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Parent Company Liability in Case of Subsidiary Insolvency Time to Rethink Liability of Corporate Shareholders?

Supervisor: Prof. Dr. iur. Peter Behrens European Company Law Academic Year 2003-2004

Thesis presented by: Vassya Prokopieva for the Degree of Master of European Studies

Statutory Declaration I hereby declare that the thesis has been written by me without any external unauthorized help, that it has been neither presented to any institution for evaluation nor previously published in its entirety or in parts. Any parts, words or ideas, of the thesis, however limited, and including tables, graphs, maps etc., which are quoted from or based on other sources, have been acknowledged as such without exception.


Keywords Parent and subsidiary companies Groups of companies Law on groups of companies Separate personality Limited liability Unlimited liability Insolvency

Abbreviations AG – Aktiengesellschaft (German joint stock company) AktG – Aktiengesetz (German Law on Joint Stock Companies from 1965) BGH – Bundesgerichtshof in Zivilsachen (German Federal Supreme Court) CA’85 – English Companies Act from 1985 CC – French Commercial Code (Code de Commerce) GmbH – Gesellschaft (German limited liability company) GmbHG – Gesellschaftgesets (German Act on Limited liability companies from 1892) EBOR – European Business Organization Law Review EBLR – European Business Law Review ECJ – European Court of Justice IA’86 – English Insolvency Act from 1986 Ltd – English (US) private limited liability company PLC – English (US) public limited liability company SA – Société Anonyme (French Joint Stock Company) SARL – Société à responsabilité limitée (French private limited liability company) EC Treaty – Treaty establishing the European Community



The US Enron, EU Parmalat and other recent corporate scandals started a heated discussion about the accountability of large multinational groups of companies. Focusing on the headline stories, the public debate on those cases shifted away from the broader subject of intra- and extra-group liability, separate personality and limited liability of controlling shareholders. In the meantime the market, on its own, has started revising the statute of limited liability of controlling corporate shareholders, as a part of the modern corporate governance reforms. The present study analyses the controversy between control and limited liability, separate personality and personal interest opposed to group interest within the parent-subsidiary context, and how national and European legislations and judiciaries reconcile them. The main idea is that limited liability of shareholders as a feature of the modern corporation was never created to protect control and corporate opportunism. “Wrongful trading”, “action en comblement du passif”, “Konzernrescht” (general law on groups) and similar concepts, proposed by English, French and German corporate and insolvency law, have provided only partial and inefficient solutions to the problem. However, the national courts demonstrate a well balanced and converging judicial activism in transforming the limited liability of the parent company (corporate shareholder in the subsidiary) into unlimited liability by “piercing the corporate veil” doctrine. The common logic in national legislations, shared values by national courts, influence by the ECJ and US courts, along with constructive academic debates, could be a good starting point in developing future European law on groups of companies. As proposed by David Millon’s “tailored limited liability” concept, there is room to rethink the price of limited liability for controlling corporate shareholders and find a way to manage the risks of irresponsible acts leading to insolvency. Backed by converging judicial reasoning


and recent legislative reforms, the corporate governance reforms should address in a new way the concepts of “group interest” and parent company liability. A new “flexible limited liability” approach sanctioning corporate opportunism or more precisely concrete acts of the controlling corporate shareholder, such as pooling of assets of the company causing the insolvency, should be embraced by the law policy makers. Further, enhancing controlling shareholders’ accountability should be subjected to economic and legal analysis and if necessary incorporated in a future European Directive on Groups of Companies.



Table of Contents
Introduction………………………………………………………………………...8 I. Risks for Shareholders and Creditors………………………………………… 10 1. Specific Risks Related to Groups…………..…………………………………….10 2. Regulatory, Judicial and Soft Law Solutions…………………….………………12 II. Main Notions Used in the Context of Penetrating Liability ……………….. 14 1. Parent and Subsidiary Companies. Groups of Companies……………………… 14 2. The State of Insolvency. Insolvency Proceedings……………………………..... 15 3. General questions in the Context of Parent Company Liability in regard to Subsidiary Insolvency………………………………………………………… 16 3.1. Separate Personality and Limited Liability vs. Fairness to Creditors………… 16 3.2. Ownership vs. Control – Who is the Decision Maker?.......................................17 3.3. Duty of Loyalty and Fiduciary Duties – Who Owes What to Whom?.............. 18 3.4. Independence of the Subsidiary Directors - a Cornerstone in ParentSubsidiary Relations…………………………………………………………... 19 III. EC and National Legal Solutions…………………………………………… 20 1. EC Law – Fractional and Sector-specific Harmonization………………………. 20 2. English Regulatory Approach…………………………………………………… 22 2.1.Traditional means – Wrongful Trading by Shadow Directors, Unfair Prejudice and Re-use of Insolvent Company Name…………………………… 22 2.2.Enterprise Act of 2002 – A Step Forward in Recognizing Flexible Liability for Groups…………………………………………………………… 24 2.3.Comparison with the US Regulatory Approach…………………………….… 25 3. French Legislative Responses……………………………………………..…… 26 3.1.Exceptions to the Principle of Separate Personality and Limited Liability…………………………………..……………………… 26 3.1.1. “Action en Comblement du Passif ”…………………………………….... 26 3.1.2. “Confusion des Patrimoines”……………………………………………... 27 3.2. New French Rules on Joint Liability within a Group of SA Companies…….. 28 4. The German Control Groups and Konzernrecht ……………………….…….. 28


4.1.Contractual Groups – Control Agreements and Integration…………………… 29 4.2.De Facto Konzern……………………………………………………………… 30 4.3.Qualified De Facto Konzern – Where Is the Limit?........................................... 31 IV. Jurisprudence of National Courts and ECJ……………………………….. 32 1. English Courts…………………………………………………………………... 32 1.1. Lifting the Corporate Veil………………………………………………..….... 32 2. French Courts……………………………………………………………….…… 32 2.1. Accor Case………………………………………………………………….…. 32 2.2.Alien Music Case………………………………………………………………..34 2.3.Rozenblum Case…………………………………………………………...…… 34 3. Evolution of the German Jurisprudence – from “Autokran” to “KBV” ……… 35 3.1. Bremer Vulkan Case………………………………………………………..…. 36 3.2.KBV Case……………………………………………………………………… 37 4. ECJ Jurisprudence……………………………………………………………… 38 V. Academic Input………………………………………………………….……. 39 1. No Limited Liability with Respect to Creditors without Bargaining Power……. 40 2. Flexible (Tailored) Limited Liability………………………………………….… 41 VI. A Way Forward – Some Proposals for EC Harmonization……………….. 43 1. Preventive Measures for Improved Disclosure………………………………..… 44 2. Sanction Measures – Enhanced Accountability of Parent Companies and Managers for Failures of the Subsidiaries…………………………….…… 45 3. Improvement of Related Instruments……………………..………………..…… 46 4. Alternative Ways to Achieve Convergence…………………………………....... 47 VII. Concluding Remarks……………………………………………………...… 47 Bibliography………………………………………………………………………. 49 Main Legal Acts………………………………………………………...………… 51 Main Cases………………………………………………………………..………. 52


INTRODUCTION Parent-subsidiary relations and groups of companies’ policies are some of the most controversial areas in modern company law. Minority shareholders and stakeholders, such as creditors, employees, and to some extent potential investors face serious risks and legal uncertainty in the context of highly integrated groups. Enhancing creditors’ and investors confidence in groups is even more important in Europe since doing business across borders may be perceived to be more risky than internally where information on the business partner may be easier to obtain. If parent companies interfere with the management of the subsidiaries and exercise control in a way, which leads to their insolvency, they breach the requirements for limited liability of shareholders in a corporation and therefore, they should no longer take advantage at the expenses of minority shareholders and stakeholders. Limited liability of shareholders as a feature of the modern corporation was never created to protect control and opportunism. The purpose of the present study is to demonstrate that in a situation of lack of general European harmonization of the parent companies liability for the insolvency of their subsidiaries, and despite different national legislations, the national corporate policy makers and before all the national courts, influenced by the European Court of Justice (ECJ), demonstrate highly converging interpretation of the problem and common willingness to address in adequate way the corporate opportunism. This could be a good starting point in developing future European law on groups of companies. The first part of this study lists some of the potential risks originating mainly with respect to the creditors of subsidiaries and discusses some of the main ways to address them (regulatory, judicial, corporate governance codes, at both national and European level. This part mentions the need of an EU involvement to limit those risks. The second part deals with the notions of parent-subsidiary relations, groups of companies, state of insolvency and insolvency proceedings. Briefly mentioned are problems of essential importance to the discussed subject matter: separate personality and limited liability of


shareholders – controlling corporate bodies, ownership, control and decision-making within the corporation, fiduciary and loyalty duties and independence of the subsidiary’s managers. The lack of general European legislation in the field of groups of companies (as well as previous unsuccessful attempts to harmonize this area) is mentioned in part three hereunder. The focus of this part is to compare the main regulatory solutions, proposed by English, French and German corporate and insolvency laws. Part four of this work presents cases decided by English, French and German courts in their efforts to adjust the concepts of limited liability to the economic reality faced in dealing with groups. The demonstrated judicial activism, under the form of “piercing the corporate veil” doctrine and the converging views of the courts are supported by some examples of the US and ECJ jurisprudence. Interesting academic views are outlined in part five of the present analysis. All of them inspired the present work, whereas their values and downsides are discussed with a reasonable extent of personal touch. The purpose of part six is to draw the attention to some proposals for future harmonization in the field of groups (planed by the European Commission in the mid-term, or in the period from 2006 to 2008). Most of the proposals are based on the ideas launched by Forum Europaeum and expressed in the Action Plan on modernization of the company law, adopted by the EU Commission in 2003.1 Based on the analysis of legal, judicial and academic views, the author’s personal opinion on the main problem is also offered in this part. The analysis of the challenges arising in the parent-subsidiary context terminates with brief concluding remarks.


Modernnising Company Law and Enhancing Corporate Governance in the European Union – A Plan to Move Forward, European Commission, Brussels, Com (2003) 284 final, 25/05/2003, hereinafter “Action Plan”


I. RISKS FOR SHAREHOLDERS AND CREDITORS: Multinational corporations and small and medium enterprises today expand and enter new markets using the advantages of share and control networks. Limited liability in subsidiaries, no withdrawal taxes on dividends paid by the subsidiary, control, less expensive intra-group loans, integrated management, shared goodwill, expertise and human resources are some of the advantages allowing a group of companies to gain market share, optimize costs and maximize profits. A subsidiary of a multinational group will be very often described as a “network company” (implying not only beneficial set-up, but also a group dependency). The lack of general legal regulation of the groups at EU level results in an enormous legal uncertainty and exposes the minority shareholders and contractual and tort creditors to specific risks, some described below: 1. Specific Risks Related to Groups: Lack of autonomy in the management and decision-making process of the subsidiary. Group’s interest, which is not always easily identifiable by the subsidiary’s creditors and could override the interests of the subsidiary. This in turn could amount to the majority shareholders’ abuse of the minority shareholders interests in the subsidiary. Patrimonial mixing (“commingling assets”) and distortion of the capital function. That is why cross-shareholding between parent and subsidiary is limited by art.24a of the Second Company Directive in the same way as acquiring of own shares.2 Use of subsidiary’s assets to cure financial difficulties of the parent corporation. Spillover effects in situation of parent’s or sister companies’ insolvency. Transactions executed not at arm’s length and transfer pricing. Jurisdiction and substantive law problems in case of cross-border group insolvency. It is still not clear whether the Insolvency Regulation (jurisdiction in cross-border insolvency for companies registered in Europe) apply in case of insolvency of a parent company and its subsidiary, since the regulation expressly refers to a branch or “related undertaking” of the parent company3. Recent overlapping insolvency

