Is the Parent Company Liable When an LLC Is Sued?

By Ari Mushell, J.D.

Is the Parent Company Liable When an LLC Is Sued?

By Ari Mushell, J.D.

The concept of limited liability provides the incentive for an entrepreneur to pursue their dreams by opening a business without the concern that a business misstep will leave them penniless. Some business entities automatically provide limited liability, but others don't protect their owners from having to surrender their personal assets if the business gets into trouble. In some cases, a business owns another business, and the lines are even blurrier.

Parent/Subsidiary Business Structure

To maximize limited liability protection, it's prudent to create a limited liability entity that is legally distinct from other entities. That is to say, it is wise to have separate limited liability entities for separate businesses to reduce exposure from one business to another. For instance, suppose you deal in real estate and are in the course of purchasing properties for investment. You plan on securing a mortgage for each property. If a single LLC is the owner of all your properties, and one property defaults on its mortgage, the mortgage lender can pursue payment from all properties owned by that LLC. If, however, each property is owned by a distinct LLC, the limited liability nature of each property shields it from becoming a target of a mortgage lender in the event of a default on one property.

On the other hand, if you operate a number of LLCs, it can burdensome to produce paperwork and other administrative requirements for each distinct LLC. To solve this issue, you can create a parent holding company that holds a stake in all the subsidiaries. This reduces much of the administrative burden and cost when managing a collection of entities.

Parent Liability

As mentioned, a parent entity is legally distinct from its subsidiaries. Sometimes, however, a parent can be liable for subsidiary mishap.If a parent and its subsidiary do not maintain proper independence from each other, their legal distinction blurs, and their liabilities become one. When one company acts as the ÔÇťalter ego" of another, the situation allows for a piercing of the corporate veil.

The facts and circumstances of each case determine whether the entities are truly separate. Common scenarios that can be red flags for alter egos include:

  • Single Business Enterprise: This occurs when the entities do not operate as distinct businesses, if both entities use the same business account, or if the subsidiary does business under the name of the parent.
  • Under Capitilization: A subsidiary that's under-funded from its inception can signal an alter ego. Courts may view this as a shell company created to absorb the parent's liabilities.
  • Fraudulent Transfers: A court may view a transfer as fraudulent when a subsidiary transfers an asset that is encumbered with liabilities to a parent. That asset would be considered an asset of the subsidiary and would not be shielded by the parent's limited liability status.

Direct Participant

In a tort or personal injury action, courts may impute a subsidiary's liability to a parent company if they acted as a direct participant by creating conditions leading to the accident. For example, suppose decision-makers of the parent entity decided to impose budget cuts on the subsidiary's factory. If employees, due to the budget cuts, are injured during the course of employment and it can be demonstrated that budget cuts created unsafe conditions, courts may allow the plaintiff employees to sue and recover from both the parent and subsidiary entities.

The theory allowing a plaintiff to pierce the corporate veil is that a parent should be held liable for creating the conditions that caused the injury. A parent/subsidiary corporate structure can be very beneficial. In general, the parent has no liability for the actions of the subsidiary. There are, however, exceptions to that rule.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.