot recover from corporate parents for the violations of their subsidiaries, and do not receive the protection of antitrust laws for price fixing between parents and subsidiaries.