Second Company Directive 77/91, /1976/, amended by Council Directive 92/101/ from 13/11/1992, art. 24a and art. 19. 3 Council Regulation on Insolvency Proceedings (ЕC) No 1346/2000 OJ 30/06/2000



proceedings, launched in different jurisdictions for one and the same subsidiary (Eurofood, Irish Subsidiary of Italian Group Parmalat) demonstrate that courts face enormous difficulties in determining the so called “center of main activities” in order to see which jurisdiction is competent to open the main proceedings. Moreover, the Rome Convention from 1980 on the law applicable to contracts excludes the relations between company and its members, thus creditors of the subsidiary may never be sure what will be the substantive law applicable to the intra-group relations and the liability of parent company for the debts of its subsidiary. Most probably it will be the law of the forum competent to open main insolvency proceedings, which introduces risks for jurisdiction races. National rules such as the recently endorsed by the German Insolvency Act from 1999 with respect to the international insolvency proceedings, prescribing that the jurisdiction of the first court seized can not be challenged by a second court, increase this risk.4 It is proposed today that the European Commission revises the Insolvency Regulation to include procedural and even substantive consolidations of bankruptcies of groups, which will minimize the risk of forum shopping.5 Creditors of the subsidiary can compete with the creditors of the parent company in case of group’s common insolvency. Challenges presented by pyramidal structures are not analyzed here, but it should be noted that these could significantly complicate the above-mentioned risks. In light of these and other challenges it is difficult to understand why the law has been extended to cover corporate shareholders that are in fact part of the enterprise in the same manner as individual shareholders.6

German Insolvency Act of 2003 as commented in “EU Regulation on Insolvency Proceedings” 2004, Freshfields Newsletter, 5 Comparative Study of Corporate Governance Codes Relevant to EU and its Member States, WEIL, GOTSHAL & MANGES LLP on behalf of the EU Commission, January, 2002, p.102 6 ALEX MAGAISA, “Corporate Groups and Victims of Corporate Torts - Towards a New Architecture of Corporate Law in a Dynamic Marketplace”, (2002) 1 Law, Social Justice & Global Development Journal (LGD) at p.6



2. Regulatory, Judicial and Soft Law Solutions National and European policy makers try to address these risks in several ways: regulation, effective justice, soft law and Codes of Corporate Governance and Best Practices and professional and academic Forums, all aiming at convergence of corporate governance practices. 2.1. Regulation: Except for special fields, such as bank and insurance supervision, labor, tax, accounting and competition law, there is no coherent law on groups in most of the EU countries. Earlier attempts of the EU Commission to harmonize by the Fifth and Ninth Directives (the Structure and Groups Directive) failed. Germany, along with Portugal, Poland and Slovenia, are the only EU countries that provide for general regulation of groups and parent-subsidiary relations and liabilities.7 Some unified rules, introduced by the Capital Directive and related to preservation of the capital, could possibly engage the parent liability for the debts of the subsidiary in its quality of a shareholder. Such is the situation of unauthorized distribution of dividends, which if made with no bona fide by the parent company will result in its obligation towards the subsidiary to pay back the dividends received in breach of the solvency and capital requirements (Art.15 of the Capital Directive; Art.57 and 58 of the AktG, art.223-40 of Code de Commerce and sec.263-281 of the Companies Act 1985).8 The parent as a major shareholder could possibly be hold liable for damages in case it breaches its obligation to react in case of inadequate capitalization (Art. 17 of the Capital Directive). Under-capitalization of the subsidiary could be regarded (although rarely in practice) as abuse by the parent company of the minority shareholders in the subsidiary.9 In addition, most national insolvency laws provide for nullification of transactions between parent and insolvent subsidiary breaching the arm’s length principle. Restitutio in integrum
For a detailed overview see KLAUS HOPT and KATHARINA PISTOR, “Company Groups in Transition Economies: A Case for Regulatory Intervention”, (2001) 2 European Business Organization Law Review (EBOR) T.M.C. Asser Press, 1-43 8 German ITT case, BGHZ 65, 15 (DB 1975/2172), ordering personal liability of the major shareholder after illegal distribution of dividends and the Second Company Law Directive 77/91 as changed by Directive 92/101/EEC of 23.11.1992, OJ N L 347/64 9 Re Poli Peck International PLC (in administration) N 3 /1996/ I BCLC 428


principle would lead to obligation of the parent company to restore back into the insolvency account the amounts received in such transactions (s.138/2/b) and 133/2/ of the German Insolvency Act as amended in January 2002; s. 343 of the English Insolvency Act from 1986, “extortionate credit transactions” and art.L-621-107 of the French Code de Commerce, 2001)10 The focus of this paper, however, is on the rules, constituting exception to the general principles of separate personality and limited liability.

2.2. Balanced Judicial Activism: The courts establish liability for the parent company on the basis of different criteria: legal norms regulating groups, breach of fiduciary duties due by legal or de facto (shadow) directors the company and shareholders, “specific duties” owed by the parent - major shareholder to the minority shareholders11 or apparent abuse of the corporate form and limited liability. All these involve application of the doctrine of lifting (or piercing in the USA) of the corporate veil, which as form of judicial activism is analyzed in part four hereby. The ECJ influence the courts’ reasoning, mainly by its judgments in completion cases. Most of them show how competition can affect old concepts of limited liability and separate personality and seek for a new, modern corporate accountability on competition context. 2.3. Soft Law and Forums. Globalization and market forces (common failures, expanding beyond national boundaries) are increasing the need of creation of voluntary codes of corporate governance, which companies, doing business responsibly adhere to. Such codes (around 40 in Europe) enjoy great extent of convergence, but unfortunately do not address directly the parent/subsidiary or groups of companies’ relations. It is advisable to improve them with that respect.12

Particularily strong in USA, where besides the bankruptcy rules on avoidable transactions, the Uniform Fraudulent Conveyance Act regulate in a general way the voidance of unfair transactions between related parties, which defraud the creditors, 2004, 11 KLAUS HOPT, “Common Principles of Corporate Governance in Europe?”, 2000, Millennium Conference, London, later published in (2000) Markensins, Oxford, 16-18, hereinafter “HOPT supra note 11” 12 WEIL, GOTSHAL & MANGES “Comparative study…”, supra note 5, p. 30



Furthermore, the national and EU legislator is inspired by the expertise provided by forums, gathering prominent academics and representatives of business and state agencies, such as Forum Europaeum13, the European Multi-stakeholder Forum, the Forum Group of Financial Analysts etc.

II. Main Notions Used in the Context of Penetrating Liability: 1. Parent and Subsidiary Companies. Groups of Companies. At present, there is no unified general definition of parent or subsidiary companies or groups of companies.14 The national definitions are not identical, but rest on the common understanding that control (obtained by majority of voting rights, power to nominate the majority of the directors) is the underlining feature of a parent-subsidiary couple.15 Examples to that include the rules of art. 16 of the German Joint Stock Corporations Act (“AktG”), s.736 of the English Companies Act from 1985 (“CA’85”) and art. L233-1 of the French Code de Commerce (“CC”). It is presumed in most of the legislations that the parent company exercises control over the subsidiary. As to the groups of companies, the German Law of affiliated companies is the most developed one and describes the affiliated enterprises as “one or more controlled enterprises together with a third enterprise able to exert control over them” (Art.18 of the AktG). A future common general definition of groups and parent-subsidiary relations would be a welcomed effort by the European Commission. A basis for development of such definition could be the definition provided in Seventh Company Directive on group accounts.16 For the purposes of consolidated financial statements (representing the accounts of the separate entities as accounts of a single unit) a parent undertaking is (art.1): (1) one, which has a majority of the shareholders' or members’ voting rights (control by ownership or voting rights) in another entity, a subsidiary;

See mainly in “Corporate Group Law for Europe”, FORUM EUROPAEUM CORPORATE GROUP LAW, (2000) 1 EBOR, 165-264 and the web site: (in German language only) 14 ERIK WERLAUFF, “EU Company Law”, 2nd edition, DJOF, 2003, at p.456 15 PAUL DAVIES, “Gower and Davies’ Principles of Modern Company Law”, 7th Edition, Sweet Maxwell, London, 2003, p.209, hereinafter “P.DAVIES supra note 15” 16 Seventh Council Directive 83/349/EEC on consolidated accounts, OJ (EC) 1983



(2) a company entitled to appoint or remove a majority of the members of the administrative, management or supervisory body of another entity (the subsidiary) and is at the same time a shareholder or a member of that undertaking; (3) a company, which can exercise a dominant influence over the subsidiary of which it is a shareholder or a member, pursuant to a contract between the two or to its memorandum or articles of association, where allowed by the national law of the subsidiary (option tailored to address the German reality); (4) a company, shareholder in another company, who has exclusively appointed the directors for the current and preceding financial years; (5) a company, which controls another company (no need to be a shareholder) by means of control agreement (Member states could provide more detailed clauses for such control agreement, as is the situation on Germany). In general the holding may be 20% or more of the voting rights. What is important is the possibility to exercise control. Similar definitions are also adopted by other community instruments, mentioned in part three hereunder. The European Company Statute also recognizes the groups of companies, but unfortunately does not provide for definition. With respect to applicable law the statute points to the national law of the state in which the European company (“SE”) is registered.17

2. The State of Insolvency. Insolvency Proceedings. A company is insolvent when it is illiquid - unable to meet its mature obligations to pay. Illiquidity is presumed as a rule if the debtor has stopped payments (art.17 of German Insolvency Act from 1999 (IA) for example). This is one of the facts, which results in obligation for the managers to file an application for insolvency proceedings within a short period of time (up to 3 weeks) or cure the company in this period. A second ground for launching insolvency proceedings is provided for corporations (public limited liability corporations (PLC (UK), AG (Germany) or SA (France) and private limited

Council Regulation (EC) No 2157/2001 of 8 October 2001 on the Statute for a European company (SE), art.3 and art.51 and Council Directive 2001/86/EC of 8 October 2001 supplementing the Statute for a European company with regard to the involvement of employees, both published in OJ L 294 of 10.11.2001


liability corporations (accordingly: Ltd, GmbH and SARL). This is the state of overindebtedness or when the assets owned by the debtor no longer cover his existing obligations to pay. (art.19 of the German IA for example). The insolvency proceedings, to which it shall be referred in this paper are universal proceedings, set in national law and Community Instruments such as the Insolvency Regulation (dealing mainly with competent jurisdiction and not substantive insolvency law), and opened for insolvent or overindebted debtor, after a request of its directors or creditors. The proceedings aim at rescuing the debtor’s business and/or securing fair distribution of its assets to the creditors and finally to the residual claimants – shareholders. Those proceedings are conducted in a strictly regulated manner, under the directions of an insolvency administrator representing the state. Creditors’ individual direct claims against the subsidiary or even against the parent company are stayed and joined into the subsidiary’s universal insolvency proceedings.

