Hepler Broom, LLC

Can Parent Companies be Held Liable for the Acts of Their Subsidiaries? The Theory of Expanded Liability for Parent Companies in Illinois

July 24, 2013

** By HeplerBroom Summer Associate Tiffany B. Wong

A. Direct Participant Liability Negligence Theory in Illinois

In Illinois, it is a bedrock principle of limited liability deeply ingrained in our economic and legal systems that a parent company is not liable for the acts of its subsidiary.  Liability for negligence arises when one person breaches a duty of care owed to another.  To establish a cause of action for negligence under the law, a plaintiff must establish four “elements”: (1) a duty of care, (2) a breach of that duty, (3) an injury caused by the breach, and (4) resulting damages.  In layman’s terms this means that persons injured by the negligent acts of their employer cannot state a negligence cause of action against their employer’s parent company.

However, in 2007 the Illinois Supreme Court set forth a very narrow exception to the bedrock principle of limited liability between a parent corporation and its subsidiary known as “direct participant liability.”  The Illinois Supreme Court was clear in Forsythe v. Clark USA, Inc., 864 N.E.2d 227, 237 (Ill. 2007) that direct participant liability gives rise to a duty “only in limited circumstances.”  Under this theory, a parent company is not necessarily immune from liability for a workplace accident that occurred at its subsidiary’s facility.  A parent company could be liable for the foreseeable injuries that arise if the nature of the relationship between parent and subsidiary companies establishes that the parent company directly participated in creating conditions that lead to the plaintiff’s injuries.

If corporate formalities are maintained, however, the bedrock principle of limited liability should still protect your corporation under a proper reading of Forsythe.

B. Seminal Case on Direct Participant Liability Negligence: Forsythe

In Forsythe, the employees of Clark Refining (the “Subsidiary”) were killed in a workplace fire and their widows sued the Subsidiary’s parent company, Clark USA (the “Parent”) under a direct participant theory of negligence.  The plaintiffs alleged that the Parent breached their duty to use reasonable care in imposing a business strategy on its subsidiary, and they knew or should have known that mandating a cost-cutting strategy would force their Subsidiary to have unqualified employees act as maintenance mechanics.  The plaintiff concluded that because the actions of the Parent created conditions which led to the fire, it directly participated in the wrongdoing, and therefore was liable.  The Parent responded that as a mere holding company it owed no duty to decedents because its subsidiary was solely responsible for its own daily operations.  The trial court granted the Parent’s motion for summary judgment and the appellate court reversed and remanded.

On appeal, the Illinois Supreme Court noted at the outset that the direct participant theory of tort liability has been adopted in other jurisdictions, but not previously addressed in Illinois.  The Court concluded that if a parent company directly participated in creating conditions that led to the injury, the parent company could be liable under the direct participant theory of liability.  The Court, after finding direct participant liability viable in Illinois, remanded the case back to the trial court to determine the issue of direct participant liability.  In order to establish a cause of action for direct liability against a parent corporation, a plaintiff must prove either:

  1. a parent corporation’s “specific direction or authorization” to its subsidiary to perform a negligent activity; or
  2. that the parent corporation “mandate[d] an overall course of action” and then “authorize[d] the manner in which specific activities contributing to that course of action are undertaken.”

Under either scenario, the “direction or authorization” at issue must lead to “foreseeable injuries.”

A parent corporation “specifically directs the actions of its subsidiary” when it uses its ownership interest to “command rather than merely cajole.”  Thus, a parent’s direct participation must supersede the discretion and interest of the subsidiary and create conditions leading to the activity complained of.  Furthermore, “articulation of general policies and procedure,” does not give rise to direct liability.

A plaintiff must establish that “the conduct complained of occurred while the officers/directors [at ] [issue] were acting in their capacity as officers/directors of the parent, rather than of the subsidiary.”  In other words, the plaintiff must overcome the presumption that “that directors are wearing their ‘subsidiary hats,’ rather than their ‘parent hats,’ when acting for the subsidiary.”  To overcome the presumption, the plaintiff must prove that the dual director or officer’s action was “plainly contrary to the interests of the subsidiary yet nonetheless advantageous to the parent.”

Moreover, the Court found that the mere fact that parent company and its subsidiary share the same directors and officers does not serve to expose the parent company to liability for its subsidiary’s acts.  Instead, the court must determine whether the officer or director was acting on behalf of the parent or subsidiary by asking the key question, whether subsidiaries were utilizing their own expertise.  A parent company’s “mere budgetary mismanagement alone” and “articulation of general policies and procedure,” does not give rise to direct liability.

C. Implications for Parent Companies Whose Subsidiaries Conduct Business in Illinois

In light of Forsythe, parent companies, especially those that share common management (directors or officers) with their subsidiaries or take highly involved roles in their subsidiaries’ budget strategies or management, should be mindful of the direct participant liability theory and note carefully the importance of observing technical corporate formality.  Parent companies involved in their subsidiary’s business should act with reasonable care.

Appropriate steps to avoid the appearance of directing a subsidiary include documenting the decision-making activities of subsidiary companies to ensure shared directors or officers do not create an impression that the parent company is mandating a course of conduct.  For example, shared directors and officers acting on behalf of the subsidiary should use the subsidiary’s letterhead and sign their communications (including emails) using their subsidiary titles.  Parent companies may also want to consider hiring a corporate attorney to review the companies’ practices and policies to assist in implementing specific procedures to help insulate parent companies from direct participant liability in the future.