Issues with the application of the doctrines of separate legal personality and limited liability to

MOFESOMO TAYO-OYETIBO, 2010

ISSUES WITH THE APPLICATION OF THE DOCTRINES OF SEPARATE LEGAL PERSONALITY AND LIMITED LIABILITY TO CORPORATE GROUPS IN THE UK MOFESOMO TAYO-OYETIBO 4/1/2010

ABSTRACT

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MOFESOMO TAYO-OYETIBO, 2010 The two most important objectives of corporate group law are the protection of creditors and outsider minority shareholders of subsidiaries.

Voluntary creditors enjoy some advantages through limited liability. The monitoring costs which they would ordinarily incur if they were required to investigate assess risks of other companies within the group may considerably reduce. Nonetheless, it is also clear that creditors of companies within corporate groups are exposed to some specific risks as a result of the balance that needs to be struck between separate legal entity theory and commercial reality. There are situations where a subsidiary may be incapable of settling its creditors, in some cases possibly due to insolvency. This paper identifies the issues with the current common law application of the doctrines of separate legal personality and limited liability to corporate groups. There should be specific pre existing rules to determine whether the parent company is liable for the losses of the subsidiary in such situations. The principle of limited liability is one of the foundations of modern company law and one of the most important justifications for its creation was the separation of ownership and control.

With regards to large parent corporations who incorporate numerous wholly owned and most likely wholly controlled subsidiaries, this justification is belied. As a result, these parent corporations should not be afforded high level protection under the limited liability doctrine when the corporate group structure is used to expose involuntary creditors who do not possess the information or the means to safeguard themselves against risk, as opposed to consensual creditors to unwanted risks. English company law currently lacks any sort of corporate group specific law to protect creditors of subsidiaries in cases of misuse of the limited liability doctrine through corporate form. This legal protection of creditors is vital and can come from the judiciary in the form of court decisions, yet the courts have not developed a specific theory of veil lifting for corporate groups and have been reluctant to depart from the rule in Salomon v Salomon. At present, the courts strictly apply the Salomon doctrine to corporate groups in such a way that the parent company of a subsidiary is being treated as an individual shareholder and completely separate from the subsidiary. This remains the case even where the parent and the subsidiary are so factually close that the business as a whole actually runs like a partnership. An adept description of the current law reveals that the current common law seems to impose legal norms, rather than leaving room for the law to reflect reality, thereby creating a situation where legal principles determine commercial reality as opposed to reflecting it.

TABLE OF CASES Adams v Cape Industries Plc [1990] Ch 433 2

MOFESOMO TAYO-OYETIBO, 2010 A-G’s Reference (No 2 of 1982) [1984] QB 624, CA Albacruz (Cargo Owners) v Albarezo (Owners) [1997] AC 77 Amalgamated Investment and Property Co. Ltd. v. Texas Commercial International Bank Ltd [1982] Q.B. 84 Barlow & Ors v Polly Peck International Finance Ltd [1996] 2 All E.R. 433 Charterbridge Corporation v Lloyd’s Bank Ltd [1970] Ch 62 DHN Food Distributors v Tower Hamlets LBC [1976] 1 WLR 852 George Fischer (Great Britain) Ltd v Multi Construction Ltd, Dexion Ltd (third Party) [1995] BCLC 260 Gilford Motor Company Ltd v Horne [1933] 1 Ch. 935 Harrods Ltd v Dow Jones & Co Inc [2003] EWHC 1162 JH Rayner (Mincing Lane) Ltd v Department of Trade and Industry [1989] Ch. 72 188 Jones and Another v Lipman and Another [1962] 1 WLR 832 Kleinwort Benson Ltd v Malaysia Mining Corp Bhd [1989] 1 W.L.R. 379 Kodak Ltd v Clark [1903] 1 KB 505 Lee v Lee’s air Farming Ltd [1961] AC 12 Lewis Trusts v. Bambers Stores [1983] F.S.R. 54 Lubbe v Cape Plc [2000] 1 WLR 1545 Macaura v Northern Assurance Co [1925] AC 619, HL Multinational Gas and Petrochemical Co. v Multinational Gas and Petrochemical Services Ltd. and Ors [1983] Ch. 258 Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360 Ord v Belhaven Pubs Ltd [1992] BCC 638 Re Augustus Barnett & Son Ltd [1986] BCLC 170 Re Darby Ex parte Broughman [1911] 1 KB 95 Re Southard & Company Ltd [1979] 3 All ER 556 Re The Albazero [1977] A.C. 774 Salomon v Salomon [1897] AC 22 Smith, Stone & Knight Ltd v Birmingham Corp [1939] 4 All ER Taylor v Standard Gas and Electric Co [1939] 306 US 323 Tunstall v Steigmann [1962] 2 Q.B. 593 Woolfson v. Strathclyde Regional Council (1979) 38 P. & C.R. 521 3

MOFESOMO TAYO-OYETIBO, 2010

Table of Contents Introduction

4

Chapter 1: Issues with Current Common Law

6

Chapter 2: Current Common Law

18

Chapter 3: Comparative Issues

24

Chapter 4: Other Outstanding Issues

33

Conclusion

38

INTRODUCTION It is important that through company law, limited liability should be one of the legal resources for sufficient creditor protection. German scholars like Herbert Wiedemann 4

MOFESOMO TAYO-OYETIBO, 2010 believe that creditor protection through company law is an ethical necessity. 1 Nevertheless, the need for this type of protection as identified by scholars like Wiedemann is lacking the current common law regulatory framework. Ever since the landmark House of Lords (Hereinafter HoL) decision in Salomon v Salomon and Co2, the UK courts have been reluctant to give weight to extra-legal considerations like the economic realities within groups of companies whilst at the same time maintaining the doctrine of separate legal entity set down in Salomon3. This paper addresses the issues with the current common law as it applies to corporate group concerns. The inadequacies of the law in dealing with corporate group problems are identified, in addition there is an analysis of how other jurisdictions deal with corporate groups through company law.

Corporate groups are legitimate entrepreneurial structures regulated by an inadequate legal regime. This problem stems from a tendency of the courts to not only highlight the possible risks involved when dealing with corporate groups but to also reach favourable decisions insofar as their interests and operations are concerned but providing highly unfavourable ones to those who might be harmed by their theoretical predominance caused by the courts determination to retain the status quo.4 In groups of companies, especially large ones, the extent to which the current formal legal structure differs from practical managerial mechanisms is discernible.5 The line of cases give the impression that the courts are struggling to apply to complex group situations established principles of law (such as agency) developed for use within individual companies. 6 Those that oppose the current application of limited liability to corporate groups base their claims on the moral hazard of parent companies taking advantage of the risky activities of their subsidiaries (possibly acting under parent company instruction) but 1 PO Mulbert, ‘A Synthetic View of Different Concepts of Creditor Protection, or: A High-Level Framework for Corporate Creditor Protection’ (2006) EBOR 7 CUP 364 2 Salomon v Salomon [1897] AC 22 3 K Wardman, ‘The search for virtual reality in corporate group relationships’ (1994) Comp. Law, 15(6), 179

4 JME Irujo, ‘Trends and Realities in the Law of Corporate Groups’ (2005) EBOR 6 74 5 T Hadden, ‘Control of Corporate Groups’ (1983) Institute of Advanced Legal Studies, University of London 5 6 Hadden (n 5) 5

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MOFESOMO TAYO-OYETIBO, 2010 are beyond reach when the costs of the subsidiary’s activities are been addressed.

These costs then become burdens of the creditors and in cases where the subsidiaries experience mishaps the jurisdictions where these subsidiaries exist also suffer. This paper does not identify the issues with the current law and fault them based on moral considerations or purely on the identification of a moral hazard of the misuse of corporate form. The issues with the common law are dealt with from a purely legal perspective as moral considerations are unlikely to adequately reflect the lacunae in the law. Corporate group interests are to be recognised and protected, and the same goes for any regulatory instruments this requires. However, given the nature of corporate groups, a balance must be struck between such interests and those of the integrating firms. As a result, the responsibility of group regulation does not fall squarely on the legislator; adequate interpretation of the rules is also required of the judiciary7. These issues have been put forward as reasons for the need for a review of the continued application of the current common law doctrine of separate legal personality to corporate groups 8. The doctrines of limited liability and separate personality run to the very core of Western economies with features so fundamental that any drastic changes would inevitably result in widespread confusion and uncertainty. The emphasis of any reform will have to crucially acknowledge the preeminence of Salomon v Salomon and Co and look to other doctrines that underpin the corporate group phenomenon.9

CHAPTER 1 ISSUES WITH CURRENT COMMON LAW

7 Irujo (n 4) 90

8 FH Easterbrook and DR Fischel ‘Limited Liability and the Corporation’ (1985) Vol. 52, No. 1 TUCLR 104 9 R Schulte, Corporate Groups and the Equitable Subordination of Claims on Insolvency (1997) Comp. Law 18(1) 2

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MOFESOMO TAYO-OYETIBO, 2010 Over the years, despite a mammoth amount of litigation, English company law has not developed any special codes on limited liability to govern corporate groups. This aspect of company law is currently governed by court decisions generated on a case by case basis. There is no corporate group specific law to protect creditors of subsidiaries in cases of misuse of the limited liability doctrine through corporate form.

