გამჭოლი პასუხისმგებლობა

The University of Manchester
School of Law
LAWS70901 RESEARCH PAPER
LAWS70081 Corporations and International Business law
“Parent Company Liabilities for the Debts of its Subsidiaries - A Comparison between the UK
and the German Law”
A research paper submitted to the University of Manchester for the degree of LL.M Masters
(International Business & Commercial Law) in the Faculty of Humanities: School of Law.
Student ID Number 9053243
30 April 2014
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Contents
Introduction ..................................................................................................................................... 1
I. Limited Liability and Separate Corporate Personality in the context of Corporate Groups ..... 4
1.1 UK Approach towards Parental Liability .............................................................................. 6
1.2 Exceptions to the Concepts of Separate Corporate Personality and Limited Liability ......... 8
1.3 Sham/façade/fraud ................................................................................................................. 9
1.4 Agency Agreement .............................................................................................................. 10
1.5 Statutory Provisions related to Group Liability ................................................................... 12
2.1 German Approach towards Parental Liability ..................................................................... 14
2.2 Parent Company Liabilities in case of Contractual Group .................................................. 16
2.3 Parent Company Liabilities in case of de facto Concern (group)........................................ 18
2.4 Piercing the Corporate Veil ................................................................................................. 18
II. Evaluation of the UK and German Approaches towards Parental Liability............................. 20
III. Perspectives in relation to the harmonisation of Rules on Parental Liability.......................... 27
Conclusion ..................................................................................................................................... 31
Bibliography .................................................................................................................................. 32
Introduction
The European Union (EU) has made significant steps to harmonise certain areas of corporate law,
such as financial reporting, auditing, capitalization etc.1 However, the issue of parental liability
still remains unregulated at the Union’s level.2 The EU has twice attempted to adopt the unified
rules regarding the conditions under which a parent company should be held liable for the
obligations of its subsidiary.3 The first effort that the EU made was within the framework of the
European Company Statute or Societas Europea (SE) in 1970, through which the EU attempted
to create a new type of corporation.4 The idea behind this attempt was to provide for a wider
option for investors to carry out the business at international arena in addition to the national one.
The draft statute envisaged strict form of liability of a parent company towards the subsidiaries
and its creditors.5
Secondly, new draft Ninth Directive was introduced between 1970 and 1984, a proposal which
similarly to the first draft contained strict form of liability of the parent company. 6 In particular,
under the Draft the controlling company would have been liable for the debts of its controlled
company.7 The Draft was criticized for undermining the concepts of limited liability and
increasing management costs.8 None of the drafts have been adopted. The United Kingdom was
amongst those countries that refused to adopt the second draft proposal arguing the proposed
1
Sandra K. Miller, “Piercing the corporate veil among affiliated companies in the European
Community and in the U.S.: A comparative analysis of U.S., German, and U.K. veil-piercing
approaches” [1998] American Business Law Journal 73, 74.
2
ibid 75.
3
Jorg Peter, “Parent Liability in German and British Law” [1999] EBOR 440, 440.
4
Meredith Dearborn, “Enterprise Liability: Reviewing and Revitalizing Liability for Corporate
Groups” [2009] CLR 195, 222.
5
ibid.
6
ibid 223.
7
ibid.
8
Miller, “Piercing the corporate veil among affiliated companies in the European Community
and in the U.S.: A comparative analysis of U.S., German, and U.K. veil-piercing approaches” (n
1) 76.
1
model was mainly based on German group law, thus ignoring the practice and legal approaches
taken by other countries.9 The fact is that Germany has a well-established regulation of the
liabilities within the corporate groups.10 On the other hand, the UK has also developed a
comprehensive body of case-law to address the parent liability issues within the groups of
companies.11 The approaches taken by these two countries compared to other EU member states
are fundamentally different.12
Despite the fact that the EU has failed to adopt the unified rules on parental liability the issue still
remains to be of high importance.13 In 2001 the European Council issued the Regulation (EC)
No2157/2001 on the Statute for a European company (SE) which intends to regulate the
establishment and operation of the Public limited liability Company at the EU level. However,
this Regulation does not contain rules on parental liability. Paragraph 4 of the introductory part of
the Regulation states that the legal framework within which businesses must be carried on in the
community is still based largely on national laws, thus creating a significant difficulty to the
creation of groups of companies from different Member States. 14 Nowadays, large businesses
tend to carry out commercial operations as corporate groups, through the webs of subsidiaries at
international level.15 This circumstance once again revives the need to address the affairs within
corporate groups, especially the issue of parental liability for the subsidiaries obligations.
However, the approaches taken by the UK and Germany are regarded as polar opposites.
Consequently, the harmonisation of the rules on parental liability at the Union’s level would
9
Peter, “Parent Liability in German and British Law” (n 3).
10
ibid.
11
Derek French, Stephen W Mayson and Christopher L Ryan, Mayson, French &Ryan on
Company Law (30th edn, Oxford University Press 2013) 144-148.
12
13
ibid.
14
Council Regulation (EC) 2157/2001 on the Statute for a European company (SE) [2001] OJ
L294.
15
Irit Mevorach, “The Role of Enterprise Principles in Shaping Management Duties at times of
Crisis” [2013] EBOR 471, 471-472.
2
only16 become possible if the law of these two countries have enough in common that would
serve as a basis to develop such rules.17
This paper attempts to compare the UK and German legislation in order to find out whether it is
possible to develop the unified rules on parental liability at the EU level, which would be
consistent with both British and German legal systems.18
The paper consists of 3 parts and will proceed as follows. First, I will examine the rationale of
limited liability and separate legal personality in the context of corporate groups. Afterwards I
will separately consider the approaches taken by the UK and Germany towards the regulation of
parental law. Finally, I will compare, contrast and evaluate both countries’ approaches and
discuss whether there are enough legal grounds to harmonise the rules on parental liability.
For the purposes of the present paper, I will focus on public companies limited by shares, because
this is the type of company which usually tends to operate through number of subsidiary
companies.19 In terms of the parent company liabilities I will only examine contractual
obligations rather than obligations deriving from tort because the latter is a different subject
matter requiring separate consideration. Finally, for the purposes of comparison I will rely on
British case law together with the UK Companies Act 2006 and the Insolvency Act 1986 in case
of the UK. In case Germany I will rely on German Stock Corporation Act. The mentioned
