Corporate Law Principles versus Corporate Groups

Abstract: Applying the traditional corporate law to regulate the contemporary corporate groups is considered to be the main cause of inconsistencies and gaps between law and reality in the field of corporate groups law. The current law of the corporation and its basic principles cannot fulfil its purpose in today’s business world. Although some countries have made gradual progress in recent years to some extent, there still has not been a systematic and comprehensive reform of the corporate group laws. It could be said that this situation is the same in most countries. In the context of the present regulation, the corporate groups’ relations are governed by positive law such as civil code and company act, case law and other sector’s laws, respectively. Regulations that are considered internationally innovative and advanced are generally based on the principle of enterprise law approach.

I. Introduction

This paper concerns the most common form of modern business that is called corporate groups. Corporate law is one of the most converged fields of law throughout the world. The fundamental legal principles and issues around corporation are generally similar in most countries, so it is common for corporate law to be studied within the scope of comparative law. However, in most of the countries, the research on the corporate law of the group is relatively less and so far, it has not reached an efficient legal solution. Generally, its fundamental issues still have not been resolved at the legislative, judicial and doctrinal level in world jurisprudence. So that, summarizing and reviewing would help to recognize the reason for the failure. Therefore, the purpose of this article is to introduce and review the global trends in corporate group law by comparing the legal regulations of such jurisdictions like the European Union, the United Kingdom, German, the U.S, Australia and New Zealand etc.; they represent the legal families as well as sources of the most literature reviews. In the introduction to this paper, we will have an overview at the phenomenon of corporate groups, current legal issues and challenges facing the corporate group; in the main section, the traditional veil lifting mechanism, the laws and regulations of the countries and common law cases will be described respectively.

The vast majority of current business participants are involved through the form of a legal entity called a company, many of them conduct their business under the structure of a corporate group. The group has also mostly become conglomerates, multinational and transnational corporations. For example, as of 1997, 89% of companies listed on the Australian Stock Exchange (“ASX”) were parent companies, with an average of twenty-eight subsidiaries each¹, while the fifty largest corporations in the UK had an average of 230 subsidiaries and their dependent companies². According to World Investment Report 2019 by the UN, the total assets of multinational enterprises’ foreign affiliates grew up to 110468b from 6202b dollars in 1990 and 2018 respectively while employment of these foreign affiliates reached approximately 76m in 2018 that was around 29m in 1990³.

Then there is the question of how to regulate those aggregated companies which the key players in the economy and business.

With regard to this question, Blumberg, a leading scholar of corporate group law, was writing two decades ago as ‘corporate law and theories of the corporate personality shaped long before to serve the needs of a much different world have become antiquated. New corporate law and new corporate theory are required to respond to the challenge presented by corporate groups to the legal systems of the world’⁴. It seems that there has been still no systematic change and reform in corporate group law worldwide. It is clearly seen in the following parts that commentators representing different jurisdictions have acknowledged the same situation. Blumberg’s statement is supported by Meredith Dearborn from University of California writing as:

‘in today’s world, globalizing investment patterns have generated massive corporate webs that may involve layers of subsidiaries, loosely affiliated corporations, subcontractors, and other structurally complex corporate arrangements; moreover, corporate groups frequently cross national borders. The ordinary concepts of piercing and limited liability do not fit easily into this new reality.⁵

The present law still fails to appropriately regulate corporate groups. Piercing the corporate veil has been used as an only single exception to the limited liability. Creating subsidiaries and controlled units might be used as a vehicle to avoid and ignore liability. Parent companies use limited liability by incorporating a controlled unit to run a risky business. Most frauds and fails vis-à-vis corporate groups in banking, finance and insolvency case. Parent corporations externalise the risk of tort liability on intention through legally formed, separate, controlled subsidiaries.

The principle of the corporation’s limited liability and separate legal personality have been the basis of the development of corporate law in countries, and investors are protected by the concept of limited liability. This principle is commonly shared in all over the jurisdictions because it is regarded that it attracts investment and is one of the legal factor of modern economic development. Blumberg observed as ‘limited liability had won political acceptance when corporate groups were unknown. Limited liability for shareholders presupposed a world in which the corporation constituted the enterprise and the shareholders were investors in the enterprise. The doctrine protected the investors from the risks of the business’⁶. Behind limited liability, there are more and more limited liabilities for the parent. This multiple liability protection raises questions for corporate groups. The limited liability principle, the main governing principle of the corporation, extends to situations in which a corporation is the owner of another corporation. Commentators have concluded the situation as:

Corporate groups dominate the modern commercial landscape. Most major business enterprises are operated not by individual companies but by groups of associated companies. Each group functions as a single economic unit, with the activities of its corporate members being coordinated and controlled so as to further the interests of the group or, more accurately the interests of the group controllers. The law recognises the separate personality of each group member but largely ignores the group structure within which those member companies operate. This legal myopia gives rise to a complex set of problems for persons both within and outside corporate groups⁷

In recent years, academic scholars have been recognizing at a greater extent that the corporate law of the group is lagging in business and due to inadequate and absence of regulation, it is still necessary to reform the law. The previously mentioned countries are considered to be relatively proactive in regulating group companies, but on the other hand, it is criticized that policymakers and courts have not been making a substantial progress in this field due to potential risks to the economic and business sector, the lack of legal framework and uncertainty of the legal principles. Most large businesses are run by a group of companies, not by individuals. In reality, the group exists as economically unified and manages the activities of the member company of the group for the sake of the interests of the group or the interests of the parent company.

The practical reality of how groups operate can be very different from strict legal form. In many instances, at least in the minds of the controllers, a corporate group is perceived and run as a single entity. There may be only one CEO and one CFO for the group, and all or most employees of the group may be employed by one or a few entities within the group. Also, for good commercial reasons, particular individuals may be on the boards of both the parent and one or more subsidiaries. The tension between legal form and commercial reality is particularly evident in considering the issues for directors and other officers where the business of a corporate group is conducted through subservient subsidiaries⁸.

