Selskabsretligt h?ftelsesansvar for direkt?rer og moderselskaber - i et britisk perspektiv

I n?rv?rende artikel kommenterer jeg p? undtagelserne til det begr?nsede ansvar for selskaber under britisk lovgivning.

Selskabsretten er en juridisk disciplin, som velsagtens har st?rst indflydelse p? virksomheders etablering og drift. I s?vel Danmark som Storbritannien har selskaber som udgangspunkt et begr?nset ansvar. Den seneste udvikling i engelsk ret har dog vist sig at modificere dette udgangspunkt ganske betragteligt - og m?ske, som der argumenteres for i det f?lgende, for aktivistisk.

Artiklen er forfattet p? engelsk for at bevare originale fagtermer og betydninger

Since the first arising of small simple companies, still more complex business structures have emerged over the last several decades. The enterprise groups are a significant phenomenon in today′s commercial world. Globalization has made it possible for companies to operate in several countries at the same time, hence the emergence of multinational enterprise groups has been possible to construct. The general idea of the law with the reform of the Companies Act 2006 “Think small first” has been challenged by the frequently and dynamically evolving of business structures. Enterprise groups are rather difficult to regulate. A wide range of diversity of legal and functional structures of de facto management can be found. As discussed further, a dilemma between law principles and the economic reality is complex and dynamical. In general, UK law is generally wedded to what is described as entity law on a strict basis of the Salomon principle. In this regard, it is discussed whether this notion is still to be applied in a modern commercial world, especially with focus on the possibility of piercing the corporate veil in an enterprise corporate group structure, where there exist various methods to defraud creditors.

Preliminary points

The fundamental principle under English law is that a company is a distinct and separate legal entity from its shareholders. Exemptions may be under statue, but importantly, there are a variety of circumstances, where the courts may disregard – or pierce – the corporate veil, resulting in the need to disregard the fundamental principle of the corporate personality and limited liability. The perhaps most important judgement in English company and corporate law, Salomon v. Salomon[1], adopted the key principle of the corporate personality – the “Salomon principle”. After Salomon, English law and courts respect the Salomon principle rather strictly, especially in the group context. Under common law, it is difficult, but possible, in circumstances to circumvent the corporate personality and limited liability – the Salomon principle. Under statute, it may be possible to some extent to make the directors of the so-called parent company liable under the provisions of fraudulent or wrongful trading or as a matter of breach of directors′ duties. Regarding the possibility of piercing the corporate veil under common law, the leading case is well said Prest.[2] As we will see, the leading judgement of Lord Sumption in the case has been highly influential, if not wholly determining, of the development of the law on the doctrine of piercing the corporate veil.

The ultimate aim and key policy of this area of English company law is striking a balance between encouraging commerce and entrepreneurship on the one hand and on the other hand handling abuse of the corporate personality and limited liability to defraud creditors as external stakeholders, thus protecting the creditors is a weighty factor to take into account when balancing interests. Mitigating the fraud of creditors and promoting business transparency has been the main subjects to consider when discussing the possibility of piercing the corporate veil.

The main and most popular business form in the world, taking into account all sizes of companies, is the limited company with the purpose to attract limited liability of its shareholders and other key advantages that incorporation entails. Hence, one of the main considerations of entrepreneurs etc. when initiating a business is the consequences should the business fail and enter into insolvent liquidation. Risk allocation and assessment is the main focus here.

In the following, corporate personality and limited liability will be introduced.

Corporate separate personality

In Salomon v. Salomon, Lord Macnaghten emphasised a key paragraph, of which is rather useful to state in its whole:

“The company is at law a different person altogether from the subscribers to the Memorandum and, although it may be said that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Act. That is, I think, the declared intention of the enactment.”[3]

The concepts explained in this paragraph is firstly the notion of corporate separate personality, secondly the doctrine of limited liability. Together, these doctrines are often called the corporate form, although Salomon did not create the corporate form. The company facilitates the raising of capital and attracts investment through shareholding because it is a separate legal person. When addressing the risk of failure, the limited company provides a protection to its investors – owners and shareholders – by limiting their risk, by which they only risk their investment in the company and will not be personally liable. The company is liable for its debts, and not the shareholders. The key implications of being a body corporate distinct from its members are mainly that the company can own assets, e.g. property, hence the property does not belong to the shareholders. This was confirmed in Macaura HL, 1925. The claims of the company′s creditors will be against the company′s property, and not the shareholders. The principle of corporate separate personality has been rather strictly applied by the courts, but with the modifications presented in the introduction with statutory provisions and piercing the corporate veil.

