In Re: Chinese-Manufactured Drywall Products Liability Litigation (CA5 May 20, 2014)

The corporate form is commonly used by entities and individuals alike to limit liability by, among other things, avoiding the jurisdictional reach of certain court systems. This is a perfectly legitimate objective provided the requisite corporate formalities are duly observed and respected – as in the relationship between, say, a parent corporation and its subsidiary, which are generally regarded as separate, distinct legal entities.

Woe tends to befall those, however, who disregard corporate separateness and operate a subsidiary as an "alter ego" or "agent." When a parent company uses a subsidiary to advance its own interests, or a subsidiary operates only for the parent's benefit, courts in the US are not reluctant to pierce the corporate veil in order to subject the parent to liability that would otherwise attach only to its subsidiary.

A Chinese drywall manufacturer's failure to heed these basic tenets of corporate law serves as an example of just how far a US court's "long-arm" jurisdiction can reach for those who put form above substance for profit. With ample evidence of improper control before it, a federal appellate court recently lifted the corporate veil in order to impute the forum contacts of the Chinese company's subsidiary to the foreign parent for purposes of exercising personal jurisdiction. See In Re: Chinese-Manufactured Drywall Products Liability Litigation, No. 12-31213 (CA5 May 20, 2014) (consolidating Mitchell, Gross and Wiltz).

Two Hurricanes, a Flood of Litigation, and a Bad Outcome 

Seeking to capitalize on a housing boom in the southeastern corner of the US following the destructive double-whammy of Hurricanes Katrina and Rita that led to a spike in demand for housing materials, Taishan Gypsum Company (TG) – one of the largest drywall manufacturers in China – manufactured large quantities of gypsum wallboard and sold it to US companies through a wholly owned subsidiary, Tai'an Taishan Plasterboard Company (TTP). 

When homeowners began experiencing problems with TG's drywall, they did what aggrieved Americans often do and filed class action lawsuits against everyone behind the manufacturing, importing, and installation of the defective Chinese drywall for property damages, including TG and TTP. When the cases multiplied, they were consolidated in a single district court sitting in Louisiana by the federal Judicial Panel of Multidistrict Litigation.

Despite being properly served in Mitchell, TG chose not to answer and suffered a default judgment as a result. In Gross and Wiltz, TG made a timely appearance and moved to dismiss the complaints for lack of personal jurisdiction. At the same time, it moved to vacate the default judgment in Mitchell and to dismiss that case as well for lack of personal jurisdiction. It lost on all counts, with the district court holding in each case that TTP's forum "contacts … could be imputed to TG for the purposes of personal jurisdiction." Slip op. at 6. 

On appeal, TG lost again. The Fifth Circuit affirmed, holding that "[t]he record in this case reflects an intimate relationship between TG and TTP" that they used to "capitalize[] on a spike in demand for drywall in the Gulf South" and purposefully "avail[] themselves of Florida and Louisiana – two of the market's focal points." Id., at 42.

An Object Lesson in the Imputation of Jurisdictional Contacts 

TG appears to have banked on the fact that in the US a foreign parent corporation is generally not "subject to the jurisdiction of a forum state merely because a subsidiary is doing business there." Id., at 8 (internal quotation marks and citation omitted). What it remarkably overlooked – given that Chinese law is not materially different – is that when:

[T]he subsidiary is merely an agent through which the parent company conducts business in a particular jurisdiction or its separate corporate status is formal only and without any semblance of individual identity, then the subsidiary's business will be viewed as that of the parent and the latter will be said to be doing business in the jurisdiction through the subsidiary for purposes of asserting personal jurisdiction.

Id. (citation omitted).

The issue of control is critical to the determination of agency, both generally and specifically for purposes of imputing the jurisdictional contacts of a subsidiary as the agent of its parent: the parent's control must be high and very significant. Id., at 9. This bar was cleared with ease in the Chinese Drywall litigation. TG's hands were all over TTP, leading to the conclusion that TTP was acting as TG's agent and that "TG's parental control over [TTP] pervaded TTP's dealings with the forum, and therefore allows TTP's [jurisdictional] contacts … to be imputed to TG for the purpose of specific jurisdiction." Id., at 11.

While reasonable minds might differ over the significance of some of the dealings between TG and TTP, too many other aspects of their relationship were textbook "no-noes." Among other things, TTP: (a) used TG's trademark on its products without payment; (b) purchased manufacturing equipment from TG without maintaining financial records to show either how much it paid for the equipment or the amounts it received when TG purchased it back when TTP ceased operation; (c) TG employees were instructed to "volunteer" their services for purposes of staffing TTP; and (d) TTP salespeople routinely introduced their company as TG. Id., at 12-13. The rub, in brief, is that "TTP consistently held itself out as being synonymous with TG in its dealings" with the US marketplace. Id., at 13.

Finding that the jurisdictional contacts imputed to TG satisfied the applicable long-arm statutes, the Fifth Circuit went on to hold that they were also consistent with the "minimum contacts" needed to satisfy federal due-process requirements. In reaching this conclusion, the court rejected TG's argument that the mere placement of a product in the stream of commerce, without more, does not constitute "purposeful availment" of the privilege of doing business in a forum for personal jurisdiction purposes. It found the "more" it needed for purposes of applying the so-called "stream of commerce plus" test in, among other things, TG's agreement to make a Florida company the sole sales agent for its drywall. Id., at 28.

Conclusion

This case serves as a reminder of the perils that a non-US company hoping to avoid the pitfalls of entanglement with the US judicial system faces when it disregards corporate separateness in order to get its products into the "stream of commerce" in the US. Legal fiction though it may be, corporate form is serious business.

A copy of the decision is available here.