General company law recognizes the characteristics of individual company as a separate legal entity but neglects specification of structure, operations, and liability of the group that those companies form. General company law contains a limited number of provisions that govern the corporate group. Currently, the most certain and global regulatory framework of the group law can be considered to be a regulation on accounting reports. While the law and lawyers still pay attention around the individual corporation law accountants have recognised realistically the issue and took legislative measurement; that adapted into most jurisdictions. In accordance with corporate acts, at the end of a financial year parent corporations have to prepare consolidated group accounting report.

In a nutshell, the fact that one person is economically but different in legal liability is considered unfair. This ‘legitimate blindness’ causes many problems between the corporate group and its small shareholders and outsiders. Prof. Ochi-Ai Sеichi from Japan concluded that the issue of corporate group legal regulation is one of the challenging issues of modern company law, and there is no single country in the world that has fully solved it⁹:

However, just criticizing the shortcomings of corporate law in Japan is not effective here. Because globally, there are a small number of countries that have established comprehensive corporate group law, and there is no guarantee that the law governs this corporate group efficiently. In that sense, the development of comprehensive and effective corporate legal norms is one of the urgent legal issues in today’s company law. Identifying the current situation is the starting point for seeking solutions to this problem.

He also noted that Japan’s corporate law may be incomplete or only partial in terms of group management and that due to the fact that current corporate law regulation has not yet been established it is a great difficulty to govern a corporate group in practice, as is generally the case for other countries¹⁰. Briefly corporate groups are out of control. Jose Antunes, a professor of Portuguese law, explained that one of the reasons why corporate law is so controversial as regulating a corporation as an autonomous and independent entity and, at the same time, to consider its status as a controlled and dependent one, seems, at first sight, a contradictory regulatory task, impossible to achieve in a single area of law¹¹.

As a distinct and more complicated form of entity, corporate groups present special problems that require exceptional consideration. It is, however, stated by scholars that there are needs to re-consider traditional corporate law applying to corporate groups. For instance, it was summarised by Haden:

‘…the group rather than its individual constituent companies is the significant entity for managerial, accounting and investment purposes. But the law is still focused almost exclusively on the individual company. It is consequently increasingly difficult to apply in practice. There are no clear rules on the liability of the group for the obligations of its constituent companies. And there is virtually no legal control at all on the complexity of the group structures which may be established with a view to concealing the true state of affairs within a complex group’¹².

Also Blumberg stated it as follows:

Over the years, the scholarly discussion of the jurisprudential nature of the corporation has been enormous. …Unfortunately, the commentaries, without exception, discuss the corporation in its early nineteenth-century model of a single corporation owned by shareholder-investors. None deals with the contemporary problems of the jurisprudential nature of the modern large corporation organised in the form of a group of corporations collectively conducting the enterprise.¹³

Additionally, Ian Ramsay, professor of Melbourne University, justified this conclusion as ‘…the tension between the traditional legal principle that treats each company in a corporate group as a distinct legal entity with its own interests, and commercial reality- which commonly involves participants within a corporate group, and creditors dealing with companies within that group, focusing on group principles rather than individual companies’¹⁴. Meanwhile, Virginia Harper Ho from the U.S, stated the theoretical and practical backwardness of corporate law as ‘in considering such rules, theories of corporate groups can play a formative role. However, traditional theories of the corporation that have been articulated only at the entity level continue to be applied by courts and analyzed by scholars as if they can be translated seamlessly from the entity to the enterprise level. Yet unlike a discrete business entity, the “enterprise” reflects an economic reality more than a legal one. At the level of theory, the effect has been a gap between the literature articulating theories of corporate identity, described and defined most often with respect to a single legal entity, and work on established theories of the firm. Moreover, recurrent debates over the nature of corporate identity as a matter of theory have begun to lose their original connection to the realities of corporate practice in a world dominated by corporate groups’¹⁵.

Enterprise liability

Many scholars and commentators have suggested enterprise liability theory which views the corporate group as the corporate group as a singular unit rather than viewing each subsidiary as a separate legal entity. They conclude that enterprise liability seeks to settle down legal and economic realities more that entity theory in case of the corporate group. The reason of enterprise liability may be seen as more realistic is that it is based on economic situation rather than legal fiction. Dearborn stated that:

In contrast to entity theory’s formalism, enterprise liability seeks to marry legal and economic realities. The legal entity of the limited liability corporation has contours that are different from the economic fact of the enterprise-a gap that enterprise liability attempts to close. As one commentator put it: The economic entity does not have any corporate charter. It is an economic choice of management. It ties in legal entities for operation in a common endeavor or enterprise. The idea behind economic entity is joinder or merger of activity-unity of life-in the goal of the common the undertaking or enterprise. In an economic entity, each legal entity has dedicated itself and its property to the success of the common undertaking. Since subsidiaries (especially wholly-owned subsidiaries) at least theoretically act for the benefit of the corporation as a whole, enterprise theory follows the profit and holds the various corporate actors in a given web accountable for the actions of other actors.¹⁶

In addition to its economic compatibility, the fairness and moralistic approach of the enterprise liability law overweigh its counterarguments. The most important point to note is that most commentators who advocate for enterprise liability propose the principle in only certain ‘emergency’ field. Namely, Blumberg and Dearborn did not suggest elimination of limited liability in all situations. Mass tort, environmental damages, human rights violation, insolvency, bankruptcy issues are ‘emergency’ fields which are more likely effected by the group when the corporation externalises risks. Those corporations in ultrahazardous industry are mostly giant corporate groups, and they are usually involved in potential harms in environment, human rights violation and torts. When the social responsibility or corporate liability issues arise, those affiliated, controlled corporations just transfer nearly all of its assets into the parent corporation existing overseas just before declaring bankruptcy to escape liability. So that, Dearborn claimed as these represent the most troubling instances of the public’s absorption of the cost of doing business¹⁷. This contour is derived from the case law and academic literatures. For instance, Dearborn wrote as the following while she proposed her true enterprise liability for tort liability.

