Supreme Court Issues Major Decision Limiting Liability of Corporate Parents Under CERCLA

The United States Supreme Court has issued a major decision addressing the circumstances in which parent companies may be held liable for the environmental problems of their subsidiaries. The decision is of interest and importance to a broad spectrum of the business community.

Businesses operate on the normal rule that corporations are limited liability entities. If they are unable to pay their debts, then, absent some specific agreement to the contrary, their creditors are out of luck and cannot go to the stockholders demanding to be paid. This is a principle, in the words of the Supreme Court, "deeply ingrained in our economic and legal systems.'"

Real estate lenders often lend funds to special-purpose vehicles set up for the express purpose of ensuring that the borrower will not be subject to liabilities of unrelated entities. Similarly, securitization trusts are themselves special-purpose, bankruptcy-remote entities that depend on their freedom from liabilities of other entities. Holding companies and other entities owning the shares of other corporations conduct their financial affairs on the assumption that they will not be liable if companies they own face environmental problems.

Under environmental laws, however, especially the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA" or "Superfund"), the assumption that environmental liabilities stop with the corporate entity owning or operating a contaminated property has not always proven true. Lower court decisions left the law in a confused state that created uncertainty and risks for the business community.

In its June 8, 1998 ruling in United States v. Bestfoods, the Supreme Court resolved years of disagreement among the lower courts, some of which had stretched CERCLA to hold parent companies liable simply because they controlled the overall affairs of their subsidiaries or had a vague "authority to control" the subsidiaries' hazardous waste decisions. The Bestfoods case overrules these expansive theories and returns instead to the "bedrock principle" that "a parent corporation . . . is not liable for the acts of its subsidiaries." The Court said that "nothing in CERCLA purports to reject this bedrock principle, and against this venerable common-law backdrop, the congressional silence is audible." (Italics added.)

The Supreme Court adopted the general rule that a parent company can be liable for the acts of its subsidiary only when a basis exists for "piercing the veil" under traditional corporate law principles, or when the parent company actually "manage[s], direct[s], or conduct[s] operations specifically related to pollution, that is, operations having to do with the leakage or disposal of hazardous waste, or decisions about compliance with environmental regulations." Even active participation in the general affairs of the subsidiary will not make a parent company liable, unless a basis exists for piercing the corporate veil.

The Law Before Bestfoods

Before Bestfoods, there had been substantial differences among the lower courts as to the standards that should apply in determining whether a parent company, or an individual corporate officer, director, or shareholder, could be held liable under CERCLA. One source of the confusion is that there are two distinct ways such liability can be be established, and the courts have sometimes mixed these two theories.

"Indirect" (sometimes called "derivative") liability is more commonly known as "veil-piercing" liability. Under veil-piercing liability, a party that may not itself meet the statutory test for liability, but is a parent or shareholder of a company that on its own behalf has direct liability, may nonetheless be liable if the corporate veil of the subsidiary company is pierced. Veil-piercing liability is based, not on CERCLA itself, but rather on common law or state corporations statutes. Under veil-piercing liability, the parent shareholder is held derivatively liable for the underlying liabilities of another entity.

Under traditional common law principles, veil piercing is used only in rare circumstances when necessary to prevent manifest injustice. It can occur essentially in two circumstances. First, the corporate veil may be pierced where a parent uses a subsidiary to perpetuate a fraud, for instance by duping a creditor into thinking it is doing business with one company when it is in fact doing business with another. Second, in certain jurisdictions a veil may be pierced where a parent controls a subsidiary's business to such an extent that it constitutes complete domination; the subsidiary functions as a mere puppet or "alter ego" of the parent and normal corporate formalities separating the two companies are altogether ignored. Domination might occur, for instance, if the separate existence of the subsidiary was ignored to such an extent that the parent and subsidiary financial accounts were commingled and in general the parent and subsidiary operated as though they were in fact one corporation. Either of these theories is employed only in the most unusual of circumstances, such as where creditors are deliberately misled.

But some courts did not believe that traditional veil-piercing theory was adequate in the Superfund context. Some courts had held that "direct" liability under CERCLA could arise for a parent company, officer, director or individual shareholder that is deemed to "own or operate" a "facility" at which hazardous substances are disposed because of its control over the actual owner or operator. This liability is called "direct," because the party itself, by either "owning" or "operating" the facility, falls within the statutory liability provisions of CERCLA section 107(a).

Prior to Bestfoods, the courts were split on the showing required to hold parent companies liable under CERCLA. A number of courts had held that there was no basis in CERCLA for direct liability against parent companies and that traditional veil-piercing was the only way in which a related entity could be held liable. Other courts, however, adopted tests that expanded the risk of related party liability. Under one test, related entities could be liable if they exercised "actual control" over another corporation's hazardous waste disposal activities. Under another test adopted by a few courts, related entities could be held liable if they had merely the "capacity to control" the company's hazardous waste decisions. Under yet another test, related entities were argued to be held liable if they exercised actual control over a company's business, even if the related entity did not actually control matters relating to hazardous waste disposal or the environment. In general, the tests articulated by the courts were conflicting and confusing, and often glossed over the distinction between direct liability under CERCLA and derivative liability under traditional veil-piercing theory.

