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Second Circuit Finds Parent not Responsible for Subsidiary’s Liability under Shared Services Agreement

The Second Circuit Court of Appeals recently issued an opinion reversing summary judgment in favor of the Federal Trade Commission (“FTC”) against a parent company based on actions its subsidiary committed.  In the same opinion, the Court affirmed summary judgment for the FTC and the State of Connecticut, against the subsidiary, an online advertiser, for deceptive advertising.

The parent had acquired the sub before the lawsuit was brought, and the parent entered into a shared services agreement, wherein the parent company provided the majority of administrative functions for the sub.  Pursuant to this shared services agreement, the parent paid millions of dollars in upfront costs and then retrieved those fees from the sub pursuant to the shared services agreement.  The FTC joined the parent to the litigation, arguing that this arrangement was improper, and thus subjected the parent company to disgorgement of those funds to pay the judgment the FTC obtained in litigation.

The Court agreed that the sub was responsible for deceptive advertising on fake news websites, which made false claims about weight-loss products sold by one of its advertising clients.  The sub argued it was not liable for the false ads because third parties created and placed the advertising on their websites.  The evidence showed, however, that sub employees had knowledge of, and authority over, the deceptive advertising material placed on the websites.  The knowledge and authority were sufficient to hold the sub responsible for the advertising.

The FTC did not argue that the parent was directly responsible for the sub’s misconduct.  Instead, the FTC argued that the parent was a “relief defendant,” liable to the extent it received funds from the sub, because the parent’s receipt of the funds did not occur pursuant to an arms-length transaction.  There was no separate documentation of any loan by the parent to the sub, and no interest was charged on the loan.

The Court disagreed, explaining the parent’s receipt of funds pursuant to the shared services agreement did not need to be independently documented to make the receipt of the funds legitimate.  The parent had advanced many millions to the sub for operating expenses, and the parent had received only a portion of those advances back through collections on the sub’s accounts receivable prior to the sub’s cessation of operations.  The advances were recorded on both companies’ ledgers as an intercompany loan, even though there was no formal loan agreement and no interest charged on the amount of the advances.  The parent was simply repaid a portion of its advances as a parent company over the sub, and was not holding ill-gotten gains of a subsidiary as a custodian.

The Court also explained that shared services agreements permit affiliated companies to utilize the same back-office administrative functions to increase efficiencies and reduce costs.  Such agreements may govern intercompany funds transfers and accounting administration functions. Funds transfers, like the one at issue in this case, occur without formal loan agreements, promissory notes or interest charges because those formalities decrease efficiencies and add transactional costs.

The funds transfer and repayment arrangement at issue here were, in the Court’s analysis, protected from disgorgement by being part of a shared services agreement.  The Court concluded that the funds the parent received, while it controlled the accounts, could not be disgorged in favor of plaintiffs.

Weiner Brodsky Kider regularly represents financial services clients throughout the United States.