First published in Westlaw Journal Intellectual Property

Lionel Lavenue, Benjamin Cassady, Joseph Miles, and Matthew Johnson of Finnegan discuss the factors courts evaluate to determine whether subsidiaries must provide discovery on the business practices of parent or sibling corporations.

Take enough visits to a school playground and eventually you will see two kids get into a fight. Maybe it is over something said, or maybe it is over the good basketball, or maybe it is a bully trying to steal another kid’s lunch money.

But what if it was a bully trying to use the other kid to steal from their parents’ bank account? Could that bully really expect the kid to be able to access their parents’ accounts? That would have to be a really intimidating and sophisticated bully.

So it mostly goes in discovery in complex corporate civil litigation.

And like the schoolyard bully who can get money from a kid but cannot reach the kid’s parents’ accounts, a subsidiary likewise cannot (usually) be compelled to provide discovery from the parent corporation because the subsidiary lacks control of information possessed and controlled by the parent.

Whether information from a parent can be obtained through a subsidiary corporation is particularly relevant in the District of Delaware, where many U.S. subsidiaries of foreign corporations are incorporated and, thus, are involved in litigation.

Cases in the District provide valuable insight into how this issue will be treated, demonstrating that, with few exceptions, the subsidiary will not be compelled to produce information held by the parent corporation.

Before proceeding into this review, it should be appreciated that the analysis of related corporate entities is highly fact-specific.

The nature of the litigation at issue, the degree of overlap of the related corporate structures, the stake the parent corporation has in the litigation of the subsidiary, and the information at issue can all play central roles in determining whether a subsidiary is deemed to have control of the information, and therefore whether courts are likely to compel the subsidiary to produce the information.

But the circumstances in which a subsidiary has (or has not) been found to control or possess information held by the parent corporation are nonetheless instructive.

Power Integrations establishes the District of Delaware’s definition of control by a subsidiary over a parent’s information.

The leading case on this issue is Power Integrations Inc. v. Fairchild Semiconductor International Inc..1 There, the plaintiff in a patent infringement case sought discovery from a United States subsidiary of a Korean company.

The U.S. subsidiary moved to quash the plaintiff’s subpoena, claiming that it did not have the documents the plaintiff sought (as the parent company in Korea had them).

In quashing the plaintiff, Power Integrations’ subpoena, Judge Farnan found that, ” A subsidiary, by definition, does not control its parent corporation,” so it should not be made to produce documents held by its parent, “except in rare circumstances justifying the application of the alter ego doctrine to pierce the corporate veil of the subsidiary.”

Judge Farnan did not pierce the corporate veil because the parent and subsidiary corporations “function as separate entities in the business world” and “have little more than a vendor relationship.”

And Judge Farnan noted that the Third Circuit has limited “control,” for discovery purposes, to “the legal right of the subpoenaed party to obtain the documents,” not the practical ability to obtain those documents.

Thus, Judge Farnan drew an important distinction between “legal control” and “practical control,” rejecting Power Integrations’ argument that, based on Second Circuit precedent, a subsidiary that has the practical ability to obtain documents from a corporate parent should be compelled to produce them.

Judge Farnan instead found that the appropriate test is whether the subsidiary has legal control, i.e., the legal right to obtain documents from a corporate parent.

Judge Farnan also found that the ability to obtain documents directly from the foreign parent through alternative means (e.g., through the Hague Convention) was an important factor — the plaintiff having an alternative avenue to obtain documents directly from the parent corporation weighs against expanding the definition of control.

The District of Delaware follows the precedent set in Power Integrations

Additional District of Delaware decisions affirm the notion that a subsidiary does not control its parent or sibling corporation’s information, and therefore cannot be compelled to produce documents under the control of related entities.

For example, in Cradle IP LLC. v. Texas Instruments Inc.,2 Judge Robinson noted that the existence of a sister corporate entity “does not automatically permit an inference that [one entity] controls the documents and information . . . that are in [the sister entity’s] possession, custody or control.”

Instructively, Cradle argued that the related sister entity participated in the invention of the accused product, but Judge Robinson found that irrelevant to whether the defendant had a legal right to produce documents controlled by the (non-party) sister corporation.

Likewise, in Princeton Digital Image Corp. v. Konami Digital Entertainment Inc.,3 Judge Burke reiterated that “documents are in the ‘control’ of a litigating party if that party has the ‘legal right to obtain the documents required on demand’ from the non-party corporation.”

Moreover, Judge Burke made clear that ”[t]he party seeking production of documents bears the burden of establishing the opposing party’s control over those documents.”

Relying on Third Circuit precedent,4 Judge Burke noted that “control has been found only where (1) ‘the sister corporation was found to be the alter ego of the litigating entity[;]’ or (2) ‘the litigating corporation had acted with its sister in effecting the transaction giving rise to suit and is litigating on its behalf[.]’”

Further, distinguishing a prior case5 where a defendant was found to be in control of a related non-party’s documents, Judge Burke noted that case involved a wholly owned subsidiary that exclusively sold the parent’s products, the subsidiary’s board of directors were all parent employees, the parent had produced documents in the litigation previously, the parent provided input to the litigation and made decisions independent of the subsidiary’s employees relating to the litigation, and the parent would directly benefit from a positive result of the litigation.

