The Liability of the Holding Company for the Debts of its Insolvent Subsidiaries

Andrew Muscat

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781351886819
• Edition: 1
• Topic: Droit
• Subtopic: Droit des faillites et de l'insolvabilité

This work deals with the liability of the holding company for the debts of its insolvent subsidiaries. In analyzing the current position under English law, the work challenges as outmoded and inadequate the virtual dogma that a holding company is not answerable for the debts of its insolvent subsidiaries. The study identifies four separate and distinct types of behavioural practices within corporate groups which may prejudice the interests of external creditors or otherwise constitute an abuse of the corporate form; the subservient subsidiary situation; the inadequately financed subsidiary situation; the integrated economic enterprise situation; and the group persona situation. After weighing the various arguments for and against a change in the law and concluding that reform is called for, the study proceeds to submit some radical proposals for reform. The basic thrust of the reform proposals is that in a number of well-defined situations entity law should give way to an enterprise analysis and holding company liability should be imposed for the debts of insolvent subsidiaries.

1 Introduction

1. THE CORPORATE GROUP - NOT A RECENT PHENOMENON

To dwell upon the problems raised by corporate groups is to lament deep-rooted deficiencies of English law. In order to appreciate this concern, a brief historical excursion into the development of corporate groups is essential.

The corporate group is by no means a late 20th century phenomenon. Indeed, at least as early as the mid-19th century in England, and some decades later in the United States, the creation of a holding-subsidiary company relationship - which is of course at the heart of the corporate group arrangement - was already possible. In England, the power of a company to acquire and own shares in another company (thus making possible the holding subsidiary relationship) has never been expressly provided for in any of the general incorporation statutes. It was however generally accepted, even in the mid-19th century, that such power could be specified in the Memorandum of Association and that such power was contrary neither to the common law nor to the applicable companies legislation.¹ Where neither express nor implied authority could be found in the Memorandum, it was considered ultra vires to acquire the shares of another company.² In the United States (where the powers of a corporation were largely specified by general incorporation statutes, and not, as in England, by the Memorandum) corporate groups emerged after state corporation laws authorised corporations generally to acquire and own shares in other corporations. This process started in the state of New Jersey in 1888³ and gradually spread to other states by the early part of the 20th century.⁴ Prior to such general authorisations, specific statutes or charters granted to a limited number of corporations the right to own shares of other corporations. Without such specific or general authorisation, it had been settled law in the United States that it was ultra vires or unlawful for a corporation to acquire shares in another corporation.¹

Notwithstanding that the holding-subsidiary relationship was in principle allowed during the 19th century, it was not until the early days of the 20th century that commercial enterprises gradually started to develop and mutate into corporate groups.² And following the Second World War, the world has witnessed an explosive proliferation of corporate groups, even of transnational corporate groups.³ Indeed, corporate groups have, over the last three decades at least, become a familiar every-day feature of the commercial scene. Business is increasingly being conducted by what are often complex organisations consisting of several companies collectively undertaking a common business enterprise.

Yet although the corporate group has for some time been the predominant form of doing business, the underlying conceptual and regulatory framework is still deeply rooted in the traditional model of the “single-company” business prevalent in the 19th century. As we approach the dawn of a new century, English law has barely begun to grapple with the unique problems raised by the corporate group phenomenon.⁴ In particular, it has ignored the fundamental problem (with which this study is primarily concerned) of holding company liability for the debts of insolvent subsidiaries.

Were corporate groups to play a minor part in contemporary society, then the group phenomenon might hardly deserve deep inquiry. Yet, as will presently be shown, corporate groups are playing an increasingly significant role in the modern world. As a result, problems stemming from the group phenomenon become magnified, meriting serious consideration.

2. PROLIFERATION, GROWTH AND POWER OF CORPORATE GROUPS

As the following pages will demonstrate, the proliferation, growth and power of corporate groups make the group phenomenon truly impressive.