sources constitute the main legislative materials applicable to the corporate group related issues
in these two countries.
16
17
ibid.
18
ibid.
19
B. G Pettet and others, Pettet's Company Law (1st, Pearson Longman, 2009) 45.
3
I. Limited Liability and Separate Corporate Personality in the context of Corporate
Groups
Before I start to review the basic company law concepts I would like to define what a
company is itself. Generally speaking, a company is a legal entity or person and a legal fiction
which only exists because the law so contemplates.20 A company has a dual nature as both an
association of its members and a person separate from its members. 21 A company’s property is
owned by the company as a separate person, not by its shareholders and it has the right to form
contracts in relation to the company’s business. 22
In today’s business world, companies, especially large corporations tend to carry out their
business through numbers of subsidiary companies, so the issue of limited liability and separate
corporate personality within corporate groups is highly important.23 These are the underlying
principles on which today’s business operations are built.24 There are several reasons why a
corporation may choose to establish a subsidiary. It may possibly create the economies of scale in
production or distribution or a reduction in transaction costs.25 Furthermore, establishment of
subsidiaries might facilitate the access to new markets. Besides, running the business as a
corporate group rather than a particular company can result in lower taxation etc.26
The laws and regulations of the world’s developed and developing countries allow running of the
business through the form of corporations with limited liability which means that company
20
Damien Murphy, “Holding Company Liability for Debts of Its Subsidiaries: Corporate
Governance Implications” [1998] Bond LR 241, 243.
21
French, Mayson, Ryan (n 11) 122.
22
ibid.
23
L.C.B Gower and others, Gower and Davies' Principles of Modern Company Law (1st edn,
Sweet & Maxwell 2012) 244.
24
Mevorach, “The Role of Enterprise Principles in Shaping Management Duties at times of
Crisis” (n 15).
25
Ian M Ramsay, “Holding Company Liability for the Debts of an Insolvent Subsidiary: A Law
and Economics Perspective” [1994] UNSWLJ 520, 533.
26
ibid.
4
shareholders liabilities are limited to the value of shares they have already paid or have to pay.27
In practice the effects of limited liability varies from the perspective of different stakeholders. For
shareholders the company’s limited liability means that in case of its insolvency the worst thing
that may happen to them is to lose the total amount of the investment they have made in the
company. However, their personal assets will be protected from creditors’ claims. If we look at
the matter from the creditors’ position their rights against the company are confined to its assets
and they do not have an access to the shareholders’ personal properties.28
As regards the concept of separate corporate personality, it should be noted that almost every
country’s company laws are based on the principle that a company is a legal entity separate and
distinct from its shareholders.29 Therefore, as far as this principle is complied with, each entity in
a group of companies is considered to be an independent legal person, responsible only for its
own debts. However, dealing with groups of companies can have detrimental effect on minority
shareholders and creditors of any of the subsidiary companies in the group.30 It is characteristic
for a group with integrated business plans to take commercial decisions in the interests of the
whole group or of a parent company instead of for the benefit of an individual subsidiary within
the group. As a result, corporate groups often ignore the interests of their subsidiaries and
subsequently their creditors.31
In the aforementioned context the first question that arises is when the law, if at all will disregard
the company’s separate existence, considering the distinction between a parent and subsidiary
27
L.C.B Gower and others (n 23) 207.
28
ibid.
29
Ramsay, “Holding Company Liability for the Debts of an Insolvent Subsidiary: A Law and
Economics Perspective” (n 25) 520.
30
Crisis' (n 15).
31
ibid.
5
companies irrelevant and thus hold a parent corporation liable for the debts of its subsidiary.32
The application of this practice is usually termed as “piercing” the corporate veil.33
In the following sub-chapters I will look at the doctrines of limited liability and separate
corporate personality in the context of corporate groups and will examine the legal approaches
taken by the UK and Germany with respect to the parent company liabilities for the debts of its
subsidiaries.
1.1 UK Approach towards Parental Liability
Browsing through the UK Companies Act 2006 it is almost impossible to find specific chapter on
group law or a section concretely dealing with parent company liabilities for the obligations of its
subsidiaries.34 However, the Act contains a detailed definition of the “holding” and “subsidiary”
companies. Pursuant to the Act a company is a “subsidiary” of its “holding company”, if that
other company holds a majority of the voting rights in it, or is a member of it and has the right to
appoint or remove a majority of its board of directors, or is a member of it and controls alone a
majority of the voting rights in it, or if it is a subsidiary of a company that is itself a subsidiary of
that other company.35
Due to the absence of explicit rules on parental liability with the Companies Act 2006 one may
even doubt whether English law regulates such situations at all.36 Yes, English law definitely
deals with group situations through the underlying principles of company law, such as limited
32
Murphy, “Holding Company Liability for Debts of Its Subsidiaries: Corporate Governance
Implications” (n 20) 253.
33
Dearborn, “Enterprise Liability: Reviewing and Revitalizing Liability for Corporate Groups”
(n 4) 222.
34
Alexander Daehnert, “Lifting the Corporate Veil: English and German Perspectives on Group
Liability” [2007] ICCLR 393, 393.
35
Companies Act 2006, s 1159(1).
36
Daehnert, “Lifting the Corporate Veil: English and German Perspectives on Group Liability”
(n 34) 393.
6
liability and separate corporate personality.37 These are the company law principles which
constitute the basis for the regulation of the English group law. Besides, the UK has a well-
developed body of case law which provides for lifting of the corporate veil within corporate
groups in exceptional circumstances.38
English Law takes a formalistic approach with respect to groups of companies and considers that
each company in the group is an independent legal person possessing its own rights and
liabilities.39 The concept of separate corporate personality has been a fundamental company law
principle in the UK since past centuries. It was first affirmed by the House of Lords in the famous
case of Salomon v. Salomon & Co. back in 1897.40 This decision strongly influenced further
development of English Company Law. Even today this case is the starting point for all judges
when examining the issue of piercing of the corporate veil of the company concerned.41 Courts
also uphold the principle of separate corporate personality given in “Salomon case” in their later
decisions concerning corporate groups.42
In the context of corporate groups, the main question has always been whether and when a group
should be treated as a single legal entity.43 In this relation, it is interesting to look at the UK case
law development. In “DHN Food Distributors LTD v London Borough of Tower Hamlets” case
DHN was a parent company which wholly owned two subsidiaries.44 All of the companies in a
group were engaged in the same business area. The mentioned two elements, whole ownership of
subsidiaries and common business sphere turned out to be the decisive ground for the court to
37
ibid.
38
French, Mayson, Ryan (n 11) 144-148.
39
ibid.
40
(n 34) 394.
41
ibid.
42
ibid.
43
Peter, “Parent Liability in German and British Law” (n 3) 450.
44