Limited liability

The principle of limited liability is importantly not the liability of the company that is limited. It is the liability of the members of the company. Should the company fail and go into liquidation due to insolvency, it is the creditors who bear the financial risk, hence the creditors cannot go after the members of the company further than their investment in the company. The principle was firmly established in Salomon v. Salomon but has been available since the enactment of the Limited Liability act 1855. Now, the principle is provided in Section 3 in the Companies Act 2006. By s.3(2), it will be ‘limited by shares’: ’If their liability is limited to the amount, if any, unpaid on the shares held by them..’. Also, The Insolvency Act (s 74) gives it effect. No contribution is required from members beyond the amount unpaid for their shares.

The argument for limited liability in a group context is weaker since it does not seek to protect individuals, but rather another separate entity. The enterprise group will be subject to throughout consideration in the following.

The corporate enterprise group

Large enterprises in today′s world will tend to be organized as groups. Especially, the largest companies will be organised as multinational enterprise groups. In this context, it is asked whether limited liability of a parent company from its subsidiaries is justified. An important question when starting a business is whether the business form provides an efficient organisational structure. The limited company provides a great opportunity to construct a group structure.

There exists no clear and agreed definition of a corporate group. Different definitions within different jurisdictions can be found. It is important to note that a group is not a body corporate. It is not a company or a legal entity as such. It is a bundle of companies or entities connected together. In the Companies Act 2006, we find two different sets of definitions. The relevant sections are Section 1162 and 1159. Neither of the sections define a group. What both sections use is the control of the parent over the subsidiary as the connecting factor. S. 1162 applies to filing consolidated accounts. The key players and factors are the subsidiary-parent relationship. S 1159 applies to other purposes. The key players are the subsidiary-holding relationship.[4] S. 1162 er newer, broader and less formalistic than s. 1159.

In reality, a variety of business structures are recognised as groups. Businesses can operate as a classic hierarchal structure with a parent company with one or more subsidiaries, and perhaps subsidiaries of the subsidiaries. The subsidiaries may me wholly or partly owned by the parent company with more shareholders. A structure of so-called sister companies, where no parent or subsidiary is present, but the companies are controlled together through the same individual(s) is recognised as a group. The same individuals sit in the board of the companies. Also, joint ventures can be recognised as a group structure, whereby two or more parent companies hold a subsidiary. As noted, multinational enterprises will often operate as groups with branches, assets or production facilities around the world. The enterprise will be separated into several entities within those countries, with perhaps head offices in those countries.

Salomon legitimated the company as a separate legal entity; thus, the decision also legitimated the group concept. Each subsidiary entity is a separate and distinct entity. The parent company as a corporate shareholder in the subsidiary and the subsidiary itself are separate legal entities.

Hence, it can be said that each of the companies in the group can reasonable expect the courts to apply the Salomon principle and respect the separation of the identities of each entity within the group. There is a consideration that commercial uncertainty should be avoided and not to undermine the benefits of incorporating a company.

Piercing of the corporate veil

The “corporate veil”, metaphorically, symbolises the distinction between the company as a legal person and its directors and especially shareholders. The company is a separate legal entity. It has a legal personality distinct from the people conducting business within the legal fiction, which a company is. The relevant question for this purpose is to ask to what extent that veil can be disregarded. In the broader picture, the question revolves around risk externalisation by shareholders or the parent company. Misuse of the corporate form will have a severe impact on external stakeholders, especially creditors. Piercing of the corporate veil under common law is an ex post measure which can come into force when the harm is done.

Development of the doctrine

The doctrine in common law of piercing the corporate veil firstly revolves around the Court of Appeal case of Adams v Cape (1990) and has contributed to the development of the doctrine.

Several grounds of piercing the corporate veil were invoked in this case and tried to be justified. The case involved an enterprise group, Cape plc., with subsidiaries in several countries. The employees of the subsidiaries were injured by asbestos, receives damages and want to enforce the damage award against the UK parent company. In order to do that, they needed to show that the UK parent company had presence in the US through its subsidiaries to make it liable for the debts of its subsidiaries. It should be noted that this case was not about making the parent company liable for the debts of its subsidiary. Here, the parent company tried to seek compensation of its subsidiary, showing that the business was a single economic unit.