3. General Questions Raised in the Context of Parent Company Liability in regard to Subsidiary Insolvency: The complexity of penetrating liability in the parent-subsidiary context cannot be fully understood without analyzing some more general preliminary questions. However, the scope of this paper would only allow their brief mentioning: 3.1. Separate Personality and Limited Liability vs. Fairness to Creditors: In English law a company may hold shares in other company if authorized to do so in its memorandum. French and German laws do not require such expressed entitlement. The incorporation, separating the personality and liability of corporate shareholders from those of the subsidiary collides with the principle of fair allocation of risks between creditors and debtors. The control exercised by corporate shareholders implies that it is no longer feasible to treat in the same way individual and passive investors on one hand, and major shareholders (parent companies) on the other. Irresponsibility (not to mention abuse) of the corporate shareholders should be subject to the corporate governance reforms in Europe and across the Atlantic. Once the appropriate limits 16

of limited liability are understood, courts, supplementing legislative efforts, can rule for holding corporate shareholders personally liable for losses that result from their irresponsible behavior.18 3.2. Ownership vs. Control - Who is the Decision Maker? Different legal approaches to the parent-subsidiary relations could be explained by corporate cultures based on either concentrated or dispersed ownership of shares in the modern corporation. Two models have been long opposed: the Anglo-Saxon, and the so called Rhineland model. The first, being market-oriented, outsider-dominated and shareholderfocused is opposed to the second, prevailing in continental Europe and the civil law countries, namely the bank (debt) -oriented, insider-dominated and stake-holder focused (the corporate governance in this model being largely interpreted as governance in the interests not only of the shareholders, but also of the stakeholders: creditors, suppliers, employees and others).19 The ownership structure (concentration v. dispersed ownership) explains for example why the question of interfering with the management of the company is much more discussed in the German and civil law literature (countries with prevailing domination in the corporate governance of major shareholders – families or other companies), than in the UK or US, where the “divorce” between ownership and control, the passiveness of the shareholders and complete control and independence of directors are taken for granted. Many recent studies however reveal that ownership structure, corporate culture and governance become more and more convergent and reconciliation of Anglo-Saxon and Civil law models turns out to be a process of smooth convergence, provoked by market forces rather than legal regulation.20

Proposals for new “tailored limited liability”, supported by DAVID MILLON, “Piercing the Corporate Veil, Financial Responsibility, and the Limits of Limited Liability”, 2003, N 03-13, Washington & Lee Public Law and Legal Theory Research Papers No and JOSÉ E. ANTUNES “Liability of Corporate Groups. Autonomy and Control in Parent-Subsidiary Relationships in US, German and EU Law”, 10, 1994, Boston, 384-410 and PETER NYGH “The Liability of Multi-national Corporations for the Torts of Their Subsidiaries” (2002) 3, EBOR, 51-81 19 See in WEIL, GOTSHAL & MANGES, supra note 5, p. 31, where it is presented that only 35.8% out of 744 listed companies in Germany don’t have a major shareholder (50% and more) and only 17.5% don’t have a significant shareholder with 25% or more voting rights, while in UK 97.6% out of 1926 listed companies do not have a major shareholder and 84.1% do not even have a significant shareholder. 20 In this sense K.HOPT, supra note 11 and JESWALD SALACUSE, “Corporate Governance, Culture and Convergence: Corporations American Style or with a European Touch?”, Corporate Governance, 2002, British Institute of International and Comparative Law, London



3.3. Duty of Loyalty and Fiduciary Duties - Who Owes What to Whom? It will be reminded here that the fiduciary duties (originating from the common law concept on trusts), are duties owed by the directors to the company and its shareholders, obliging the first not only to act within the interest of the latter, but to refrain from personally benefiting at the expense of the shareholders. It is alleged (although arguably) that directors owe also fiduciary duties to the creditors when the company is insolvent21 and therefore creditors may have a direct claim against the wrong doing directors.22 It is interesting to note in that respect that art. L-223-22 of the French CC expressly imposes the duty of loyalty (due by natural or corporate persons acting as legal or de facto directors) towards the creditors as well. Civil law countries adopt the duty of loyalty (and an additional duty of care – the diligence of a good businessman), which only requires acting in the interests of the company and shareholders. Concentrated ownership in private and public companies here lead to extension of the duty of loyalty to shareholders.23 The focus shifts from self-dealing and abuse of trust by directors to protection of arm’s length transactions between parent and subsidiary and sanctions for abuse of minority shareholders and stakeholders (creditors, employees) by the controlling majority shareholder.24 It seems that one of the difficulties in addressing the parent-subsidiary relations is the mingling notions of duty of loyalty and fiduciary duties on one hand and duty of care on the other.25 The possible breach of the duty of loyalty or fiduciary duty is a question, which leads to another subject, which is of essential importance to the parent-subsidiary relations:

P.DAVIES, supra 15, p.373 and ROSS GRANTHAM, “The Judicial Extension of Directors’ Duties to Creditors ”, 1991, Journal of Business Law 1-18 22 TEODOR BAUMS and KENNETH E.SCOTT, “Taking shareholders protection seriously? Corporate governance in the United States and Germany ”, European Corporate Governance Institute, Working Paper N 17/2003, p.811, 23 Linotype case, BGHZ 103, 184, recognizing duty of loyalties amongst shareholders in AG (PLC) 24 JESWALD W. SALACUSE “Corporate Governance..”, supra note 20, p. 474-475 and T.BAUMS and K.SCOTT, supra note 22, p. 12 25 P. DAVIES, supra 15



3.4. Independence of the Subsidiary Directors – a Cornerstone in ParentSubsidiary Relations: As it stands today the EC law would not allow that managers of a subsidiary act to its detriment (and breach its duty of loyalty/fiduciary duty) and escape liability towards the company they manage and its creditors on the basis that they acted under the instructions of the parent company and in respect of the group’s interest.26 Harmonization legalizing the groups in general and providing for conditions that allow interference with the subsidiary’s management is scheduled for no earlier than 2006 (see part six hereunder). The general principle, adopted by national laws, is that directors must always act in the interest of their company (see art. L-223-22 of the French CC, art. 76, 93, 116, 121 I, 131 III of AktG and art. 43, 49 II of GmbHG and sec.309, CA’85). Exceptions to that rule are the decisions reserved by law or articles of associations for approval by the shareholders. Most of the national legislations also provide for actions in favor of the minority shareholders against the abusing majority.27 However, some shades of differences are reflected in each national corporate law and jurisdiction: Thus, English courts are at the opinion that a wholly owned subsidiary is to be run in the interest of the parent company. Otherwise, directors have to observe also the interests of the subsidiary. Such reasoning runs the risks of being found circular since fiduciary duties are owed to the shareholders of the subsidiary and to the parent company only (sole shareholder) in case of a wholly owened subsidiary. Should the English courts try to find the balance between the interests of the parent company – sole shareholder and the subsidiary’s creditors in case of insolvency, such a balance is to be seized in the light of the subsidiarity of the shareholders’ claims in the universal insolvency proceedings and through the special responsibility of the directors under the wrongful trading concept. The French legislator establishes that every member in the group is responsible for its own debts and that the parent company and its directors can not (under the risk of “gestion de

ERIC WERLAUFF, supra note 14, p.426 DOMINIQUE VIDAL, “Droit des sociétés”, E.J.A., Paris, 2001 for “action sociale in France” p.90-95 and HANSCHISTOPH HIRT, “The Duty of Loyalty Between Shareholders in Respect of the Company’s Decision to Litigate Against Wrongdoing Directors in Germany: Lessons for Britain?”, (2003) 4, European Business Law Review (EBLR) for “unfair prejudice in UK and Anfechtungsklage in Germany”, at p.530



faute”) interfere with the interests of the subsidiary.28 French jurisprudence, as demonstrated hereunder in part four, offers the Rozenblum doctrine, which is similar to the effects of the German contract groups, but applies to de facto groups. German law expressly imposes on the shareholders not to interfere with the management of the AG (Art.76 AktG). The Konzernrecht (general law on groups with dependent AG companies), however, provides that in case of a control contract the controlling undertaking can impose acts, detrimental to the controlled undertaking, upon providing compensation thereof (see. Art. 302 and 317 AktG). All these concepts will be subject to further analysis in parts three and four, but for the time being, it is not difficult to see that the “independence” of subsidiary’s directors, in cases of integrated group management, group policy and prevailing group’s interest looks as smooth, shiny and deceitful as thin ice. Unifying rules adjusting their duties of loyalty and independence to the economic realities of groups of companies are therefore absolutely necessary.

III. EC and National Legal Solutions. The above mentioned factors and the lack of EC general harmonization on groups explain the different national legal solutions. However, European efforts to deal with the parentsubsidiary interdependency have been made and therefore, here they will be mentioned and followed by a comparative analysis of English, French and German legal approaches. 1. EC Law – Fractional and Sector-Specific Harmonization Groups of companies as legitimate forms of doing business are recognized by European law, but regulation in this field is only fragmental and sector-specific. Thus EC law harmonizes in detail group’s consolidated accounts (Seventh Directive), banking and insurance groups (including the recently established EU banking and insurance supervision committees) as well as taxes on dividends, interests and allotments, information for employees and others.29

28 29

Fruechaut case, Paris, 22/05/1965, JCP 1965, II, 14274 Council Directive 90/435/EEC OJ 23 July 1990 on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States, Council Directive 2003/49/EC OJ 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated


Recently EC law starts focusing more on groups of listed companies. Thus according to the Market Abuse Directive a parent company may be liable for insider dealing (using company information, not available to the shareholders and investors to benefit personally) and market manipulation (using misleading information to influence the price setting mechanism for traded shares).30 Earlier attempts to harmonize in a general way the parent-subsidiary relations and companies’ affiliations, by the Structure Directive, the draft of Societa Europea Statute from 1975 and the drafts for the Directive on Groups from 1974 and 1980 have not proven successful.31 The proposal for a new “intra-group liability” of the Groups Directive (too much influenced by the German contractual groups) had very correct purposes indeed: legalization of group leadership, recognition of the prevailing group’s interest and direct liability for the due exercise of the leadership rights, which was to relieve the members of the subsidiary’s managing board of their liability to a reasonable extent.32 The proposed text failed because of overregulation and automatism, i.e. lack of consent as to the substance of the regulation, not lack of need for regulation. The draft was too much focused on contractual groups, where the subsidiary is a PLC. The economic reality and the jurisprudence, however, demonstrate that de facto groups, with subsidiaries in the form of Ltd companies are much more spread and de facto control leading to insolvency needs to be addressed with few, but effective minimal safeguards for share and stakeholders.

companies of different Member States; Transparency Directive 88/627/EEC OJ 12.12.1988, OJ(EC) /1988/ (allocation of voting rights in controlled companies), Council Directive 94/45/EC on the establishment of a European Works Council or a procedure in Community-scale undertakings and Community-scale groups of undertakings for the purposes of informing and consulting employees, 22/09/1994; Directive 2002/87/EC of the EP and of the Council of 16 December 2002 on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate and amending Council Directives 73/239/EEC, 79/267/EEC, 92/49/EEC, 92/96/EEC, 93/6/EEC and 93/22/EEC, Directives 98/78/EC and 2000/12/EC (Banking and Insurance Directives) and Amended draft Directive on takeover bids, OJ (EC) /1990/ C 240/7 30 Directive 2003/6/EC of the EP and of the Council on insider dealing and market manipulation OJ 06/06/2003, vesting fiduciary duties on the parent companies towards the subsidiaries. 31 See Third amendment to the Proposal of 20th December 1990 for Fifth Council Directive concerning the structure of PLC and the powers and obligations of their organs; Since the Ninth Directive on Groups of Companies was never officially proposed or published, discussion is based on thorough analysis by Prof. PETER BEHRENS in “Introduction to EC Company Law”, 2003-2004, EC Company Law, College of Europe, Bruges, E.WERLAUFF, supra note 14, p.460 and seq., and VANESSA EDWARDS, “EC Company Law”, Clarendon Press, Oxford, 1999, p.390-393 32 PETER BEHRENS, ibid.


