Class action plaintiffs often attempt to drag an out-of-state parent company into a forum based solely on the contacts of a subsidiary under the so-called alter ego theory of personal jurisdiction (sometimes called a jurisdictional veil-piercing theory). This theory allows a court to impute a subsidiary’s contacts with a forum to its parent when the subsidiary is found to be an “alter ego” of the parent company.

Companies must understand how courts apply the alter ego jurisdictional theory and best practices to minimize the unique risks this theory presents.

Why class action plaintiffs assert this jurisdictional theory. Plaintiffs often try to impute a subsidiary’s contacts for a variety of reasons:

  • The parent is a foreign corporation. Plaintiffs often rely on this theory in an attempt to assert jurisdiction over a foreign corporation that does not do business in the U.S.
  • Forum shopping. The law may be more favorable to plaintiffs in a forum where a parent company’s subsidiary is located or does business.
  • Settlement leverage. Because the alter ego analysis may implicate a fact-intensive inquiry, a court may order jurisdictional discovery (more on that below), potentially putting settlement pressure on defendants seeking to avoid this burden.

How the alter ego jurisdictional theory compares to the alter ego liability theory.Although the precise test varies by jurisdiction, both theories typically require a plaintiff to demonstrate two elements: (1) the parent company exercised complete domination and control over the subsidiary, and (2) the failure to disregard their separate identities would result in fraud or injustice. In the jurisdictional context, and depending on the forum, some courts may apply a “less onerous standard” as compared to assessing an alter ego theory for liability purposes. See, e.g., Glob. Gaming Philippines, LLC v. Razon, 2022 WL 836716, at *4 (S.D.N.Y. Mar. 21, 2022).

The unique risks of the alter ego jurisdictional theory. A parent company challenging an alter ego jurisdictional theory should plan to do so at the outset of litigation or else risk waiving the right to challenge personal jurisdiction later. Plaintiffs may respond by claiming that jurisdictional discovery is warranted, and the universe of potentially relevant documents in an alter ego analysis may be vast.

This means that, at the earliest stages of the case, a court could compel a parent company mounting such a challenge to turn over a broad range of documents about the company and its relationship with its subsidiary. In the worst case scenario, class action plaintiffs will use jurisdictional discovery as a license to engage in a fishing expedition into the merits – seeking executives’ emails and documents – all before the litigation has started in earnest.

Best practices for parent companies to mitigate these risks. Companies will benefit most by focusing their mitigation efforts on the domination-and-control element. The factors courts consider in evaluating this element generally boil down to three considerations: (1) whether the subsidiary operates independently, (2) whether transactions between the entities are conducted at arm’s length, and (3) whether the subsidiary is adequately capitalized.

In line with these considerations, parent companies should consider taking the following steps to reduce their risk exposure:

  • Ensure the subsidiary operates independently of the parent company.
    • Hold separate board meetings and keep separate minutes;
    • Keep separate books and records, bank accounts, and payroll;
    • Have the subsidiary handle employment issues, including the hiring and firing of employees;
    • Maintain separate offices, addresses, phone numbers, and email domains;
    • File separate tax returns; and
    • Avoid referring to the subsidiary as a “department,” “division,” or similar term.
  • Maintain arm’s-length transactions with the subsidiary.
    • Negotiate and conduct all transactions at arm’s length, including any intercompany loan, financing, or other transactions; and
    • Separately record and document all intercompany loans, financing, or other transactions.
  • Adequately capitalize the subsidiary.
    • Adequately capitalize the subsidiary with sufficient capital to operate its business and pay its debts as they come due;
    • Document the reasons for the subsidiary’s capital structure; and
    • Avoid guaranteeing or paying the subsidiary’s debts.

No single factor is dispositive. But the more such steps a company takes, the less likely it is that a plaintiff will assert alter ego jurisdiction in the first place. Taking these steps will also allow the parent company to submit a stronger declaration in support of a motion to dismiss – which may in turn reduce the likelihood that a court will order burdensome jurisdictional discovery. See, e.g., Scanlon v. Curtis Int’l Ltd., 465 F. Supp. 3d 1054, 1067–68 (E.D. Cal. 2020) (denying jurisdictional discovery where parent company submitted declarations addressing alter ego factors).

It may not be feasible for a parent company to take all of these steps. In most cases, at least some of the considerations supporting alter ego jurisdiction will exist, such as overlapping directors and officers. But the mere presence of a few adverse facts is ordinarily insufficient. Rather, the goal should be to create a totality of circumstances that firmly rebuts any allegation that the parent “dictates every facet of the subsidiary’s business – from broad policy decisions to routine matters of day-to-day operation.” Ranza v. Nike, Inc., 793 F.3d 1059, 1073 (9th Cir. 2015).