French, Mayson, Ryan (n 11) 144-147.
7
determine that the group represented a single legal entity, thus justifying the piercing of the
corporate veil of subsidiary companies.45
However, this approach was later overruled by the decision on “Adams v Cape Industries PLC”
that similarly to “Salomon case”, is frequently cited in the context of corporate groups.46 In
“ Adams v Cape” the main legal issue was whether Cape, an English parent company, had
been present in the United States by way of its wholly-owned subsidiary. If yes, US court would
have been able to enforce the judgement against the parent company in England. The Court of
Appeal rejected the idea of the parent and its subsidiary being a single entity merely because
of some kind of economic connections between them. 47 This way, the Court declined Cape’s
presence in the USA, thus rejecting its liability for the wholly-owned subsidiary’s
obligations. The Court stated that it was not entitled to ignore the principle of separate corporate
personality only because that it would be just to do so. The Court mentioned in the judgement
that English law allows the establishment of subsidiary companies that are to be considered as
separate legal persons, possessing their own rights and obligations, despite being the sub-
holdings of their parent companies.48 Therefore, a subsidiary company may not be considered as
an agent of its parent company simply because of being the creature of its mother company.49
1.2 Exceptions to the Concepts of Separate Corporate Personality and Limited Liability
Despite the strict adherence to “Salomon” principle several exceptions to the well-recognized
doctrine of separate legal personality are still available in English law, when the courts will
45
ibid.
46
ibid 146-148.
47
48
ibid.
49
(n 34) 394.
8
depart from the mentioned rule and lift the corporate veil to impose subsidiary’s obligations on its
parent company.50 These exceptions are also applicable in the context of groups of
companies.51Among them are sham/façade/fraud situations, as well as the company being an
agent of its parent, or that the corporations in a group form a “single economic unit”.52 The latter
has already been discussed above.53 The other exceptions will be examined in the subsequent
chapters.
1.3 Sham/façade/fraud
As already stated one of the most prominent exceptions to the Concepts of Separate legal
Personality and Limited Liability is the sham/façade/fraud situation. Here the main issue is
whether a subsidiary within a group represents a body corporate used to hide the real facts, to
commit fraud or to evade pre-existing obligations of the parent.54 The most important factor in
sham/façade/fraud situations is the misuse component of the corporate structure, which enables
the court to disregard company’s separate personality and thus impose its liabilities on the parent
company.55
It is notable that although in “Adams v Cape Industries PLC” Court rejected the single economic
unit argument and did not find Cape, as a parent liable for the obligations of its wholly owned
subsidiary present in the US, the court determined that the other subsidiary of Cape, named AMC
50
1) 112.
51
(n 34) 394.
52
53
See n 47.
54
(n 34) 394.
55
L.C.B Gower and others (n 23) 219-220.
9
incorporated in Liechtenstein to be a façade of its parent company.56 This was not the main issue
in the given case, however, the court justified this decision by saying that in fact, AMC was not
only the wholly owned subsidiary of Cape but it was merely a body corporate of which name was
used on invoices by Cape and other companies in the group.57 The approach in sham/façade/fraud
situations is that a subsidiary company should not be misused by its parent for dishonest or
unlawful purposes otherwise parent is at risk of becoming liable for subsidiary’s debts. 58
1.4 Agency Agreement
The other notable exception to “Salomon” principle is the agency relationship between a parent
and subsidiary companies.59 As it was uphold in the case of “Smith, Stone & Knight LTD v
Birmingham Corp”, a company may act as an agent of the other company if it is authorised to do
so and in such a case the authorising company is bound by the acts of its agent.60 In the
mentioned case the court referred to that there were circumstances indicating agency relationship,
such as who the real controller of the business was and who received the benefits from that
business.61
In “Smith, Stone & Knight LTD v Birmingham Corp” the court determined that establishment of
agency relationship between two companies is a matter of fact which should be decided on a case
by case basis.62 However, in English law there is no automatic assumption of an agency
56
ibid.
57
ibid.
58
1) 113.
59
(n 34) 395.
60
ibid.
61
ibid.
62
ibid.
10
relationship between a parent and its subsidiary unless there is an express agency agreement.63
Therefore, in the absence of an express agreement it is very difficult to find out one.64 Such an
assumption would have undermined the whole idea of separate corporate personality and thus the
running of the business through subsidiary companies.65 As it appears from “Salomon,” as well
as from “Adams v Cape Industries PLC” the threshold for establishing the agency relationship is
high and the fact that a member exercises a dominant control over the company’s affairs through
the ownership of shares is not enough to establish agency.66 Therefore, single economic unit
argument, together with the mere control of the company’s shares is not sufficient to persuade
British courts in the presence of the agency relationship.67 Courts might establish this kind of a
relationship in case if the subsidiary is entirely depended and under the control of its mother
company.68
English law recognizes other grounds for lifting the corporate veil, such as impropriety, interests
of justice in certain cases.69 However, this list is not exhaustive. For this reason, it can be
observed that Britain has no clearly defined criteria for lifting the corporate veil to attribute
subsidiary company’s debts to its parent company. Due to the adherence of the “Salomon’s”
principle in the UK it is for sure that courts are not very much willing to disregard company’s
separate legal personality and even if they apply this practice, they will do it only in very
exceptional and limited circumstances.70
It is notable that the fact that the UK tends to be reluctant when a case comes to piercing of the
63
64
ibid.
65
ibid 452.
66
(n 34) 395.
67
ibid.
68
ibid.
69
L.C.B Gower and others (n 23) 221-222.
70
11
corporate veil, it would be wrong to conclude that British legal system ignores the existence of
corporate law structures.71 The clear example would be the issue of financial reporting under the
Companies Act 2006. In case if the parent company exercises control over the subsidiary the
former is under an obligation to provide financial accounts not only on its behalf but, on behalf
of the corporate group as a whole in order to ensure transparency and accountability. Besides,
subsidiary companies must also prepare and submit their own financial statements. 72
1.5 Statutory Provisions related to Group Liability
Although there are no specific group liability provisions in the UK Companies Act 2006, British
legislature still has a legal remedy to set aside company’s limited liability in certain cases and
make it responsible for subsidiary’s obligations.73 Some sections of the Insolvency Act 1986 such
as Section 213 and 214 are applicable to group situations as well.74
Section 213 is a provision on fraudulent trading which is applicable if in the course of the
winding up of a company it appears that any business of the company has been carried on with
intent to defraud creditors of the company the court.75 In this case on the application of the
liquidator the court may declare that any persons who were knowingly parties to the carrying on
of the business in the manner above-mentioned are to be liable to make such contributions to the
company’s assets as the court thinks proper. 76 This provision reflects the objective possibility of
the company controllers to defraud creditors using company’s limited liability, knowing that