Concrete drafts for a Directive in this aspect are scheduled for mid-term, by which moment feasibility studies and research shall be done.33 2. English Regulatory Approach34:

2.1. Traditional means – Wrongful Trading by Shadow Directors, Unfair Prejudice of the Majority and Re-use of Insolvent Company Name by Directors: It should be noted at the outset, that the English corporate policy maker is more concerned with preventing situations in which one member of the corporate group could entail by its insolvency the failure of another and therefore traditionally focuses much more over the disclosure and transparency requirements specifically addressed to groups and mainly listed companies. Liability of the parent company can be engaged on the basis of breach of fiduciary duties, subject to this part or abuse of corporate form (lifting of the veil, subject to part four hereunder). The legal acts containing the exception rules are mainly the Companies Act from 1985 (CA’85) and the Insolvency Act form 1986 (IA’86). Almost each doctrinal analysis of English corporate law underlines the notorious Salomon v. A. Salomon & Co case, stating that an individual shareholder is not liable for the debts or insolvency of the company, and firmly rooting into the legal mind the separation between personality and liability of the corporation and its members.35 However, s. 306 of CA’85 provides that directors’ liability may be unlimited if so provided by the memorandum. There is no expressed prohibition for corporate bodies to be legal directors, but it is common ground in Great Britain that directors are natural persons and parent companies may act only as shadow directors. 2.1.1. Wrongful Trading by Shadow Director - s.214 IA’86 The wrongful trading could engage the liability of the shadow director (parent company) on the basis of objective criteria. A shadow director is a natural person or company (also parent company) who instructs the legal directors of the company. The directors act in accordance with the instructions of the shadow director and are accustomed to act so.36 Once the lack of
Action Plan, supra note 1 and “Report on the High Level Group of Company Law Experts”,2002 34 This paper refers to the law of England, as English law may differ from Scotland and Wales laws; 35 Re Salomon v. A. Salomon & Co Ltd (1897), AC 22 discussed by P. DAVIES, supra note 15; note that the facts of this case did not prove abuse by the majority shareholder and at the time nobody could have thought about corporate body holding shares in another corporation and the advantages and risks out of this; 36 Re Hydrodam (Corby) Ltd 1994, 2 B.C.L.C. 182


independence of the subsidiary’s managers is established, three more conditions have to be met: (1) Insolvency of the subsidiary; (2) Knowledge (actual or objectively necessary) of the present or even imminent insolvency. The knowledge is presumed (214/2/ and /4/ IA). The parent company can only try to prove that there was no way that as a shadow director it had or could have had knowledge of these facts; (3) Omission to do the necessary acts to minimize the potential losses of the subsidiary’s creditors (214/3/ IA). The only plausible defense of the parent company would be that, as a shadow director, it did all the necessary steps to minimize the damages occurring for the creditors. The onus probabandi (burden of proof) is over the parent company (as in German law and in contrast with French law). I shall not deal here with the case of fraudulent trading (s.213 IA), since the “positives steps of influence on behalf of the directors” and the “intent to defraud the company’s creditors” make the task of engaging the parent company’s liability as a shadow director almost impossible on this particular legal ground although parent company’s officers (natural persons), interfering with the subsidiary could be subjects to it.37 2.1.2. Re-use of Insolvent Company Name - s.216 and 217 IA’86 These sections deal with cases when one subsidiary is insolvent and the parent company, acting as a shadow director at the time or some time before insolvency transfers at a very low price its remaining assets to a new subsidiary, continues the same business under the name of the first subsidiary (to benefit from the goodwill of the first subsidiary) and leaves the creditors of the insolvent daughter company with no value for their claims (see ss.216 and 217 of IA). In such case the court may decide to engage the liability of the shadow director towards the creditors of the “drained” subsidiary. Note that the new subsidiary can not be held liable for the claims against the insolvent sister subsidiary.38

Re Augustus Barnet & Son Ltd /1986/, B.C.L.C., 170 and P. DAVIES, supra 15, p.195-196 A similar decision was rendered by the German BGH, in KBV case, BGHZ, Urteil vom 24 Juni 2002 – II ZR 300/00, part 4.3. hereunder



While the wrongful trading requires demand on behalf of the liquidator and a declaration by the court in the insolvency proceedings, the phoenix cases establish direct liability of the directors towards the subsidiary’s creditors.39 2.1.3. “Unfair Prejudice” and Single-Member PLC (art.24 of CA of 1989): The “unfair prejudice action” of the minority against the abusing majority shareholder is based on particular rules (s.459-461 of CA’85) protecting the minority shareholders against abuses of the majority and not sanctioning a breach of fiduciary duties. It could however, be considered as a means to hold liable the parent company by the minority shareholders in the subsidiary. “Unfair prejudice action” resembles to a great extent to the protection against “illegal pooling of assets”, which was the main reason for the German Federal Supreme Court (BGH) to hold liable the parent company in Bremer Vulkan case, discussed later in part four. The last exception mentioned here, becomes relevant only where the subsidiary company is a PLC and remains for more than six months with less than “at least two members”. In such case the single left member becomes unlimitedly liable for the debts incurred during these months (see s.1 of the CA in connection to s.24 of the CA’1989)40

2.2. Enterprise Act of 2002 – a Step forward in Recognizing Flexible Liability for Groups A very recent and interesting legislative development in UK is presented by the Enterprise Act, enforced in 2003.41 Enhancing the competition and consumer protection, the act provides in Chapter 40, Part 8 (“Special protection of consumers”) art.222 (5), that in cases of infringement of domestic or EU regulations protecting the consumers, enforcement could be ordered directly against the controlling enterprise (controlling corporate body – called

It is arguable whether the liability of the parent company in “wrongful trading” is directly to the creditors or of direct favor to the insolvent subsidiary and indirectly – to its creditors. See for a support of the direct liability to creditors, ROSS GRANTHAM, supra note 21 and PETER HOMMELHOFF, “Protection of Minority Shareholders, Investors and Creditors in Corporate Groups: the Strengths and Weakness of German Corporate Group Law”, (2001) 2 EBOR 61-80 40 After the adoption of the 12th Company Law Directive 89/667/EEC, OJ L 232, 02/09/1999 (single-member private company) the minimum number of members of the French PLC (SA) is still 7. Only German law accepts that the AG (Plc) has one single member. 41 Chapter 40, Part 8, s.220 et seq. of Enterprise Act, 2002, DTI, UK,



“accessory”, which could in no doubt be a parent company) even if the liability of the controlled body is not engaged. By regulating the control between two corporate bodies (due to ownership or de facto management) the legislator demonstrates the close connection between competition and consumer law on one hand and business organization law on the other. The latter should serve the former, especially when rights of weaker parts have to be protected. The Enterprises Act is perhaps the first step in recognizing in general way (out of competition context) the groups of companies and the flexible liability (at least towards consumers) as their feature.

2.3. Comparison with the US Regulatory Approach: It is interesting to note how another member of the common law family, the USA, addresses that problem. The Business Corporation Model Act (art.6.22) recognizes the general possibility for liability of the shareholder for the company’s debts due to his own conduct.42 Art.342 in connection with art.351 of Delaware General Corporation Law set rules about the so called “close corporation” (resembling GmbH (Ltd) or small, not listed AG (PLC)) where the shares are held by no more than 30 shareholders, including corporate bodies. If shareholders in such close corporations decide upon incorporation that management will be in their hands, they are personally liable as directors!43 This rule embraces the same logic as the proposal of the Forum Europeaum Group for introduction of EU rule on wrongful trading by parent companies, acting as shadow or de facto directors.44 US courts apply such rules and pierce the veil of the company with much greater easiness and economic justification than the English courts (see part four).


Sample act of the American Bar Association implying liability in case of insolvency due to the acts of the shareholders, 43 Delaware General Corporate Law, Title 8 Corporations, Division of Research of Legislative Council of the General Assembly with the assistance of the Government Information Center, 2004, LexisNexis, USA 44 FORUM EUROPAEUM, supra note 13, 165-264


3. French Legislative Responses: With the exception of sector-oriented regulations, such as in labor, taxation and banking laws45, the French law (as the English one) traditionally offers only partial solutions. 3.1. Exceptions to the Principle of Separate Personality and Limited Liability: The liability of the parent company could be established by proving breach of subsidiary duties of the de facto director of SARL subsidiary (Ltd)46 or de facto and legal director of a subsidiary SA (art.L 225-21 CC from 2001 allowing corporate body as a member of the “conseil d’administration”). The liability of the parent company influencing the subsidiary through the supervisory board (conseil de surveillance) is under question, but seems very possible especially after the corporate scandals, demonstrating that if a company fails today, it is not only due to the poor management and lack of supervision. 3.1.1. “Action en Comblement du Passif” – L-624-3 French CC, 2001.47 Under the action for compensation of the company’s passif, any person (including a parent company) who is responsible by law or by fact for the management or supervision of the affaires of a company, directly or through intermediaries, remunerated or not, may be ordered by the Court to pay the whole or part of the debts of the controlled company in case of its insolvency, judicial administration or compulsory liquidation. Three requirements have to be met: (1) Insolvency or insufficient assets of the subsidiary; (2) “Gestion de faute” (intentional acts against the interests of the subsidiary, such as payment to the shareholder in case of risk of insolvency48 and even “lack of interest in the company’s affaires or the negligent management”49) and (3) Direct causal link between the management actions and/or omission to act and the insolvency or indebtedness.
See for example Loi 84-46 from 24/01/1984 related to bank groups, allowing acts imposed by the parent company to the detriment of the subsidiaries, subject to the risk of liability for abuse 46 Case from 25/01/1994, R.J.D.A – “any person (natural or legal) who interferes or substitutes de facto wholly or partially the management of the company ” 47 DOMINIQUE VIDAL, supra note 27 and PAUL CANNU, JEAN-MICHEL LUCHEX, REICHEL PITRON, JEAN-PIER SENECHAL, “Entreprises en difficultés”, CNL Joly, 1994 48 Paris, 29 September 1987, Juris-Data no 27335. 49 Cass. com., 7 July 1992, Bull. Joly 1992, p. 1192, ; 24 October 1995, no 1859 D.


Largely interpreted, the concept of “gestion de faute” resembles a lot to the “financial irresponsibility” used in the US doctrine, discussed in part 5 hereby and is just the opposite side of the recently confirmed by the German BGH in “Bremer Vulkan” case “special duty of loyalty of the parent company-shareholder to its subsidiary and the other shareholders” (see part 4.3. and part 5) In practice only management acts amounting to abuse are sanctioned.50 The parent company can escape liability by proving that it did all necessary to cure the subsidiary or that the subsidiary was completely dependent by another person indeed, which confirms the previously advanced idea that control should be sanctioned, not ownership.51 The onus probabandi after amendments in 1985 is shifted over the plaintiff (in contrast to the English and German law and to balance the broad formulation of this liability).52 3.1.2. “Confusion des Patrimoines” – art. L-624-5 CC: Similar to the case of “commingling of assets”, the situations provided in this rule of the French CC (collateral to the “comblement du passif”) can lead to combined insolvency proceedings for the subsidiary and the parent company. Thus, in cases where the parent company in its quality of a legal or de facto director: (1) used the subsidiary as a “masque” (“masquant ses agissements”) in its own interest, (resulting in “appearance” or veil piercing) or (2) used the assets to the detriment of the subsidiary and in its own or a third person’s interest or (3) exploited the subsidiary abusively in its personal interest, which caused the latter insolvency (reminding of the situation in KBV case, discussed in part four hereby) or (4) maintained common accountancy or (5) circumvented the legal requirements relating to the corporations or hided the subsidiary’s assets,
Cassation (chamber commerciale), 14 mai 1991, R.J.D.A. 1991, no 852 ; 30 novembre 1993, Bull. Joly 1994, p. 410 ; 8 octobre 1996, Bull. Joly 1996, p. 1057; 25 mars 1997, Review Juridiques Des Affaires. 1997, no 6.
51 50

Paris, 16 novembre 1993, Bull. Joly 1994, p. 101. and YVES GUYON, “Droit Commercial Général et Sociétés. Entreprises on Difficultés. Redressement Judiciaire et Faillite”, 2nd édition, Paris, Economica, 1988 JEAN CALVO, “L’action en comblement de passif et la notion de gestion de faute”, (1998) N 63, LPA, at p.5



the court has discretion to decide to open the rehabilitation or insolvency proceedings also with respect to it. Opened proceedings for the subsidiary is a conditio sine qua non for the proceedings for the de facto director53. Prescribed with 3-year period as of the date of the judgment opening of the proceedings for the subsidiary, these two actions can be initiated ox officio by the court, by the directors of the subsidiary (administrateurs!), by the creditors’ representative, the person charged with the recovery plan, the liquidator and even the Attorney General. Creditors’ direct claims are stayed and joined in the insolvency proceedings, with the exception of secured (mortgaged) creditors’ claims, which can continue their individual development if the administrator has not done anything within 3 weeks to encash the securities in question (art.622-24 CC).

