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

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1 COLLEGE OF EUROPE BRUGES CAMPUS LAW DEPARTMENT 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 Thesis presented by: Vassya Prokopieva for the Degree of Master of European Studies

2 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. 2

3 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 3

4 III Abstract 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 4

5 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. 5

6 IV Table of Contents Introduction...8 I. Risks for Shareholders and Creditors Specific Risks Related to Groups Regulatory, Judicial and Soft Law Solutions. 12 II. Main Notions Used in the Context of Penetrating Liability Parent and Subsidiary Companies. Groups of Companies The State of Insolvency. Insolvency Proceedings General questions in the Context of Parent Company Liability in regard to Subsidiary Insolvency Separate Personality and Limited Liability vs. Fairness to Creditors Ownership vs. Control Who is the Decision Maker? Duty of Loyalty and Fiduciary Duties Who Owes What to Whom? Independence of the Subsidiary Directors - a Cornerstone in Parent- Subsidiary Relations III. EC and National Legal Solutions EC Law Fractional and Sector-specific Harmonization English Regulatory Approach Traditional means Wrongful Trading by Shadow Directors, Unfair Prejudice and Re-use of Insolvent Company Name Enterprise Act of 2002 A Step Forward in Recognizing Flexible Liability for Groups Comparison with the US Regulatory Approach French Legislative Responses Exceptions to the Principle of Separate Personality and Limited Liability Action en Comblement du Passif Confusion des Patrimoines New French Rules on Joint Liability within a Group of SA Companies The German Control Groups and Konzernrecht

7 4.1.Contractual Groups Control Agreements and Integration De Facto Konzern Qualified De Facto Konzern Where Is the Limit? IV. Jurisprudence of National Courts and ECJ English Courts Lifting the Corporate Veil French Courts Accor Case Alien Music Case Rozenblum Case Evolution of the German Jurisprudence from Autokran to KBV Bremer Vulkan Case KBV Case ECJ Jurisprudence 38 V. Academic Input No Limited Liability with Respect to Creditors without Bargaining Power Flexible (Tailored) Limited Liability. 41 VI. A Way Forward Some Proposals for EC Harmonization Preventive Measures for Improved Disclosure Sanction Measures Enhanced Accountability of Parent Companies and Managers for Failures of the Subsidiaries Improvement of Related Instruments Alternative Ways to Achieve Convergence VII. Concluding Remarks Bibliography. 49 Main Legal Acts Main Cases

8 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 8

9 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 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. 1 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 9

10 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 company 3. Recent overlapping insolvency 2 Second Company Directive 77/91, /1976/, amended by Council Directive 92/101/ from 13/11/1992, art. 24a and art Council Regulation on Insolvency Proceedings (ЕC) No 1346/2000 OJ 30/06/

11 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 4 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 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 11

12 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 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 of Code de Commerce and sec 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 7 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, 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 , OJ N L 347/64 9 Re Poli Peck International PLC (in administration) N 3 /1996/ I BCLC

13 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 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 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 shareholders 11 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 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 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 WEIL, GOTSHAL & MANGES Comparative study, supra note 5, p

14 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 Europaeum 13, 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; 13 See mainly in Corporate Group Law for Europe, FORUM EUROPAEUM CORPORATE GROUP LAW, (2000) 1 EBOR, and the web site: (in German language only) 14 ERIK WERLAUFF, EU Company Law, 2 nd edition, DJOF, 2003, at p PAUL DAVIES, Gower and Davies Principles of Modern Company Law, 7 th Edition, Sweet Maxwell, London, 2003, p.209, hereinafter P.DAVIES supra note Seventh Council Directive 83/349/EEC on consolidated accounts, OJ (EC)

15 (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 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 17 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

16 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

17 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 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 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, and PETER NYGH The Liability of Multi-national Corporations for the Torts of Their Subsidiaries (2002) 3, EBOR, 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 17

18 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 insolvent 21 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 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: 21 P.DAVIES, supra 15, p.373 and ROSS GRANTHAM, The Judicial Extension of Directors Duties to Creditors, 1991, Journal of Business Law 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.8-11, 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 and T.BAUMS and K.SCOTT, supra note 22, p P. DAVIES, supra 15 18

19 3.4. Independence of the Subsidiary Directors a Cornerstone in Parent- Subsidiary 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 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 26 ERIC WERLAUFF, supra note 14, p DOMINIQUE VIDAL, Droit des sociétés, E.J.A., Paris, 2001 for action sociale in France p and HANS- CHISTOPH 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

20 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 Fruechaut case, Paris, 22/05/1965, JCP 1965, II, 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 20

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