Greenberg Traurig Alert

The Liability of Parent Companies Under CERCLA: United States v. Bestfoods

August 1998
By Peter M. Gillon, Greenberg Traurig, Washington, D.C. Office

  View or download the PDF version of this Alert here.

In the explosion of superfund litigation over the past eighteen years, an unfortunate casualty has been the time-honored doctrine of the limited liability of parent corporations. The common perception within the corporate boardroom, well-justified by years of conflicting appeals court decisions, has been that parent corporations and individual directors and officers may be subjected to liability under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) merely because of their exercise of managerial control over a company that has polluted the environment--even when they had no involvement in the polluting activity.

Naturally, many companies have taken steps to insulate themselves from potential liability, avoiding involvement in their subsidiaries' activities and creating complex corporate structures to isolate environmental exposures at the subsidiary level. These are hardly the incentives the superfund law was designed to create. Without doubt, the need for legal clarity in this area has been great.

The Supreme Court's recent decision in United States v. Bestfoods, 118 S.Ct. 1876 (1998), represents a valiant, although not altogether successful, attempt to provide this clarity. This Alert examines Bestfoods and its implications for corporate management, concluding that the decision fails to provide sufficient guidance to the corporate community. In what is plainly intended to be a return to the rule of respect for the corporate form, the U.S. Supreme Court held June 25th that the standard business practices used by a parent company to monitor and maintain control over its subsidiaries, such as management of the subsidiary's finances, expenditures, and personnel, and the setting of policies and procedures, will not lead to direct "operator" liability under Section 107(a) of the Comprehensive Environmental Response, Compensation, and Liability Act.¹ The Court likewise held that, under most circumstances, a parent corporation's common practice of placing directors and officers on the management team of the subsidiary will not create CERCLA liability. The entire decision was premised on the legal distinction between the liability imposed directly on a parent company when the parent "operates" the "facility" that caused contamination, and the liability imposed indirectly, or derivatively, on the parent for the subsidiary's actions when the corporate veil has been pierced.²

The "Bestfoods" Decision

The Bestfoods case stems from the Environmental Protection Agency's (EPA) action to recover response costs incurred at a Michigan site under CERCLA Section 107(a)(2). Section 107(a)(2) imposes liability on "any person who at the time of disposal of any hazardous substance owned or operated any facility." The EPA is seeking to recover its costs from CPC International Inc., parent corporation of the now defunct Ott Chemical under CPC's ownership.

After a trial on liability issues, the district court found CPC liable as a former operator of the site.³ The trial court emphasized several facts as probative: that CPC selected Ott's board of directors and placed CPC officials in its executive ranks, that CPC played an active role in day-to-day management, and that one official "played a significant role in shaping Ott's environmental compliance policy."⁴ The U.S. Court of Appeals for the Sixth Circuit, in its first decision in the case, upheld the trial court.⁵ Sitting en banc, however, the court reversed itself and the district court.⁶ Striking out on a path untrodden by the other courts of appeal, the en banc court held that a parent company may not be held liable under CERCLA as a former operator unless there is a basis to pierce the corporate veil of the parent. ⁷ In that way, the appeals court superimposed the requirement of veil-piercing on top of the statutory test for "operator" liability. CPC cannot be held liable for controlling the actions of its subsidiary, the Sixth Circuit held, because the parent and subsidiary corporations "maintained separate personalities and the parent[] did not utilize the subsidiary corporate form to perpetrate fraud or subvert justice"--standard tests under the traditional veil-piercing doctrine. Bestfoods, 118 S. Ct. 1876, 1884.

The Supreme Court (per Justice David Souter) rejected the Sixth Circuit's analysis, but declined to rule on the question of liability, remanding for further fact-finding in light of the Court's pronouncements on corporate liability.

"Bestfoods" Validates Two Modes of Liability: Derivative and Direct

The touchstone of the Court's decision in Bestfoods is the distinction between liability imposed on a parent company directly as the owner or operator of a facility, and the liability imposed on a parent company indirectly, or derivatively, when there is a basis to pierce the corporate veil. As the opinion makes clear, derivative liability is concerned with the parent company's relationship with the subsidiary entity and whether the parent has abused the corporate form to commit fraud, whereas direct CERCLA operator liability is concerned with the parent company's operation of the physical facility that caused the site contamination.⁸ In fact, as the Court notes, there are circumstances in which a parent may have observed the corporate formalities sufficiently to escape derivative liability on a veil-piercing theory, but may nevertheless be liable because the parent controlled the machinery, tank or other facility that caused the contamination. Id at 1886, n. 12.