3.2. New French Rules on Joint Liability within a Group of SA Companies Under article L 233- 3 CC, combined with L-233-10 CC of 2001, a parent company holding at least 50% of the shares is presumed to exercise control over the subsidiary; control by itself is a presumption for the so called “action de concert” (two companies acting as economic unit set in art.L233-3). Such a group, as well as to separate companies, which have concluded a voting agreement to allow the implementation of common business policy in these companies (art.L-233-10, not necessarily parent-subsidiary affiliation) are jointly liable for non compliance with the requirements for information of significant shareholdings and cross-shareholdings (art.L-233-10, III of CC as amended in 2001).54 All these presumptions are the first step of the French legislator in regulating in a more general way groups, where control is acquired through equity holding or voting agreements between listed companies and as suggested by some even not listed SA. 4. The German Control Groups and Konzernrecht (Regulated Groups of

Companies): Some preliminary notes will be made before comparing control groups, de facto groups or qualified de facto groups:


OMV case, Cour de Cassation, Chambre Commerciale, 04/03/2003, where the Court also adds that the proceedings are no longer independents in their development and outcome. 54 For an extensive overview of the “action de consert” and the new presumptions for control, voting agreements and obligations for information, see Dominique Vidal, supra note 27


German statutory law does not allow that a company is a legal director of another company. There are proposals today to enact in German law rules recognizing that a corporate body, including a parent company could be regarded as de facto or a shadow director of its subsidiaries.55 Directors in Germany as natural persons are subjects to the duty of loyalty (Treupflicht) and duty of care (to act with the diligence of the good businessman) and are liable for the damages which they cause to the company, unless they use successfully the “business judgment defense” and prove that they acted in the interests of the company and relied on adequate information).56 Duty of loyalty, as it was mentioned previously in part 2.1., spreads among shareholders as well and this affects to a great extent the solutions, provided by law and courts. Germany is one the very few EU countries (along with Portugal, Poland and Slovenia), whose legislation pays special attention to the groups of companies AG.57 Detailed and sui generis regulation of contractual and de facto groups (art.291-320 AktG) has affected the judge-made law on groups with GmbH subsidiaries (much more popular than subsidiaries AG). The problematic application of the doctrine of “veil piercing” was clarified by some recent judgments of the German BGH (see part four). 4.1. Contractual Groups – Control Agreements and Integration (art.291-310 AktG): “Contractual groups” (art.291 AktG) are groups created by two companies (not necessarily parent and subsidiary), which legalize control from the controlling company and acts to the detriment of the controlled company, coupled with obligation of the controlling company to compensate the dependent company for the damages suffered before the end of each

See JORG PETER, “Parent Liability in German and British Law. Too far apart for EU legislation”, (1999) 11/12, EBLR 56 BGHZ 134, 244 ARAG/Garmenbeck case, the control, and not the legal form, determines the duty of loyalty amongst shareholders. See also in TEODOR BAUMS supra note 22 and HANS-CHRISTOPH HIRT, supra note 27. 57 KLAUS HOPT, “Company Law Reform in OECD Countries”, OECD Conference on corporate governance, Stockholm, Sweden, 12/2001



financial year (art.302 AktG)58. Agreements on profit transfer are very often signed in addition to control contracts for a final result of control and reduced taxes. This is liability towards the subsidiary only, based on a contract. Because of the obligation for compensation, instructions given to the management board of the subsidiary are completely legal, even if they are detrimental to the subsidiary (art.308 AktG). Although such contractual groups do not enjoy great popularity in practice, the benefits of legalizing the group’s interest can not be denied.59 Secondly, when the parent company holds at least 95% of the shares of the subsidiary AG, the GM of the two companies have to approve the so called “integration” of the subsidiary in the parent company, which allows the two companies to remain separate legal persons, but to have the benefits of the “contractual groups”. The integration is registered and made public to third parties. In case of failure to register it, the group will be regarded as a qualified de facto group (although some authors support that qualified de facto groups are not allowed by the AktG).60 4.2. De Facto Konzern - art.311 – 317 AktG. De facto groups (which have not been created by contract) are of bigger practical importance61. They are established by de facto control over the subsidiary. The control could be exercised in different ways, but in the context of parent-subsidiary relationship it will most probably stem from the power of the majority shareholder to select, directly control and instructs the supervisory board (3/4 majority needed), which nominates and supervises the managing board and the auditors. Control is also possible by influencing supervisory board or shareholders in approving or not important business decisions. In de facto groups, the management of the subsidiary cannot legally undertake acts against its interests (Art.311) and if it does so, it has to have arranged for compensation, under the risk of personal liability (.317/3/). A possible defense is to prove that any prudent and independent person would have done the acts in question, which is not easy if the acts in question are detrimental to the subsidiary.

Supermarkt case, BGH recognizes the possibility for establishing a group liability for the controlling company on the basis of a contract. 59 In this sense PETER BEHRENS, supra note 31 60 JORG PETER, supra note 55, at p.443 61 See PETER HOMMELHOFF, supra note 39, at p.70


The subsidiary may seek compensation from the parent company and its managers for those losses only, which are caused due to the acts of influence and control. Some authors believe that this could result in direct liability of the parent company towards the subsidiary’s creditors.62 However, direct liability to creditors seems at this stage more plausible (yet still extracted from the liability towards the subsidiary) in case of contractual groups, namely because of the contract setting up firmly the liability of the parent company. Onus probandi is over the parent company, which may prove to have acted in a diligent and prudent way63 (has not acted against the subsidiary’s interests or provided for compensation). Usually this is a defense, which is attributed to legal or de facto managers. One very welcomed idea of the German de facto group is to oblige the management of the subsidiary to submit annual dependency reports (all transactions, potential damages and compensations), for approval by the auditor and the management board of the subsidiary (art.312 AktG). The ultimate purpose is to safeguard the rights of the minority shareholders and it is also a very strong guarantee for the creditors.64 Therefore, such report should be brought to their knowledge. 4.3. Qualified De Facto Konzern – Where Is the Limit? Qualified de facto group (not regulated in the AktG) is established in case of permanent control, where there is no longer corporate autonomy of the subsidiary and it is not possible to distinguish isolated acts of interference in order to qualify the parent and subsidiary as a simple de facto group. The BGH has confirmed its existence at least with respect to dependent GmbH and sanctioned it with full liability of the controlling company or person.65 Although criticized for their rigidity and automatism,66 these rules if adjusted to economic reality can serve as a good example for future group law.

62 63

PETER HOMMLHOFF, supra note 39, p.70 K.HOPT, supra note 11, at p.16 64 PETER BEHRENS, supra note 31 65 Atokran BGH 95 BGHZ 344 66 JOSE ANTUNES, supra note 18, p. 330-376


IV. Jurisprudence of National Courts and ECJ. Although with different intensity, all courts sense the necessity of adjusting the limited liability of corporate shareholders and holding account of the influence exercised by the parent companies. The majority of the cases concern liability of majority shareholder in subsidiary, taking the form of Ltd. The divergences are due to judicial policy, not to different legal reasoning. 1. English Courts: “English company law possesses some curious features, which may generate curious results. A parent company may spawn a number of subsidiary companies, all controlled directly or indirectly by shareholders of the parent company. If one of the subsidiary companies, to change the metaphor, turns out to be the runt of the litter and declines into insolvency to the dismay of its creditors, the parent company and other subsidiary companies prosper to the joy of the shareholders without any liability for the debts of the insolvent subsidiary.’67 This is still the predominant view of English courts hundreds of years after the seminal Solomon v Solomon & Co case.68 English courts are reluctant to engage the liability of the parent on the above discussed statutory exceptions (wrongful trading).69 1.1. Lifting of the Corporate Veil The doctrine of “lifting the veil” (in the sense of disregard of the separate liability and limited liability of shareholders) helps in exceptional circumstances (except for taxation cases), where the parent company used the subsidiary for the purposes of fraud or dishonestly, depriving the creditors,70 or as a mere device, sham, facade to evade a contractual or other legal obligation. These exceptions can be summarized as “apparent abuse of the corporate form”71.

Templeton L.J. in Re Sothhard & Co Ltd [1979] 3 AER 556 at 565 Solomon v Solomon & Co Ltd /1897/ AC 22 and a study by Dr CHARLES MITCHELL, “Lifting the Veil in the English Courts: an Empirical Study”, (1999) 15, C.F.I.L.R. p.21-22, revealing that no case exist in English law where the shareholders have been held liable for the liabilities of a public limited company. 69 Re Hydrodan (Corby) Ltd /1994/ 2, B.C.L.C., 180, where the court stated that the mere imposition of business guidelines is not sufficient to regard the parent company as a shadow director and P.DAVIES, supra note 15 70 James Hardie & Co Pty Ltd v. Hall, New South Wales Court of Appeal, (1998) 43 NSWLR 554 71 Trustor AB -v- Smallbone and Others (2001) NSWLR 50;



English courts have established penetrating liability on the modern basis of “enterprise unit”. In DHN Food Distributors case72 the veil was lifted on the basis not of abuse, but because the separate entities actually formed one single unit. Later, in Adam v. Cape case,73 it was held that “the mere economic unity or connections between companies are insufficient to regard the companies as one unit”. This case is often cited to underline the conservative position of the English courts in lifting the veil. Authors omit however to note a very important feature of this judgment, namely the fact that the English court denied to enforce a US judgment because of lack of jurisdiction of the US court (the latter assuming jurisdiction to sue a parent English-based company constituting “one single unit” with its US-based subsidiaries), and not because it did not agree to the substance of the US judgment, holding liable the parent company for the debts of its subsidiaries. Nothing in this case implies that if the problem was to be decided by the English court, the latter would have decided otherwise. With all these examples, it is suggested that the veil lifting still remains a very controversial and obscure area.74 With respect to the English conservatism, it is interesting to note the greater willingness on the part of US courts to pierce the corporate veil, especially in tort cases, where US courts are ready to sanction the effective control and even negligence by the parent over the subsidiary.75 2. French Jurisprudence: French courts are much more open to hold the parent company (legal or de facto director) liable by using the statutory provided “action en comblement du passif” and “commingling assets”. Logic similar to the English one is applied in the veil lifting (“apparence”)76 It is required for this purpose close connection between the parent and the subsidiary and very often common objectives and real acts of control.77 The simple fact of majority shareholding

DHN Food Distributors Ltd v. London Borough of Tower Hamlets /1976/, 1 WLR 852 Adam v Cape /1990/ Ch 536 74 Ord v. Belhaven /1998/ BCC 615, stating that “the possible abuse from the parent company was not sufficient to pierce the veil” 75 PHILIP BLUMBERG, “The Law of Corporate Groups – Problems of Parent and Subsidiary Corporations under Statutory Law of General Appreciation”, Boston, Little, 1990, hereinafter “Blumberg supra note 75” 76 FRANK WOOLDRIDGE, “Groups of Companies. The Law and Practice in Britain, France and Germany”, University of London, 1981; Case Versaille, 17/09/1986, Rev.Jur.Com., 1987 and Cassation, commerciale, 05/02/1991, Dalloz, 92,27 77 L’invulnerable (Bologne-Italie et Lyon) v. Etablissement Pontille, 7/01/1946, S. 1947.1.32, which implies that lifting the veil is much plausible in vertically integrated groups.