The theories of liability may sound abstract, but they have important, real-world implications. In most any parent-subsidiary relationship, the parent exercises considerable control over the subsidiary's business. A parent company probably does not control the day-to-day operation of its subsidiary's facility, but it is likely to own 100 percent of a subsidiary's stock; share the same (or at least many of the same) individual directors and officers; monitor the subsidiary's performance, supervise the subsidiary's finance and capital budget decisions; and articulate general policies and procedures for the subsidiary to follow. These are all accepted norms of parental ownership and oversight, and they are factors that by themselves would not result in veil piercing under the standards relied on in some of the leading courts of appeals rulings. Yet, they are key factors that some courts have used to find, along with other factors, that a parent "actually controlled" a subsidiary. Thus, the actual control standard would unfairly make a parent liable even where the parent did nothing to pollute the site and did nothing that would warrant veil piercing.

The Law Under Bestfoods

The Bestfoods decision has resolved many of these ambiguities and adopted a highly circumscribed rule governing direct and indirect liability of related parties under CERCLA. The Court asked "whether a parent corporation that actively participated in, and exercised control over the operations of a subsidiary may, without more, be held liable as an operator of a polluting facility owned or operated by the subsidiary," and answered: "no, unless the corporate veil may be pierced." The Court held that "when (but only when) the corporate veil may be pierced may a parent corporation be charged with derivative liability for its subsidiary's actions." (Italics added.)

The Court explained that there is no "CERCLA-specific rule of derivative liability that would banish traditional standards and expectations from the law of CERCLA liability. . . . [S]uch a rule does not arise from congressional silence, and CERCLA's silence is dispositive."

Having thrown out the loose "actual control" standard that had been articulated by numerous lower courts, the Court went on to specify those narrow circumstances in which a parent company could be deemed to have direct liability under Superfund as an "operator" within the meaning of the statute. The correct "operator" standard for direct liability, ruled the Supreme Court, is whether a parent controls its subsidiary's facility, not its overall business.

After rejecting the "actual control" standard focus on control of a subsidiary's business, the Court discussed the limited circumstances in which a parent could be viewed as operating a subsidiary's facility. The Court stated that an "operator" includes a party "who directs the workings of, manages, or conducts the affairs of a facility." Most importantly, the Court stated: "an operator must manage, direct, or conduct operations specifically related to pollution, that is operations having to do with the leakage or disposal of hazardous waste, or decisions about compliance with environmental regulations."

The Supreme Court listed three ways a parent could become an operator. First, a parent could be directly liable if its operates a facility in the stead of its subsidiary, or as a co-operator in a joint venture. Second, an individual employed as a dual officer or director for both parent and subsidiary might be held to have operated a facility while wearing his or her parent hat. The Court stressed that there is a presumption that dual officers/directors are in fact wearing their subsidiary hat when ostensibly acting for the subsidiary. The presumption "is strongest when the act is perfectly consistent with the norms of corporate behavior, but wanes as the distance from those accepted norms approaches the point of action . . . plainly contrary to the interests of the subsidiary yet nonetheless advantageous to the parent." Third, an individual working for the parent and not for the subsidiary might be held to have been managing or directing activities at the facility. Again, norms of corporate behavior are applied; activities consistent with the parent's investor status, such as monitoring the subsidiary's performance, supervising finance and budget decisions, and setting general policies and procedures for the subsidiary would not constitute operating its facility.

The Supreme Court's ruling should preserve some safe harbors for corporate parents that honor the traditional "bedrock" proscriptions against abusing the corporate relationships with their subsidiaries. The Court stated that limited liability of corporations is "the rule, not the exception."

The proper application of veil piercing was not one of the focuses of the Supreme Court's ruling, and the Court did not address issues about the precise circumstances in which the corporate veil may be pierced in the CERCLA context. For instance, the Court did not resolve differences among lower courts as to whether to apply individual state veil piercing standards, or a common federal standard (or, if there were a federal standard, what that federal standard should be). Some state standards rule out any consideration of veil piercing if there is no clear evidence of fraud or other outright abuse, while others weigh numerous factors that allow courts somewhat greater discretion to pierce, or refuse to pierce, to right an alleged injustice. The problem remains, as one commentator observed more than a decade ago, that traditional veil piercing occurs "freakishly," and like "lightning, it is rare, severe, and unprincipled." Nonetheless, veil piercing remains the truly unusual exception to the rule of limited liability.

The Bestfoods case is helpful to the extent that businesses now know, first, that they will not be held derivatively liable for the acts of their facilities absent grounds for veil piercing, and, second, the nature of the standard that applies in any court considering direct liability. Although the Court did not tell us whether it would apply exactly the same standard in cases considering the liability of individual directors, officers, or shareholders, it would seem logical that the Court's rulings would be instructive in that area as well. Structuring or re-structuring corporate families to prevent the needless assumption of CERCLA liability, while retaining functionality, and defending against CERCLA veil piercing litigation, remains an issue that must be considered by a wide variety of companies and their counsel.