These tort-based concerns are at their sharpest when mass personal injury torts, environmental harms, and human rights violations are at issue. These harms carry the most normative weight and impose the greatest costs on society. In addition, they are the most likely causes of bankruptcy for a subsidiary or affiliate tortfeasor, as the subsidiary or affiliate is usually not insured against, nor adequately capitalized for, harms of this magnitude. If the subsidiary cannot pay for the damages caused by the tort or harm, the tort victim’s only option is to proceed against the corporate shareholder-the parent corporation.¹⁸

Much scholarly literature suggest that the application of enterprise principle of liability is difficult, since the structure, control, relationship and interconnected activities of a corporate group are diverse. Witting and Rankin apparently posited that statement by writing as ‘there are various problems with enterprise liability, which substantially weaken its potential in resolving problems of insolvent subsidiary liabilities. At the most general level, there is a lack of criteria in determining whether or not companies are sufficiently economically integrated. This blends into a second problem, which is the potential cost of evidence-gathering and expert opinion in determining that issue. But a more fundamental problem is that it does not seem possible to allow the enterprise liability ‘genie’ only half way out of the bottle. This is to say that the results of an inquiry into economic interdependencies might be that ‘everything is connected to everything else’ and that there is no confining the enterprise to any pre-conceived notion of the corporate group’¹⁹. Perhaps this is one reason why the principle is still unanimous. However, we may disagree with these findings, because it is not so important to determine the existence of a group structure, internal relationships or genuine control when adopting the principle over a particular selected area of the law, but having a legitimate parent-subsidiary relationship can be justification for legal responsibility. If any test begins to be put into the enterprise liability, it can mean that the difficulties and ineffectiveness with applying the lifting the veil principle will also same for the principle. Just as the principle of limited liability and separate entity is not applied to any criterion as fundamental, the enterprise principle must be treated with the same approach.

Dearborn proposed true enterprise liability that requires an economically integrated enterprise, which is defined as ‘inquiry of economic, and not behavioral, control’. In contrary to it, Blumberg, suggested that such groups are characterized by the unifying factors of control and economic interrelationship, ‘control-based form of enterprise liability’. Due to that, protracted disputes around control based rule among academic debate have weakened recognizing principle.

II. Regulating corporate groups

Klaus J.Hopt, Max Planck Institute, acknowledged that ‘there are three regulatory models for dealing with groups of companies: regulation by general corporate and/or civil law (prototype: the UK); regulation by special group law (prototype: Germany); and regulation by areas of the law such as banking, competition, and tax law (to be found in many countries, either combined with the first or the second model)^2§. The regulation of most countries except for the few European Union countries applies to the first model.

Although countries may have differently defined group companies by law, it can theoretically be defined as a group of companies with a controlling mechanism (parent) and its controlled companies. It is a corporate group if a company:

– owns the majority of voting rights of another company;

– has the power to appoint and release a majority of the directors of another company.

1. Corporate groups in case law

Traditionally, the UK, Australia and the United States apply the “veil lifting” principle, which disclaims limited liability of a company, depending on the circumstance of each case. In the United Kingdom, the Salomon Principle²¹, which refers to the company’s separate legal entities and limited liability, is very strong. Therefore, it is criticised that the recognition of group corporate responsibility in the UK has been lagging due the courts reluctancy²², this attitude may have increased due to the case of Adams v Cape Industries. Sharon Belenzon conducted an interesting empirical study of veil lifting in a comparative context. According to the survey which indicated the tendency of their courts to lift the corporate veil in lawsuits involving corporate group affliates, ‘Germany has the highest piercing corporate veil score of 3.93 reflecting its unique attitude of considering a subsidiary an integral part of the corporation that controls it while, by contrast, the lowest piercing corporate veil rating of 1.3 for Great Britain reflects the country’s strong bias towards the view that firms are distinct legal entities, even when they operate under the directions of a parent firm’²³.

However, some court cases of English law so far the most referenced in academic research and debate. When it comes to the discussion on the extension of corporate group liability, cases often cited are related to asbestos mines and operations. These cases raised awareness around the corporate group and made a significant contribution to the academic debate as to notions of fairness and regulatory should be contemplated for a parent and subsidiary corporates.

Veil lifting is quite traditional for common law and Dignam described the principle of veil lifting in the UK historically in three ways²⁴:

Classical veil lifting, 1897-1966-even though Salomon principle dominated there were some veil lifting occurred. Firstly, it was applied for Daimler Co Ltd v Continental Tyre and Rubber Co Ltd to determine if the company was an ‘enemy’ of the First World War in 1916.

The interventionist years,1966-1989-he noted that ‘by the 1960s the courts were increasingly demonstrating a tendency to free themselves from old precedence they saw as increasingly unjust’²⁵.

Back to basics, 1989-present-the court narrowed to lift the veil of incorporation by a well-recognised case of Adams v Cape Industries Plc (1990).

Adams v Cape Industries Plc (1990)²⁶

Cape was an English company mining and trading asbestos in South Africa and was involved in the world market through its subsidiary, Capasco which locates in the UK. Their U.S. market was also operated by a NAAC, Illinois registered subsidiary. In 1974, 462 Texas employees filed lawsuits against Cape, Capasco, NAAC, and other branches in Texas. These claimants were those who suffered health damage from the asbestos. In subsequent years, the number of claimants increased, and Cape was deemed to have no legal jurisdiction to settle the Texas lawsuit; and they were gradually losing its business in America. The claimants went to court in the UK, where the majority of the parent company’s assets existed. The court examined whether Cape was present in the US jurisdiction through its subsidiaries, whether the group could be considered as one entity and that the subsidiaries were agents or mere facades. The court limited applying the veil lifting principle further by rejecting the Cape group could be treated as a single entity and stating that the court is not free to disregard the principle of Salomon. Upon further legal consequences of the case, Martin Petrin and Barnali Choudhury stated that:

In the UK, however, the tendency to allow piercing in line with the traditional principles came to a halt with the 1989 decision in Adams v. Cape Industries plc. The Court acknowledged that there were three main instances in which piercing may be justified. First, when a parent’s responsibility for a subsidiary may be construed based on specific circumstances, particularly where a statute or contract allows for a broad interpretation to references to members of a group of companies. Second, in cases indicating that a company is a mere façade to conceal true facts and avoid legal obligations. Third, where a subsidiary acts as its parent company’s agent²⁷.