is not enough to engage the liability of the parent company and what is needed is effective control.78 Three cases will be mentioned hereunder: 2.1. Accor Case79 – “Comblement du Passif” (art.L-624-3 CC) A SA was held liable as de facto director of a company, which was based in French Polynesia on grounds that the contract for management (hotel management in this case), concluded by Accor and the claimant vested to the first complete de facto control over the latter and since the de facto director could have seen and prevented the insolvency, but did not do anything to reduce the deficit (resulting in “gestion de faute”, even if this was not the single reason for the insolvency!) he was held liable for 2/3 of the debts. It is interesting to note that such failure would perhaps not be sufficient enough to engage the contractual liability of Accor, but was sufficient to engage its liability in the action for compensation of the passif. Such discrepancy may result in legal uncertainty. 2.2. Aline Music Case80 – “Confusion des Patrimonies”81 (art.624-5 CC) In this case due to the close relations between the two companies (common managers and shareholding) the subsidiary was found to have served as a mere instrumentality for a particular investment of the parent company. The parent company at the same time was qualified as de facto director. The court, ruling for joint liability, mixed the concept of the de facto management (624-3), the mingling assets and appearance (624-5) and finally did not state the legal ground of its decision, for which reason its decision was struck down by the Cour de Cassation. 2.3. Rozenblum Case82– Prevailing Group Interest Doctrine In this leading case (demonstrating the courts’ awareness of group particularities) the criminal court decided that in some cases the interests of the group can override the interests of the subsidiary and this, will not lead to penal liability for “abus de biens sociaux” for the managing directors of the subsidiary and parent, if three conditions are met: (1) existence of firmly established group;
78 79

Cour de Cassation, 26/11/2002 Accor case, Cour de Cassation, 19/12/1995, N 2245 80 Aline music case Cour de Cassation, 25/06/1993, Bul N 190, N 93-11-264 81 Also Limoges, 19/12/1960, Gaz. Pal.1.215 82 Rozenblum case, Cour de Cassation, Chambre Criminelle, 04/02/1998, confirms earlier “Willot” case, Tribumal de Paris, 16/051974.


(2) actions taken in the interest of the group (positive actions are needed, not simply major shareholding) and in conformity with the group’s coherent policy and (3) preservation of the financial equilibrium within the group, i.e. compensation of the subsidiary suffering the negative consequences of the action in question.83 The legal effects of this doctrine remind of the German AG contractual and qualified de facto groups. The present doctrine does not discharge the de facto director from civil liability (as under art.L 223-23 for SARL for example), which may arise for negligent management and a further development of it on a EC level, strongly advocated by Forum Europaeum, should make clear what is the liability covered in these circumstances. 3. Evolution of the German Jurisprudence – from “Autokran” to “KBV” “German law of groups does not trust instruments used by the English courts, such as lifting the corporate veil…”84 Some recent judgments of the German BGH however confirm the application of “Durchgriffshaftung” or piercing the corporate veil in de facto group cases. Leading judgments, such as Autokran, Tiefbau and mostly Video cases85 have been criticized, because of the unjustified analogy of rules relating to AG dependent companies to cases involving GmbH subsidiaries and lack of clear distinction between simple and qualified de facto groups. In Autokran the simple presence of a permanent and extensive control was sufficient to consider the group as qualified de facto konzern and rule for full liability of the majority shareholder on the basis of contractual groups. In Tiefbau the BGH went further and accepted that even only financial control is enough to rule for the same consequences. At least this time the BGH underlined the requirement for causal link between the control and the damages suffered by the subsidiary. In Video case the BGH ruled (again on the basis of art.302 AktG) for liability of the major shareholder (a natural person and a managing director of the company in this case) engaged in independent businesses as well, but however introduced a new requirement - a “prejudicial conduct on behalf of the major shareholder to the interests of the dependent company” and causal link.

83 84

PHILIPPE MERLE, “Droit commercial. Sociétés commerciales”, 8th edition, Dalloz, 2001 K. HOPT, supra 11, at p.16 85 Autokran BGHZ 95,330, Tiefbau BGHZ 107,7, Video BGHZ 115, 187


A first departure from this jurisprudence was made in 1993 in TBB case, where BGH required not simply control on behalf of the parent, but also “objective abuse of the directors’ power” or breach of a specific standard (insufficient consideration for the controlled company in the case) and “failure of the individual compensation system”, i.e. lack of possibility to distinguish isolate single acts and to compensate the damages”86 What was sanctioned was a particular conduct, breaching the duties of loyalty and care, and not the general possibility for control. Breach of these duties was the ground for penetrating liability, not application of art.302 and 303 of AktG. The possibility for application of veil lifting was implied. Two recent judgments of the BGH (Bremer Vulkan and KBV cases) solve the long debated application of “lifting the corporate veil” doctrine in Germany. They will be discussed briefly herein: 3.1. Bremer Vulkan Case87 Bremer Vulkan AG, one of the biggest European shipbuilders and parent company (49% of the shares) of the shipbuilder Volkswert GmbH pooled out in around DM 600 mln provided as state aid to the subsidiary by the German state and put them in a centrally managed cash system. Thus the assets of the parent and the subsidiary were mingled into a common master account used to manage the solvency of all companies centrally. Bremer Vulkan AG using its control used the money to stabilize its own financial difficulties, which led to insolvency of the subsidiary. The BGH found that this was a de facto group and that the subsidies were meant to be exclusively used by the East German subsidiaries. BGH underlined that the controlling company has a two-stage fiduciary duty: first, the parent company has to make sure when managing the cash pool that the subsidiary will always and at any time have the means at its disposal which are necessary to secure the adequacy of the share capital and solvency. Secondly, the parent company has to take care of the subsidiary's property in as much as it has to make sure when it makes arrangements for the subsidiary's assets that the subsidiary is still able to settle due liabilities. BGH stated in a general way, that

TBB BGHZ, 1993-II ZR 265/91, DB Heft 04/16/1993 as discussed by PETER HAMMELHOFF, supra note 39 and Peter Jorg, supra note 55 and FORUM EUROPAEUM, supra note 13 87 Bremer Vulkan case, BGHZ, 17th of September 2001, 149, 10


shareholders of the subsidiary will be liable for the disadvantages in depriving the company of the property it needs to meet its obligations. The involvement and control on behalf of the parent company amounted to “ruinous interference", misuse of the legal form of association and also a breach of the above duties. This misuse allowed for exception to the general principle of limited liability. On the other hand, the management of the parent company was found to be bound to inform the subsidiaries in the case of own or other sister companies’ crises, which can endanger the subsidiary. Omission is subject to a criminal sanction (s.263 subsection 1 German Penal Code, dealing with fraud). Moreover, the subsidiary's managers also had to act in the interests in the subsidiary, which meant that if the parent company was in financial crisis, the subsidiary's managers were obliged to immediately reclaim its pooled assets, sanctioned by their personal liability.88 3.2. KBV Case89: BGH confirmed the application of the “lifting the corporate veil” doctrine (Durchgriffshaftung) to cases of corporate abuse. Here a GmbH subsidiary was owned by two shareholders, holding respectively 40% and 60%. The shareholders, seeing that the GmbH has much lower assets than liabilities decided to dissolve it, and transferred all remaining assets to a new company. The contractual creditors of the subsidiary brought civil actions against the new company “KBV” GmbH and the shareholders. The BGH upheld the liability of the shareholders on grounds that they abused the legal form of the GmbH by its own behavior, which led to eliminating the legal conditions, allowing the advantages of the limited liability (“existenzvernichtenden Eingriffs”). The particular conduct was in breach of the legal rules on liquidation, which guarantee special protection for creditors first and than for shareholders. Art.31 of GmbHG, prohibiting shareholders to pool out assets or dividends if the assets/liabilities ratio is under the registered capital, was also breached.


See for a comment on the Bremer Vulkan case, PETRA KORTS, “Cash Pooling -Hidden risks for managers and partners”, Korts Rechtsanwaltsgesellschaft GmbH, 2003,Cologne, (englisch).htm 89 KBV case, BGHZ, Urteil vom 24 Juni 2002 – II ZR 300/00


Since this conduct amounted to abuse of the limited liability, it was sufficient grounds to pierce the veil and hold the shareholders liable, even though “they did not receive any benefit from the pooling of the assets”, as the court said. Furthermore, the BGH confirmed the direct liability of the shareholders towards the creditors, before opening the insolvency proceedings. It is interesting here to draw an analogy with a leading US case - Federal Deposit Insurance Corp. v. Sea Pines Co, decided in 198290. In this case, the court held a parent liable for the bank debt of its 90 percent-owned insolvent subsidiary, which under the instructions of the parent mortgaged its property to secure the parents’ debts. The court concluded that the acts of the parent were "fundamentally unfair towards the creditors” and went further to state that when a corporation becomes insolvent, those in control have a fiduciary duty to creditors and may not divert corporate assets for their own benefit to the detriment of creditors. Whether owed to the creditors or to the company, the breached fiduciary duties in this case gave reason to the bankruptcy trustee to claim the parent company liability for this act and fill the subsidiar’s bankruptcy estate with the assets received in compensation form the parent company. One cannot say that such a liability is only directed to creditors of the subsidiary, since the shareholders of this subsidiary will also (even as subsidiary or secondary claimants) take benefit of the positive balance of the bankruptcy estate. 4. ECJ Jurisprudence: ECJ demonstrates its flexible and economically adequate perception of groups of companies when dealing with competition cases. 91 It is a constant practice that a parent company can be held liable for the acts of its subsidiary, breaching the antitrust law, when it exercised control over it.92 It is also supported that art.81/1/ (anticompetitive agreements concluded by separate enterprises) of the Treaty on European Communities does not apply in case of agreements concluded between separate companies, members of one group, because they represent a “single economic unit” and would rather be sanctioned as such a single unit, abusing of its dominant position (art.82 of the EC Treaty). A majority shareholding in such case is seen

90 91

Discussed by BLUMBERG supra note 75 For more details see RICHARD WHISH, “Competition Law”, 5th Edition, LexisNexis UK, 2003, p.87 and 177 92 Cases T-65/89 BPB Industries plc v Commission /1993/ ECL II-139; Amico Acids OJ, 2001 L 152/24, 2001 5 CMLR, p. 322


only as a presumption for control, but what is needed to form a group is effective control exercised by the major shareholder over the subsidiary’s conduct93. Advocate-General Warner concludes in Commercial Solvents case that “to export blindly the Salomon rigid doctrine into branches of law, where it has little relevance, could serve only to divorce the law from reality”. The willingness of the ECJ to address (even in a general way) abuses on behalf of the shareholders was also confirmed in the recent judgment given on 30th of September 2003 in Inspire Art case (C-167/01). Here the court concluded that a company may not invoke the rights guaranteed by the freedom of establishment (art.43 and 48 of the TEC) if the existence of an abuse is established on a case-by-case basis. Although this case concerned a secondary establishment by setting up a branch, the reasoning of the ECJ could be transposed to cases dealing with parent-subsidiary relations. It is apparent that the ECJ leaves the national court to analize the particular facts and conclude whether there is or not an abuse on behalf of the corporate shareholder. This comes to say that the ECJ is inclined, and rightly I believe, to allow sanctioning on national level of concrete acts of the shareholders amounting to abuse or insolvency. The border between transacting and competing could be very difficult to seize and business organization law cannot stay unaffected by competition law. The analyzed jurisprudence relies on similar efforts of the courts to interpret and apply legal concepts such as separate legal personality and limited liability with respect to socioeconomic realities. This form of judicial activism is to be welcomed when it rests on correct logical reasoning and common general principles, such as: good faith (nobody should be allowed to take advantage of its illegal conduct) and fair competition.