i) Single economic unit. An argument based on enterprise law, where the parent and the subsidiaries were a single economic unit, and the veil should be pierced. All entities within the group were sufficiently inter-connected according to the lawyer. The argument was based on the Court of Appeal case of DHN (1976). The argument was rejected in Adams v. Cape; hence the Salomon principle must be respected strictly. As noted above, the English courts are generally wedded to entity law.

ii) Achieving justice. This argument was, correctly, rejected in the case. The company law principles on the corporate form and limited liability are too important to be exempted on the basis of fairness. Even though it was clearly unfair that the parent company would not compensate the employees in the situation when the subsidiary could not compensate the involuntary creditors.

iii) Sham/ impropriety. It was argued that the subsidiaries of the parent company were just a fa?ade. It was in fact the parent company who did business, and therefore present in the countries where the subsidiaries were placed. This was a recognised exception to the Salomon principle. Note that below, Prest is discussed. The court applied it strictly to the facts and rejected the argument. Hence, the argument is to be understood rather narrowly. An improper use of companies was accepted in other cases, but on limited circumstances where there is an evasion of the existing obligations. When there is an attempt to evade existing obligations, the argument is accepted. The mere evasion of anticipated obligations should clearly not be accepted as an exemption to the Salomon principle. When considering enterprise groups, when the group sets up a subsidiary to conduct risky business to externalise risks and undercapitalize it, the present author is critical towards a road where the courts would allow the corporate veil to be pierced.

iiii) Agency. An agency relationship between the parent and the subsidiary was confirmed as a possible ground in Adams. But no agency relationship existed, even though the subsidiaries were wholly owned by the parent company and controlled them. There is no presumption of agency according to Salomon, but needs to be established on the facts, which is usually not the case. This is not a basis of piercing the corporate veil and should not be discussed further.

To summarize, in Adams, the court generally rejected the single economic unit argument and the injustice argument but recognized the narrow application of the sham/improperty argument and rejected on the facts the agency argument.

Prest

The case was a divorce case and about whether Mr. Prest should transfer certain properties to his wife, which were owned by different companies in a group owned by Mr. Prest. The decision of the case was that the property was held by the companies with Mr Prest as beneficiary, hence the companies could be ordered to transfer that property to Mrs Prest. The court′s considerations regarding piercing the corporate veil was rather obiter, albeit highly influential. The Supreme Court considered the authorities on veil-piercing at length, and came to the following conclusions:

i) Piercing the corporate veil should be limited to those circumstances where a person owning and controlling the company is identified with the company, as a law matter, because of this control and ownership.

ii) The underlying basis of the common law′s mechanism of piercing the corporate veil is the principle that people cannot rely upon a legal rule to carry out fraudulent acts.

iii) The courts can pierce the corporate veil only in those circumstances where the company′s separate legal personality is being abused for the purpose of some relevant wrongdoing.

iiii) The courts are only justified to pierce the corporate veil if there is no other remedy available.

Hence, the impropriety argument can properly be invoked to pierce the corporate veil at common law. Due to a strict application of the Salomon principle, the courts cannot pierce the corporate veil in the case of the single economic unit argument is clearly abandoned.

Post Prest

It can be questioned whether Prest represents something new, but the decision clarified the scope of piercing the corporate veil doctrine that we know today. The law prior to Prest was rather unclear and inconsistent regarding piercing the corporate veil. The court uses different metaphors, reaching different conclusions on different legal basises. The leading judgement was given by Lord Sumption. The main points are as follow. The court is justified in piercing the corporate veil where it is satisfied that the company’s separate corporate personality is being abused by the company’s controllers for the purpose of some relevant wrongdoing and if there is no other available remedy. The decision in Prest shows that the scope of piercing the corporate veil is rather narrow and could have been abolished by their lordships. Lord Sumption and Lord Neuberger considered this matter but left the possibility of piercing the corporate veil open to those narrow circumstances as discussed. Flexibility is remained, which is important with the emerging of complex enterprise group structures. Two distinct principles are identified underlying the improperty argument. The evasion principle; evasion of an existing legal obligation justifies the piercing of the corporate veil. A controller of a company breaches a contract by interposing a company for the purpose of defeating or frustrating a legal obligation. The concealment principle justifies lifting the veil, and involves the courts identifying the real “actors”. The company is not used to evade existing obligations, but the real person who misappropriated the money is the controller, but held by the company, which is used to conceal acts through a company. Lifting the corporate veil is a basic legal manoeuvre and should not be criticized.