James Hardie & Co. v Hall (1998)²⁸

In Australia, researchers in the field of corporate group law have done a lot of research relatively, and they have come up with some number of ideas and initiatives, including a comprehensive research report of corporate group law, named Corporate Groups Final Report, by the Companies & Securities Advisory Committee²⁹. It seems like that they were inspired by EU’s initiatives steps of corporate group law. Although the advisory committee delivered an official report and proposed a legal reform on corporate group law, it did not produce full results in terms of legislation. The committee recommended to adopt single enterprise principle; however, it did not come to fruition.

CASAC in its Final Report on Corporate Groups in May 200010 recommended the adoption of the single enterprise principle in regulating corporate groups. Under the proposal, wholly owned corporate groups could choose12 whether or not to be so regulated, by choosing to be consolidated or non-consolidated. If choosing to be consolidated then a term such as ‘consolidated corporate group company’ would be included on all public documents of the group companies. Single enterprise principles would then govern the consolidated corporate group company as ‘the Corporations Law would treat the consolidated corporate group as one legal structure³⁰.

Also, Dickfos posited that ‘of the Final Report’s 24 Recommendations, to date, only two recommendations, permitting the pooling of assets and liabilities in a liquidation of group companies have led to changes in Australian corporate law. Of the remaining 22 recommendations, 11 involved no change to the current law, while the remaining 11 recommendations have not been implemented³¹’. Sharon Belenzon’s empirical data points the country got piercing corporate veil score of 2.73³².

Later, a controversy case, James Hardie Industries, that took attention not only the country’s court and lawmakers but also the business community to looked up responsibility for the corporate group.

James Hardie Industries was an asbestos production company. It was a high-profile, operating at the international market through its two subsidiaries. Workers of the asbestos factory (its subsidiaries) suffering from the mesothelioma have filed a lawsuit with the Supreme Court of New South Wales, Australia, and demanded that lifting the veil of the parent company. The court held common law entity principles as usual. In 2001, James Hardie was requested to establish tort claimants’ compensation fund when moving the parent company to the Netherlands. In 2003, they cancelled the partly paid shares held by the parent company, that freed the parent company from compensation. It led an outcry from past employees of the subsidiaries, their representative trade unions and politicians³³. James Hardie argued that the parent company had no legal liable adequately to fund the tort liabilities of its subsidiaries, cited the 1980s court decision. In 2004 a special commission was appointed by the state government to hold a public inquiry on this issue and found that the laws of the Australian company were so flawed that it would be appropriate to further pay attention the principle of limited liability and reflect modern and public opinion and standards. They confessed that there were significant deficiencies in Australian corporate law. While not violating the law, for the sake of moral and corporate social responsibility, the parent company agreed to pay its tort claimants compensation for at least 40 years by increasing their compensation funds.

From the Australian experience, traditional corporate law with very limited veil lifting principles, in fact, does not meet the standards required for proper legalization and operation of a corporate group, according to John Kluver, head of Corporations and Market Advisory Committee³⁴. He also said in the James Hardy case that it is becoming less commonplace for the general public to rely on corporate entity law principles, especially when the group imposes risks on its subsidiary to avoid, particularly in regard to involuntary creditors. In the addition, Virginia Harper’s posited from the case:

The cases reveal a lack of systematic and consistent application of corporate theory even within discrete doctrinal arenas. In Citizens United, this discontinuity appears within the majority opinion itself. While these examples may suggest that judges are simply drawing on the theory that best suits their intended conclusion, they clearly show that corporate theory is not determinative in a mechanistic sense and that there is a need for courts to use greater care when drawing on corporate theory. The opinions also demonstrate that even if limited liability and other fundamental characteristics of the corporate form are presumed, enterprise perspectives lead to new ways of approaching decisions involving corporate groups³⁵.

After the case, the administration decided that it would be necessary to review the law of Australian corporate law, and in the course of their work, lawyers advised³⁶ them to examine where, how the principles of enterprise law³⁷ could be applied, and how they were effective. However, so far no significant change has been made.

This indicates that the reform of the corporate group law remains a controversial topic throughout the world, as it stands at the midpoint of law, economics and politics. William J.Rands pointed out regarding the US’s situation as ‘stimulating as the academic debate has been, state legislatures have paid no attention to it. Not wanting to be left behind, virtually every state has enacted legislation that authorizes the creation of limited liability companies and limited liability partnerships, two types of entities that provide limited liability for their owners. In truth, however, their ears are more attuned to the entreaties of their respective business communities. What the business community wants, the business community usually gets³⁸.

The U.S ‘s score is 2.63 for piercing the veil, averaging among its 16 counterparts³⁹. ‘In a few number of states such as Louisiana and Texas, courts have applied an enterprise approach as an independent basis for ignoring limited liability. Louisiana courts, in particular, treat affiliated corporations as a single business enterprise if the level of control reaches a certain threshold, regardless of whether the parent abused the corporate form. In other jurisdictions, courts consider parent-subsidiary cases under the general corporate veil piercing framework, with no reference to an overarching enterprise theory⁴⁰’. Blumberg opined the contradictory situation of the jurisdiction by stating:

Further, “piercing” jurisprudence in many jurisdictions has become self-contradictory. Traditional “piercing” jurisprudence rests on a demonstration of three fundamental elements: the subsidiary’s lack of independent existence; the fraudulent, inequitable, or wrongful use of the corporate form; and a causal relationship to the plaintiff’s loss. Unless each of these three elements has been shown, courts have traditionally held “piercing” unavailable. However, the traditional “three-factor” doctrine has presented so many problems that some courts such as the Court of Appeals for the Second Circuit have abandoned it entirely and have adopted “single-factor piercing”” as governing law for “piercing” cases. Other courts have continued to apply “three-factor piercing,” but no longer rely on it exclusively. In a separate line of decisions that do not cite the “three-factor piercing” decisions in the jurisdictions, these courts have rejected the need to demonstrate each of the elements of the traditional three-factor doctrine⁴¹.