This needed protection can come from the judiciary, yet the courts have not developed a specific theory of veil lifting for corporate groups and have been reluctant to depart from the rule in Salomon10. The two most important objectives of corporate group law are the protection of creditors and outsider minority shareholders of subsidiaries. There are situations where a subsidiary may be incapable of settling its creditors, in some cases possibly due to insolvency. There should be specific pre existing rules to determine whether the parent company is liable for the losses of the subsidiary in such situations but this is presently not the case.

The law needs to recognise that strong economic motives are the main influences behind corporate group structures and ventures; therefore a suitable regulatory framework is needed to reflect and regulate this. A re-examination of the relationships between the corporate entities is needed, to enable the law, via principles of group responsibility hold a representative of the team as a whole responsible for the acts of its members 11. The separate legal personality of a company, although a ‘technicality’ according to Lord Denning 12, is ‘no matter of form; it is a matter of substance and reality’ 13. The structure of the common law currently allows a parent company to sidestep the disadvantages of an arrangement voluntarily entered into for reasons considered by the parent company to be advantageous, without any legal intervention 14. This chapter addresses this issue as well as the restrictions on the current law and identifying how the common law fails

10 M Eroğlu, ‘Limited Liability in Turkish Law’ (2008) EBOR 9 246 11 H Collins, ‘Ascription of Legal Responsibility to Groups in Complex Patterns of Economic Integration’ (1990) 53 MLR 732 12 DHN Food Distributors v Tower Hamlets LBC [1976] 1 WLR 852, per Lord Denning MR at 860 13 Tunstall v Steigmann [1962] 2 Q.B. 593, per Willmer L.J. at 605 14 FG Rixon, ‘Lifting the Veil Between Holding and Subsidiary Companies’ (1986) 102 LQR 423

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MOFESOMO TAYO-OYETIBO, 2010 to adequately regulate the realities of corporate groups by allowing parent companies to legally misuse the corporate group structure without fear of liability.

LEGAL ISSUES The problems associated with the operation of common law principles within the realm of corporate groups can be attributed to a fundamental failure of the legal system to develop specified principles of group responsibility within complex economic organisations comprising different entities 15. Stating that the common law does not recognise any form of group responsibility will be fallacious. This is because, over time, the common law has accepted a form of group responsibility through the metaphorical lifting of the corporate veil within the narrow confines of situations where there is a mere facade concealing the true facts. The absence of an over-arching legal identity in the case of corporate groups has, however, been a barrier to effective integration of principles of group responsibility 16 into UK Company Law.

One

would

ordinarily associate

these

to

be

characteristics

of an

underdeveloped legal and economic system, which the UK clearly is not, so this has to be seen as a problem niche in the legal system.

As stated above, the common law currently deals with issues concerning limited liability and separate legal personality in corporate groups on a case by case basis.

For this to be effective, without any corporate group specific legislation, judges need to have a range of judicial solutions available to them. At present, in situations where there are claims for misuse of the corporate group structure, the courts are not adequately exposed to a wide range of options when trying to reach a decision. 17 A reason for this is that the courts have been put in this position by restrictive precedents. Some court decisions have restricted the options of succeeding cases by limiting the avenues through which a court can lift the corporate veil. An example of such restrictive precedent is Adams v Cape Industries. In Adams, it was held that when considering whether to lift the corporate veil, the ‘interest of justice’ is not a

15 Collins (n 11) 732 16 J Hill, ‘Corporate Groups, Creditor Protection and Cross Guarantees: Australian Perspectives’ (1995) 24 CBLJ 3 332 17 Eroğlu (n 10) 247

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MOFESOMO TAYO-OYETIBO, 2010 valid consideration18. As a result, further decisions have been denied the justification of interests of justice as a possible avenue when trying to lift the veil where there has been a misuse of the corporate form. An issue such as this consequentially means the courts are not best equipped to deal with corporate group complexities when they arise as they are left with limited options.

The current system of regulating corporate group liability appears to be a paradigm of infantile simplicity, i.e. an underdeveloped legal framework. This is because considering that over a hundred years have passed since the elaboration of the Salomon doctrine of separate legal personality, no abstract criteria or specific rules have been devised by either the judiciary or legislature to enable a certain prediction of when a parent company will be held liable for the activities of its subsidiary. 19 The amount of time that has elapsed means that modern day corporate group concerns could not have been within the contemplation of the HoL in terms of the application of the doctrine to corporate groups. The current law is ignorant of this, thereby creating a situation where an ancient, yet useful doctrine is applied widely out of context. Naturally, corporate groups as an object for regulation are complex and require a complex and diverse legal policy. A sufficient level of understanding by both the judiciary and the legislature is required to help construct an adequate regulatory framework for corporate groups20, without this understanding any form of adequate regulation is not feasible.

Despite some stray cases attempting to vary the application of the Salomon doctrine, the current common law only recognises one justification for lifting the corporate veil.

This is where there is a Mere Facade or Sham concealing the true facts. In modern company structures where most corporate groups are multinationals or large companies that set up subsidiaries to make the overall business venture more efficient, this justification is unlikely to be contentious. This is because large companies tend to set up subsidiaries as they expand making the likelihood of a large company incorporating a subsidiary to carry out a venture that can jeopardise the whole group minimal. Hobhouse LJ in Ord v Belhaven Pubs Ltd stated that a 18 Adams v Cape Industries Plc [1990] Ch 433 19 A Daehnert, ‘Lifting the corporate veil: English and German perspectives on group liability’ (2007) 18(11) ICCLR 398 20 Irujo (n 4) 91

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MOFESOMO TAYO-OYETIBO, 2010 company is allowed to set itself up in any legally permitted way and is right to expect that he court would give the rule from Salomon an ordinary interpretation21 and companies follow this. Lord Hobhouse’s opinion of the application of Salomon to corporate groups clearly disregards the realities of corporate group configurations.

This is because, as will be explained below, the ordinary interpretation and application of Salomon is in most cases futile in the regulation of corporate groups because it disregards problems that can arise from corporate groups.

Substantial discussion on how the facade justification for lifting the veil applies to small scale groups will be counterproductive because the real problem lies in the application of the rule to large scale enterprises. Small scale enterprises generally fall under this justification because usually the sham company is incorporated to enable the incorporator to do through, and under cover of, the company what he might not do openly and in person 22. Cases like Re Darby Ex parte Broughman 23, Gilford Motor Company Limited v Horne24 and Jones and Another v Lipman and Another25 show where the corporate veil has been lifted under this justification without much difficulty. Where the court has had considerable difficulty, is in determining the point at which impropriety makes the need to lift the corporate veil necessary. Similarly, the courts continue to face considerable difficulty in addressing cases for lifting of the veil where impropriety exists and the company is being used to conceal the truth of material facts, but where some elements of the company are being used for legitimate purposes. 26 In an attempt to clarify this, the Court of Appeal (hereinafter CoA) in Adams held that a company can be incorporated before the crystallisation of its liabilities for the purpose of avoiding, limiting or otherwise managing those liabilities. While this may seem generally helpful, it gives no adequate assistance when trying to identify whether a company is a sham or a facade for the purposes of lifting the veil. A parent company’s detrimental conduct will not give rise to a cause of action whereby the parent's conduct affects its right to 21 Ord v Belhaven Pubs Ltd [1992] BCC 638 per Hobhouse LJ at 615 22 Rixon (n 14) 423 23 Re Darby Ex parte Broughman [1911] 1 KB 95 24 Gilford Motor Company Ltd v Horne [1933] 1 Ch. 935 25 Jones and Another v Lipman and Another [1962] 1 WLR 832 26 N Hawke, ‘Corporate Liability: Smoke and Mirrors’ (2003) ICCLR 14(2) 82

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MOFESOMO TAYO-OYETIBO, 2010 claim in a subsidiary's liquidation. Indeed, beyond the remedies associated with fraud, maintenance of capital and wrongful and fraudulent trading, because of the doctrine of separate personality a subsidiary's creditor has no case against a parent company27 through company law. This allows a parent company to use a subsidiary outside these relatively discrete boundaries with an eye single to its own interests 28.

The problem with this justification is where a perfectly legitimate parent company can set a business up knowing that without any legal impropriety existing, overt abuse of the corporate group configuration is uncaught by the only legal justification for ignoring separate legal personality. The possibility of the only justification for lifting the corporate veil being potentially inapplicable to a parent company in the face of perfectly legal abuse of the corporate group configuration has to be seen as a lacuna in the law. Needless to say, this failure makes any misuse of the corporate form devoid of a mere facade concealing the true facts potentially unchallengeable in the courts. These issues have been identified by the judiciary; Roskill L.J. in Albacruz (Cargo Owners) v. Albazero (Owners) was of the opinion that it is perhaps permissible under modern commercial conditions to regret the application of the principles of separate legal personality and limited liability to corporate groups. But went on to say it is impossible to deny, ignore or disobey them 29. Templeman LJ in Re Southard & Company Ltd stated that; English company law possesses some curious features which may generate curious results. A parent company may spawn a number of subsidiary companies, all controlled directly and indirectly by the shareholders of the parent company. If one of the subsidiary companies, to change the metaphor, turns out to be the runt of the litter and declines into insolvency to the dismay of its creditors, the parent company and other subsidiary companies may prosper to the joy of the shareholders without any liability for the debts of the insolvent subsidiary.30

27 Schulte (n 9) 2 28 Taylor v Standard Gas and Electric Co [1939] 306 US 323 29 Albacruz (Cargo Owners) v Albarezo (Owners) [1997] AC 77, per Roskill LJ at 807 30 Re Southard & Company Ltd [1979] 3 All ER 556

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MOFESOMO TAYO-OYETIBO, 2010 Some of the curious features referred to by Templeman LJ are likely to include the courts preference for lifting the veil when it is advantageous for the parent company but refusing to do so when it would be disadvantageous 31, not based on a coherent strategy or policy but on a case by case basis. 32 Lord Wedderburn in his note on Multinational Gas and Petrochemical Co. v Multinational Gas and Petrochemical Services Ltd. and Ors also identified the unresolved issues with the common law in stating that there are geriatric deficiencies with the common law in this regard as well as others in company law.33 Despite the recognition of the problems by notable members of the judiciary, a suitable remedy is still elusive.