creditors’ claims are confined to company’s assets.77 And this might often be a case in a group
scenario where a parent company uses its subsidiary to perpetrate such an act. Despite the
71
72
ibid 248.
73
ibid 225.
74
75
Insolvency Act 1986, s 213 (1).
76
77
12
difficulty of finding the proof of fraud fraudulent trading provision can still be a sufficient legal
ground to catch parent and make it liable for the subsidiary’s debts. 78 It should also be noted that
the parent company’s dominant control over its subsidiary is not an enough for holding it liable
for the debts of its subsidiary.79
Section 214 is a provision on wrongful trading which was proposed as an international standard
to ensure that directors of the company, being under the risk of insolvency, act in the interests of
that company and thus minimise the threat of insolvency. 80 Liability envisaged by this provision
is also aimed at creditor protection.81 Declaration under the wrongful trading provision can be
made if the company has gone into insolvent liquidation and a person who was a director of the
company at some time before the commencement of the winding up knew at that time, or ought
to have concluded at that time, that there was no reasonable prospect that the company would
avoid going into insolvent liquidation.82 Since this provision imposes a duty on directors in the
context of a parental liability, it becomes applicable if a parent company at the same time is a
director of its subsidiary.83
It should be noted that Sections 213 and 214 appears to be effective in the group scenarios since
these provisions allow the court to impose any part of the debt owed by the subsidiary on a
person against whom the declaration is made, including its parent.84
78
ibid 227-230.
79
Peter, “Parent Liability in German and British Law” (n 3) 451-454.
80
Crisis” [2013] EBOR 471, 479-480.
81
(n 34) 400-401.
82
Insolvency Act 1986, s 214 (1).
83
84
ibid.
13
2.1 German Approach towards Parental Liability
Germany is the first country within the European Union to have a separate law governing the
corporate group related matters.85 The Law has been developed from German Stock Corporation
Act (GSCA) reform carried out in Germany in 1965.86 The legislature considered the existence of
number of corporations, which apparently had independent legal presence but in fact were
controlled by another company, to be a problem. Therefore, in the Stock Corporation Act the
legislature tried to address the potential conflict of interest in corporate groups where the parent
company has an objective possibility to make the most of its wealth through its subsidiary at the
expense of the latter’s minority shareholders and creditors.87 The Act contains the liability
scheme that is helpful to find a balance between the interests of the parent companies and
subsidiary companies and thus to protect the latter’s creditors interests. 88 Details will be
discussed below.
It should be noted that there are two Acts on Corporations in force in Germany.89 The first one is
the German Stock Corporation Act (GSCA) and the second one is the Limited Liability Company
Act. Despite certain differences GSCA is comparable to British Public Company (PLC) whereas
German Limited Liability Company is analogous to British Private Company (LTD).90 Under
German law both types of companies are entitled to enjoy the benefits of limited liability.91
85
Klaus J Hopt and Katharina Pistor, “Company Groups In Transition Economies: A Case for
Regulatory Intervention?” [2001] EBOR 1, 7.
86
(n 4) 215.
87
ibid 216.
88
ibid.
89
René Reich-Graefe, “Changing Paradigms: The Liability of Corporate Groups in Germany”
[2005] ConnLRev 785, 785-788.
90
91
1) 99.
14
For the purposes of the present paper, I will focus on German Stock Corporation Act (GSCA)
because it contains all the corporate group related provisions.92 The GSCA recognizes various
kinds of corporate groups, such as parent-subsidiary enterprises, controlled and controlling
enterprises and members of a group of companies.93 Pursuant to Section 16 (1) of the GSCA if
the majority of shares in a legally separate enterprise are held by another enterprise such
enterprise is considered to be a subsidiary and the other enterprise to be its parent enterprise. In
this case the law makes a presumption that the subsidiary is under the control of its parent.94 This
approach differs from the British position according to which companies in a group are regarded
to be independent from other corporate group members. Therefore no automatic dependence of
subsidiary upon its parent is presumed, unless contrary is proved.95
In the context of a group liability the most important are the definitions of controlled and
controlling enterprise, since similarly to British law, a Concern (group) in Germany is not
considered to be an independent legal person.96 However, if a controlling and one or more
controlled enterprises are subject to the common direction of the controlling enterprise, it is
presumed that a controlled and its controlling enterprises form a corporate group.97 I will consider
the legal regulations of this kind of a relationship from the perspective of a controlling enterprise
being a parent company of the controlled enterprise.
The idea behind the law concerning controlling and controlled enterprises is that the former
should not cause its controlled company to enter into legally or financially disadvantageous
92
Vicky Priskich, “Corporate Groups: Current Proposals for Reform in Australia, the UK and A
Comparative Analysis of the Regime in Germany” [2002] Intl Comp Corp LJ 37, 46.
93
(n 4) 217.
94
ibid.
95
French, Mayson, Ryan (n 11) 144.
96
97
German Stock Corporation Act 1965, s 18.
15
transactions unless any loss is compensated by the controlling enterprise. 98 This is the provision
through which German legislature intends to protect the interests of creditors and minority
shareholders of the subsidiary company.99 It is apparent that the presumption given in Section 18
differs from the British position where the mere fact of the dominant control over the subsidiary
does not make the parent liable for its obligations.100
2.2 Parent Company Liabilities in case of Contractual Group
Two types of corporate groups can be classified under the GSCA, contractual groups, together
with integration agreements and de facto groups, depending on whether there is a separate control
agreement among the group members.101 Controlling entities have a choice to formalise their
dominance over subsidiaries through contracts. 102 In case of a contractual group the dominated
enterprise is brought under the total control of its parent.103 In return, the parent company is
required to compensate its subsidiary for annual losses no matter whether they are caused by the
dominant control or not.104
It is notable that in the event of forming a contractual corporate group, the terms of the enterprise
contract are subject to public record, so that creditors’ interests are ensured through providing
98
(n 4) 218.
99
ibid.
100
(n 34) 395.
101
Priskich, “Corporate Groups: Current Proposals for Reform in Australia, the UK and A
Comparative Analysis of the Regime in Germany” (n 92) 46-48.
102
(n 34) 396-397.
103
ibid.
104
(n 4) 218.
16
them with information about the intra-group relationships.105 Secondly, in order to safeguard
creditors’ interests the parent is under an obligation to provide a legal reserve for the amounts
which are payable to the subsidiary.106 And thirdly, in case of the termination of an enterprise
agreement the parent company is under an obligation to provide security to the creditors whose
claims arose prior to the date on which the termination was announced in the commercial
register.107 In the exchange of security, the dominating party may provide a guarantee to the
creditors. Considering all of the above mentioned it becomes apparent that a parent company has
to pay the cost for its dominance over the subsidiary. 108
Integration agreements as mentioned above belong to the category of contractual groups where a
controlling company acquires the whole ownership of another company.109 Under this kind of an
