Can You Hold a Parent Company Liable for the Lease Obligations of Its Corporate Subsidiary?
When tenants go out of business landlords pay the price. One way to cushion the financial blow is to go after the tenant’s parent corporation for the unpaid rents and other revenues owed under the lease. But without an express lease guaranty, holding a corporation liable for the debts of its subsidiaries is a tough thing to pull off. Recognition of corporations as distinct legal entities that are separate from their subsidiaries and affiliates is a fundamental and longstanding principle of U.S. law. By the same token, insulation from liability is far from absolute. Courts will hold corporations accountable for the debts of their subsidiaries if they believe companies are abusing the corporate form as a shield against liability for wrongful business conduct.
The name of this judicial remedy is piercing the corporate veil, and it may be available to landlords who get burned by corporations that deliberately use subsidiaries and affiliates to avoid financial obligations under a commercial lease. The theory: The subsidiary or affiliate that owes rent and other sums under the lease is actually the “alter ego” of the parent corporation. As a result, the parent is legally responsible for paying those debts. To get a court to pierce the corporate veil on the basis of the alter ego theory, a landlord must prove two things:
- There’s “unity interest and ownership” between the parent and subsidiary such that they really are alter egos of the same person or entity without separate existences; and
- Observing the corporate form would sanction a fraud, promote injustice, or lead to an inequitable result.
The following cases illustrate the factors courts consider in determining whether to invoke the alter ego doctrine to hold a tenant’s parent company liable for the lease obligations of its subsidiary.
Situation: Global Rescue LLC, a teleservices company based in New Hampshire, creates a wholly owned subsidiary named GR Direct LLC to manage its new network marketing business. GR Direct enters into a three-year lease in its own name for commercial property in Salt Lake City. A year later, Global Rescue cuts off funding to the subsidiary. As a result, GR Direct goes out of business, defaults on its lease, and abandons the premises. All of GR Direct’s remaining monetary and physical assets go to Global Rescue. The landlord sues Global Rescue for breach of lease and unpaid rent, claiming that it’s the alter ego of GR Direct. The jury rules in the landlord’s favor. Global Rescue contends that the verdict is wrong and asks the court to set it aside.
Ruling: The Utah appeals court grants what’s called JNOV, judgment notwithstanding the verdict, to Global Rescue.
Explanation: When a trial is held and a jury that has heard all of the evidence renders a decision, courts are generally reluctant to overturn the verdict. But the court felt that JNOV was warranted in this case because there was insufficient evidence for the jury to find that GR Rescue and GR Direct were alter egos formed to carry out a fraudulent purpose. The landlord might have won had the case been decided merely on the first prong of the test to the extent that the two companies had the requisite unity in interest and ownership.
But the fact that Global Rescue and GR Direct were alter egos wasn’t enough, the court continued. To justify piercing the corporate veil, the court must also feel as if an injustice is being done. While the lower court found that the relationship between the two companies might “have been misleading under certain circumstances,” it ultimately concluded that it wasn’t fraud. Even so, the court felt the need to pierce the corporate veil and hold Global Rescue liable for its subsidiary lease obligations to protect the landlord from what would otherwise have been an unfair result.
This decision was an abuse of discretion, the appeals court found, especially since the lower court didn’t explain exactly why it would have been unfair to the landlord to treat Global Rescue and GR Direct as separate corporate entities [Commercial Club Bldg. LLC v. Global Rescue LLC, 2023 UT App 37, 2023 Utah App. LEXIS 35, 2023 WL 2922556].
Situation: American Supply Company, Inc., wants to lease the second floor of a Boston office building. In furtherance of its general policy of avoiding long-term commitments, American has its wholly owned and nearly penniless subsidiary, Kelmerchanic Realty Corporation (KRC) enter into the lease agreement. American pays the rent to KRC, which then remits the money to the landlord. Seven years and one extension later, American moves its operations to another space and stops paying rent to KRC, which in turn stops paying rent to the landlord. The landlord sues American for the money. American denies responsibility for the debts of its subsidiary, but the landlord claims the companies are alter egos and asks the court to pierce the corporate veil. The jury sides with the landlord, and American moves for JNOV.
Ruling: The Appeals Court of Massachusetts denies the motion and upholds the verdict.
Explanation: There was ample evidence to support the jury’s finding that KRC wasn’t a separate company but just an extension of American:
- The two corporations had the same officers and directors;
- KRC had no employees, files, or offices of its own;
- KRC never made any distributions or declared any dividends and its sole source of income was American;
However, the big difference between this case and Global Rescue was the evidence suggesting that American deliberately abused the corporate form to carry out wrongdoing by setting up KRC to do its dirty work:
- American coveted the prime office space, but had KRC sign the lease because it was allergic to long-term commitment;
- As part of the plan, American made misleading statements to the landlord about KRC’s financial assets and net worth, which the landlord believed to its ultimate detriment; and
- American stopped financing KRC’s rent payments once it decided to move out of the space [Gopen v. American Supply Co., Inc., 10 Mass. App. Ct. 342 (1980), 407 N.E.2d 1255].
A Lease Guaranty Is a Lot Better than an Alter Ego Lawsuit
Alter ego and piercing the corporate veil are remedies of last resort. They come into play only in rare circumstances where it’s clear that you’ve been abused by unscrupulous corporations that use their subsidiaries as pawns to deceive and evade lease obligations. Although it’s nice to know that the remedies are there in case you need them, your strategy should be to ensure that you never do need them.
At a minimum, be sure to carry out thorough due diligence on all of your prospective tenants with regard to their financial assets and corporate ownership. But the best way to avoid getting burned by shell games when leasing to corporate subsidiaries and affiliates is to get an express lease guaranty directly from the parent or controlling company making the latter financially responsible for the tenant’s lease obligations. That lease guaranty should be carefully drafted by an experienced attorney with knowledge of guaranty mechanics and defenses that corporate guarantors should be required to waive.
The 6 Key Factors of Alter Ego Liability
It’s up to the court to decide whether to invoke the alter ego theory to pierce the corporate veil and hold a corporation liable for the lease obligations of its subsidiary or affiliate. Although the factors that courts use to make this determination may vary, they typically include:
- Adequate Capitalization: Whether the subsidiary was adequately capitalized when formed and solvent enough to pay its anticipated debts when signing the lease—undercapitalization and insolvency are red flags of an alter ego relationship.
- Independent Officers: While officers may overlap, the key question is whether the subsidiary’s officers have the power to run the business independently, including with regard to hiring and firing of employees.
- Observation of Corporate Formalities: Whether the subsidiary holds duly noticed director and shareholder meetings, keeps minutes and other books and records, issues stock, has bylaws, files annual reports, pays franchise taxes, maintains a registered agent and registered office, and complies with corporations law governance requirements.
- Separate Assets: Whether the parent’s and subsidiary’s assets are kept separate—commingling of assets is evidence of an alter ego relationship.
- Parent’s Representations: Whether the parent holds the subsidiary out as being a part of it, rather than a separate corporation.
- Separate Identity: Whether the subsidiary has its own office address, telephone number, email address, and employees.