V. Academic Discussion and Input The question to what extent the limited liability concept (adopted more than a century ago) addresses problems raised by globalization of business and expansion of multinational network companies has been subject to animated discussions amongst policy makers, businesses and academics. The High Level Group, on whose report the Commission mainly

Case 6/73 Instituto Chemiotherapico Spa and Commercial Solvents Corporation v. Commission as discussed by JOSE ANTUNES, supra note 18 page. 417-419 ; also aff. 6/72, Europemballage Corporation et Continental Can Company Inc. c. Commission des Communautés européennes. Recueil, 1973, 215.


based its Action Plan on company law reforms, gathered famous academicians, some of them - members of the Forum Europaeum, mentioned above. Any future harmonization efforts in the field of parent-subsidiaries dependencies and liabilities will have as a starting point the proposals made, namely by this and other forums (see part six below). Some of the most innovative academic views inspired this paper and therefore are mentioned hereunder: 1. No Limited Liability of Parent Companies for Creditors without Bargaining Power (Including Tort Creditors) Blumberg’s school analyzes the subsidiary and parent companies as “highly intertwined in their operational and economic functioning” and economically acting as a “single enterprise” It is recognized that the group’s interest is allowed to prevail over interests of “the parts of the group”.94 Different criteria for liability are proposed to groups depending on the type of creditors. Contractual creditors with no power to bargain a transaction and to request a security from the parent company (consumer, employees, small suppliers), as well as tort creditors should be allowed to hold the parent company directly liable in case of insolvency of its subsidiary. In contrast, the parent company should continue to enjoy limited liability in claims of creditors who had or could have had enough information about the subsidiary and could freely bargain for security of their claims. Blumberg separates breach of fiduciary duties from liability through veil piercing. He considers the above mentioned “Federal Deposit Insurance Corp. v. Sea Pines Co” US case (discussed above, page 38) as liability, triggered by the breach of fiduciary duties of the parent company to the creditors, and not traditional veil lifting case. Most authors however perceive the breach of duties as a condition and the veil piercing – more as a result, provoked by breach of duties. The direct liability of parent corporations is strongly recommended especially for tort creditors with respect to the environmental and product liability of the subsidiary. A lot of cases where US courts have adopted such liberal approach support this proposal.

PHILIP BLUMBERG, “The Corporate Entity in an Era of Multinational Corporations”, (1990) Delaware Journal of Corporation Law, p.287-307


A similar theory by Hansmann and Kraakman advocate for unlimited liability of shareholders in general for actions in tort against the subsidiary. 95 They argue that such unlimited liability will lead to new “affirmative assets partitioning”, which will be more beneficial for the corporations and creditors, which is one of the points of the “tailored limited liability”, advocated by David Millon (discussed below in this part). José Antunes, influenced by the schools of Lutter and Blumberg, comes up with a proposal for a “flexible limited liability” designated for groups of companies. His main idea is to support the emergence of an “economic unit” (group), as also explained by Lutter, and to attach liability to concrete decision of the parent company leading to insolvency.96 Onus probandi (the burden of proof) is proposed to be over the parent. Both Antunes and Blumberg criticize the requirement for abuse, arguing that the courts would face difficulties first in tracing the “intent” of the parent company and than assessing it through market criteria. The above theories fail to take into account that it will be often difficult to decide if the claim is a tort or a contractual one (for instance misrepresentation of financial status in precontractual liability). Moreover, wrong assessment of the bargaining power of two type of creditors, allowing only one of them (the weak creditors) to have recourse to the parents’ assets could breach the principle of pari passu (equal treatment of similar ranks of creditors in insolvency proceedings).97

2. Flexible (Tailored) Limited Liability or the Price of Corporate Shareholders’ Limited Liability: A truly balanced approach, which seems more appealing to me, is presented by David Millon.98

HANSMANN and KRAAKMAN, “Towards Unlimited Shareholder Liability for Corporate Torts”, (1991) 7 Yale Law Review 96 See JOSE ANTUNES, supra note 18, p. 294 97 See in details in VANESSA FINCH, “Corporate Insolvency Law – Principles and Perspectives”, Cambridge University Press, 2002 98 DAVID MILLON, supra note 18, at p.50



The analysis starts from the essence and functions of limited liability. Shielding the investors from losses higher than their initial investment, it is expected to increase entrepreneurship. Perhaps, this is true only for individual investors (natural persons) who do not posses market expertise. Corporations, however, invest not because of their limited liability in subsidiaries, but because a subsidiary will be treated as a local company (which is of importance in jurisdiction with more favorable regime for local legal persons) and because they expect profits. It is advocated by this author that if banks were allowed to have access to the parent liability, subsidiaries would most probably get cheaper and more accessible debt financing, which would lower the costs of business and would maximize shareholders’ returns. This in turn would finally encourage investments by using corporations, which is the underlying policy of the traditional limited liability concept. In my opinion this conclusion seems to be unfortunately limited solely to the assumption that investors make investment decisions based on cost of debt mainly. However, other economic factors are equally, if not more important, in making an investment decision. Therefore, the idea that the price of limited liability of corporate shareholders could be too high for their real needs and way of doing business needs further economic analysis before turning into a sound conclusion. Despite this limitation, Millon’s theory offers a balanced allocation of risks between creditors and debtors achieved by “tailored limited liability”. This new form of limited liability does not distinguish between tort and contract creditors, but rather holds account of the reasons for failure of the subsidiary. In case of “objective market failure” (insolvency, which is not due to the financially irresponsible conduct of the parent company), the limited liability is to be maintained; in contrast, where the insolvency is due to the “financial irresponsibility” – the advantages of the limited liability should no longer be available for the parent company. Financial responsibility (reminding of the German specific duties of the parent towards the subsidiary) should be analyzed and confirmed by the court. This places huge responsibility over courts, which may lack the expertise to decide when a market failure was objective and when it was caused by the parent company’s acts, which would lead, in my opinion, to sanctioning of the obvious abuses only.


The burden of proof is suggested to be over the plaintiff (as in the French law, and in contrast to English and German law). However, I believe that in highly complex and integrated modern corporate groups it can become almost impossible for outsiders to trace and prove past violations of the subsidiary’s interests by the parent and therefore onus probabandi over the parent company would achieve more efficient proceedings and effective protection.

VI. A Way Forward – Some Proposals for EC Harmonization: Harmonization is necessary, but only to the extent of minimum safeguards of shareholders and stakeholders. Reduced legal uncertainty in the field of corporate groups’ law will enhance the freedom of establishment and movement of capital. This is crucial for crossborder trade and entrepreneurial spirit, especially today, when the European family is increasing with ten new members. Overall understanding of the parent-subsidiary interdependency with a view to the interests of shareholders and stakeholders as well as a balance between strict regulation and regulatory competition should be the foundations of future harmonization efforts. Dialogue between EU policy makers, academics, representatives of Member States, industries and service providers can help identify the real needs of parent companies (at the end they are also investors!) and managers of the subsidiaries. For that purpose an in-depth feasibility study is the first step to make. There is no need to impose on member states contractual groups and stringent rules as to their liability. Such groups are not very popular even in Germany. There is need however, to recognize the de facto groups, confirm the responsibility of the parent companies for specific acts due to their effective control, leading to insolvency of the subsidiary. Control should be seen only as a indication of higher risks. Liability, however, should be the consequence of concrete acts (assets pooling, overdue debts towards the subsidiary, particular acts against the interests of the subsidiary not backed up by sufficient guarantee and etc.) which have by themselves or taken with other factors led to insolvency of the subsidiary. Only this form of irresponsible corporate governance could justify direct liability of the parent company.


It is my belief that a future regulation in this field should differentiate between listed companies on one hand, and not listed PLC and Ltd companies on the other. More intense attention should be paid with respect to disclosure and transparency for the first group, since ownership structure and control would be exposed to easier changes. Preventive and sanction measures should be laid down (perhaps not in a single document), along with improvement of existing EC legal instruments and national codes of corporate governance:99 1. Preventive Measures for Improved Disclosure: Disclosure of financial and especially the financial situation of the various parts of the group (structure of ownership and control) with short deadlines for listed companies, which must disclose major shareholders and their voting and control rights as well as key agreements and other direct and indirect relationships between these major shareholders and the company and any material transactions with related parties.100 Sell-out option for the shareholders of the subsidiary before and after entering a strongly integrated group (95% and more of the shares). Creation of public electronic register of all registered companies, including their members; liability of the directors for submitting and up-dating relevant information. Special investigation procedure and solvency tests (known in Germany, France, UK and some other EU countries) at request of the minority (holding 5%-10% of the shares) and conducted by special committees (such as the recently established bank and insurance committees at EU level) or national agencies.101 Internal supervision and early alert by preparation of dependency reports brought to the knowledge of the shareholders (as in German Konzern law). Such reports, if presented to the stakeholders will increase also the possibility for reaction on their behalf. Analysis and rating agencies could be created at EU level. EU commission has to launch a feasibility study to see if there is such a need.

A lot of the proposals are made by FORUM EUROPAEUM, supra note 13 See the Action Plan, supra note 1, p.18-21 and the Report of the High Level Group of Company Law Expert on A Modern Regulatory Framework for Company Law, November 4th, 2002, 101 K. HOPT, “Modern Company and Capital Market Problems. Improving European Corporate Governance after Enron”, Working Paper, (11/2002) Max Planck Institute for Foreign Private and Private International Law



Participation and role of the institutional investors in other companies has to be clarified and disclosed. Discharge of the subsidiary from some onerous disclosure requirements if the parent company guarantees for its liabilities (as in the Company law reform in England, 2001). 2. Sanction Measures - Enhanced Accountability of Parent Companies and Managers for the Failure of the Subsidiaries: It is proposed by Forum Europaeum that equity control (control through major shareholding) be subject to more positive regulation, while de facto control (by any other means) is to be left to the courts.102 In my opinion future Guidelines of the EC Commission explaining the different faces of abuse of the corporate form and pointing to concrete acts leading to insolvency could be very helpful instrument along with the harmonizing ones, for the national courts to decide on the direct liability of the parent company. Perhaps equity control should be subject to the above-mentioned preventive measures, while the sanctioning regulation should address the failure of the subsidiary due to the parent irresponsible interference. It seems to me that the converging reasoning of national courts support that a general principle in the following sense could be adopted at EC level: If the parent company interfered with the management of its subsidiary (concrete act) and caused its insolvency or significantly contributed to it, than the parent company could be subject to direct liability for the unsatisfied debts of the subsidiary, caused by its acts, at discretion of the court (case-by-case analysis). Equity control should be just a presumption for effective control and interference. The burden of proof should be over the parent company, which can demonstrate that for the concrete acts, transactions or conduct, leading to insolvency, the subsidiary’s management took independent decision (the parent did not interfere by giving orders, instructions or using its power to choose the members of the managing board of the subsidiary) or that there is no causal link between the parent company’s interference and the subsidiary’s insolvency (i.e. its failure was due to market