As seen, by only piercing the veil after the evasion principle, a strict application of the Salomon principle is present after Prest, where the doctrine has been clarified, but arguably rather minimal of importance. The strict adherence to the Salomon principle is not appropriate in the modern commerce world. Much business activity is conducted by companies operating as enterprise groups. The decision in Salomon v. Salomon from 1897 is outdated, since the emerging of new ways of conducting business could not have been foreseen back then. The doctrine of piercing the corporate veil should be more relaxedly applied in the group context. The law should develop in such a way, where obligations and legal responsibilities should be attached to the enterprise group as a whole, and not to the separate legal entities within the group. This approach would perhaps reflect the economic reality, where commerce often is carried on in corporate groups, and businesses and persons dealing with the group also considers that they are dealing with a group and not with a separate legal entity within the group. Support for such a development was made by Lord Denning MR in the Court of Appeal case of DHN Food Distributors Ltd v. Tower Hamlets LBG (1976). This support was rejected by the House of Lords in the case of Woolfson v. Strathclyde Regional Council (1979). In a broader context, english courts do not embark a development of an enterprise group law. Slade LJ noted in Adams v. Cape Industries plc (1990) that: ”There is no general legal principle that all companies in a group of companies are to be regarded as one. On the contrary, the fundamental principle is that ”each company in a group of companies (a relatively modern concept) is a separate legal entity possessed of separate legal rights and liabilities”. He went on to state that ”..we are concerned not with economics but with law.” On the other hand, it can be argued that the separate legal existence of group companies is particularly important when creditors are involved. Especially in multinational groups, the structure will often not be very hierarchical in terms of the level of unity and central control with the subsidiaries being autonomous and the parent company will merely coordinate the strategies of the enterprise, but with a rather locally founded control, being just an alliance through cross shareholding.

Other legal ground to impose liability on parent companies

In a group context there are other ways to make parent companies liable through various mechanisms. These will briefly be presented in the following, since this is not about piercing the corporate veil, but the courts do refer to company law in an enterprise context.

Duty of care

Parent companies may be liable for injuries caused by subsidiaries where they were involved and controlled their activities and assumed responsibility. In Chandler v Cape plc (2012) CA, Mr Chandler had been subject to exposure of asbestos while employed by Cape Products, and brought a claim against the parent company, Cape Plc. The parent company owed a direct duty of care to the employees. There existed a level of integration between the parent and its subsidiary, thus the court referred to the company law enterprise theory.

In Vedanta (2016, 2017, UKSC 2019) Zambian villagers suffered injuries and losses arising out of alleged pollution caused by the mine operated by the Zambian subsidiary. A potential expansion scope of Chandler in the context of a multinational enterprise group. The scope of Chandler is narrow, since the Salomon principle is such a strong principle in UK company law. Again, the UK courts are generally wedded to entity law.

Directors duties

A specific provision in this regard is s. 172(1), Companies Act 2006 about a duty to promote the success of the company. If a director fails to respect the separate legal identity of a subsidiary in an insolvency situation, it may disqualify him.

Statute

On insolvency, it is possible that a liquidator may succeed in establishing that the parent company has had such control over its subsidiary to render the parent company a shadow director of the subsidiary for matters as wrongful trading by the subsidiary. Sections 213 and 214, Insolvency Act are potential remedies for directors taking risks at the expense of creditors. Here, the piercing of the corporate veil is done de facto under statue by making a parent company liable for the debts of its subsidiaries.

There is an overlap between the subject of piercing the corporate veil, wrongful trading and directors′ duties, in the sense that at the time approaching insolvency, focus is mainly on the directors. It is possible to impose liability on directors, shareholders and most important a parent company. Limited liability in the group context is primarily to protect parent companies. The courts are reluctant to make parent companies liable under sections on wrongful trading. It requires significant involvement in the management of the subsidiary, and replacement of the independent decision-making process of the subsidiary has to be shown.[5] The courts seem wedded to entity law rather than to the enterprise theory and seing the entities as a collected enterprise. The judgement in Hydrodan can be questioned. The parent company will usually have the funds to cover the debts of the insolvent subsidiaries, hence the decision is to narrow.

The deterrent effect of the wrongful trading provisions could be transferred to the group context. It will discourage the entities within the group context to mismanage and take large risks on the behalf of the creditors by allocating the risky business to the subsidiary. Parent companies will perhaps control and be more cautious regarding its subsidiaries if it knows that piercing the corporate veil is easier.

Need for a law reform?

