A parent and subsidiary relationship exists when the parent company controls the subsidiary company, either through owning the majority of membership interests or stock. Regardless of this ownership, the parent and subsidiary are and remain two distinct entities, wholly separate from one another. While the two entities may share similar ownership and common interests, they do not share funds, bank accounts, corporate records, and so on. Based on their separate status, parents and subsidiaries usually cannot bind one another to contracts unilaterally. However, in a recent decision, a Court of Appeals held that a subsidiary can in fact bind its parent company to an arbitration provision, despite the parent company not signing the contract including the provision.
In order for the subsidiary’s agreement to bind its parent entity, (1) the parent must control the subsidiary to such an extent that the subsidiary was a mere agent or instrumentality of the parent, and (2) the claims against the parent must have arisen from the agency relationship.
In Cohen v. TNP 2008 Participating Notes Program, the parent company had created an LLC to raise funds for an endeavor. One of the investors who signed a subscription agreement required the agreement to include an arbitration provision, which was in fact included in the final agreement. When it came time to sign the agreement, an agent of the parent company signed the agreement on behalf of the subsidiary LLC. The agent’s title was noted as the LLC’s “managing member.” The Court of Appeal held the parent’s agent had acted on behalf of the LLC to the extent that the agent was also an agent of the LLC, because the agent signed the agreement as the LLC’s “managing member.”
After the investments did not yield the promised returns, the investor initiated arbitration proceedings against the LLC and the parent company for breaching the subscription agreement. The parent company argued that because it was not a signatory to the agreement including the arbitration provision, it was not bound to arbitrate the investor’s claims. Because these claims arose directly from the breached subscription agreement, which the parent’s agent had entered into on behalf of the LLC, the Court of Appeal held the claims against the parent arose directly from the agency relationship between the parent and the LLC. The parent company, despite not having signed the agreement containing the arbitration provision, was compelled to arbitrate the investor’s claims.
In order to avoid this type of accidental binding of parent or subsidiary companies to contractual provisions, parent and subsidiary companies should be mindful of the following:
- Carefully review contracts to ensure the correct entity is listed as a party to the contract.
- Ensure the signatory for each party is not an agent of another party, and is signing on behalf of the intended signatory.
- Allow the subsidiary to control its day-to-day operations. Conversely, limit the parent company’s control over the subsidiary to that of providing goals and direction.
- When persons have titles under both the parent and subsidiary, ensure they are acting on behalf of the correct entity when entering into contracts.
If these types of parent-subsidiary issues may affect your business operations, call the attorneys at Navigato & Battin. We are available to review these relationships to help make sure one company is not inadvertently taking actions for which a separate but related entity may ultimately be held responsible.