When a construction project in Texas, for example, has problems causing stakeholders, such as general contractors, making a successful claim resulting in a recovery of damages can be difficult. Part of this difficulty is simply the political climate, where most Texans seem to cast a jaundiced eye on anyone involved in a lawsuit who is the plaintiff. Another part of this difficulty, which this article will focus on, is the increasing sophistication of developers and owners, as well as their use of laws regarding corporations, to insulate their companies and assets from any recovery.
The most common use of the corporate laws to shield a company from risk in construction is the use of special purpose entities (SPE). An SPE is an entity, like an LLC, that is set up by a parent company to do one thing, which is to own a single asset such as a building under construction. Generally speaking, there is nothing wrong with such a scheme, in fact, it is why the corporate laws are structured the way they are. Circumstances do arise where the use of SPEs can be improper and can result in damages to stakeholders on a construction project, especially during a construction dispute when the claimant is told by an SPE that it is “judgment proof,” meaning that it has no assets to recover.
While breaking through to the parent company where there may be assets is difficult, it is not impossible. Breaking through to the parent company to collect assets can be done when a claimant can prove that the parent company is the “alter ego” of the SPE, and if the proof is strong enough a court may allow a claimant to “pierce the corporate veil” and collect against the parent company. The factors below are considered when a claimant seeks to pierce the corporate veil of a parent company are discussed.
Under the alter ego doctrine, a corporation may be bound by an agreement entered into by its subsidiary regardless of the agreement’s structure or the subsidiary’s attempt to bind itself alone to the terms, when their conduct demonstrates lack of separateness. This is due to the doctrine’s strong link to equity. In other words, alter ego applies when there is such unity between the entities so that the separateness of the corporations has ceased and holding only the subsidiary liable would result in injustice.
Courts must examine all relevant facts and circumstances to determine whether the parent and subsidiary should be considered separate or joined. Factors to consider include:
- whether distinct and adequately capitalized financial units are incorporated and maintained;
- whether daily operations of the corporations are separate;
- whether formal barriers between the management of the entities are erected, with each functioning in its own best interest;
- whether the companies filed consolidated tax returns or financial statements;
- whether operating capital is financed by the parent or borrowed from other sources;
- whether the subsidiary’s stock is owned by the parent;
- whether the companies share common officers and directors;
- the extent to which separate books and accounts are kept;
- whether the companies have common departments of businesses;
- whether the companies have separate meetings of shareholders and directors;
- whether an officer or director of one corporation is permitted to determine the policies of the other;
- whether those with whom the corporation comes into contact are apprised of their separate identity;
- the extent to which contracts between the parent and subsidiary favor one over the other;
- the parent pays salaries and other expenses of subsidiary; and
- whether the alleged dominator deals with the dominated corporation at arm’s length.
Not all of these factors need be present or considered when a claimant seeks to pierce the corporate veil.
Alter ego determinations are highly fact based and require considering the totality of the circumstances in which the instrumentality functions. The existence of an alter ego relationship is determined by considering all relevant facts and circumstances, utilizing the above referenced factors which have been articulated by the courts. When making a claim against an SPE, attention to a myriad of details is important. Consider whether the SPE has any employees, and if not, who is paying for the people acting on its behalf. Is there discipline in terms of business cards, email addresses and the like, clearly identifying the parent and subsidiary as separate entities? As noted above, this is a fact intensive analysis, but when making a claim, it is important to realize that it is possible to reach a parent company’s assets in order to satisfy a judgment under the right circumstances, and do not accept that a subsidiary company’s assertions that it is insolvent is automatically the end of a claim.