THE LAW REFLECTING REALITY At present, the courts strictly apply the Salomon doctrine to corporate groups in such a way that the parent company of a subsidiary is being treated as an individual shareholder and completely separate from the subsidiary. This is so even where the parent and the subsidiary are so factually close that the business as a whole actually runs like a partnership. This seems to impose legal norms, rather than leaving room for the law to reflect reality, thereby creating a situation where legal principles determine commercial reality as opposed to reflecting it 34. As such, there is still no developed concept of corporate group liability in English law and corporate form still triumphs over business substance35.

The ignorance of the issues with the common law can be attributed to the contractualist reasoning and approach of the courts to issues concerning corporate veil lifting.36 The group is seen by the courts to be a reflection of contractual agreements, and the reasoning is that managers must focus only on the immediate company they serve at the point of decision making. The extent to which the current 31 George Fischer (Great Britain) Ltd v Multi Construction Ltd, Dexion Ltd (third Party) [1995] BCLC 260 32 J Dine, The Governance of Corporate Groups (CUP, Cambridge 2006) 55 33 Multinational Gas and Petrochemical Co. v Multinational Gas and Petrochemical Services Ltd. and Ors [1983] Ch. 258 34 LE Talbot, Critical Company Law (Routledge-Cavendish, London 2007) 25 35 A Walters, ‘Corporate Veil’ (1998) Comp. Law 19(8) 226 36 AJ Boyle, ‘The Company Law Review and group reform’ (2002) Comp. Law 23(2), 35

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MOFESOMO TAYO-OYETIBO, 2010 legal regime can be reconciled with the reality of corporate groups is that the interests of the group may be relevant when determining the interests of the company37. In addition, ‘whether an intelligent and honest man in the position of the director of the company concerned could, in the whole of the existing circumstances, have reasonably believed that the transaction would have benefitted the company.’ 38 While this approach can be seen as decentralising group management, it is so far removed from the practical reality of corporate group concerns that it is of doubtful utility39. This does not necessarily mean that limited liability is misplaced in the corporate group sphere as limited liability and the Salomon separate legal entity doctrine are undoubtedly immensely beneficial to companies and the economy as it protects the risk taking culture40 which needless to say, is the fulcrum of company progress. The issue is that the usefulness of these doctrines is muddled where a parent company in most cases indirectly but actively influences the endeavours of its subsidiary41.

It is a matter of fact that the instrumental use of one company by another is quite likely to occur in corporate groups. In any situation where this occurs two issues are concerned; supremacy and liability. A parent company can act in two capacities towards a subsidiary. First, the parent is a shareholder. The common law recognises and construes a parent company's actions in this limited dimension. Second, a parent is a controller. UK company law fails to adequately attribute any responsibility to a parent in this role.42 While express contractual supremacy leads to structural control and structural liability, this kind of arrangement is uncommon in corporate groups and it is crucial for the law to recognise this 43. This is a reason why the current contractual approach of the courts to groups is ineffectual.

37 Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360 38 Charterbridge Corporation v Lloyd’s Bank Ltd [1970] Ch 62 39 Dine (n 32) 44 40 K Hofstetter, ‘Parent Responsibility For Subsidiary Corporations: Evaluating European Trends’ (1990) 39 (3) CUP 577 41 Hofstetter (n 40) 577 42 Schulte (n 9) 2 43 Daehnert (n 19) 399

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MOFESOMO TAYO-OYETIBO, 2010 The danger of a company potentially misusing the corporate form without being found liable can put creditors in a vulnerable position and this vulnerability can be attributed to the Salomon separate legal entity theory44. The corporate group through limited liability is a phenomenon that is said to have exacerbated the position of creditors through certain factors that will be identified below. The corporate group configuration is one which has been described as achieving ‘limited liability within limited liability’45. This is because this result is consistent with an entity theory of the corporation and with the contemporary contractual model of the structure of a productive enterprise, in which the parent-subsidiary relationship is interpreted as a contractual investment relationship46. However, the long established entity theory fails to capture the reality and true nature of corporate groups, where it is the group as a whole, rather than its component parts which is ‘the significant entity for managerial, accounting and investment purposes’ 47.

Claimants traditionally referred to as corporate creditors include at least two categories; voluntary and involuntary creditors, whose protection implicates different social goals and merits quite different levels of legal intervention 48. One foundation for arguments in favour of reforming the current law is that even if it is accepted that limited liability allows for an efficient general presumption of the allocation of risks 49 with regard to the shareholders and contractual creditors, there is no reason to believe that this is the case in relation to involuntary creditors 50. The presumption that contractual creditors can bargain for their own protection or higher returns for their exposure to risk and can diversify their investments to adapt to any risk is absent in the case of involuntary creditors.51 This is because involuntary creditors, namely the 44 Hill (n 16) 3 45 P Blumberg, ‘The Law of Corporate Groups: Procedural Law’ (1983) Little Brown and Co. 5 46 H Collins, ‘Organizational Regulation and the Limits of Contract’ in J McCahery, S Picciotto, C Scott (eds), Corporate Control and Accountability: Changing Structures and the Dynamics of Regulation (Clarendon Press, Oxford 1993) 93 47 T Hadden, ‘The Regulation of Corporate Groups in Australia’ (1992) 15 UNSWLJ 61 48 R Kraakman, ‘Concluding Remarks on Creditor Protection’ (2006) EBOR 7, 470 49 RC Clark, Corporate Law (Little, Brown and Co., Boston 1986) 9 50 Hill (n 16) 9 51 D Leebron, ‘Limited Liability, Tort Victims, and Creditors’ (1991) 91 Colum L Rev 1565, 160

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MOFESOMO TAYO-OYETIBO, 2010 State (e.g., taxes) and public agencies (e.g., social insurance) 52 are not in a position to demand compensation for the credit risks that they bear involuntarily.53 It seems reasonable to expect the law to track the complexity in offering protections for these two contrasting categories of creditors54. While it is unreasonable to expect this protection to exist entirely within the confines of company law, some level of legal protection is at least needed.

Voluntary creditors enjoy some advantages through limited liability. The monitoring costs which they would ordinarily incur if they were required to investigate assess risks of other companies within the group may considerably reduce. Nonetheless, it is also clear that creditors of companies within corporate groups are exposed to some specific risks as a result of the balance that needs to be struck between separate legal entity theory and commercial reality. 55 One basic risk that creditors may be exposed to when dealing with corporate groups is identifying the particular company with which the creditor has contracted. This may be a subsidiary within the group or even the parent company. The choice of the contracting party within the group may in some cases be arbitrary. Initially this may not be problematic; however, eventually problems may arise because the choice becomes crucial to the creditor if the borrower becomes insolvent. This is still an issue even where the borrower is the subsidiary and the parent company issues guarantees to the creditors of the subsidiary. In Re Augustus Barnett & Son Ltd, a Spanish parent company issued ‘letters of comfort’ to the creditors of its subsidiary as an indication of continued support for the subsidiary as it was trading at a loss.

Eventually the subsidiary went into liquidation and the parent company did not assist with the settlement of the subsidiary’s debts. Hoffman J decided that the guarantees issued by the parent company had no effect legally with regard to liability for the acts of the subsidiary as they were true when made, not fraudulent and the subsequent change of mind did not make them retrospectively fraudulent. 56 This was echoed by the CoA in Kleinwort Benson Ltd v Malaysia Mining Corp Bhd where it was held that 52 Mulbert (n 1) 366 53 Kraakman (n 48) 465 54 Kraakman (n 48) 466 55 Hill (n 16) 23 56 Re Augustus Barnett & Son Ltd [1986] BCLC 170

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MOFESOMO TAYO-OYETIBO, 2010 a letter of comfort from a parent company to a lender has no contractual effect if it is merely a statement of present fact regarding the parent company's intentions and was not a contractual promise as to the parent company's future conduct. 57 Another risk creditors may be exposed to, posed by the tenets of entity law, relates to how assets and liabilities can easily and legally be manoeuvred within a group.