2. Statutory of corporate groups

Economically and legally developed countries have attempted some measures to regulate corporate group issues. For example, namely, the European Union held the Forum Europaeum Corporate Group Law, High Level Group of Company Law Experts, and the Reflection Group ⁴². Although there is not a positive law, these EU initiatives have attracted the attention of other countries. Commentators say that the legal status of the EU corporate group is still in the developing stage⁴³.

In order to ensure corporate law’s harmonisation in European countries, developed the draft of 9th Directive on Corporate group Law in the 1970s, which was based on the German’s konzernrecht system and principles. Experts have criticised that the German corporate group law’s implementation and managing group are inefficient, so that subsequent research and development was based more on the French rozenblum principle. Exempt from the liability of a subsidiary company under this French case law: if the companies meet the criteria that they are closely structured and business, with a unified group policy, proper distribution of positive and negative conditions within the group, and the subsidiary has no support beyond its financial capacity. The majority of western European countries now follow this principle. In Europe, corporate group regulation mainly aimed at protecting small shareholders, as German law does, but changes in the legislation since the 2000s have a tendency enabling the director of a subsidiary to be released from liability if he has followed the guidance of the parent company. As Koji Funatsu concluded ‘this change indicates that the law has changed from protective law to enabling law’⁴⁴. Some scholars explain the strategy as the EU policies that promote business activities through their member states⁴⁵.

According to the Forum Europaeum Corporate Group Law, European corporate law should seek two main goals. It included protecting the small shareholders and debtors of the controlled company, helping the business and economy by recognizing the group’s legal framework and recognizing the group as an organisation. The current legal policy of the EU, however, is aimed at establishing a basic standard and leaving the member countries to deal with specific issues related to the types and activities of group companies.

Jose Antunes states the EU’s contribution to the development of corporate group law and its future results are as follows⁴⁶:

The EU legal system breaks new ground on the topic of intragroup liability. Notwithstanding the fact that the proposed regulatory strategy still remains today purely de lege ferenda (none of the above-mentioned proposals have so far been enacted), it holds an undeniable interest and actuality since it symbolizes, worldwide, the strongest reaction against the prevailing traditional ‘entity law approach” to the legal treatment of liability questions in parent-subsidiary relationships and provides the most far-reaching institutional effort advocating a revolutionary reality-adherent approach to the topic. The limited liability for parent corporations, issued from an approach backed up by the formal dogmas of the separate legal personality and the limited liability of the shareholders, should be replaced by the opposite rule of the unlimited liability of the parent issuing from an approach dominated by the reality of the group as a single economic unity or as a single enterprise.

European countries were and are the most innovative in the development and improvement of corporate group law. Especially since Germany was the first country in the world to have a specific corporate group law that was passed over 50 years ago, it has been always exemplified for other jurisdictions. German is exemplified as an industrialized country that has adopted a milder form of enterprise principles without disastrous results for domestic or international investment capitalism⁴⁷.

Peter Hommelhoff identified its importance having a specific corporate codified law like German as the following:

Many German lawyers dealing with corporate group law believe that the distinctive strength of this body of law lies first and foremost in its existence. Its rules address specific problems and conflicts that cannot be solved as satisfactorily by mere company law, at least not if it has not been adapted to suit the specific needs of corporate groups. Besides, it seems arguable whether corporate conflicts can be solved by the mechanisms of insolvency law. The penetrating force of the “shadow director’s wrongful trading” as a legal concept, which was suggested by the Forum Europaeum, is met with skepticism by English law experts⁴⁸.

German corporate group law regulates two types of companies: de facto and agreement. The latter one is formed by an agreement between the parent and its subsidiary, while the former group is by the voting rights of the shares in the possession of the affiliated company. To regard as the agreement group, the parent company is allowed to operate in the common interest of the group, but it has legal responsibility for the loss and damage to the minor shareholders of the subsidiary. Legislators of the country originally expected that this form of the group would be chosen more, as it allows managing the group. However, that hope was not fulfilled⁴⁹.

In fact, the rarity of agreement groups has led to criticism of German law as ineffective. Without such an agreement, the company will be de facto controlled and, all transactions which are contrary to the interests of the subsidiary, but under the parent company’s guidance, must be fully settled by the parent. Funatsu noted that ‘this rule is meant to be implemented very strictly: every legal and factual act must be verified to determine whether it is disadvantageous’^5§. This rule is implemented through a mechanism such as a group report on the parent company’s directors’ duty, auditing, the examination of the parent company’s supervisory board, and rights of any shareholder in the parent company who has enabled to be examined by court order. The effect of these mechanisms is an open question for lawyers and scholars.

In light of adopting an enterprise approach in tort, human rights, environmental harms regulation, German law is else criticized as follows:

German law recognizes group companies in this manner in an effort to address the inherent conflict of interest that exists between parents and their subsidiaries, which could benefit the parent’s shareholders at the expense of the subsidiary’s shareholders and creditors. However, this also means that the Konzernrecht regime is mostly geared towards the protection of minority shareholders and contractual creditors, not victims of torts or human rights violations that are the focus of the present inquiry⁵¹.

Moreover, the Germany law has more focuses on internal protection rather than outer involuntary creditors; the situation is said as ‘the most developed of the enterprise systems, the Konzernrecht, fails to address the problem of tort creditors because its system of liability is primarily internal, meaning that the subsidiary accrues a cause of action against the parent, but outside creditors do not’⁵².

German’s corporate group law has been copied by Brazil, Portugal, Slovenia, Croatia, and Taiwan⁵³. Although their regulations are little known beyond their borders, there are some works of literatures related to Portuguese and Italian laws.

A part of Portugal’s Corporate Law is designed to regulate group relations, and it was developed within the concept of corporate law but not a broad concept which is valid to all branches of the law⁵⁴. The most important issue that Portuguese law tries to respond is to eliminate the gaps that arise from the regulatory differences between traditional and modern company law.

