A recent case in New York serves as an important reminder to follow corporate formalities to protect against “piercing of the corporate veil.” In RPH Hotels 51st S. Owner, LLC v. Icon Parking Holdings, LLC, the defendant holding company was found liable for the debts of three wholly owned subsidiaries. Applying Delaware law, the Court rather summarily rejected the holding company’s contention it served as a “management company” for each subsidiary that leased commercial property to operate parking garages.
The holding company engaged in classic acts and failures to act that led to the Court ruling against it. In each case, the acts were avoidable with minimum foresight:
- No management agreements existed between the holding company and each of the subsidiaries.
Contracts—even at below market terms—prove the entities intended to operate at arm’s length. Hiring an attorney to draft one agreement for use for each subsidiary would have been a strong defense.
- The holding company swept the funds from each subsidiary’s bank account daily. This rendered each subsidiary effectively insolvent, which resulted in the holding company directly making payroll and paying expenses for two of the subsidiaries out of its own account.
The holding company could have left minimum funds in the subsidiaries’ accounts to make payroll that the holding company was making any way. If not, then the holding company could have offered each subsidiary a revolving line of credit to show the entities were not interchangeable. Any payments by the subsidiaries against their lines of credit could have legitimated the separate existence of the entities.
- The entities did not file separate tax returns. Admitting to the IRS that the holding company and the three subsidiaries are effectively one company makes it easy for a state court to reach the same conclusion.
Presumably, each subsidiary had its own FEIN. Whether the holding company did not want to pay any additional amounts to its accountants or did not want to be inconvenienced, this decision was a glaring admission against the argument raised in court.
- Each subsidiary did not procure its own insurance policy.
Holding companies should work with their insurance brokers to ensure each company has its own insurance policy even if they are all combined into one master policy. The subsidiary should then pay or borrow to pay for its insurance.
Following these formalities also provides insurance against liability spreading to all the entities through the holding company. While following these rules may add time and inconvenience, they are necessary to avoid legal and, therefore, financial catastrophe.
David Seidman is the principal and founder of Seidman Law Group, LLC. He serves as outside general counsel for companies, which requires him to consider a diverse range of corporate, dispute resolution and avoidance, contract drafting and negotiation, real estate, and other issues.
He can be reached at david@seidmanlawgroup.com or 312-399-7390. This blog post is not legal advice. Please consult an experienced attorney to assist with your legal issues.