The mobility of assets and liabilities and the ability to specifically direct resources within the group to maximize group profits are great benefits of corporate groups 58. It allows for efficient and effective use of capital but at the same time, for creditors it is one of the most acute dangers of dealing with an entity within a corporate group. It counteracts one of the fundamental justifications of limited liability for contractual debts; that it is an efficient allocation of risk since contractual creditors can determine, through information about the corporation's net assets, the level of risk and alter credit terms accordingly.59 Limited liability can also allow firms to externalise risks. This means that a firm can voluntarily shift a portion of its finance costs on to involuntary creditors. This shift occurs because the company’s investors and voluntary creditors receive a higher return than they would have if the company had settled the claims of the involuntary creditor. This issue is one that stretches beyond the boundaries of company law because it counteracts the purposes of tort law by allowing a company commit torts without being held liable60. As regards corporate groups, risk externalisation can occur where a parent corporation uses a subsidiary to protect the group’s assets from the risks in which the corporation engages. This problem arises when the subsidiary, because its assets are held by the parent to protect them, is not an independently viable entity. If such arrangements were allowed, a corporation could engage in risks without risking its own assets by separating itself into many corporations on paper, while operating as one corporation 61. This sort of arrangement 57 Kleinwort Benson Ltd v Malaysia Mining Corp Bhd [1989] 1 W.L.R. 379 58 P Blumberg, ‘Intragroup (Upstream, Cross-stream, and Downstream) Guaranties Under the Uniform Fraudulent Transfer Act’ (1987) 9 Cardozo L Rev 686 59 RE Meiners, J Mofsky and RD Tollison, ‘Piercing the Veil of Limited Liability’ (1979) 4 Del J Corp L 361 60 A Ashwin, ‘Tortious Liability of Company in Winding Up: An Analysis’ (2005) Comp. Law 26 (6) 172 61 A Price, ‘Tort Creditor Super Priority and other Proposed Solutions to Corporate Limited Liability and the Problem of Externalities’ (1995) 2 George Mason University Law Review 449

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MOFESOMO TAYO-OYETIBO, 2010 is usually not challengeable in the courts because in most instances the courts will fail to find that there is a facade concealing the true facts. The lack of liability for the subsidiary’s debts can serve as an incentive to the parent company to act opportunistically. A parent company may shift assets away from risky operating subsidiaries precisely to minimise exposure to liability. Some empirical studies have shown that this undercapitalization of a subsidiary strategy is practiced by companies in hazardous industries 62 either in the form of a subsequent distribution of assets to its shareholders or by taking on riskier ventures, i.e., projects with more volatile earnings prospects. In practice, this kind of opportunistic behaviour will most often be initiated by the parent company, making use of actual influence, knowing that in all likelihood the liabilities of the subsidiary will not be transferred to it. 63 In conclusion, the effects of the Salomon entity doctrine in the corporate group sphere are far from subtle. The current common law application of the doctrine has deflected attention from the complex relations between legal entities which form part of a corporate group. On one hand, it is arguable that these far from subtle principles have played an important role in promoting certainty in the law. This is because litigants know that in the absence of a mere facade concealing the true facts the court will be unwilling to lift the corporate veil. On the other hand, the principles have had a stagnating effect on the development of law in this area. 64 There are often very good reasons to sue the parent corporation rather than the subsidiary. The reason is, usually the subsidiary has limited assets and offers little scope for recovery. In some situations the subsidiary may even have disappeared altogether. In situations where the facade justification is inapplicable to the parent company, claimants can be left with no one to sue. Lord Craighead in Lubbe v Cape Plc65 concluded that there will usually be little hope of recovery for claimants in this situation, unless the parent company can be made liable, which as seen above, may be impossible. While subsidiary corporations are generally employed legitimately, their use involves certain perils that the law does not adequately regulate. The reason for this is that the parent can manipulate the directors and the funding of subsidiaries. To the extent 62 AH Ringleb and SN Wiggins, ‘Liability and Large Scale, Long Term Hazards’ (1990) 98 JPE 574 63 Mulbert (n 1) 369 64 Collins (n 11) 744 65 Lubbe v Cape Plc [2000] 1 WLR 1545 at 1550

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MOFESOMO TAYO-OYETIBO, 2010 that the corporate form shields a parent company from creditors or regulatory fines, a parent is free to opt out of the laws that control the negative externalities of a group 66.

The reality of control by a parent means there must be some form of accountability 67.

Existing remedies such as piercing the veil and fraudulent and wrongful trading seek to redress misuse of the corporate form and provide creditor protection by merely pitting

inadequate

normative

standards68

against

an

increasingly

complex

phenomenon.

These remedies in no way capture the control relationship between parent and subsidiary, to impose for the benefit of creditors, a minimum standard of conduct that deters abuse of corporate structure. This inadequacy in the law can be remedied by a legislative measure that bridges the gap between the law's overly formal treatment of a parent as no more than a shareholder and the reality of a parent's control over a subsidiary. This can be achieved through a measure that does not merely lift the veil, but rather focuses on the control that parents in fact exercise over subsidiaries. 69 ‘A law cannot afford, at least in the long run...to live with a contradiction between law and reality. This would undermine the credibility of the legal order as a whole’ 70.

66 R Kraakman and others, The Anatomy of Corporate Law: A Comparative and Functional Approach (OUP, Oxford 2009) 120 67 Schulte (n9) 13 68 RC Clark, ‘The Duties of the Corporate Debtor to its Creditors’ (1977) 90 Harvard Law Review 505 69 Schulte (n 9) 2 70 Buxbaum, Hertig, Hirsch and Hopt (eds), European Business Law: Legal and Economic Analyses on Integration and Harmonization (Berlin, New York, de Gruyter, 1991) 243

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CHAPTER 2 CURRENT COMMON LAW The starting point for courts, when considering the question of whether the corporate veil should be lifted71 in any applicable situation is the doctrine laid down in Salomon.

This chapter focuses on how the courts have through a long list of judgements, preserved the separate entity principle from this groundbreaking case. The decision in Salomon is important because it applied the judicial understanding of separate corporate personality, which had previously been applied to large concerns alone, to a small one man private company. By doing this, the HoL effectively laid down what can in fact be considered a starting point for all separate legal personality and limited liability cases and also made the said doctrine applicable to all companies 72. The crucial point on which the HoL decided Salomon was precisely the rejection of the doctrine that agency between a corporation and its members in relation to the corporations contracts can be inferred from the control exercisable by the members over the corporation. That rejection of the doctrine of agency to impugn the nonliability of the members for the acts of the corporation has been described as the foundation of modern company law.73 Effectively, the consequences of the Salomon doctrine are that the proper legal incorporation of a company allows the company to have its own separate legal personality, separate from its members, with the result being that the subsidiary company may sue and be sued in its own corporate name and capacity 74. An incorporated subsidiary has perpetual succession, until dissolved a subsidiary continues to exist and survives the death of its directors and shareholders. A 71 Daehnert, (n 19) 393 72 Talbot (n 34) 25 73 JH Rayner (Mincing Lane) Ltd v Department of Trade and Industry [1989] Ch. 72 188 74 J Lowry and A Reisberg, Pettet's Company Law : Company and Capital Markets Law (Longman, 2009) 31

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MOFESOMO TAYO-OYETIBO, 2010 subsidiary company may hold property in its own name and the properties of the subsidiary is not the property of the parent company or the main shareholder and as a result, the parent company will have no insurable interests in any of the properties of the subsidiary.75 This in turn allows for a situation where the parent company can be sued for stealing from its subsidiary76. This allows for a subsidiary to hire its own staff separate from the staff of the parent company and in some situations the subsidiary may also hire its parent company to undertake certain tasks or execute certain contracts77.

There have been instances where the courts have ignored the Salomon principle of separate legal personality. However they have not done this in a particularly systematic or progressive way by defining specific point at which the incorporation of a company and its separate legal personality will be ignored. The courts have instead decided on this by moving on a case to case basis 78. As a result, some common law exceptions to the doctrine have been developed through case law. The consequence of the activation of these exceptions to the Salomon rule is that the metaphorical ‘Veil of Incorporation’ will be lifted. This said lifting of the veil of incorporation is not the end result but can be regarded effectively as a means to the end79. The end result being that after the veil is lifted, limited liability and separate legal personality will be set aside and claimants against a subsidiary will have Locus Standi to sue the parent company behind the veil for the debts of the subsidiary.

There has been considerable uncertainty created by the courts about the established circumstances where the veil of incorporation will be lifted, as a result, a plausible conclusion or explanation is elusive. A number of recent decisions confirm that principles of English law on limited liability as it applies to corporate groups are far from adequate and are not well defined. In addition, there is no strong justification for this. Given the complexity of modern day company dealings in a relatively developed UK economy and legal system, a modern and strategic legal framework should be in 75 Macaura v Northern Assurance Co [1925] AC 619, HL 76 A-G’s Reference (No 2 of 1982) [1984] QB 624, CA 77 Lee v Lee’s air Farming Ltd [1961] AC 12 78 JH Farrar, NE Furey and BM Hannigan, Farrar’s Company Law (3rd edn) (Butterworths, London 1991) 73 79 Talbot (n 34) 29

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MOFESOMO TAYO-OYETIBO, 2010 place to reflect this. Below are some situations arising from case law that at one point seemed to sway the decision making process of the courts and provide an alternative application of limited liability. However, ultimately as seen below they proved only to be slight obstacles in the way of the courts’ continued perseverance to preserve the Salomon doctrine.

There have been court decisions that have tried to ignore the Salomon doctrine and lift the corporate veil using the doctrine of Agency as a justification. The basis for this is where a subsidiary has merely been acting as an agent of the parent company. In Adams v Cape, the CoA held that an agency relationship between a parent company and its subsidiary could only be proven by evidence of an express arrangement to that effect and the subsidiary was instructed by the holding company to act as it did. Although the primary issue in Adams was one concerning jurisdiction and whether a United States’ personal injuries court’s award that used quantification techniques regarded as contrary to English principles of justice should be recognised in the UK, it is still highly relevant80. When the courts apply the Salomon doctrine, a registered company is not, per se, the agent of its shareholders even in situations where all the shares of that registered company is held by one entity. Every case needs to be construed on its facts81. It is conceivable that an agency relationship may be inferred from the facts based on the relationship between the parent company and subsidiary, but it must arise out of the circumstances and not from mere control of the company or of ownership of its shares. Determining whether such circumstances exist involves the court in a detailed factual examination in order to determine whether the company is carrying on business on its own account or on the account of a controlling shareholder which in this case will be the parent company 82.