Drawing on this legal distinction, the Court applied a literal reading of CERCLA operator liability as requiring proof that the parent was involved in the "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." Id. at 1886. As the Court put it, "[t]he question is not whether the parent operates the subsidiary, but rather whether it operates the facility, and that operation is evidenced by participation in the activities of the facility, not the subsidiary." Id. at 1887 (citations omitted).

The Court thus rejected the ruling of five circuits which emphasized the parent’s control over the subsidiary’s business affairs generally. ⁹ The correct analysis is not whether the parent controlled the sub’s general business affairs, but whether it controlled the polluting facility. Id. The Court remanded for analysis of "the relationship between CPC [the parent] and the Muskegon facility itself." Id. at 1887.

"Bestfoods" Approves Parent Officer Involvement

By itself, the distinction between derivative liability and direct CERCLA liability would be of primarily academic interest, but Justice Souter uses the distinction as a foundation for laying out the factors relevant to determining whether a parent company or shareholder is a CERCLA operator.

Focusing on the relationship between the parent and the polluting facility, the Court announced this general test for operator liability: "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." Id.

Applying this test, the Court dismissed as irrelevant a factor emphasized by the district court: that the parent company placed officers and directors in management positions in the subsidiary where they "made major policy decisions and conducted day-to-day operations at the facility." Id. at 1888. Interlocking directorates and involvement by a parent company's management may be "entirely appropriate" and courts generally presume that such directors and officers are acting on behalf of the subsidiary, not the parent, the Court said. Id. To overcome this presumption, "[t]he government would have to show that ... the officers and directors were acting in their capacities as [parent company] officers and directors, and not as [subsidiary] officers and directors" when they made policy decisions and supervised activities at the facility. Id.

The Court thus adopted a subjective test for determining whether the actions of a parent company's officer constitute parent company operation: The question is whether the officer was wearing his "parent hat" or his "subsidiary hat." Recognizing the difficulty trial courts will have with such a determination, the Court offered that the presumption that the officer is acting on behalf of the subsidiary 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 by a dual officer plainly contrary to the interests of the subsidiary yet nonetheless advantageous to the parent." Id. at 1889, n. 13. Put another way, if the dual officer acted consistent with the interest of the subsidiary, he is presumably acting on behalf of the subsidiary, and therefore his actions will not be questioned. Here the Court appears to be utilizing factors normally used in the veil-piercing analysis: i.e., whether the parent, through the dual officer, is using the subsidiary as an instrumentality or tool for the parent's purposes. Thus, on remand, the district court will presumably be required to examine whether the parent observed corporate formalities, and whether the dual officers somehow provided benefit to the parent greater than that provided to the subsidiary.

Court's Failure to Draw Clear Lines On Meaning of "Operating"

Although Bestfoods is chock full of verbiage on the meaning of "operation" that will no doubt be seized upon by future litigants, ultimately the Court fails to draw clear lines. A major theme of the decision is the Court's emphasis on who controlled the polluting facility. Id. at 1886. As the Court notes, CERCLA Section 107(a)(2) holds directly liable anyone who operated a facility. In numerous places the Court states that a parent may become the facility operator only if the parent, through its officers, directors, agents, and employees, managed or directed the facility operations that caused the pollution. Id. at 1887. If the Court had adopted this test fully, the Court would have created a helpful, bright line test for determining who is an "operator."

The Court declined to go that far, however. By way of caution, the Court stated that "operation of a facility" means "something more than mere mechanical activation of pumps and valves, and must be read to contemplate 'operation' as including the exercise of direction over the facility's activities." Id. at 1889. Put another way, the government need not prove that the parent's employee, acting on behalf of the parent, actually turned the valve that caused the release giving rise to the government's claim. Rather, it is sufficient that the individual directed another person to do so.¹⁰

Potential Direct Liability for Acts Of Parent's Environmental Director

Having concluded that CERCLA operator liability can result from the direction given by the parent to its subsidiary, the Court raised the possibility that the parent could be found to be an operator of the facility based upon the actions of one who is strictly an employee or agent (and not an officer) of the parent company. Id. at 1889. As in the case of dual officers and directors, the Court held that to overcome the presumption that the employee or agent is acting consistent with the legitimate interest and role of the parent, "the critical question is whether, in degree and detail, actions directed to the facility by an agent of the parent alone are eccentric under accepted norms of parental oversight of a subsidiary's facility." Id. The Court noted that because the district court found that the environmental affairs director of CPC International (the parent) had played a "conspicuous part" in dealing with the facility giving rise to the contamination at the subsidiary's site, there was enough to raise an issue for further findings by the trial court on whether CPC operated the subsidiary through the environmental affairs director. Id. at 1889-1890. Accordingly, the Court remanded the case for reevaluation of the director's role in light of the Court's ruling. Id. at 1890.