To address the deficiency of the traditional rules to govern corporate group matters and inability to provide real protection to affiliated companies, the Portuguese law was developed in the situation that all the theoretical coherence, completeness and practicality were uncertain⁵⁵. This problem is one of the reasons why group corporate law development still is not progressing even in other countries. Unlike German law, Portuguese law does not specify general and abstract types of groups but appeared to have three organizational instruments: a fully dominant control, an agreement for a horizontally organized group, and a subordinate agreement⁵⁶. Within these types of, it regulates how the subsidiary is protected, the rights of its shareholders and creditors, the financial obligations of the parent company, the relationships between the member companies of the group, the participation and the transferring of shares.

Italy introduced a special legal regulation of the corporate group in 2004. Embid Irujo wrote as ‘the Italian example is most illustrative in this regard. It is one of the systems containing significant corporate group rules from a company law perspective’⁵⁷. At the heart of it are the provisions of the Italian Civil Code on the activities of parent companies, such as “direction and co-ordination of companies”. Apart from the duties and various rights of the directors and member companies of the group, the main feature of this reform was that it provided a liability of the parent and its directors to subsidiaries’ shareholders and creditors when the legal requirements are met. Exemption from this liability is provided in the event that the performance of the obligation is satisfied. In addition, conflicts of interest rule have been toughened to apply not only to a separate company but also to a corporate group. In the cases provided for, minority shareholders’ rights are regulated⁵⁸.

As corporate group issues have become more and more of an interdisciplinary law, the recent major reforms and driving forces behind the handling of this phenomenon may rely upon not only corporate law as well as other sectors of law.

3. Corporate groups in other branch laws

Apart from the fundamental issues of corporate law, there are also other legal areas where the corporate responsibility of the group is a priority. When transforming the dynamic approach into legal rules, company law obviously demands a key role, but other branches of law must also be considered⁵⁹ because there is need to deal with the problem of intercompany relationships. Adopting the enterprise law principle into other branches deems as a priority. It is assumed by Blumberg stating as in selected areas, the law is beginning to recognize corporate groups rather than a particular subsidiary company, as the juridical unit, and to impose group obligations and, less frequently, to recognize group rights as well. In this movement, still in its early stages, the enterprise theory of the corporation is beginning to emerge⁶⁰. Virginia H.Ho pointed out that ‘despite the acceptance of enterprise principles in many areas of the law, Professor Blumberg–whose writings form the foundation of legal scholarship on corporate groups–concludes, based on a comprehensive survey across different areas of the law, that “enterprise law is not transcendental. It is applied only in selected areas of the law where it more effectively implements the underlying purposes and objectives of the law. In other respects, entity law continues unaffected.’⁶¹

These law sectors are accounting,⁶² taxation, auditing, conflict of interest, securities regulation, banking and financial institutions, bankruptcy, insolvency, employment relations, competition,⁶³ human rights and environment. Particularly, there are some measures initiated in human rights and environmental area at the domestic and international level. France and Switzerland have taken steps which companies even the groups have liability to vigilant risks to environmental harms, human rights, injuries via due diligence actions⁶⁴.

Insolvency regulation is the most commonly discussed issue. This is because it is necessary to prevent the corporate group structure from being used for fraud bankruptcy. So, we here have a brief look at some examples of legal bankruptcy and insolvency in a corporate group. The insolvency case of the group, and especially the transnational group, is problematic because of the inadequate legal framework between the parent company and its subsidiary company.

According to Petrin and Choudhury, ‘enterprise liability is therefore particularly useful where a subsidiary company is unable to satisfy debts or claims but the corporate group as a whole, but not necessarily the insolvent company’s parent company, has sufficient assets’⁶⁵. So, there are more jurisdictions with acceptance enterprise approach in insolvency law, compared to other branches of laws.

In many countries, there are two common mechanisms of insolvency: subordination and substantive consolidation. The subordination mechanism is used in many countries: Austria, Germany, Italy, Spain, USA, New Zealand⁶⁶. The regulation that combines the assets of independent legal entities in bankruptcy and insolvency proceedings is theoretically an example of adhering to the principle of enterprise law.

The proceedings of several members of the corporate group may be pooled with a court decision in the event of insolvency if the group companies of the group are considered as one entity. In other words, a merger considers companies that belong to a corporate group to be a unit of bankruptcy. Different mechanisms can be used to consolidate the assets and debt of members of different groups of companies. Subject to the New Zealand Companies Act of 1993 as well as substantive consolidation is allowed for under United States insolvency laws. Unlike New Zealand and Australia, there is no specific law in the United States to handle group insolvency issues. Of these, the regulations set forth in the New Zealand company laws are special. In the context of practical implementation, it is analysed that the courts have shown reluctance to use these provisions and therefore pooling has not been a common occurrence. The New Zealand courts are beginning to develop a jurisprudence regarding when the court will exercise its powers under these provisions⁶⁷.

The Australian Corporate Law contains few provisions that specifically regulating the corporate group. For example, a parent must list its affiliates each year in its report and provide consolidated accounts for itself and other subsidiaries. The most specific enterprise law approach (not covered in most other countries)⁶⁸ reflection on corporate law is that if a subsidiary is considered insolvent, the parent company will be liable for any debt incurred. This insolvency settlement creates a parent company’s ability to control its subsidiary’s operations and to prevent any loss to the subsidiary’s creditors, and ceases trading in the subsidiary when it becomes insolvent. It provides incentives to constantly monitor the financial situation of subsidiaries and to prevent financial risks.

Academic scholars propose various suggestions on how to properly integrate enterprise law approach and other branch laws, and in this regard, Petrin.M, and Choudhury summarized the following:

While Blumberg acknowledges the relevance of added elements such as administrative and financial interdependence, integration of employee relationships, and use of a common group persona, control remains the central tenet of conceptualizing corporate groups and as such, according to Blumberg, accordingly also justifies a ‘control-based form of enterprise liability’. In recent years, notable scholarly proposals building upon enterprise liability concepts have also been outlined by other commentators. Skinner suggests, for instance, that parent company liability be imposed through a statutory enactment for violations of customary international human rights and serious environmental torts. However, she limits her suggestion of imposing statutory liability to corporations operating as part of a unified economic enterprise in ‘high risk host countries’. Conversely, Dearborn proposes a model of enterprise liability that requires an economically integrated enterprise, which is defined on a case specific ‘inquiry of economic, and not behavioral, control’; and an instance of a mass tort, human rights violation, or environmental harm⁶⁹.