Through Adams, the courts have now firmly rejected the justification of agency for lifting the veil of incorporation. Authorities have confirmed that the courts will not be willing to lift the veil of incorporation in order to set aside limited liability if an agency relationship can only be shown to exist in the factual relationship between the two companies.

80 J De Lacy, The Reform of United Kingdom Company Law (Cavendish, London 2003) 259 81 Smith, Stone & Knight Ltd v Birmingham Corp [1939] 4 All ER 116 Per Lord Atkinson at 121 82 B Hannigan Company Law (OUP, Oxford 2009) 59

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MOFESOMO TAYO-OYETIBO, 2010 Some decisions have also tried to justify lifting the corporate veil under the Single Economic Unit argument. The reason why the courts were prepared to lift the veil of incorporation under this justification was that where there was a group of companies that were legally distinct but essentially coexist as one single interdependent unit, the veil should be lifted to allow liability to flow to other members of the group. The CoA in Adams advanced a leading judgement on the application of this justification to corporate group concerns. Lord Keith said the Single Economic Unit argument was only relevant in situations where legal technicalities would bring about injustice in cases involving members of a group of companies. He also stated that the courts were in a position to lift the veil only where a defendant is using the corporate structure in an attempt to evade limitations imposed on his specific conduct by law or pre existing third party rights against him. He went on to say the veil will not be lifted to set aside limited liability if the rights of the third parties against the company were acquired after a legitimate incorporation of the company. The sense of Lord Keith’s judgement is that the veil of incorporation will only be lifted where the company is operating as a sham or acting as a facade, a principle already long established in Salomon. The veil will only be lifted where special circumstances exist indicating that there is a mere facade concealing the true facts.83 The principal authority on the application of the single economic unit justification is DHN Ltd v Tower Hamlets 84. In DHN the court was quick to ignore the rule in Salomon and therefore lifted the veil of incorporation in order to allow for what was regarded in the decision as an equitable result. The CoA was of the opinion that when presented with cases where there is the option of lifting the veil of incorporation to allow liability to flow, members of a corporate group should not be treated as separate so that the group was not defeated on a technical point 85. In the same case Goff LJ said the veil could be lifted between companies in a corporate group if the companies were wholly owned subsidiaries that had no separate business interests. Although the decision in DHN was followed in cases like Amalgamated Investment and Property Co. Ltd. v. Texas Commercial International

83 Adams v Cape Industries Plc [1990] Ch 433 84 DHN Ltd v Tower Hamlets [1976] 1 WLR 852 85 DHN v Tower Hamlets (n 82) Per Lord Denning at 860

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MOFESOMO TAYO-OYETIBO, 2010 Bank Ltd86 and Lewis Trusts v. Bambers Stores87 and has been described as a decision where the court ‘looked at the business realities of a situation rather than confining itself to a narrow legalistic view’, 88 most of the authorities succeeding DHN treated the decision with contempt. One of such cases is Ord v Belhaven Pubs Ltd89.

A comprehendible deduction from the Ord decision is that as far as common law is concerned, the principles upon which the court will ignore corporate personality and lift the veil of incorporation are almost completely inelastic. In addition to this, common law has no concept of the business enterprise or the economic unit.

The HoL in Woolfson v. Strathclyde Regional Council90 and the CoA in Multinational Gas and Petrochemical Co. v Multinational Gas and Petrochemical Services Ltd. and Ors91 limited the application of DHN and its use as a precedent. The views expressed by the CoA Multinational Gas in addition to the HoL decision in Woolfson indicate that the DHN decision was an aberration92. As a result, this has implicitly made the separate entity principle now practically ‘unchallengeable by judicial decision’ 93. It is suggested that impact of the decisions in Woolfson and Multinational Gas on UK company law can be considered in the same light as that of Salomon94.

Other authorities irreconcilable with DHN give weight to the idea that when companies are insolvent, the separate legal existence of each company within the group becomes more, and not less, important. It has also been held that lifting the veil under this justification will be adding to the exceptions set down in Adams,95 and the courts seem to currently be unwilling to do so. Earlier authorities before DHN like 86 Amalgamated Investment and Property Co. Ltd. v. Texas Commercial International Bank Ltd [1982] Q.B. 84 87 Lewis Trusts v. Bambers Stores [1983] F.S.R. 54 88 D Hayton, ‘Contractual Licences and Corporate Veils’ [1977] C.L.J. 12 89 Ord v Belhaven Pubs Ltd [1998] BCC 607, CA 90 Woolfson v. Strathclyde Regional Council (1979) 38 P. & C.R. 521 91 Multinational Gas and Petrochemical Co. v Multinational Gas and Petrochemical Services Ltd. and Ors [1983] Ch. 258 92 Rixon (n 14) 422 93 Re The Albazero [1977] A.C. 774, per Roskill L.J at 807 94 P Ziegler and L Gallagher, ‘Lifting The Corporate Veil In The Interests of Justice’ (1990) JBL 297 95 Barlow & Ors v Polly Peck International Finance Ltd [1996] 2 All E.R. 433

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MOFESOMO TAYO-OYETIBO, 2010 Kodak Ltd v Clark where it was held that a 98 percent shareholding of a company does not of itself result in an agency relationship for the consideration of a parent company and its subsidiary as one enterprise 96 and later authorities like Woolfson show a general hostility to the development of a notion of enterprise law by the courts97. These authorities have effectively put an end to the single economic unit argument as a justification for lifting the veil. They have also ensured that DHN is confined to its facts by authoritatively stating the instances qualifying as special circumstances where the veil will be lifted.

In conclusion, what can be construed from the authorities considered throughout this chapter is that the courts will usually look to widely apply the Salomon doctrine and will almost always favour the preservation of the legal principles of limited liability and separate legal personality unless special circumstances where there is evidence of a facade concealing the true facts exist. This is confirmed in Adams where Slade LJ said no matter what class of case, the courts are not open to disregard the Salomon doctrine merely because the court considers it ‘just to do so’. 98 Although some cases have tried to apply the separate legal entity doctrine more liberally than usually prescribed by the courts, eventually those stray cases were isolated. The consequence being that the policy of strict adherence to Salomon as an overriding precedent is preserved.

96 Kodak Ltd v Clark [1903] 1 KB 505 97 Dine (n 32) 45 98 Adams v Cape Industries [1990] BCLC 513

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CHAPTER 3 COMPARATIVE ISSUES The doctrines of separate legal personality and limited liability as they apply to corporate groups have been subject to criticism in almost every jurisdiction they have been introduced to. The basis of the criticism is not the economic efficiency of limited liability as limited liability has unarguably made much of economic progress in several jurisdictions possible.99 The negative effects on creditors and the misuse of limited liability through the corporate group structure have been the main points of criticism. Needless to say, striking a balance between these two interests is crucial to the effective regulation of corporate groups. Corporate groups have become remarkably significant in both the economy and society and this has served to refute any statements ignoring their practical importance. 100 The sheer complexity of corporate group structure makes limited liability in corporate groups very difficult to efficiently regulate.101 Outside the UK, some jurisdictions have relatively addressed this situation by paying due attention to this area of company law. This chapter focuses on the law in other jurisdictions regarding the regulation of corporate groups in order to emphasise that both the UK legislature and judiciary are non reactive to identified issues concerning the current law. Due to the many possible ways in which jurisdictions may structure their company law, any inter-jurisdictional comparison of the respective levels of corporate group limited liability regulation is particularly difficult. Such a comparison cannot be effective by positing a particular jurisdiction as a yardstick and asking whether the legal order in question provides for the same or 99 T Orhnial, Limited Liability and the Corporation (Biddles, London 1982) 12 100 Irujo (n 4) 67 101 EroÄ&#x;lu (n 10) 246

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MOFESOMO TAYO-OYETIBO, 2010 at least similar laws and rules. This can be done by seeing how best each system effectively caters for the main purpose the law was formulated.

GERMANY The fundamental philosophies underlying the regulatory frameworks of English and German corporate group law could not be more dissimilar. German corporate group law is primarily oriented towards the so-called group danger by stating that a legal entity controlled by another legal entity is particularly difficult to regulate. It is thought that in these said circumstances the parent company sacrifices the interests of the subsidiary entity on behalf of its own overreaching entrepreneurial interest and this in turn harms the subsidiary and its minority shareholders and creditors. Therefore the fundamental philosophy of German group law is to protect those categories of interests and to organise relationships within groups,102 with the German courts adopting a more balanced ‘solvency threatening’ parent intervention doctrine 103.

English company law on the other hand fails to recognise the inherent dangers of group structures, does not specifically organise corporate group relationships and is not as protective of a subsidiary’s creditors through company law as expected. The regulatory core of German corporate group law is laid down in the Konzernrecht.

Contained in it is the AktG (German law on stock corporations), applying primarily to controlled AGs (company limited by shares) and also the GmbH. The role of GmbH (company with limited liability) in corporate groups is not explicitly regulated and is thus more difficult to categorise, although the basic principles remain the same, 104 for this reason reference will only be made to the AktG in this paper.