agreement a parent company is entitled to instruct its wholly owned subsidiary to enter into such
transactions that are harmful or even places the future existence of the subsidiary enterprise at
risk.110 However, in case of such an agreement the parent owes direct liability to all the creditors
of its subsidiary and will be responsible for all the losses of its wholly owned company. 111
105
1) 101.
106
ibid 102.
107
ibid 103.
108
(n 34) 396-397.
109
(n 4) 218.
110
German Stock Corporation Act 1965, s 319, 323.
111
ibid s 322.
17
2.3 Parent Company Liabilities in case of de facto Concern (group)
The other type of a corporate group where a parent company factually controls its subsidiary, but
no agreement has been executed between them is referred to as a de facto Concern (group).112 In
such a case a parent is still subject to the statutory scheme given in the GSCA, the same one
applicable to controlled and controlling enterprises. Namely, a parent will be under an obligation
to pay compensation for the losses incurred by the subsidiary caused by detrimental transactions
entered into under the parent’s instructions.113 It is notable that in contrast to contractual groups,
in case of de facto Concern (group) a parent can be held liable only for those losses that are
caused by its instructions. And finally if a parent fails to indemnify the losses to its subsidiary it
will liable for any resulting damage to such controlled company. 114
2.4 Piercing the Corporate Veil
German law recognizes the concept of corporate veil-piercing as one of the ways for holding a
parent company liable.115 However, it is notable that the GSCA contains almost all the
circumstances in which this practice might be applicable in parent-subsidiary relationship.116
Upon all of the above mentioned, it can be observed that the German statutory scheme on
corporate group liability is sufficiently clear-cut which allows creditors to determine the risks
relating to such groups. Consequently, the practice of applying the veil-piercing jurisprudence for
112
113
(n 4) 219-220.
114
German Stock Corporation Act 1965, s 317.
115
116
(n 4) 219.
18
the purposes of holding a parent liable for subsidiary’s debts is of little significance in
Germany.117
117
ibid.
19
II. Evaluation of the UK and German Approaches towards Parental Liability
The study of British and German law reveals that, even though both countries’ corporate laws
recognize the doctrine of company’s limited liability there are still significant differences in their
approaches towards parental liability within the corporate groups.118 Whereas group liability
related issues are not explicitly regulated by English law, Germany appears to be the first country
to adopt a comprehensive statutory scheme on group law.119
Under English law group liability issue arises only if courts are trying to disregard subsidiary
company’s separate corporate personality to hold its parent liable. Even in these cases courts tend
to find an agency relationship or sham/façade situation.120 Perhaps this is the reason why England
has not yet adopted a separate law governing corporate group liabilities and continues to deal
with the matter through the body of case law, or through fraudulent/wrongful trading regime. It is
accepted in the UK that each company in a group is responsible for its own debts. Therefore, a
parent company does not have to undertake subsidiary’s obligations merely because of being its
parent and because of exercising dominant control over it.121
In contrast, German law views particular threats deriving from group structures, considering that
the controlling enterprise while acting for its interests might endanger the interests of its
subsidiary and accordingly the interests of its minority shareholders and creditors.122 For this
reason, German Stock Corporation Act particularly addresses the interests of subsidiaries,
118
1) 75.
119
Comparative Analysis of the Regime in Germany” (n 92) 46.
120
(n 34) 398-399.
121
Crisis” (n15) 479-480.
122
(n 34) 398-399.
20
together with its minority shareholders and creditors by imposing particular liabilities upon the
parent.123 As we have seen above, the Act is structured in a way that it governs both formalised
and non-formalized relationships between the parent and its subsidiary. 124 In any case, the Act
provides for particular statutory remedies, such as compensation and indemnities on the part of
the parent so that to ensure the interests of the controlled enterprise and its minority shareholders
and creditors.125
Overall, it can be observed that while in the UK the creation and control over subsidiaries does
not entail any special liability upon the parent, in Germany the controlling entity has to pay the
price for exercising dominant control over its subsidiaries.126
Among Corporate law scholars the British approach towards group liability is known as being
pro-entity meaning that it is highly protective of the concepts of limited liability and separate
legal personality of corporate group members.127 On the other hand, the alternative approach
taken by Germany where the liability upon the parent is imposed for the obligations of its
subsidiaries is considered to be pro-enterprise.128
Both pro-entity and pro-enterprise approaches have their proponents and opponents considering
the strengths and weaknesses of these concepts.
As it was already mentioned, entity law recognizes the concepts of limited liability and separate
corporate personality within corporate groups. In practice the benefits of these doctrines are well
123
ibid.
124
Reich-Graefe, “Changing Paradigms: The Liability of Corporate Groups in Germany” (n 89)
788-793.
125
(n 4) 216.
126
(n 34) 398-399.
127
Crisis” (n15) 471-473.
128
1) 75-76.
21
identified.129 Economic theory suggests that the concept of limited liability is essential for the
effective functioning of the financial markets.130 It is acknowledged that limited liability
facilitates running of the business by reducing the risk of investment and operational costs,
together with investor’s need to manage the corporation. Limited liability is also advantageous in
the context of corporate groups, as without this concept companies might have avoided running
of the business through subsidiaries.131 A logical question might be asked - if limited liability is
applicable to natural persons, why should it not be applicable to legal persons as well. If the
parent company was responsible for the debts of its subsidiary, it would have created an unfair
situation compared to shareholders of single companies, since conducting of the business through
subsidiary companies would have become too expensive.132 Therefore, the economic rationale of
limited liability in the context of corporate groups is still relevant since it serves as a risk insuring
and cost reductive mechanism for company owners, thus facilitating the economic growth, which
itself is a risky process.133
Despite its advantages, entity law has been criticised by number of commentators, considering
that benefits of limited liability should not generally be applicable to corporate groups. According
to authors such as Easterbrook and Fischel through the veil-piercing of a subsidiary only the
assets of its parent company are reached and thus capital formation of the subsidiary is not
affected as much as it would have been in the situation where corporate veil-piercing takes place
129
Crisis” (n15) 473-474.
130
1) 131.
131
Crisis” (n15) 473-474.
132
(n 34) 400-401.
133
ibid.
22
against a single corporation.134 Professor Landers considers that in most cases for company
owners prefer profit maximisation at the level of whole corporate group rather than a single
subsidiary within the group. Therefore, Professor observes that a company within the corporate
group should enjoy the limited liability only if the company is organised in a way that enables it
to maximise profit independently. It means that a subsidiary should not be totally dependent on
its parent and the latter should treat it as an independent entity.135
According to Professor Philip Blumberg modern corporations tend to operate through numbers of
