The SBE theory of liability has been applied in situations where one entity “is so organized and controlled as to make it merely an instrumentality or adjunct” of another entity. In those cases, the courts have imposed liability on the related entity and rejected the argument that the related entity is free from liability because it is a separately organized or incorporated entity.
In Green v. Champion Insurance Company, the court outlined a set of factors to be considered when determining whether several related entities constitute a single business enterprise:
1. companies with substantial identity of ownership or ownership sufficient to give actual working control;
2. common directors, officers or members;
3. unified administrative control of entities with similar business functions;
4. directors and officers of one entity act independently in the interest of that entity;
5. one entity financing another entity;
6. inadequate capitalization;
7. one entity causing the incorporation or organization of another affiliated entity;
8. one entity paying the salaries and other expenses or losses of another entity;
9. receiving no business other than that given to it by its affiliated entities;
10. one entity using the property of another entity as its own;
11. noncompliance with corporate formalities;
12. common employees;
13. services rendered by the employees of one entity on behalf of another entity;
14. common offices;
15. centralized accounting;
16. undocumented transfers of funds between entities;
17. unclear allocation of profits and losses between entities; and
18. excessive fragmentation of a single enterprise into separate entities.
The court in Green ruled that several related insurance companies could be held liable for the debts and obligations of the others because the entities were operated as a single business enterprise. The facts the court found important were:
1. The same family members were the controlling shareholders of all of the corporations;
2. Two of the shareholders “dominated the affairs of all of the corporations”;
3. The corporations entered into some transactions without economic justification and solely for the benefit of another related entity;
4. There was “a tremendous amount of intercompany debt due to the lack of adequate initial capitalization”;
5. The entities were financed primarily through intercompany debt;
6. The income of the companies was largely dependent on collecting receivables from the other entities;
7. There were common employees and at least one entity had no employees;
8. Some employees received salaries from more than one entity;
9. Almost all of the business of the entities was given to them by the other entities;
10. Some employees were compensated by more than one member of the group;
11. Substantial intercompany debt;
12. Corporate formalities were not observed;
13. Centralized offices for the entities; and,
14. Transactions among the entities were not properly reflected in the accounting records.
All of the entities in Green were liable for the debts and obligations because the court found that the entities “were not operated as separate entities,” but rather “functioned as a single economic entity despite the internal compartmentalization of ownership and operation by means of separate incorporation.” An important point to note about the factors from Green is that fraud is not identified as a requirement. Simply operating the entities as one economic unit could be sufficient for the courts to impose liability on all the entities.
The lesson for a small business owner is similar to the lesson learned from understanding the “alter ego/veil piercing” theory (see my previous blog post: “Why an LLC won’t protect your personal assets (and how to actually protect those assets)”). While some overlap among related entities is acceptable and obviously efficient, maintaining the distinction among them as truly separate entities is critical to protecting the assets and interests held by the entities. In order to accomplish the ultimate purpose of the corporate structure, keep their dealings separate and treat them as separate companies in all respects.