German company law’s specific legislative provisions have been devised to deal with corporate groups. By making such special provisions the legislature unambiguously expressed the view that, in the case of a dependent company (AktG) the ordinary company law was incapable of protecting outsiders (minority shareholders and creditors in insolvency) against the dangers posed by such affiliation even if updated

102 Daehnert (n 19) 398 103 Kraakman (n 66) 141 104 Daehnert (n 19) 398

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MOFESOMO TAYO-OYETIBO, 2010 specifically to cater for corporate groups. 105 The German legislature wanted to secure the protection of outsiders of corporate groups. This protection is achieved through a very elaborate and specified system introduced in the Marketable Share Company Act of 1965.106 Pivotal to this system is a document referred to as a ‘dependency report’. This report is issued by the subsidiary's management board highlighting the relationship of the company to its affiliated enterprises; it is basically a dominion contract107. This report must contain all the affairs and transactions of the subsidiary carried out with other group companies, as well as all the steps that the subsidiary has taken in furthering or hampering the interests of these companies. These details need to be further specified, and the advantages and disadvantages of all the steps taken need to be described in detail. The parent’s group report must also make audited comments on such relationships with its subsidiary. This protective system was regarded by the legislature as being so effective that it was willing to grant the parent company an additional, exceptional benefit: the capacity to compel its subsidiary to partake in any detrimental measures or transactions, without the burden of having to immediately offset the disadvantages arising from such measures for the subsidiary. Instead, the parent company can determine when and how these disadvantageous engagements will be offset by other advantageous ones until the end of the latter's business year. In view of the duty to offset disadvantages suffered by the subsidiary, the report must also contain indications as to when and how this offset has taken place or how it is guaranteed 108. Where there is a dominion relationship existing between a parent company and a subsidiary without a dependency report/dominion contract, the parent company cannot force the subsidiary to act contrary its interests without incurring liability to the subsidiary for any losses thereby caused. This said, liability in practice is enforceable by minority shareholders of the subsidiary and creditors in insolvency109.

105 A Dunne, ‘Corporate Group Law for Europe: Forum Europaeum Corporate Group Law’ (2000) EBOR 1 Issue 2 171

106 P Hommelhoff, ‘Protection of Minority Shareholders, Investors and Creditors in Corporate Groups: the Strengths and Weaknesses of German Corporate Group Law’ (2001) EBOR 2, 67 107 Orhnial (n 99) 109 108 Hommelhoff (n 106) 67 109 Orhnial (n 99) 110

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MOFESOMO TAYO-OYETIBO, 2010 The protection afforded by the dependency report system was initially criticised for being overly complicated and costly. The system of documentation within the companies is time and energy consuming, and the annual auditing is costly.

Moreover, the whole system was regarded as ineffective for various reasons. It has been argued that there are more subtle ways than those suggested by the German legislature's cryptic "compelling" to induce the subsidiary's management board to act in the interests of the group as a whole. The decision of what should be viewed as disadvantageous is fundamentally economically and business laden and therefore hardly justiciable. The auditor who prepares the annual report in most cases also the one who prepares the reports of the parent company and this is by all means legal.

As a result of this, the dependency report can hardly be expected to be an effective safeguard for the dependent company. 110 In the past, all these considerations gave rise to the belief that the German requirement of a dependency report and its auditing should be regarded as a legal policy miscarriage. But more recent surveys, carried out over time, have clearly made them look more effective. Compulsion by the subsidiary's management board to require the inclusion of certain measures in the dependency report have resulted in some parent companies not compelling the subsidiary's management board to act carelessly so as not to potentially incur liability. Nonetheless, legal scholars and practitioners alike still approach the dependency report with considerable reservation, without however being able to devise an alternative system to cater for outsider protection for the dependent company that would prove viable. 111 It is worthy of mention that the protection of creditors in the de facto corporate group is to some extent differentiated. De facto corporate groups are groups where the parent company is not bound to its subsidiary by a dominion contract 112. The activities of the subsidiary in this case are also controlled in terms of personal decisions. Shortly after the entry into force of the Marketable Share Company Act 1965, the Federal Supreme Court of Germany rejected the idea of applying the dependency report system and the accompanying auditing procedures to de facto corporate groups for purposes of protecting the creditors of the subsidiary. The 110 Hommelhoff (n 106) 68 111 Hommelhoff (n 106) 69 112 Kraakman (n 66) 140

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MOFESOMO TAYO-OYETIBO, 2010 Federal Supreme Court decided that basic company law should rather be relied upon. The Court accordingly determined that the parent limited company is not allowed to overlook the interests of the dependent private company and thus cause harm to the latter. If the parent company acts in contravention of this, which emanates from its corporate fiduciary duties, it must compensate the resulting damages of the dependent company113.

Although German law on groups of companies is designed both to provide a framework within which groups can operate effectively, and to protect minority shareholders and creditors, it has been criticised for relying too much on a conflict model and on the protection of the subsidiary. It has been argued that it is not directed at achieving an even balance between the interests of the individual companies in a group and the overall interests of the group 114. In practice, these rules and procedures are not implemented with any particularly sufficient precision or detail115 but at least the foundation is there with the rules being in place, and the onus is on the regulators to ensure compliance. The German legislature considered the interests of shareholders and creditors to be inadequately covered and continuously endangered, that they believed that the existing company law was incapable of satisfactorily providing the requisite protection. Therefore, it was deemed necessary to introduce a system of protection that would, to a certain extent, be independent from existing general company law, in order to guarantee effective protection for minority shareholders, i.e., outside investors, as well as creditors of the subsidiary in dependent subsidiary companies.116 In contrast, English company law does not regard protection of these interests through company law as paramount. The common law may on occasion indirectly cater for these issues when the veil is lifted, nevertheless any presumption that these interests were the rationale for lifting the veil may be regarded as mythical. This is because they are not persuasive considerations when English courts are trying to lift the veil and in the absence of a facade concealing the true facts the veil is not likely to be lifted.

113 Hommelhoff (n 106) 71 114 M Andenas and F Wooldridge, European Comparative Company Law (CUP, Cambridge 2009) 452 115 Wirtschaftsprufer-Handbuch (1996), Vol. 1 (Dusseldorf) 506 116 Hommelhoff (n 106) 62

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MOFESOMO TAYO-OYETIBO, 2010 The approach of the UK judiciary to corporate groups is described as contractually based above and the same can be said of German group law because of the dependency report. Yet, despite this seemingly similar approach by the two jurisdictions to group law in theory, they are fundamentally different in practice. The UK courts treat entities within corporate groups as contractually linked without really compelling them to actually base their relationships on contract. This gives rise to a situation where there are in theory legal solutions to a problem that is virtually inexistent in reality or practice. German law on the other hand imposes a contractual based relationship on corporate groups. Where the fundamental difference lies, is that German group law theoretically dictates corporate group relationships and also has the added security of practical regulatory solutions where the corporate groups misuse corporate form. Even in de facto groups where German law ignores the contractualist approach, there are still safeguards to regulate the control of subsidiaries by parent companies. The rationale behind the German system is the identification of the factual and economic reality of the group structure. It recognises that corporate group structures are not purely legal phenomena and where appropriate they should be treated as such. The provisions of the company law are adapted (mainly by progressive judicial interpretation) to the special features of corporate group matters in order to deal appropriately, effectively and flexibly with the dangers to minority shareholders and creditors which arise within a group situation. 117 This model of group law on limited liability and separate legal personality has to be seen as the first and probably lasting attempt to diminish greatly the role of traditional “piercing of the corporate veil” in the corporate group context, 118 and although it provides several mandatory organisational and control rules, the fundamental principles of separation and limited liability are not sacrificed in order to eliminate given group dangers,119 this is what UK company law on corporate groups is in need of.

TURKEY

117 Dunne, (n 105) 174 118 K Hofsstetter, ‘Parent Responsibility for Subsidiary Cooperations: Evaluating European Trends’ (1990) International and Comparative Law Quarterly 579 119 Daehnert (n 19) 400

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MOFESOMO TAYO-OYETIBO, 2010 The law in Turkey on corporate groups is identical to that of the UK. Just like in the UK, there is no direct rule that allows the courts to lift the corporate veil in case of misuse of the corporate group structure. The courts base their decisions on rules pertaining to good faith. In the case of a breach of good faith rules, Article 2(1) of the Turkish Civil Code states that ‘every person is bound to exercise his rights and fulfil his obligations according to the principles of good faith’. The courts might lift the corporate veil and make a parent company liable to its subsidiary’s creditors based on the facts of the particular case. In this instance, judges will look at whether conditions separating corporate personality and limited liability are used in breach of good faith. Article 2(2) of the same Civil Code stipulates that ‘the law does not sanction the evident abuse of a person’s rights’. This regulation might be used by the courts to ignore the corporate veil in cases where the corporate structure has been misused, in the absence of clear principles provided by either statute or case law, in order to solve the problem of misuse (by individual shareholders or the parent company) of corporate personality and limited liability. Therefore, the courts have to use good faith principles to balance the situation of misuse of limited liability. In a recent decision, the Turkish Supreme Court built its justifications for lifting the corporate veil on the foundations of good faith principles, stating that the law does not protect the misuse of limited liability and separate legal personality. 120 Moreover, in another Supreme Court decision, while deciding on the personal bankruptcy of a person, the Court stated that the person owned shares in a number of companies and that this fact was sufficient to classify him as a trader, which would make him eligible to be declared bankrupt. This decision is also presented as an important application of veil lifting in Turkey. This as an indication that the Turkish judiciary is following inter jurisdictional developments and becoming more open to adopt developments from other jurisdictions into their corporate law. The Turkish courts give weight to extralegal considerations based on good faith principles where necessary if a strict application of the general law as it applies will bring about a curious end result. As has been previously stated above, this is not a position favoured by the UK courts. Some peculiar circumstances make extra-legal considerations like good faith relevant when trying to reach a just result, incorporating this into UK company law may have more benefits than burdens.

