Inhouse Counsel Update: CERCLA Liability of Parent Corporation for Contamination at Facility of Subsidiary

Andrew D. Otis

In 1998, the Supreme Court told us when and how parent corporations could be liable under CERCLA (The Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended ("CERCLA," 42 U.S.C. 9601 et seq.)) for the costs of cleaning up subsidiary's facilities. United States v. Bestfoods, 524 U.S. 51 (1998). The Court ruled that parent corporations are only liable if:

i. the subsidiary's "corporate veil" could otherwise be pierced so that the parent company is indirectly liable (so-called "derivative liability"), or
ii. the parent company so controlled the operations of the subsidiary's polluting facility that the parent acted as the facility "operator" under CERCLA (so-called "direct liability").

But the Court did not decide two additional and important issues:

i. whether to apply state or federal common law to determine when to pierce the corporate veil of the subsidiary, and
ii. what actions by the parent will constitute "operation" of the subsidiary's facility by the parent.

Since 1998, over 100 cases and 90 scholarly articles have cited the Supreme Court's Bestfoods decision. While this subsequent jurisprudence and analysis has not definitively resolved these two additional issues, we do have some clarifying detail.

The First Unanswered Question: Which Law to Apply When Determining Whether to Pierce the Corporate Veil?
Most courts since Bestfoods have applied state law when determining whether to pierce the corporate veil in CERCLA cases. But, the resolution of this issue may have little practical effect because state and federal "veil piercing" law is almost identical. As most law students know, "veil piercing" originated as an equitable theory. As such, courts retain significant discretion in applying the principle to prevent perceived fraud or ensure equitable outcomes. What may matter ultimately more than whether a court applies state or federal "veil piercing" law is the extent to which a particular federal court of appeals - or even a district judge respects the corporate form.

Companies should benefit if corporate counsel evaluate the corporate form and company practices by both the veil piercing standard of (a) the incorporating state for the parent and the subsidiary, (b) the jurisdictions in which the subsidiary operates, and (c) the federal standard in the appropriate circuits - and the law of the state(s) in which the subsidiary has its facilities.

A preliminary checklist for corporate counsel's evaluation can include:

i. Do the parent and subsidiary have functioning and independent boards of directors?
ii. Does the subsidiary have a functioning and separate management team?
iii. Are the parent and the subsidiary sufficiently capitalized?
iv. Are the parent and the subsidiary solvent?

Answering "no" to any of these four questions should prompt counsel to conduct a more detailed inquiry, and perhaps engage outside counsel, to determine the implications of the current corporate structure and practices - particularly for CERCLA liability for the parent company.

The Second Unanswered Question: What Constitutes "Operation" by the Parent of the Subsidiary's Facility?
The Supreme Court's Bestfoods opinion was not completely clear regarding a parent's CERCLA liability as an "operator." The Court stressed that to find a parent to be a CERCLA "operator," a court must find the parent operated the waste generating or contaminating activity at the subsidiary's facility. The Court stressed that the relevant inquiry is not the parent's control of the subsidiary's business operations, but the parent's control of the contaminating activity. However, the Court also stated that a plaintiff could prove parental control of the contaminating activity by proving the parent's undue and unusual control over the subsidiary as a whole. While lower courts have attempted to clarify the operator test, it is still confusing.

The Supreme Court remanded Bestfoods to the Western District of Michigan to determine if the parent could be held directly liable. The District Court recently issued findings of fact and conclusions of law regarding the direct CERCLA liability of the parent for contamination at the subsidiary's facility (See, Bestfoods v. Aerojet-General Corp., Case No. 1:89-cv-503 (W.D. Mich. Nov. 9, 2001), 2001 U.S. Dist. LEXIS 18676.

The District Court found that the parent was not liable despite:

i. Setting environmental policy for the subsidiary;
ii. Requesting that the subsidiary consult the parent before contacting or negotiating with regulators. (The subsidiary ignored the parent's requests.)
iii. Participating, through the parent's attorney, in negotiation of one settlement agreement among many related to waste disposal at the subsidiary's facility;
iv. Setting production specifications for the subsidiary;
v. Using a portion of the subsidiary's facility to produce products sold only to the parent at market price;
vi. Using a portion of the subsidiary's facility to develop production techniques for new products designed by the parent.

Three weeks after the Michigan district court found the parent not liable, the First Circuit upheld the Rhode Island district court in United States v. Kayser-Roth Corporation, 272 F.3d 89 (1st Cir. 2001), affirming 103 F.Supp.2d 74 (2000). The First Circuit upheld the lower court's finding of liability because:

i. The parent approved the installation by the subsidiary of the production process that ultimately caused the contamination at the facility;
ii. The parent required that that the subsidiary notify the parent's legal department of any governmental agency contacts with the subsidiary regarding environmental matters;
iii. The parent made the final decision on settlement when the subsidiary was sued on a separate environmental matter prior to the discovery of the contamination;
iv. An agent of the parent who was not an officer or employee of the subsidiary was the lead decision maker in the choice to install the polluting process and to settle the unrelated environmental matter.

What are the critical distinctions between Bestfoods and Kayser-Roth? First, the cases had different procedural postures. In Kayser-Roth, the parent company was requesting the court to vacate an order that was entered before the Supreme Court decided Bestfoods. The parent company had to prove that the change in law resulting from the Supreme Court's Bestfoods decision resulted in a potentially meritorious defense to the Rhode Island court's existing finding of liability under CERCLA. The parent company's proof had to be sufficient to give the court reason to believe that vacating an existing judgment would not be an empty exercise. In contrast, even though Michigan federal court in Bestfoods was hearing the case on remand, the court was not being asked to vacate a judgment. Instead, the Michigan court was attempting to determine liability in the first instance.

Second, the reported facts show a distinct difference in the level of control asserted by the parent's agents in the two cases. In Bestfoods, the parent's agents set overall environmental policy for the parent and subsidiary and were involved in the negotiation of one specific environmental claim but did not appear to be in decision making roles. In Kayser-Roth, the parent's agents played a role in making decisions, even if they did not have the ultimate authority to make the decisions.

Lessons for Corporate Counsel
The lesson from Bestfoods and Kayser-Roth is that the standard for defining "operators" is evolving under CERCLA. Different courts can reach different conclusions when reviewing similar facts. Corporate counsel who seek to manage such risks from the relatively vague standards for "piercing the corporate veil" should consider:

i. Reviewing the relationship between the parent and subsidiary for potential veil piercing and operator liability issues. This review should include not only the present relationship between parents and subsidiaries but past relationships and subsidiaries that have been sold;
ii. Understanding decision making authority and processes for various environmental matters at the parent and subsidiary levels and clarifying authority and processes where they are vague or undefined; and
iii. Understanding the decision making process by which new production methods or chemicals are chosen at the parent and subsidiary level and clarifying those processes where they are vague or undefined.

Andrew D. Otis is with Curtis, Mallet-Prevost, Colt and Mosle LLP in New York City. He specializes in environmental law. From 1990 until 1998, Mr. Otis worked at various positions at the USEPA. He can be reached at aotis@cm-p.com.