K.HOPT and K.PISTOR, supra note 7, p.39-40


changes and would have happened even without the negative influence of the parent company and its positive influence to cure the subsidiary).103 Secondly, the group overriding interest and the liability of the subsidiary’s management should be fixed. The management of the subsidiary should not be held liable for acts, imposed by the parent company, to its detriment, but with respect to the group’s interests and providing the management bodies of the two companies have agreed on a balance of risks and the subsidiary’s solvency is not threatened. Otherwise, the subsidiary managers should be liable, (with or without direct liability of the parent company) for acts against the sub’s interests (ordered by the parent or not), unless they prove that these acts fall within the “business judgment defense”. Thus, the Rozenblum concept (Rozenblum case, part four) and the German rules on director’s liability (art.317 AG) will be combined and in compliance with the rule on wrongful trading. On another note, the role of the supervisory directors in parent and subsidiary companies should be reconsidered and their gross negligence should be sanctioned. Last, disqualification of directors at EU level, proposed by the Forum Europaeum should be analyzed carefully, before adoption, in light of the recent liberalization of rules relating to disqualification of directors after bankruptcy (see the Enterprise Act, reducing the disqualification period form 2 to 1 years for certain bankruptcy cases). The guiding purpose should be not to sanction, but to boost entrepreneurial spirit. 3. Improvement of Related Instruments: Along with the SLIM reform and the revision of the rules related to the function of the capital, the Commission is redrafting the Seventh Directive to achieve better information on group structures, managing system and persons effectively entrusted with power of direction, existing intra-group transactions, procedures and the activities through which the direction is exercised. International accounting standards and International financial reporting standards (mandatory as of 2005) lead to great convergence for cross-border groups.104

Similar to the proposal of the FORUM EUROPAEUM for EU rule on “wrongful trading of shadow directors”, supra note 13 104 See Commission Regulation (EC) N 707/2004 of 6th of April 2004, amending Regulation n 1725/2003 adopting certain international accounting standards in accordance with Regulation n 1606/2002 of EP and EC;



Moreover, the Eight Directive on the Statutory Audit Function105 is also under revision to strengthen control over the audit profession in the EU and secure stronger ethical and educational principles and high quality audit standards.106 There is even a proposal for introduction of full group auditor responsibility for consolidated accounts of a group of companies. The independent audit committees are proposed to be mandatory for listed companies. The Insolvency Regulation should be clarified to resolve the problem with the interpretation of “center of main interests” (COMI) and if “related undertakings of parent companies” include also subsidiaries. 4. Alternative Ways to Achieve Convergence: National Corporate Governance and Best Practices Codes should be mandatory only for listed companies (“comply or explain” principle). The existing codes should be improved to include parts dealing with groups, group policy, decision making and prevailing interests. Special attention should be paid to new member states in order to confirm the availability of such codes, their level of convergence and wide acceptance.


Concluding Remarks

Lack of harmonized minimum safeguards for minority shareholders, creditors, employees and potential investors, dealing with parent-subsidiaries affiliation, results in different national legal solutions to the associated risks. National law, however, relies on common logic: a parent company is presumed (not irreversibly) to exercise control over its subsidiary as equity holder or shadow (or de facto) director. As such, the parent company has certain duties – to interfere with the subsidiary’s

under this last amendment the companies subject to the IAS after 2005 will have to prepare their financial statements and consolidated financial statements according to IFRS for 2004, including groups of companies. 105 Eighth Council Directive 84/253/EEC of 10 April 1984 based on Article 54 (3) (g) of the Treaty on the approval of persons responsible for carrying out the statutory audits of accounting documents 106 Speech/04/70, Date 11/02/2004, FRITS BOLKENSTEIN, Member of the EC, DG Internal Market, Taxation and Customs and Commission Recommendation of 15 November 2000 on quality assurance for the statutory audit in the European Union: minimum requirements C(2000) 3304


management in a responsible manner. Irresponsible interference (sometimes amounting to abuse) is sanctioned by personal liability of the equity holder or de facto director. Despite the differences in national law and in corporate governance models (civil law and common law approaches), the jurisprudence of national courts demonstrate that similar problems, raised in the parent-subsidiary context are resolved on the basis of converging reasoning. Fiduciary duties may be understood in a different way and attached to different companies’ organs, German companies may differ in their ownership structure and control from US and UK companies, but courts (when they are willing to face economic reality and enhance justice) are moving forward in the same direction and establish judge-made principles, overriding quarrels over legal or policy differences. Both continental and transatlantic judiciaries express their strong willingness to adjust century-old concepts such as separate liability and limited liability to groups of companies, and thus introduce and support a new, high standard corporate liability in doing business. If English courts remain conservative in that respect, it is not because of differences in substance, but as a result of the so called rescue policy. However, this rescue policy should be interpreted in light of the recently adopted Enterprise Act, which recognizes the group liability towards consumers. Moreover, the jurisprudence of ECJ demonstrates how competition law can affect our traditional understanding of the corporate law. Effective economic control, which leads to market dominance or breakdown, becomes the cornerstone in preserving limited liability for individual investors and providing for flexible limited liability for corporate investors. Financial irresponsibility by the controlling corporate shareholders (parent company) causing the insolvency of the dependent subsidiary should be sanctioned. Subsidiary’s stakeholders and minority shareholders with unsatisfied claims should be able to hold accountable the controlling parent company for its detrimental interference. In line of recent converging court decisions and academic proposals regarding limited liability of shareholders, it is desirable that EC policy makers address in a new way corporate opportunism to improve corporate governance and promote common corporate values.


E. WERLAUFF, “EU Company Law”, 2nd edition, DJOF, 2003 P. DAVIES, “Gower and Davies’ Principles of Modern Company Law”, 7th Edition, Sweet & Maxwell, London, 2003 J. ANTUNES “Liability of Corporate Groups. Autonomy and Control in Parent-Subsidiary Relationships in US, German and EU Law”,10, 1994, Boston D. VIDAL, “Droit des sociétés”, E.J.A., Paris, 2001 V.EDWARDS, “EC Company Law”, Clarendon Press, Oxford, 1999 P. CANNU, J. LUCHEX, R. PITRON and J-P. SENECHAL, “Entreprises en difficultés”, CNL Joly, 1994 YVES GUYON, “Droit Commercial General et Sociétés. Entreprises on Difucultés. Redressement Judiciare et Faillite.”, 2nd edition, Paris, Economica, 1988 V. FINCH, “Corporate Insolvency Law – Principles and Perspectives”, Cambridge University Press, 2002 P. BLUMBERG, “The Law of Corporate Groups – Problems of Parent and Subsidiary Corporations under Statutory Law of General Appreciation”, Boston, Little, 1990 P. MERLE, “Droit commercial. Sociétés commerciales”, 8th ed., Dalloz, 2001 F.WOOLDRIDGE,“Groups of Companies. The Law and Practice in Britain, France and Germany”, University of London, 1981 R.WHISH, “Competition Law”, 5th Edition, LexisNexis UK, 2003

K. HOPT and K.PISTOR, “Company Groups in Transition Economies: A Case for Regulatory Intervention”, (2001) 2 European Business Organization Law Review (EBOR) T.M.C. Asser Press K. HOPT, “Common Principles of Corporate Governance in Europe?”, Millennium Conference, London, 2000, published in 2000, Markensins, Oxford K. HOPT, “Company Law Reform in OECD Countries”, OECD Conference on corporate governance, Stockholm, Sweden, December 2001 49

K. HOPT, “Modern Company and Capital Market Problems. Improving European Corporate Governance after Enron”, Working Paper, (11/2002) Max Planck Institute for Foreign Private and Private International Law A. MAGAISA, “Corporate Groups and Victims of Corporate Torts - Towards a New Architecture of Corporate Law in a Dynamic Marketplace', 1 Law, Social Justice & Global Development Journal (LGD), 2002 FORUM EUROPAEUM CORPORATE GROUP LAW, “Corporate Group Law for Europe”, EBOR, 1, 2000, D. MILLON, “Piercing the Corporate Veil, Financial Responsibility, and the Limits of Limited Liability”, 2003, No 03-13, Washington & Lee Public Law and Legal Theory Research Papers J.SALACUSE, “Corporate Governance, Culture and Convergence: Corporations American Style or with a European Touch?”, 2002, British Institute of International and Comparative Law, London R.GRANTHAM, “The Judicial Extension of Directors’ Duties to Creditors ”, 1991, Journal of Business Law (JBL) T. BAUMS and K.E. SCOTT, “Taking shareholders protection seriously? Corporate governance in the United States and Germany”, European Corporate Governance Institute, Law Working Paper N 17/2003, H. HIRT, “The Duty of Loyalty Between Shareholders in Respect of the Company’s Decision to Litigate Against Wrongdoing Directors in Germany: Lessons for Britain?”, 2003, European Business Law Review (EBLR) P.BEHRENS, “Introduction to EC Company Law”, presented in EC Company Law seminar, College of Europe, Campus Bruges, Academic Year 2003-2004 P.HOMMELHOFF, “Protection of Minority Shareholders, Investors and Creditors in Corporate Groups: the Strengths and Weakness of German Corporate Group Law”, (2001) 2 EBOR PETER NYGH “The Liability of Multi-national Corporations for the Torts of Their Subsidiaries” (2002) 3, EBOR P.BLUMBERG, “The Corporate Entity in an Era of Multinational Corporations”, (1990) Delaware Journal of Corporation Law J. PETER, “Parent Liability in German and British Law. Too far apart for EU legislation”, (1999) 11/12, EBLR J. CALVO, “L’action en comblement du passif et la notion de gestion de faute”, (1998) N 63, LPA, CH. MITCHELL, “Lifting the Veil in the English Courts: an Empirical Study”, (1999) 15, C.F.I.L.R.P.


P.KORTS, “Cash Pooling -Hidden risks for managers and partners”, Korts Rechtsanwaltsgesellschaft GmbH, Cologne,, 2003 FRESHFIELDS NEWSLETTER, “EU Regulation on Insolvency Proceedings”, 1/2004,

Report of the High Level Group of Company Law Experts on a Modern Regulatory Framework for Company Law, November 4th, 2002,

Modernizing Company Law and Enhancing Corporate Governance in the European Union – A Plan to Move Forward, European Commission, Brussels, Com (2003) 284 final, May 25th 2003 Comparative Study of Corporate Governance Codes Relevant to EU and its Member States, Weil, Gotshal & Manges LLP on behalf of the EU Commission, Brussels, January, 2002

Main Legal Acts
European primary and secondary legislation: EC Treaty Council Regulation on Insolvency Proceedings (ЕC) No 1346/2000 OJ 30/06/2000 Seventh Council Directive 83/349/EEC of 13 June 1983 OJ (EC) 1983 on consolidated accounts Draft for Ninth Company Law Directive on Groups of Companies German legislation: Aktiengesetz (Joint Stock Companies Act) of 1965 GmbH-Gesetz (Act on Limited Liability Companies) of 1892 German Insolvency Act of 1999 (amended in 2003) French legislation: Code de Commerce as amended in 2001 English legislation: Companies Act from 1985 (amended in 1989) Enterprise Act from 2002


Insolvency Act from 1986

Main Cases:
European Court of Justice: Case T-65/89 BPB Industries plc v Commission /1993/ ECL II-139; Case Amico Acids OJ, 2001 L 152/24, 2001 5 CMLR Case 6/73 Instituto Chemiotherapico Spa and Commercial Solvents Corporation v. Commission, Recueil, 1973, 215 Case 6/72, Europemballage Corporation et Continental Can Company Inc. v. Commission, Recueil, 1973, 215. Case C-167/01, Inspire Art, 30th of September, 2003, English Courts: Solomon v Solomon & Co Ltd /1897/ AC 22 DHN Food Distributors Ltd v. London Borough of Tower Hamlets /1976/, 1 WLR 852 Adam v Cape /1990/ Ch 536 French courts: Accor case, Cour de Cassation, 19/12/1995, N 2245 Aline music case, Cour de Cassation, 25/06/1993, N 190, N 93-11-264 Rozenblum case, Cour de Cassation, Chambre Criminelle, 04/02/1998 German courts: Autokran BGHZ 95,330 Tiefbau BGHZ 107,7 Video BGHZ 115, 187 TBB BGHZ, 1993-II ZR 265/91, DB Heft 04/16/1993 Bremer Vulkan case, BGHZ, 17th of September 2001, 149, 10 KBV case, BGHZ, Urteil vom 24 Juni 2002 – II ZR 300/00