120 Yargıtay [Supreme Court] 19. HD. 2005/8774E and K. 2006/5232 (15 May 2006) in M Eroğlu, ‘Limited Liability in Turkish Law’ (2008) EBOR 9 248

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SPAIN The Spanish proposal for a corporations’ code includes some interesting proposals that may be applicable to UK company law if a few practical adjustments are made.

The proposal addresses the public nature of the corporate group and the management power of the parent company and also establishes protection measures for external shareholders and the creditors of the subsidiaries. The type of corporate group system acknowledged in the proposal is a hierarchic or a legally vertical one. Providing the parent company with managerial power means that its directors can dictate binding instructions to the subsidiary’s directors. If these instructions then go on to have a damaging effect on the subsidiary, the subsidiary is entitled to suitable compensation from the parent company. This proposed system is based on an individualised compensatory view, giving a damaged subsidiary restitution in cases where the damage is a direct result of exercise of managerial power by the parent company. This proposal recognises that no matter how a parent group legally relates with its subsidiary, it will in actual fact always have a highly persuasive influence on the subsidiary even if they appear legally distinct. This is a factual reality that the UK courts seem to be unwilling to embrace.

As regards the creditors of the group’s companies, the parent company will be held liable for any debts of the subsidiary, provided the latter declares its connection to the group when it incurs the debt. Finally, the proposal also acknowledges the liability of the parent company’s directors in relation to the subsidiary, its members and creditors as regards damage caused to the subsidiary’s directors without adequate compensation121. Generally, this proposal presents a relatively robust legal framework for the regulation of corporate groups that allows for the recognition of the relationships that subsidiaries have with their parent companies in fact. But on the other hand the consequences that are attached to mismanagement on the part parent company are draconian and are likely to inhibit company investment. This is because the remedies open to the creditors of the subsidiary are too wide reaching.

This is not to say that the proposal is not practical but for it to be workable, a fine balance will have to be struck between stated regulations and preserving the interest

121 Irujo (n 4) 87 32

MOFESOMO TAYO-OYETIBO, 2010 of investors. Considerable weight will also have to be given to economic considerations.

The approaches of the above considered jurisdictions to corporate group regulation show that a suitably balanced combination of regulation and autonomous will, which seeks to defend corporate freedom and protect weak interests at the same time, is needed in UK company law. As far as corporate groups are concerned, the balance criterion may be useful in building a trustworthy regulatory framework. This would bring further legitimacy and avoid the indiscriminate application of criteria such as the ‘lifting of the corporate veil’, which is inadequate to suitably reflect intrinsic corporate group complexities.122 Furthermore, the major focus of English group law is on the question of liability, while publicity, legitimacy and accountability questions have just peripheral roles to play. 123 Lord Halsbury made clear in Salomon that whether the result reached was “right or wrong, politic or impolitic” 124 was irrelevant because pragmatism had no role to play125. This theme was also emphasised by the CoA in Adams v Cape Industries, where Slade L.J. stated, “save in cases which turn on the wording of particular statutes or contracts, the court is not free to disregard the principle of Salomon v Salomon merely because it considers that justice so requires”126. For any suitable group law to be applied, this strongly persuasive theme will have to be at the very least varied.

122 Irujo (n 4) 75 123 Daehnert (n 19) 398 124 Salomon v Salomon [1897] A.C. 22 at 34

125 L Linklater, ‘"Piercing the Corporate Veil" - The Never Ending Story?’ (2006) Comp. Law 27(3) 65 126 Adams v Cape Industries [1990] Ch. 433 at 536

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CHAPTER 4 OTHER OUTSTANDING ISSUES There are several reasons why the current law on limited liability and separate legal personality as they apply to corporate groups may remain unchanged for the foreseeable future. Several factors influence the preservation of the separate entity doctrine and hinder any potential fettering of the current law. The problems associated with the common law have been identified by the judiciary as seen above. Nevertheless, no authoritative solutions to those problems have been enunciated as yet. Outside of the courts, there is still a continued ignorance of the issues with the current law. The Steering Group in its Final Report on Company Law Review discussed the current law but ultimately concluded that no reform was needed because of the potential problems in defining the circumstances where the use of limited liability should be regarded as abusive by corporate groups. 127 Reform of corporate group law, is generally viewed from the perspective of corporate insiders (essentially directors and shareholders). Attending to corporate insider needs is seen as priority, as opposed to those on whom group corporate activity has an adverse impact. The familiar inherent issues with the modern case law on lifting the corporate veil in the case of corporate groups is simply ignored, as well as any proper comparative law assessment of the differing approaches of other legal systems.

A structured, specific and systematic regulatory framework is needed to suitably govern corporate groups and systematically protect minority shareholders and creditors of a subsidiary within a group. As with all systematic legislation, regulation would provide not only obligations but also legal certainty which would benefit the 127 Company Law Review Steering Group, ‘Modern Company Law for a Competitive Economy: Final Report of the Company Law Review Steering Group’ (DTI, URN 01/942 and 01/943, July 27, 2001)

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MOFESOMO TAYO-OYETIBO, 2010 management of groups operating nationally and even more so groups that operate internationally. A corporate group law could, therefore, facilitate the work of company management.128 The dissolution of legal boundaries within an integrated economic organization to create a new single basic unit is probably not the most effective solution to the problems with the current law. This is because it is the devolution that exists in corporate groups that makes them efficient as a group.

Having said all of this, in all likelihood, the current common law regime is likely to remain intact without the sanction of parliament. 129 Whether the priorities of economic order, such as the protection of capital, free market competition and the interests of specific economic sectors need to be balanced against those of public interest, particularly those of workers and creditors, in framing company law group specific limited liability legislation is a normative question. The case law suggests that, a whole range of societal and economic aspects are ignored when the courts are trying to reach a decision on corporate group issues. For the legislature to resolve the identified issues with the current common law, this will have to change, if the lawmaker is to remain in tune with developments in society and economy 130.

The issues with the current law are not wholly internal. Inter-jurisdictional obstacles add to the conundrum UK law already faces; effective regulation of corporate groups.

The current common law struggles to deal with cases where the claimants, subsidiary or even parent company are foreign. In considering whether to lift the corporate veil, jurisdictional issues often play an important role because they can determine whether the corporate veil is lifted at all. The HoL in JH Rayner (Mincing Lane) Ltd v Department of Trade and Industry concluded that English company law does not impose any liability for a subsidiary’s debts upon the parent company. If such liability does exist, it exists in international law which is not enforceable in English courts.131 This proved decisive because ultimately, the corporate veil was not lifted in this instance. This case is an example of how jurisdictional complexities can operate to frustrate the effective regulation of cross border corporate groups.

Litigants can also encounter problems in trying to enforce foreign judgements. In 128 Dunne (n 105) 171 129 A Walters, ‘Corporate Veil’ (1998) Comp. Law 19(8) 227 130 Orhnial (n 99) 66 131 JH Rayner (Mincing Lane) Ltd v Department of Trade and Industry [1990] 2 AC 418

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MOFESOMO TAYO-OYETIBO, 2010 Adams v Cape the issue was whether a United States’ personal injuries court’s award that used quantification techniques regarded as contrary to English principles of justice should be recognised in the UK. The CoA held that for the purposes of enforcement of a foreign judgment, a defendant will only be regarded as falling under the jurisdiction of the foreign court where it was present within the jurisdiction or had submitted to such jurisdiction. This was echoed in Harrods Ltd v Dow Jones & Co Inc because the defendant had not established a place of business in Great Britain132. These two cases are good examples of problems with regulation of multinationals. In the two cases, the court required physical presence of the company in the UK. Corporate groups, in reality do not always establish branded subsidiaries in several jurisdictions in order to be present. Some multinationals are economically present in host jurisdictions without having branded jurisdictions as they can maintain effective presence in the jurisdictions through agents. As seen above, an agency relationship is insufficient evidence to hold a parent company responsible for the acts of its subsidiary. In essence, the fact that a company is not present in a jurisdiction through a branded subsidiary, notwithstanding the fact that it may be flourishing economically through an agent will be insufficient to hold a company responsible for the acts of its agent in the host jurisdiction. This is a crucial point which Adams and Harrods miss. In such situations, as evidenced in both decisions, despite heavy presence of a parent company in a host jurisdiction through an agent, the parent company is unlikely to ever be held responsible due to its lack of presence through a subsidiary. These kinds of inter-jurisdictional concerns in addition to the sheer size of some multinational corporations make corporate group regulation particularly difficult where more than one jurisdiction is concerned.

In the EU, company law is a matter for the national law of each State, as it is throughout the world133. While national company laws within the EU are, similar in structure as well as in some details, there are considerable differences in the company laws applicable to corporate groups. The differences lie in the legal attitude to and the evaluation of the corporate group concept 134. This situation creates enforcement issues and a situation where litigants indulge in forum shopping for 132 Harrods Ltd v Dow Jones & Co Inc [2003] EWHC 1162 133 Dunne (n 105) 167 134 A Dunne, ‘Corporate Group Law for Europe’ EBOR 1; 169

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MOFESOMO TAYO-OYETIBO, 2010 suitable jurisdictions. For example, in an intertwined group situation, the effort and resources required to disentangle assets and debts, litigate, obtain the information, all in an international arena, will be overwhelming for the national level and will place an extensive burden on the insolvent estate.