The question on whether the corporate group should be legally treated as one entity has been subject to great consideration. The European Commission discussed the Directive on Groups, but in 2002 the Commission abandoned the directive. The Commission has considered to recognize the interests of the group. Greater transparency from groups is needed to protect creditors′ interests when dealing with which what turns out to be a complex group structure. On the other hand, creditors can protect themselves by demanding guarantees from a parent company to cover the eventual losses of its subsidiaries, through security in company assets and through pricing mechanisms. It should be noted that large financial institutions as banks have greater bargain power and can seek security in another scale than small, maybe unvoluntary creditors that will be able to seek a letter of comfort from the parent company.

The parent company will as a matter of good business practice disregard their legal right to not pay the debts of its subsidiaries but will pay and support the subsidiaries′ obligations. Especially if the creditors of the subsidiary are also creditors of the parent company. On the other hand, if the size of the debts is rather large, the parent company is more likely to avoid the debts of its subsidiary, since this can put a risk on the parent company′s own creditors and obligations.

When considering involuntary tort creditors of a subsidiary, the application of the Salomon principle seems unfair. The courts are, as showed in Adams v. Cape Industries plc (1990), unwilling to regard tort creditors any disregarding of the Salomon principle. Adams is a strong affirmation of the Salomon principle. The courts are reluctant to pierce the corporate veil, thus the court in Adams emphasized that the group structure secures the parent company no liability of its subsidiary, and this point is inherent in English law. Often these creditors will be secured by protection, so it can be argued that the need for the possibility to pierce the corporate veil here is limited.

The doctrine has to be balanced by policies, so it still promotes investment. If the doctrine is changed, perhaps it will not facilitate the raising of the required capital. To meet this concern, ex ante disclosure requirements could be enhanced to promote transparency. In other jurisdictions, piercing the corporate veil is a more basic legal manoeuvre, for instance in the US, they are more open to the concept of the enterprise theory, considering the group to a greater extent than the English approach.[6] We may see more regulation of the group circumstances. In 2018, the forthcoming reform in corporate governance was presented. A need for enhancement of disclosure in enterprise groups, whereby parent companies shall consider the interests of its subsidiaries when selling subsidiaries at financial difficult times, based on the rationale that parent companies can abuse its subsidiaries on the expense of creditors at times approaching insolvency. Other international standards have been emerging. The UNCITRAL Legislative Guide on Insolvency Law and World Bank Principles has deliberated various actions regarding standards on enterprise groups in solvency and directors′ duties at times before insolvency. A draft directive on group liability and cross border insolvency has been presented by the EU on group accounts. These legislative developments show that there is a big focus on enterprise groups. There are gaps in the law, thus it is not unrealistic that we will see a law reform regarding the possibility of piercing the corporate veil, addressing the issues that the arising of large enterprise groups entails. In terms of the de facto economic reality, it is difficult to uniform this area of the law. There are different levels of group unity.

Conclusion

The law needs to balance the interests of the corporate form, encouraging commerce and entrepreneurship and tackle abuse and protect other stakeholders, especially creditors. When considering the piercing of the corporate veil, it should be reserved to those circumstances where true and considerably exceptions to the Salomon principle are justified. For instance, as showed, where a company wholly owned by the same shareholder, by ownership and control deliberately evades existing obligations. The scope of piercing the corporate veil is rather minimal after Prest.

In general, company law and common law in this area shall seek to promote social welfare and be efficient. We know that the company is just a fictional form reflection different interests of the various stakeholders. Conflicting interests must be balanced in an appropriate way. Ultimately, fair and efficient rules providing social welfare must be found.

The wrongful trading regime is perhaps the easiest way to impose liability on parent companies and directors, and the doctrine of piercing the corporate veil is justified in those circumstances described. 

[1] Salomon v Salomon & Co Ltd [1897] A.C. 22 1896 WL 4725

[2] Petrodel Resources Ltd v Prest [2013] UKSC 34

[3] Salomon v Salomon & Co Ltd [1897] A.C. 22 1896 WL 4725

[4] The term ”Parent company” is preferable over the term ”holding company”, as holding company may suggest that the company can only hold shares in its subsidiary, while it cannot do other things, which is necessarily not the case nor the meaning of s. 1159.

[5] Re Hydrodan (Corby) Ltd [1994] B.C.C. 161

[6] Easterbrook and Fischel., “Limited Liability and the Corporation” (1985) 52 University of Chicago Law Review 89

7 Easterbrook and Fischel., “Limited Liability and the Corporation” (1985) 52 University of Chicago Law Review 89