This portion of the decision is particularly troubling both for what is stated and what is implied. The CPC environmental director was found to be "heavily involved in environmental issues" at the subsidiary's site, including issuing directives regarding "responses to regulatory inquiries." Id. This type of involvement would appear to be consistent with the general management and control over a subsidiary's business that the Court said was protected corporate oversight. But the Court added the important caveat that it drew "no ultimate conclusion" from these findings, noting that the trial court "offered little in the way of concrete detail for its conclusions about [the environmental director's] role in the subsidiary's environmental affairs." Id. It is therefore likely that the government will have difficulty overcoming the presumption against parent company liability that the environmental director acted in accordance with the parent's legitimate interests in its subsidiary's performance.

Even so, Bestfoods fails to provide the guidance that corporations need to plan and structure their activities. Moreover, in placing at the fulcrum of its test whether the actions taken by the parent's employee are within the "accepted norms of parental oversight of a subsidiary's facility," the Court opens an entirely new area of inquiry as to what is normal and what is "eccentric" corporate involvement. Again, the Court appears less concerned with what the employee did than with which entity's hat he was wearing. Presumably, recognizing that a totally subjective test would be entirely useless, the courts will use common sense when applying this test.

Court's Failure to Elaborate On the Test for Derivative Liability

Nowhere is the Court's decision more confusing than in its attempt to distinguish the test for direct CERCLA liability from the corporate veil-piercing analysis.

As a general rule, because a corporation is recognized as a legal entity distinct from its owners, they ordinarily are insulated from liability for the corporation's actions beyond the amount of their equity investment.¹¹ Id. at 1884. The rule of limited liability for the owners of a corporation applies not only when individual shareholders are the owners, but also when the owner is another corporation.¹² Corporations have long used this principle to limit their potential exposure to liability by conducting operations that carry a risk of liability through bona fide, separately incorporated, and wholly owned subsidiaries. The rights of stock ownership, as the Court points out, include "the election of directors, the making of by-laws ... [and] duplication of some or all of the directors or executive officers." ¹³ Id. Furthermore, as the Court emphasizes, "nothing in CERCLA purports to reject this bedrock principle, and against this venerable common-law backdrop, the congressional silence is audible." Id. at 1885.

Notwithstanding the general rule of limited liability for corporate owners, courts will occasionally disregard the separate identities of the corporation and its owners, i.e., "pierce the corporate veil," to impose liability for the corporation's actions upon its owners. Given the Congressional silence on the issue, the Court said it saw no reason to abrogate this common-law doctrine. Id. at 1885. Accordingly, the Court held that "when (but only when) the corporate veil may be pierced, may a parent corporation be charged with derivative CERCLA liability for its subsidiary's actions." Id. at 1885-1886.

The Bestfoods court did not elaborate on the application of the veil-piercing doctrine to the case before it, or even provide general guidance. The general common law rule may be stated as follows: Where the parent corporation exercises such a high degree of control over its subsidiary that the latter can be viewed as a "mere instrumentality" or "alter ego" of the parent, courts will pierce the corporate veil where such a finding is necessary to prevent fraud, injustice, or circumvention of a statute or public policy.¹⁴

That is where Bestfoods ends its analysis of this issue. It does not discuss the facts that would support a claim under the catch-phrase "mere instrumentality" or "alter ego," and no attempt is made to apply the veil-piercing test to the facts of the case. Judicial opinions on veil-piercing raise innumerable indicia of liability. Boiled down to the essential, it appears that the courts have developed a two-pronged test to determine when to disregard the corporate form, deciding that piercing is appropriate when: (1) the subsidiary corporation is so dominated by the parent corporation that it ceases to have any interest or existence of its own; and (2) treating the shareholder and corporation as separate entities would lead to an unjust result.

The first prong of the test depends on the degree of control exercised by the parent or a substantial (i.e., greater than 50 percent) stockholder. The more the parent corporation or individual shareholder dominates the management, finances, and day-to-day decisions of the subsidiary, the more readily the court will disregard the corporate form, declaring the parent and the subsidiary to be the same entity. Control of a subsidiary may be proven through a number of factors, but the courts seem to focus on three broad categories: control of management, observance of corporate formalities, and adequacy of capitalization.¹⁵ In environmental cases, courts evaluating the level of control look at factors such as whether the parent: (1) approves capital expenditures such as environmental costs, (2) meets with environmental agencies on behalf of the subsidiary, (3) approves environmental decisions such as the method of waste disposal, and (4) retains contractors or consultants and approves their recommendations.