III. Conclusion

The long corporate groups story has been still unfolding. Blumberg and others who support the enterprise law approach concluding that the application of the limited liability principle to a corporate group happened historically unplanned and accidental⁷⁰. Mostly, lawyers, researchers, and legislators pay attention to the traditional legal issues regarding corporations, but they do not look out sufficiently to the legal issues of modern corporations operating through group structure. Even though some regulations and provisions of group relations have been in few countries since the 1960s, they have been discussed only in a few academic studies and court documents. In today’s business world, corporate groups have become dominant, we are facing the challenge to develop a compatible regulation with modern reality for the groups. It is complicated to regulate the groups, as the subsidiary company has the contradictory features: on the one hand, independent, separate entity but on the other hand, controlled unit. Therefore, legislators might be wary that denying the traditional legal protection of the company could adversely affect the economy and business. These are the main reason why the legislation in the corporation is left behind.

The limitations and uncertainties of lifting the corporate veil cannot provide the regulation of the corporate groups which need a selective and specific manner. The principle of veil lifting is ineffective and incomplete, and it does not have a proper legal response to the dynamics and the reality of corporate business activities, so it may be more efficient to adhere to enterprise law approach in further legislation. This mechanism has the advantage of flexibility but lacks the certainty that suitable theory-based legislation would present. There is a tendency that countries are beginning to apply the enterprise principle somehow, nevertheless, the corporate group law’s failure to formulate comprehensive and coherent group regulations and laws do make it difficult for the court to apply it.

Rather than completely denying the limited liability of corporate groups, because of avoiding adverse economic consequences and radical changes, the tendency to legitimize this principle may be proper today in some areas of the law. It would be recommended to introduce the principle of extended liability in the areas of insolvency, mass tort, compensation for harm and damage to the environment at first. A broader perspective of regulation here is demanded. In doing so, consideration should be given further to when adopting enterprise liability principle, whether there must be criteria for the relationship and structure of the subsidiaries and parent or not. Understanding the distinct mechanisms of corporate groups may be a key to a fresh approach-enterprise liability.

When legal issues on corporate groups raising, law makers and researchers do not look at its regulation as complete, systematic rules must be there but just consider its single part and provision. As a result, lawyers are faced with incomprehensible and irreconcilable court decisions in legal practice. Since no systematic examinations of corporate group law have been undertaken, a full legal analysis of the relevant law at academic level is needed. Academic research based on an appropriate doctrine, with a theoretical approach is the base for solving these legal issues and difficulties.

References

1
See Kluver.J, Entity vs. Enterprise Liability: Issues for Australia, 37 Connecticut law review, 2005, p.765.

2
See Christian A.Witting, Liability of Corporate Groups and Networks, Cambridge University Press, 2018, p.66.

3
See United Nations Conference on Trade and Development, World Investment Report 2019, Geneva 2019, p.18

4
See Phillip.I.Blumberg, The Multinational Challenge to Corporation Law, Oxford University Press, 1993, p.49, 50

5
See Dearborn, M., Enterprise Liability: Reviewing and Revitalizing Liability for Corporate Groups, California Law Review, Vol.97, Issue 1, 2009, p.208

6
See Phillip.I.Blumberg, The Multinational Challenge to Corporation Law-the New search for a New Corporate Personality, Oxford University Press, 1993 p.58

7
See Michael Gillooly (ed), The Law Relating to Corporate Groups, Annandale, N.S.W: Federation Press, 1993 as quoted in Alison Mccourt, A Comparative Study of the Doctrine of Corporate Groups with Special Emphasis on Insolvency, 2007, p.31

8
See John Kluver., Entity vs. Enterprise Liability: Issues for Australia, 37 Connecticut law review, 2005, p.776

9
See Очи-Ай Сэйчи, Компанийн эрх зүйн үндсэн ойлголт, УБ.2017, p.398

10 Ibid

11
See Jose.E.Antunes, Liability of Corporate Groups, Kluwer Law and Taxation Publisher, 1994, p.15.

12
See Tom Hadden, Regulation of Corporate Groups in Australia, 15 U.N.S.W. Law Journal, 61, 1992, p.62

13
See Phillip.I.Blumberg, The Multinational Challenge to Corporation Law, Oxford University Press, 1993, p.22

14
See Ian.R and Geof.S, Corporate Groups in Australia, research report, University of Melbourne, 1998, p.13

15
See Virginia Harper Ho, Theories of Corporate groups, Seton Hall Law Review, Vol.42, 2012, p.951

16
See Dearborn, M., Enterprise Liability: Reviewing and Revitalizing Liability for Corporate Groups, California Law Review, Vol.97, Issue 1, 2009, p.210

17 Ibid

18 Ibid., p.207

19
See Witting. C., and Rankin. J., Tortious Liability of Corporate Groups: From Control to Coordination, 2014, p.11. available at https://ore.exeter.ac.uk/repository/handle/10871/16770

20
See Hopt.K., Groups of Companies-A Comparative Study on the Economics, Law and Regulation of Corporate Groups, ECGI-Working paper No.286, 2015, p.25

21
Salomon & Salomon Co (1897) case law-based principle of limited liability where the company, being a legal entity, is separate from the shareholder and cannot hold liable to each other.

22
See for example, Witting.C., Liability of Corporate Groups and Networks, Cambridge University Press, 2018, p.184; Klaus J.Hopt., Groups of Companies-A Comparative Study on the Economics, Law and Regulation of Corporate Groups, ECGI-Working paper No.286, 2015, p.22

23
See Belenzon, S and Lee, H and Patacconi, A, Towards a Legal Theory of the Firm: The Effects of Enterprise Liability on Asset Partitioning, Decentralization and Corporate Group Growth, NBER Working Paper No. w24720, 2018, p.4

24
See Alan.D and John.L., Corporate Law, 5th ed, Oxford University, 2009, pp.35-37

25 Ibid., p.35

26 Ibid., p.37

27
See Petrin.M., and Choudhury.B., Group Company Liability, European Business Organisation Law Review, 2018, p.775

28
See Kluver.J., Entity vs. Enterprise Liability: Issues for Australia, 37 Connecticut law review, 2005, pp.768-774

29
See Companies & Securities Advisory Committee, Corporate Groups Final Report, 2000

30
See Jennifer, D, Enterprise liability for corporate groups: A more efficient outcome for creditors, p.244

31
See Jennifer, D, Enterprise liability for corporate groups: A more efficient outcome for creditors, 2011, p.242

32
See Belenzon, Sharon and Lee, Honggi and Patacconi, Andrea,Towards a Legal Theory of the Firm: The Effects of Enterprise Liability on Asset Partitioning, Decentralization and Corporate Group Growth, 2018, Annex 1.

