Growing and expanding your business inherently means increased exposure to liability. As you grow and scale your business into a larger and more complex operation, it is critical to adapt the corporate structure to maximize profits and limit the exposure to your existing infrastructure. Thankfully, there are organizational strategies that companies can use to help shield themselves from liability. This article discusses how subsidiaries can be beneficial in achieving your expansion goals, the potential pitfalls of this strategy, and some best practices to consider.
A subsidiary is a company with voting stock that is more than 50% controlled by another company. Subsidiaries are created to serve several business needs ranging from corporate structuring, development of new products and research, regulatory compliance, and other strategic efficiencies. The "parent" LLC or corporation of a subsidiary is a separate entity that controls the other, smaller ventures by retaining (or obtaining via acquisition/merger) a majority ownership percentage or voting rights. For liability purposes, as companies expand and offer more diverse products or services, the company structure should adapt to protect commercial assets.
To be clear, both the parent and the subsidiary are recognized as separate legal entities and independent of one another. The parent organizes the subsidiary's management structure and company bylaws. In business law, the corporate "veil" protects the parent company from being liable for the acts of a subsidiary. If the corporate structure is respected by the courts, the companies judged separately and the parent likely absolved from liability. However, under North Carolina's alter ego or mere instrumentality doctrines, the court may "pierce" the corporate veil of the parent if it finds that the companies were indeed acting as one corporation, and require the parent to satisfy any judgements won against the subsidiary.
The courts decision whether to pierce the veil is determined by considering several factors including the level of control exerted by the parent; i.e., whether the parent controlled the conduct of the subsidiary to such extent that it had no separate mind or existence of its own. This is commonly found when one company dominates the finances and policy making decisions of the other. If the subsidiary is inadequately funded or underinsured, this likely would indicate to the court that significant control is being exerted by the parent. Other important factors include whether the parent commingles funds in a bank account with the subsidiary, shares insurance contracts, or otherwise markets the companies as one entity.
There is one, almost sure-fire way to avoid parent liability: INDEPENDENCE! Although the parent/subsidiary relationship exists through ownership, it is crucial that both entities establish guidelines and procedures to prevent shareholders and managers from treating the companies as one. The parent should file separately with the North Carolina Secretary of State, maintain separate bank accounts, report taxes and financials separately, and allow the subsidiary to operate independently from the parent. For sole-member LLCs and corporations with few shareholders, this is a cumbersome but necessary task. However, by establishing a system that maintains the corporate structure, a parent company can enjoy the benefits of the subsidiary while shielding itself from liability.
Creating the right corporate structure for your business is an investment in your future. I highly recommend consulting with an attorney to sort through the complexities. If you are considering reorganizing or establishing a subsidiary LLC or corporation, let’s meet and discuss the best options for your business. Please visit www.craineylaw.com or call the Law Office of Cedric Rainey to schedule an initial consultation.
[This blog does not offer legal advice. If you need legal advice, contact the Law Offices of Cedric Rainey to speak with a licensed attorney.]