subsidiaries and these corporate groups often carry out their business across the national borders.
In this reality the concept of limited liability and separate legal personality are not appropriate,
since they hinder the accountability of corporate structures at international level.136 Furthermore,
these two concepts by safeguarding the corporate formality and treating subsidiary companies as
distinct legal persons, serve as the shield from liability which would have been imposed upon the
parent company in the absence of such a corporate structure.137
Unlike the UK, Germany has chosen explicit group law regulation by taking into account
contractual or factual relationships between companies.138 Pro-enterprise liability approach
taken by Germany originates from the enterprise liability theory elaborated by Adolf Berle in
1947. Berle considered that company’s separate legal personality problematic when its
shareholders are other legal entities, rather than natural persons. He urges that separate legal
personality within corporate group is not appropriate, since the behaviour of the group acting for
the common purpose is unified from the economic standpoint. In this respect, establishment of
134
1) 131-132.
135
ibid.
136
(n 4) 208.
137
ibid.
138
Karen Vandekerckhove, “Piercing the Corporate Veil” [2007] ECL 191, 191.
23
subsidiaries becomes legal formalism which indirectly forces the minority shareholders, as well
as creditors, to pay for the losses incurred due to the hazardous actions of the subsidiary. In
order to avoid this result Berle suggests the theory of enterprise liability, according to which a
parent should be liable for subsidiary’s operation, which is beneficial to the group as a whole
but harmful for the interests of subsidiary and the society.139
Looking at German regulation which illustrates exactly the enterprise liability theory one might
think that it is just and fair, because if the parent company benefits from using the subsidiary, it
is logical that it should also undertake proper responsibilities.140 However, everything is not as
simple as it may seem, because German regulations have frequently become subject to
criticisms for being ineffective in number of ways.141
As it was mentioned above German Stock Corporation Act provides for liability scheme for
both contractual and de facto relationships between the parent and its subsidiary.142 Through
enacting this law, the legislature expected that corporate groups would find it beneficial to use
the option of formalising intra-group relationship through a contract. However, the provision on
contractual concern proved to be hardly applicable in practice. The reason for this is that the law
largely focuses on the actions of the parent company towards its subsidiary therefore,
discouraging the parent to organize its relationship with subsidiaries through contractual
form.143 The incentive to make enterprise contracts attractive seem to have been unsuccessful
according to the statistics in 1970-1980. The Data shows that only small number of enterprise
139
(n 4) 199.
140
1) 133.
141
142
See n 124.
143
(n 4) 224.
24
agreements have been formed during these years, despite the fact that more than half of German
stock corporations belonged to a corporate group.144
Deficiencies are also apparent in the context of de facto groups. While German Stock
Corporation Act directly defends the interests of the subsidiary, rules given in Sections 311 and
317 appear to be less protective of subsidiary’s creditors and especially its minority
shareholders.145 The parent’s liability towards subsidiary for losses and damages is of internal
character. It means that, if the parent company refuses or otherwise avoids indemnifying the
losses incurred by the subsidiary for disadvantageous actions, creditors cannot sue the parent
company directly. In fact, parent company owes direct liabilities to its subsidiaries but not to
their creditors.146
If we look at the situation within de facto groups from the perspective of minority shareholders,
we will see that usually they are not in a strong position to obtain the evidence that the parent
company is exercising harmful influence over the subsidiary company. Section 317 obliges the
controlling enterprise to compensate the shareholders of the controlled company any damage
incurred as a result of the damage to that company. However, normally, minority shareholders
do not have sufficient access to information regarding the administration of the subsidiary,
which would enable minority shareholders to prove that detrimental transaction is the parent
company’s fault.147 Acquiring evidence is more problematic for the subsidiary’s creditors, no
matter operating as a member of de facto or contractual group. Therefore, compared to minority
shareholders creditors have even less possibility to prove the parent company’s detrimental
144
145
ibid 51.
146
(n 4) 224.
147
25
actions towards subsidiary. 148
Overall, it should be noted that despite explicit regulation of parental liability German legal
system is criticised for being ineffective when a case comes to its enforcement.149
148
ibid.
149
(n 4) 226.
26
III. Perspectives in relation to the harmonisation of Rules on Parental Liability
Analysing the approaches taken by the UK and Germany makes it in fact challenging to think of
adopting the unified regulation on parental liability at the EU level.150 Both of the countries
appear to have a long standing case and statutory laws governing the parental liability for the
debts of its subsidiaries. The positions of both countries have their merits, which we have
already discussed above. It is too unrealistic to think that either pro-entity or pro-enterprise
approach is universal and applicable to all situations.151 In order to elaborate common rules on
parental liability mutual compromises would be necessary. Although it would be beneficial to
have a unified regulation of parental law at the EU level, there are certain factors both on the
part of the UK and Germany which would turn the harmonisation process into a difficult task.
In the judgement on the recent case of “Prest v Petrodel Resources Ltd & Ors” the House of
Lords reviewed the conditions under which a court is entitled to disregard company’s separate
legal personality and hold its members liable for its activities. 152 In its judgement the House of
Lords once again emphasized the strength of the “Salomon” principle together with recognizing
the court’s jurisdiction to pierce the corporate veil. However, according to the court, piercing of
the veil may only take place in very limited circumstances such as in the case of a deliberate
evasion and in the absence of other alternative remedies.153 Obviously, alternative ways for
imposing liability upon the parent company are still available in English law.154 However, the
judgement on “Prest v Petrodel Resources Ltd & Ors” despite being a family law rather than
150
151
1) 148.
152
Prest v Petrodel Resources Ltd & Ors [2013] UKSC 34.
153
Brenda Hannigan, “Wedded to Salomon: Evasion, Concealment and Confusion on Piercing
the Veil of the One-Man Company” [2013] Irish Jurist 11, 15-16.
154
See n 52.
27
specifically company law case reveals no incentive for softening the “Salomon” principle.
Rather, it once again reveals and emphasises the significance and firmness of the concepts of
limited liability and separate legal personality for the United Kingdom.155
On the other hand, Germany has a well-developed statutory regime on corporate groups which
although argued to be ineffective still governs corporate group law issues step by step. German
system sets precise obligations upon the parent and stresses on the values such as the protection
of the interests of subsidiary’s creditors and minority shareholders. 156 Therefore, it is unrealistic
to expect that Germany would change its approach in favour of any other approaches.157
Despite the different approaches taken by the UK and Germany some ways might still be found
which could be developed to provide a ground for the elaboration of common standards with