As to the observance of corporate formalities, the types of lapses frequently cited to support piercing include a subsidiary's failure to maintain proper books and records, hold annual meetings, have functioning boards of directors, and otherwise comply with applicable corporate law requirements.¹⁶ Also relevant is the adequacy of capitalization test, which bears little relationship to the accounting concept, and is a legal shorthand meaning that the subsidiary is a solvent business whose net assets, credit, third-party guarantees and insurance coverage are adequate to cover reasonably foreseeable liabilities.¹⁷

The consideration of equities called for by the second prong of the traditional test is more subjective. It allows the court to hold a parent or controlling shareholder liable where the corporate structure has been used to perpetrate fraud or illegality or to circumvent a statute or public policy.¹⁸ Id. at 1885.

Courts consider the two prongs of the test together when determining whether to pierce the corporate veil so that if one prong weighs heavily in favor of piercing, less weight need be placed on the other to justify disregarding the corporate form.

In addition to its failure to elaborate on the veil-piercing test, the Bestfoods court may be criticized for creating two, arguably contrary, tests for CERCLA operator liability. In addressing the impact of CPC's environmental affairs manager, the court concluded that a manager working for the parent company who was "heavily involved in environmental issues" at the subsidiary's site could, by his involvement, render the parent company an "operator" of the subsidiary's site under CERCLA. This analysis suggests that a corporation's central environmental manager should attempt to act under the badge of the subsidiary to avoid any confusion as to which company is being served. However, under the Court's veil-piercing analysis, if the parent company's environmental manager is acting on behalf of the subsidiary, that is prima-facie evidence that the parent is violating the subsidiary's independence. In other words, the environmental manager could cause the parent to be held liable whether he is acting for the parent or the subsidiary. Thus, even after Bestfoods, the same disincentives to active parent company environmental management remain in place. The Court's analysis is almost certainly likely to lead to further confusion and will only exacerbate the fear of CERCLA exposure in the corporate boardroom.

Guidance for Corporate Management

Given that Bestfoods recasts the law on the derivative and direct liability of parent corporations under CERCLA, it is useful to summarize the guidelines stated and implied by the Court's analysis.

Bestfoods establishes two critical tests for evaluating a corporate parent's management practices. The first is whether the parent company rendered the subsidiary a mere agent by ignoring corporate formalities and then utilized its control to commit fraud or wrongdoing. The second is whether the parent company, through general directives or the authority of its individual employees or agents acting on behalf of the parent, operated the facility causing the offending release of hazardous waste. The Court defined operator to mean a person who manages, directs, or conducts 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." Id. at 1887.

Although the Court did not intend that the direct and indirect liability tests be considered together, a company must necessarily do just that in evaluating its management structure prospectively. Taking these tests together, it is clear that the Court intended to ratify as entirely appropriate the standard management tools employed by parent companies to monitor and control subsidiary companies. These include centralized cash management, approval of capital expenditures, hiring and firing of employees, and the setting of policies and procedures (without the need to obtain approval for specific operational decisions). Such practices do not lead to derivative liability unless they are used to commit fraud or other wrongdoing, nor do they create direct liability so long as they are focused on the subsidiary's business rather than the polluting facility.

Similarly, Bestfoods recognizes the standard practice of placing certain directors and officers of the parent company, whether officially or otherwise, in a subsidiary's management team. Again, this practice will not lead to derivative liability unless the parent uses the employees to commit fraud or wrongdoing. The activities of such individuals also should not lead to direct operator liability so long as the individual director or officer is acting on behalf of the subsidiary and not the parent (or, if acting on behalf of both, the individual acts consistently with the subsidiary's interests) and provided that the parent scrupulously avoids any of the other factors that would justify a court in piercing the corporate veil.

Unresolved by Bestfoods are the issues arising in the important area of environmental management. In remanding for further findings on the role of CPC International's environmental manager, the Court left many unanswered questions. Clearly a parent company is safe in issuing general environmental policies and exercising control over major expenditures. The Court left unresolved, however, just how involved the parent company's environmental manager may become without crossing the line of CERCLA operation--particularly where the activity has the potential to cause releases of hazardous waste. If protection against parent liability were the paramount concern of a corporation, it would be prudent to limit the role of a parent company's environmental manager to general oversight and policy matters, avoiding issues directly related to the operation of specific manufacturing, processing, or storage units having the potential to cause releases. For example, a corporate environmental health and safety manager would not be safe in instructing a plant manager on how to store waste materials on-site, other than to issue general policy guidance. This is an issue, however, where practicality and other competing concerns may dictate a different conclusion, and companies will need to evaluate the Bestfoods case in view of their unique circumstances.

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