Finally, in Re XPRT Ventures LLC v. eBay Inc.,6 the District of Delaware explained that “the term, ‘control’” means “the legal right to obtain the documents required on demand,” and that the court has “resisted the urge to expand its definition of control beyond the legal rights of a litigant to include a party’s practical ability to obtain the requested documents.”

The court went on to sustain the defendant’s objection to requiring employees of a separate corporate entity to produce documents for the present litigation.

The Third and Ninth Circuits agree with the standard set in Power Integrations

The conclusion that a subsidiary lacks control over information of related entities is not limited to Delaware.

For instance, in In Re Novartis and Par Antitrust Litigation,7 the Eastern District of Pennsylvania recognized that ”[a]lthough control is often found when a parent corporation is requested to produce documents of a wholly owned subsidiary, separate and distinct corporate identities are not readily disregarded, ‘except in rare circumstances justifying the application of the alter ego doctrine to pierce the corporate veil of the subsidiary.’”

The court took particular interest in the fact that the subsidiary was two corporate levels removed from the parent corporation, suggesting the degree of corporate separation was a relevant factor.

Similarly, courts in the Ninth Circuit have found no control over a parent by a subsidiary sufficient to compel document production where the related entities maintain corporate separateness.8

Ninth Circuit courts have consistently reasoned that subsidiary companies lacked the possession or control of documents possessed by the parent corporation and that extending the definition of “control” to include the practical ability to obtain documents would be inappropriate due to the concept of corporate legal separateness.9

The minority position on subsidiary control over a parent’s information

As previously mentioned, courts do not uniformly follow the majority position that a subsidiary does not control documents held by its parent unless it “legally” controls them.

For instance, the Southern District of New York required a subsidiary to produce its parent’s documents in Hunter Douglas Inc. v. Comfortex Corp.10

However, the subsidiary and parent corporation both used the documents in question in the normal course of the subsidiary’s business, a distinction that still suggests something more than simple practical control test is required to compel a subsidiary to produce documents of a related non-party.

Other cases suggest that a corporate parent’s actions in the litigation can also be informative on the issue of control by a subsidiary.

For example, if the parent previously participated in the litigation, or especially if the parent previously produced documents to aid the subsidiary’s case, courts have been inclined to compel production.11

This problem of parent involvement happens in Delaware as well. In Robert Bosch LLC v. Alberee Products Inc.,12 the foreign parent selectively provided documents to aid its subsidiary on previous occasions, and the court therefore found the subsidiary demonstrated sufficient control over other of the parent’s documents to produce them.

How to avoid subsidiary legal control over parent-controlled information

So how do related corporate entities avoid potential pitfalls in this type of situation? And what factors will courts weigh most heavily in determining whether to compel a subsidiary to produce documents of the parent?

Although there are not bright-line rules, significant factors arise from familiar aspects of corporate law: corporate separateness and alter ego/piercing the corporate veil.

Corporate separateness is a foundational concept in corporate law. In determining whether two entities are truly separate corporations, courts consider commonality of ownership; exchange or intermingling of directors, officers or employees of the corporations; exchange of documents between the companies in the ordinary course of business; any benefit or involvement by the non-party corporation in the litigation; the corporate party’s marketing and/or servicing of the non-party company’s products; and the financial relationship between the companies.

For instance, Power Integrations found that the United States-based subsidiary was effectively a vendor of the foreign parent corporation with no overlap with otherwise completely distinct legal identities, as these corporate formalities were observed.

The more of these formalities that are observed, the less likely that a subsidiary will be found to “control” its parent’s information.

These corporate structural considerations lead naturally into the concept of corporate alter ego/piercing the corporate veil.

To find that two companies are alter egos of each other, i.e., to “pierce the corporate veil,” the courts examine the existence of corporate formalities, undercapitalization of the corporation, commingling of assets between the related entities, and misconduct on the behalf of the corporation that would cause the court to pierce through the corporation to the persons or related entities controlling that corporation.

For example, in In re Advance Nanotech,13 a Delaware bankruptcy court found that the United States-based subsidiary that shared corporate officers with its foreign parent was merely a holding company and therefore the subsidiary exercised legal control over the parent corporation. (The subsidiary was attempting to argue that they cannot have a fiduciary duty for the parent obtaining financing because a subsidiary does not legally control the parent corporation.)

In addition to the corporate separateness and alter ego analyses, the District of New Jersey laid out so-called “alternate grounds” for establishing control between related corporate entities.

In Camden Iron & Metal Inc. v. Marubeni America Corp.,14 the court reasoned that subsidiary control of a parent’s information can be established if the subsidiary acted as an agent of the parent in the transaction underlying the litigation and the relationship is such that the subsidiary can secure documents of the parent to meet the subsidiary’s business needs or to support the subsidiary’s positions in litigation.

Conclusion: Subsidiaries mostly will not be compelled to produce information controlled by a related entity so long as separateness and corporate formalities are maintained

Most courts generally follow a rule that a subsidiary corporation cannot be compelled to produce its parent’s (or sibling’s) information because the subsidiary lacks legal control over the related entity.

However, this fact-specific analysis requires examining the degree to which the corporations maintain separateness and observe corporate formalities.

And while some courts have extended the definition of “control” to cover situations where the subsidiary has a practical ability to obtain information from the parent, especially when the subsidiary regularly obtains such information in the course of its business or produces self-serving documents from the parent in litigation, there is no bright-line rule dictating when and what information a subsidiary can be compelled to collect and produce from its parent.