2.1. The corporate group : the typical form of business organisation

The stark reality of the business enterprise in contemporary society is no longer the “single-company” organisation. Rather, the typical form of business organisation is the complex corporate group¹ composed of interrelated corporate components operating under a “parent entity’s corporate umbrella”.² Nor is the use of the corporate group structure limited to the large business enterprises. Even with medium sized and smaller enterprises, it has become common for the business to be divided amongst a number of companies each constituting a separate legal unit. Only in the case of the smallest private business enterprise is the single independent company the typical form of organisation.³

The phenomenon of corporate group activity is certainly not unique to the United Kingdom. On the contrary, it is evident that the corporate group has become a familiar characteristic of commercial life throughout the developed world.⁴

2.2. Widespread transnational character

The proliferation of corporate groups is by no means confined to the domestic arena. Today’s business world is replete with immensely powerful corporate groups whose operations span the entire globe.¹ Indeed it is in the form of the transnational organisation that the corporate group achieves its most complex and problematic form, with enterprises often multiplying into intricate networks of foreign and local subsidiaries and affiliates which could number in the hundreds world-wide.

Transnational corporate groups have been around for quite some time.² But it was only following the Second World War that the spectacular rise in the growth and proliferation of transnational corporate groups has occurred.³ In Europe, post-war growth has been largely attributed to the recovery of the various European economies, greater political stability, the return of European currencies to convertibility and the creation of the European Community.⁴ World-wide, the spread of transnational corporate groups can be credited to a number of factors including advances in technology, improvement in communications and transportation, a relatively free trading and investment environment and the ease with which assets are able to move across national boundaries. All these factors combine to facilitate the “globalisation of production”.¹ Undoubtedly, the end of the Cold War and the emergence of new market economies in Eastern Europe and the Far East is also accelerating the trend.

Recently published statistics on transnational corporations bear witness to the extensive proliferation of corporate groups in the international arena.² By the early 1990s there were over 37,000 transnational corporations with over 170,000 foreign affiliates.³ And the number of transnational corporations has been steadily increasing. For example, those that are based in 14 major developed home countries “have more than tripled during the past two decades, from slightly more than 7,000 in 1969 … to nearly 24,000 in 1990” ⁴ The universe of transnational corporations is indeed large, diverse, dynamic, and flourishing.

2.3. Immensity of corporate group activity

The sheer number of corporate groups and the multitude of subsidiaries comprised therein is certainly noteworthy; yet it is the size and the extent of the business activity collectively undertaken by such organisations that is really striking.⁵ Recent estimates, for example, calculate that about one third of the world’s private sector productive assets are under the common governance of transnational corporations.⁶ The growing influence of transnational corporations can be noticed in the increase in the stock of foreign direct investment : since the early 1980’s annual foreign direct investment flows have grown rapidly¹ so that by 1992, the global stock of foreign direct investment had reached approximately US$ 2 trillion, which generated about US$ 5.5 trillion in sales by foreign affiliates.² And the indications are that in the future corporate groups will continue to handle a growing proportion of world trade.³

2.4. Diversity of corporate group activity

Corporate groups are now to be found in virtually all sectors of domestic and international economies.⁴ Moreover, there is a marked tendency for diversification even within groups of companies, with groups expanding into production processes, markets, products and services outside the scope of their original business activity.⁵ Such diversification - horizontally into new product lines, vertically in upstream or downstream processes, or conglomerate diversification into new business sectors - effectively commenced with the acquisition strategies of the 1960’s.⁶ More recently there has been a tendency amongst corporate groups to divest subsidiaries and rationalise their product and market strategies. The extent of diversification, however, remains high.¹

2.5. Power of corporate groups

The proliferation, size, growth and diversity of corporate groups combine to make the emergence of the group phenomenon one of the most dramatic developments of recent decades.² And their significance is not merely economic or industrial. Corporate groups have become dominant institutions in the modern world, profoundly affecting the role of governments in national domestic economies and even the relationship between states.³

In every age, power has been founded upon the dominant interests of the time. Over 60 years ago, Justice Brandeis had asserted that corporations “have become an institution … which has brought such concentration of economic power that so-called private corporations are sometimes able to dominate the State.”⁴ Justice Brandeis may have slightly overstated the case for his times. Today, however, his statement would more closely reflect the truth. Indeed, there can be little doubt that nowadays corporate groups - though not quite so powerful as to actually dominate the state - do sometimes compete on practically equal terms therewith. Sometimes, corporate groups rival the state in the influence they exert on society. Often they effectively outrun the state in the efficiency of their organisation. On the domestic level, powerful corporate groups are perhaps reminiscent of the feudal system.⁵ And where corporate groups are trans...