7th Circuit Rejects Attempts to Saddle Corporation with Liability for Subsidiary’s Breach of Contract
In the recent case of Northbound Group, Inc., v. Norvax, Inc., et al., the U.S. Court of Appeals for the Seventh Circuit rejected Plaintiff's attempt to hold the defendant corporation liable for the alleged breach of contract by its subsidiary. Plaintiff, a seller of insurance leads that was in financial distress, reached an agreement with Norvax to sell its business to "Leadbot LLC," a subsidiary formed by Norvax for purposes of the transaction. There was no cash consideration paid to Plaintiff at the time of the sale. Instead, pursuant to a contract solely between Plaintiff and Leadbot, Plaintiff was to receive an "earn-out" based upon Leadbot's net revenue. When Leadbot allegedly breached the contract, Plaintiff sued Norvax, as it discovered that Leadbot had no assets against which it could recover. Although Norvax was not a party to the contract, Plaintiff sought to recover against it under theories that it was a "direct participant" in the alleged breach, and was the alter ego of its subsidiary. In affirming summary judgment in favor of Norvax, the Appellate Court rejected both theories. While the Court acknowledged that a corporation that "directly participates" in its subsidiary's commission of a tort or violation of a statute could be held liable (along with the subsidiary), it declined to extend this theory of recovery to cases involving breach of contract. Similarly, the Court rejected the alter ego theory, reasoning that Plaintiff could not demonstrate that equating Norvax with Leadbot was necessary to prevent a fraud or injustice, a necessary element of imposing liability under such a theory. Indeed, the Court reiterated its belief that the alter ego theory should be applied sparingly in cases involving breach of contract where parties have the ability to negotiate terms that shift and mitigate their respective risks. The case speaks to the importance of conducting due diligence into the financial wherewithal of your contracting partner. In the face of any question about Leadbot's ability to satisfy any future obligation under the contract, it was incumbent upon Plaintiff at the time to have required Norvax to be a party to and obligor under the contract, or to have guaranteed some or all of the payments due thereunder.