respect to parental liability for the debts of its insolvent subsidiary. This could be done through
the joint and coordinated application of the entity and enterprise law principles as suggested by
Irit Mevorach in her Article – “The role of enterprise principles in shaping management duties at
the time of crisis.”158
The author of the mentioned Article reviews the UNCITRAL Insolvency Working Group’s
recommendations in relation to the wrongful trading regime. As it appears, British standards on
wrongful trading are becoming an international best practice for imposing the liability upon the
company perpetrating such an act.159The wrongful trading rule stresses on the role of directors
and obliges them to take into account the interests of the creditors when the company is having
155
Hannigan, “Wedded to Salomon: Evasion, Concealment and Confusion on Piercing the Veil
of the One-Man Company” (n 153) 19-20.
156
(n 4) 226.
157
1) 148.
158
Crisis” (n15) 471-473.
159
ibid.
28
financial crisis or is at risk of insolvency.160 Creditors’ interest is something that is of common
concern and consideration in the corporate group context both in the UK and Germany. However,
in the UK creditors’ interest is a matter of directors’ duties, whereas in Germany it is a question
of shareholders’ duties.161
It is notable that the innovative international standards on managerial obligations as proposed by
UNCITRAL, adopts a wide view of the persons responsible for the management of a company.162
In particular, the definition of “director” covers persons exercising actual control and carrying
out the functions of directors.163 In case of the UK this might include directors that are also
parents of the companies concerned. However, in case of Germany the mentioned definition
would cover a parent company controlling its subsidiary, rather than a director of the subsidiary
as under German Stock Corporation Act a company cannot be a director of another company. 164
As already explained, under British wrongful trading regime company directors have to take
appropriate actions to cope with company’s financial difficulties. Nevertheless, this obligation
does not exclude directors’ possibility to act in the interests of the whole group if this is suitable
for the group reality. As Irit Mevorach proposes in her Article this case is consistent with entity
law requirements.165
160
ibid.
161
162
Crisis” (n15) 487.
163
United Nations Commission on International Trade Law Working Group V , 'Directors’
obligations in the period approaching insolvency ' (http://daccess-dds-ny.un.org/ 2013)
<http://daccess-dds-
ny.un.org/doc/UNDOC/LTD/V13/807/89/PDF/V1380789.pdf?OpenElement> accessed 29 April
14.
164
German Stock Corporation Act 1965, s 76 (3).
165
Crisis” (n15) 495.
29
Furthermore, she suggests that if the corporate group management breaches its obligation owed
to the insolvent company, then the parent should become liable for the debts of such a company.
This is the case where enterprise law might play its role but only the limited one. According to
the author, enterprise law should not impose the subsidiary’s debts upon the parent company
simply because of the group factor, but rather for the breach of the management duties owed to
the insolvent company. In such case enterprise law should serve as a mechanism for
acknowledging the group reality and identifying those persons who should bear the responsibility
because of not complying with their obligations to save the company concerned. In this respect
enterprise law might be helpful to enhance the directors’ (including factual directors)
accountability towards the members of the corporate group and their creditors.166
Upon the abovementioned, I would like to conclude that to the extent that the scheme as
suggested by Mevorach contains the elements of both entity and enterprise law, it would not be
too unrealistic to expect further development of the unified rules in relation to parental liability,
at least under the wrongful trading regime.
166
ibid 488.
30
Conclusion
The purpose of this Article was to compare the UK and German legislation in order to find out
whether it was possible to develop the unified rules on parental liability at the EU level, which
would be consistent with both British and German legal systems. 167 To achieve the aim of the
paper I summarised and analysed the legal basis for the regulation of parental liability in the UK
and Germany. As a result, I came to the conclusion that despite the fact that both countries’
Company laws have more or less regulated the issue of parental liability, there are still
deficiencies which need to be further addressed.168
On the one hand, the adoption of the unified regulation on parental liability at the EU level seems
to be unlikely considering the different approaches taken by these two countries. 169 As already
discussed above both British and German positions have their justification, thus making
unrealistic the fundamental changes of these approaches. On the other hand, considering that
today’s businesses are largely carried out through numbers of subsidiaries, there is a great need
for precise rules on parental liability. In this respect, the international standards on wrongful
trading elaborated under the UNCITRAL Insolvency Working Group, together with the liability
scheme as suggested by Mevorach’s reveal a potential for further development.170 Therefore, the
joint and coordinated application of the entity and enterprise law principles as mentioned above
might serve as a basis for achieving the certain degree of harmonisation of the parental law at the
EU level, which would be consistent with both the UK and German law.
167
168
(n 34) 402-403.
169
170
See n165-166.
31
Bibliography
Books
Gower L and others, Gower and Davies' Principles of Modern Company Law (1st edn, Sweet &
Maxwell 2012).
French D, Mayson S and Ryan C, Mayson, French &Ryan on Company Law (1st edn, Oxford
University Press 2013).
Pettet B and others, Pettet's Company Law (1st edn, Pearson Longman 2009).
Journal Articles
Daehnert A, “Lifting the Corporate Veil: English and German Perspectives on Group Liability”
(2007) ICCLR 393.
Dearborn M, “Enterprise Liability: Reviewing and Revitalizing Liability for Corporate Groups”
(2009) CLR 195, 222.
Hannigan H, “Wedded to Salomon: Evasion, Concealment and Confusion on Piercing the Veil of
the One-Man Company” (2013) Irish Jurist 11.
Hopt K and Pistor K, “Company Groups In Transition Economies: A Case for Regulatory
Intervention?” (2001) EBOR 1.
Mevorach I, “The Role of Enterprise Principles in Shaping Management Duties at times of
Crisis” (2013) EBOR 471.
32
Milller S, “Piercing the corporate veil among affiliated companies in the European Community
and in the U.S.: A comparative analysis of U.S., German, and U.K. veil-piercing approaches”
(1998) American Business Law Journal 73.
Murphy D, “Holding Company Liability for Debts of Its Subsidiaries: Corporate Governance
Implications” (1998) Bond LR 241.
Peter J, “Parent Liability in German and British Law” (1999) 10 EBOR 440.
Priskich V, “Corporate Groups: Current Proposals for Reform in Australia, the UK and A
Comparative Analysis of the Regime in Germany” (2002) Intl Comp Corp LJ 37.
Ramsay I, “Holding Company Liability for the Debts of an Insolvent Subsidiary: A Law and
Economics Perspective” (1994) UNSWLJ 520.
Reich-Graefe R, “Changing Paradigms: The Liability of Corporate Groups in Germany” (2005)
ConnLRev 785.
Vandekerckhove K, “Piercing the Corporate Veil” (2007) ECL 191.
Legislation
German Stock Corporation Act 1965.
The UK Companies Act 2006.
The UK Insolvency Act 1986.
33
EU Legislation
Council Regulation (EC) 2157/2001 on the Statute for a European company (SE) (2001) OJ
L294.
Cases
Prest v Petrodel Resources Ltd & Ors [2013] UKSC 34.
Websites
1
United Nations Commission on International Trade Law Working Group V , 'Directors’
obligations in the period approaching insolvency ' (http://daccess-dds-ny.un.org/ 2013)
<http://daccess-dds-
ny.un.org/doc/UNDOC/LTD/V13/807/89/PDF/V1380789.pdf?OpenElement> accessed 29 April
14.
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The University of Manchester