33
See Kluver.J, Entity vs. Enterprise Liability: Issues for Australia, 37 Connecticut law review, 2005, p.770

34 Ibid, p.783

35
See Virginia H.Ho, Theories of Corporate groups, Seton Hall Law Review, Vol.42, 2012, p.944

36
See Kluver.J., Entity vs. Enterprise Liability: Issues for Australia, 37 Connecticut law review, 2005, p.783

37
enterprise law approach-Parents and subsidiaries are considered to be one liability and offer innovative and fundamentally different principles against the traditional theory.

38
See William J. Rands, Domination of a subsidiary by a parent, Indiana Law Review, Vol. 32 No.2, 1999 p.430

39
See Belenzon, Sharon and Lee, H and Patacconi, A., Towards a Legal Theory of the Firm: The Effects of Enterprise Liability on Asset Partitioning, Decentralization and Corporate Group Growth, 2018, Annex.1.

40 Ibid.

41
See Phillip.I.Blumberg, The Transformation of Modem Corporation Law: The Law of Corporate Groups, p.612

42
See Klaus Hopt, Groups of Companies-A Comparative Study on the Economics, Law and Regulation of Corporate Groups, ECGI-Working paper No.286/2015, p.11

43 ibid

44
See Koji Funatsu, Trends in European Corporate Group Law Systems and the Future of Japan’s Corporate Law System, Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.11, No.3, July 2015, p.477

45 ibid

46
See Jose.E.Antunes, Liability of Corporate Groups, Kluwer Law and Taxation Publisher, 1994, p.293

47
See Dearborn, M., Enterprise Liability: Reviewing and Revitalizing Liability for Corporate Groups, California Law Review, Vol.97, Issue 1, 2009, p.215

48
See Peter Hommelhoff, Protection of Minority Shareholders, Investors and Creditors in Corporate Groups: the Strengths and Weaknesses of German Corporate Group Law, Cambridge University Press, 2009, p.10

49
See Hopt.J.K., Groups of Companies-A Comparative Study on the Economics, Law and Regulation of Corporate Groups, ECGI-Working paper No.286, 2015, p.10

50
See Koji Funatsu, Trends in European Corporate Group Law Systems and the Future of Japan’s Corporate Law System, Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.11, No.3, July 2015, p.476

51
See Petrin.M., and Choudhury.B., Group Company Liability, European Business Organisation Law Review, 2018

52
See Dearborn, M., Enterprise Liability: Reviewing and Revitalizing Liability for Corporate Groups, California Law Review, Vol.97, Issue 1, 2009, p.254

53
See Mähӧnen. J.,The Pervasive Issue of Liability in Corporate Groups, European Company Law journal, Vol.13, No. 5, 2016, p.19

54
See Jose.E.Antunes, The Law of Corporate Groups in Portugal, Institute for Law and Finance, Working paper series No.84, 05/2008, p.4

55 Ibid.

56 Ibid., p.5

57
See Jose Miguel Embid Irujo, Trends and Realities in the Law of Corporate Groups, European Business Organisation Law Review, Vol.6, No.1., p.83

58
See Klaus J.Hopt, Groups of Companies-A Comparative Study on the Economics, Law and Regulation of Corporate Groups, 2015, p.10

59
See Jose Miguel Embid Irujo, Trends and Realities in the Law of Corporate Groups, European Business Organisation Law Review, Vol.6, No.1., p.77

60
See Phillip.I.Blumberg, The Corporate Entity in an Era of Multinational Corporation, Delaware Journal of Corporate Law, 1990, Vo.15, No.2, p.298

61
See Virginia H.Ho, Theories of Corporate groups, Seton Hall Law Review, Vol.42, 2012, p.901

62
See Zoltán, Zéman and Csaba, Lentner, The Changing Role Of Going Concern Assumption Supporting Management Decisions After Financial Crisis Polish Journal Of Management Studies Vol. 18 : 1 pp. 428-441., (2018)

63
See Péter, Miskolczi Bodnár and Róbert, Szuchy, Joint and Several Liability of Competition Law Infringers in the Legislation of Central and Eastern European Member States. Yearbook Of Antitrust And Regulatory Studies Vol. 10 No. 15 pp. 85-109. (2017)

64
See Petrin.M, and Choudhury.B, Group Company Liability, European Business Organisation Law Review, 2018, p.784

65
See Petrin.M, and Choudhury.B, Group Company Liability, European Business Organisation Law Review, 2018, p.786

66
See Klaus J.Hopt, Groups of Companies-A Comparative Study on the Economics, Law and Regulation of Corporate Groups, 2015, p.23

67
See Alison Mccourt, A Comparative Study of the Doctrine of Corporate Groups with Special Emphasis on Insolvency, p.26

68
See Kluver.J, Entity vs. Enterprise Liability: Issues for Australia, 37 Connecticut law review, 2005, p.767

69
See Petrin.M, and Choudhury.B, Group Company Liability, European Business Organisation Law Review, 2018, p.787

70
See Phillip.I.Blumberg, The Multinational Challenge to Corporation Law, Oxford University Press, 1993; Phillip.I.Blumberg, The Transformation of Modem Corporation Law: The Law of Corporate Groups, Connecticut Law Review, 2005, Vo.37, No.5

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Очи-Ай Сэйчи, Компанийн эрх зүйн үндсэн ойлголт, УБ.2017

Bold, Urnaa

PhD Student, University of Pécs, Faculty of Law