The European Union has not managed to adopt a complete corporate group regime in the field of company law, despite the great efforts that were put into the production of a specific directive that ended up collapsing. 135 There is a committee called the Forum Europaeum Konzernrecht (Forum Europaeum Corporate Group Law) consisting of a group of numerous European legal scholars who develop theses and recommendations for a European corporate group law. The Forum Europaeum in its Corporate Group Law for Europe proposal puts forward principles and proposals for a harmonised European corporate group law. 136 The forum focuses on the adequate protection of minority shareholders and creditors of controlled group companies 137.

The Forum Europaeum proposes that the regulation of corporate groups in Europe should be based on the concept of "control" as defined in Article 1, paragraph 1of the Seventh EU Directive. Under that Directive, one company is in control of another company if it has a majority of the voting rights, has the power to appoint or remove majority of the members of the board of directors or the supervisory board, or has the right to exercise a dominant influence pursuant to a contract entered into with the controlled company or pursuant to a provision in the controlled company's constitution.

In a situation where the subsidiary company is in danger of not being able to settle its creditors or can no longer settle its creditors, the Forum Europaeum proposes an obligation on the parent company to either rescue or wind up a subsidiary company that has reached "crisis point". That is, where the subsidiary has "no reasonable prospect" of avoiding insolvency through its own resources. A holding company which fails to act in these circumstances would be liable for any consequential losses of the subsidiary. An alternative proposal is to impose this liability only where a

135 Irujo (n 4) 66 136 J Kluver, ‘European and Australian Proposals for Corporate Group Law: A Comparative Analysis’ (2000) EBOR 289 137 Kluver, (n 136) 291

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MOFESOMO TAYO-OYETIBO, 2010 parent company has exercised actual control over the subsidiary. 138 The Forum’s proposal is designed to provide for legal certainty and practicality and to be in harmony with the existing national laws of the Member States. 139 An examination of the EU Company Law Action Plan reveals that the European Union has no intention of paying any more attention to principles of limited liability as it applies to corporate groups. In fact, the Action Plan prioritises share capital and corporate governance problems.

140

As a result, it will be unreasonable to expect any persuasive influence

on the review of UK corporate group law form the EU. Devices are needed to link foreign proceedings and safeguard foreign creditors. A Universalist approach to corporate groups may be useful in achieving this. This will essentially adopt a global perspective on international insolvencies.

Ordinarily, with regard to single entities, this approach aims for the administration of multinational insolvencies by a single court applying a single insolvency law. In the scenario of a multi-forum, multi-law world, however, the idea is that courts will apply a ‘modified universalist’ approach, seeking a solution as close as possible to this idea.141 Thus, handling the insolvency proceedings could take a worldwide approach which will also maximise cooperation among courts. Universalistic concepts and tools should therefore be promoted within a national framework with regard to corporate groups. This can assist in nullifying some jurisdictional complexities that arise as a result of international insolvencies in a way that enhances the needed coherence between foreign proceedings.142 Mevorach is of the opinion that there is a contrast between the desire to find ways of connecting between the components of a corporate group and in certain cases lifting the corporate veil on the one hand, and the obvious demands on behalf of traditional 138 Kluver (n 136) 308 139 Kluver (n 136) 291 140 Eroğlu (n 10) 264

141 JL Westbrook, ‘A Global Solution to Multinational Default’, (2000) 98 Mich L Rev 2276 in I Mevorach, ‘Appropriate Treatment of Corporate Groups in Insolvency: A Universal View’ (2007) EBOR 8, 185 142 I Mevorach, ‘Appropriate Treatment of Corporate Groups in Insolvency: A Universal View’ (2007) EBOR 8 185

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MOFESOMO TAYO-OYETIBO, 2010 corporate theory that the integrity and distinctiveness of the corporate form will be respected, on the other. Hence, a balance needs to be struck between the need for a compatible approach and the promotion of commercial enterprise, considering the characteristics of corporate groups, the different policies regarding this issue and the various possible circumstances and scenarios that may exist in any given case. A suitable way of achieving this is the use of flexible and specific framework that appreciates the peculiarity of corporate group situations. This should be based on the functional structures related to the implementation of insolvency laws, in addition to preserving the virtues of corporate personality and limited liability. Interventionist mechanisms involving lifting the veil should demand close assessment of the circumstances and should be applied in exceptional and well-defined cases. These will in effect facilitate corporate groups’ insolvency proceedings and provide appropriate remedies within the insolvency regime, while at the same time preventing the current potential abuse corporate form. One derivative of this notion is that the boundaries and the consequences of the use of corporate form in the context of corporate group insolvency will be better formulated. Only then, will there be an opportunity to strike the right balance between insolvency goals and traditional corporate theory. In considering policy options for domestic approaches, both national and multinational groups should be considered. It is crucial to make sure that corporate groups cannot evade legal consequences or be deprived of the benefits of any proposed approach, if certain parts of the group are located in a separate jurisdiction. This is especially relevant due to the lack of a comprehensive international model for this issue and the increasing number of multinational corporate groups due to globalisation143.

CONCLUSION Given the limitations of the current common law system in the regulation of corporate groups, it is suggested that at least in the case of parent/subsidiary relationships, where the parent company is the controlling shareholder, the principles of limited liability and separate legal personality may be fettered and making the parent company liable for the acts of its subsidiary. For example in some EU states, a 143 Mevorach (n 142) 184

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MOFESOMO TAYO-OYETIBO, 2010 parent company’s liability for its subsidiary debts may be based on familiar doctrines like agency or tort. In the Netherlands, a Dutch parent company acting as a director of its subsidiary can potentially be held liable in tort towards its subsidiary’s creditors if a breach of duty of care towards them is found by the courts. If the parent company permitted the subsidiary to incur debts when it was aware that the claims of the creditors of the subsidiary could potentially remain unsatisfied 144 and if a parent company has involved itself to a considerable extent in the subsidiary’s affairs without having proper regard to the interests of the creditors, it may incur tortuous liability even if it is not a director of the subsidiary145 The principle of limited liability is one of the foundations of modern company law and one of the most important justifications for its creation was the separation of ownership and control. With regards to large parent corporations who incorporate numerous wholly owned and most likely wholly controlled subsidiaries, this justification is belied. As a result, these parent corporations should not be afforded high level protection under the limited liability doctrine when the corporate group structure is used to expose involuntary creditors who do not possess the information or the means to safeguard themselves against risk, as opposed to consensual creditors to unwanted risks.

It is...unrealistic to adopt the view that the relationships between the constituent parts of the group are entirely a matter for contractual agreement...There is a need for both national and international regulation to protect the legitimate interests of the principal parties involved in group transactions, notably those of external investors, employees, voluntary and involuntary creditors or consumers and the host and home state of the enterprise involved 146 Even if courts apply the veil-piercing rules consistently, this consistency does not necessarily mean that the rules are as effective as they should be. The Legislature will always be in a better position to formulate laws than the courts because they 144 Judgement of 19 February 1988, HR 1988, NJ No. 487 In M Andenas and F Wooldridge, European Comparative Company Law (CUP 2009 Cambridge 481 145 Judgement of 18 November 1994, HR 1995, NJ No. 170 in M Andenas and F Wooldridge, European Comparative Company Law (CUP 2009 Cambridge 482 146 T Hadden, ‘Regulating corporate Groups’ in J Dine The Governance of Corporate Groups (CUP, Cambridge 2006) 39

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MOFESOMO TAYO-OYETIBO, 2010 receive input from interested parties and others, allowing for a more robustly formulated law. The judiciary on the other hand suffers from an adverse selection problem because only unsatisfied creditors will bring their claims before a court.

Court enunciated rules are less likely to take account of the rules' effects on firms have not had claims brought against them. Therefore, although a limited veil-piercing power is an excellent equitable power for the court to use to prevent ‘extreme’ abuse of the corporate form, continued allowance of its widespread as opposed to a set of pre-determined corporate group specific rules creates too much uncertainty in a bustling market-place that requires firm rules.147 Given the fact that the principle of lifting the corporate veil is practically as firmly entrenched in company law jurisprudence as the principle of limited liability, a slight variation of the principle would not constitute a radical departure from the well established principle of limited liability, but will allow for better corporate group regulation. 148 It is crucial for UK law to recognise limited liability and separate legal personality as privileges resulting directly from the clear distinction between the shareholder and company assets been separately maintained and this must not be abused 149. The dogmatic basis for this misuse doctrine is a teleological reduction of the limited liability privilege; in specific circumstances, shareholders are directly exposed to creditors. There should be strong consequences for such misuses as this could further strengthen the separation principle. The removal of assets, preventing the company from fulfilling obligations are creditor harming actions that need to be addressed by the law and where necessary, such actions should be penalised by lifting the corporate veil. 150 Any regulation of corporate groups should establish legitimacy for the promotion of interests and legal safety for corporate group specific operations, in addition, measures will also have to be put in place for the protection of those that may suffer from the primacy of the group’s interests over those of the constituent companies 151.

147 Price (n 61) 457

148 Ashwin (n 60) 178 149 H Roth, ‘Gläubigerschutz durch Existenzschutz’ (2003) 23 Neue Zeitschrift für Gesellschaftsrecht 1081 150 Daehnert (n 19) 401 151 Irujo (n 4) 71

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