LAWS70901 RESEARCH PAPER

LAWS70081 Corporations and International Business law

and the German Law”

Student ID Number 9053243

will prescribe the terms and conditions of any such agreement.

1.1 UK Approach towards Parental Liability .............................................................................. 6

1.3 Sham/façade/fraud ................................................................................................................. 9

1.4 Agency Agreement .............................................................................................................. 10

1.5 Statutory Provisions related to Group Liability ................................................................... 12

2.1 German Approach towards Parental Liability ..................................................................... 14

2.2 Parent Company Liabilities in case of Contractual Group .................................................. 16

2.3 Parent Company Liabilities in case of de facto Concern (group)........................................ 18

2.4 Piercing the Corporate Veil ................................................................................................. 18

II. Evaluation of the UK and German Approaches towards Parental Liability............................. 20

III. Perspectives in relation to the harmonisation of Rules on Parental Liability.......................... 27

and its creditors.5

are fundamentally different.12

serve as a basis to develop such rules.17

consistent with both British and German legal systems.18

in these two countries.

contracts in relation to the company’s business. 22

production or distribution or a reduction in transaction costs.25 Furthermore, establishment of

and they do not have an access to the shareholders’ personal properties.28

subsequently their creditors.31

1.1 UK Approach towards Parental Liability

that other company.35

groups in exceptional circumstances.38

decisions concerning corporate groups.42

corporate veil of subsidiary companies.45

companies.51Among them are sham/façade/fraud situations, as well as the company being an

1.4 Agency Agreement

by case basis.62 However, in English law there is no automatic assumption of an agency

exceptional and limited circumstances.70

1.5 Statutory Provisions related to Group Liability

as Section 213 and 214 are applicable to group situations as well.74

for the debts of its subsidiary.79

director of its subsidiary.83

person against whom the declaration is made, including its parent.84

kinds of corporate groups, such as parent-subsidiary enterprises, controlled and controlling

to be independent from other corporate group members. Therefore no automatic dependence of

subsidiary upon its parent is presumed, unless contrary is proved.95

considered to be an independent legal person.96 However, if a controlling and one or more

being a parent company of the controlled enterprise.

does not make the parent liable for its obligations.100

2.2 Parent Company Liabilities in case of Contractual Group

dominant control or not.104

2.4 Piercing the Corporate Veil

circumstances in which this practice might be applicable in parent-subsidiary relationship.116

to adopt a comprehensive statutory scheme on group law.119

parent and because of exercising dominant control over it.121

price for exercising dominant control over its subsidiaries.126

subsidiaries is considered to be pro-enterprise.128

the strengths and weaknesses of these concepts.

effective functioning of the financial markets.130 It is acknowledged that limited liability

itself is a risky process.133

its parent and the latter should treat it as an independent entity.135

parent company in the absence of such a corporate structure.137

contractual or factual relationships between companies.138 Pro-enterprise liability approach

but harmful for the interests of subsidiary and the society.139