Effective Corporate Governance - Essay Example

In the recent company law review, it was found that “there is no merit in imposing a more integrated regime on groups of companies which would take away flexibility and strike at the limited basis of company law”. Also there is not evidence of abuse of corporate status by parent companies. Through a critical analysis of the corporate structure assess the validity of this statement. Pay particular attention to the relationship of a parent to its subsidiary and potential liability of a parent for the acts of a subsidiary. The recent company law review statement commenting that “there is no merit in imposing a more integrated regime on group of companies which would take away the flexibility and strike at the limited basis of company law” appears to be motivated by the needs of commerce and arguably ignores the wider legal issues of corporate group structures. Indeed, the sacrosanct principle of limited liability as established by the case of Salomon v Salomon, 1has created problems regarding effective corporate governance in relation to activities of a corporate group and multinational enterprises (MNE), with practical difficulties of enforcement and accountability. This has led commentators to criticise the inherent limitations of the law as a tool for the regulation of MNEs and group structures2. The limitations of the law as a tool for regulation of corporate structures was further evidenced by the dictum of Slade LJ in the case of Adams v Cape3 per Slade LJ where he asserted that “we do not accept as a matter of law that the court is entitled to lift the corporate veil against a defendant company which is the member of a corporate group merely because corporate structure has been used so as to ensure that legal liability (if any) in respect of particular future activities of the group (and correspondingly the risk of enforcement of liability) will fall on another member of the group rather than the defendant company. Whether or not this is desirable, the right to use a corporate structure is inherent in our corporate law4”. Whilst it is imperative that the UK legal and economic framework facilitate business innovation and growth, it is equally vital to ensure that the need for “flexibility” isn’t exploited by flouting perceived loopholes in legal principles regulating corporate accountability. As such, in order to be truly effective, the system needs to strike a balance. The focus of this analysis is to evaluate the current system for regulating corporate structures and how effective the law is as a regulator of corporate structures and MNEs. The core focus of this analysis is to critically evaluate the inherent problems within the current political, social and legal structure for holding complex corporate structures to account and effective corporate governance. It will be demonstrated that case of Salomon arguably set an entrenched benchmark, thereby promulgating the inherent limitation of corporate legal personality rendering accountability of complex group company structures through the piercing of the corporate veil difficult. Indeed, the UK courts have struggles to address the commercial reality of group companies, indicating a distinct preference for maintaining the sanctity of the separate legal entity principle5. Ad hoc approaches to lifting the corporate veil have been made to circumvent the strict application of Salomon however the courts have been reticent to lift the corporate veil limiting such cases to decisions based on achieving “justice”6. However, group company structures often create problems of effective regulation and accountability, yet existing principles of law have arguably been stretched to ignore separate legal personality within a group7. Large corporate groups commonly operate as an MNE, which are effectively, a number of individually incorporated companies related to each other through common ownership and policy control in various jurisdictions8. From a plaintiff’s perspective, they will often be in a better position if legal action is instituted against a parent company as opposed to the subsidiary. This is due to the reality that subsidiaries will often have limited assets, thereby offering reduced scope for recovery9. However, even if the subsidiary company within the MNE has assets, it will be accountable in local courts and the local law may be less favourable to plaintiffs than the jurisdiction covering parent company10. However, the position and use of law as a tool to regulate MNEs for default of subsidiaries and group liability remains uncertain in practice, exposing innocent third parties to a costly lack of legal clarity11. The liability of an MNE can be established in various ways, however there is a distinction and liability is difficult to establish for contract based MNEs12. However, it has been propounded that extending such liability would undermine established English legal principles of privity of contract and the veil of incorporation13. Conversely, in equity based MNEs liability can fall under two headings; namely, direct and derivative14. Direct liability imposes liability on a parent for its own actions including negligent breach of governance of a subsidiary or a breach of contract by subsidiary acting as an agent for a parent15. However, notwithstanding this apparent tool of accountability, it imposes cost implications on a plaintiff having to establish agency under complex legal principles. The derivative liability imposes liability on the parent company for the acts of its subsidiary, even though they are separate companies. This may be done by lifting the corporate veil or by establishing a single economic entity, which in practice has proved problematic for the judicial authorities. This is further compounded limited availability of statutory exceptions to the Salomon rule coupled with the ad hoc judicial obfuscation of the inherently restricted exceptions to corporate personality16. This in turn clearly questions the efficacy of the current law as a tool for the regulation of group companies, thereby undermining the sentiments of the Company Law Review. With regard to fraud, the exceptions have been formulated by judicial extrapolations of “shams”17. For example, in the case of Gilford Motor Company Limited v Horne18 it was held that the incorporation of a company the sole purpose of which was intended to breach a restraint of trade clause with a previous employer, rendered the company’s status as a corporate personality a “sham”, justifying the piercing of the veil. Similarly, in Jones v Lipman19, the corporate veil was pierced to order specific performance against a defendant who had transferred his property (which was subject to an agreed contract of sale) to his newly incorporated company to avoid his obligations as seller. However, whilst these decisions are clearly justifiable on their facts, the difficulty is that abuses of the MNE group company structure often fall just short of the established justifications for piercing the corporate veil, thereby undermining any effective legal regulation20. For example, it appears that it is not fraudulent abuse of corporate principles to manipulate the structure of group companies to ensure legal liability falls on a particular member of a group21. Furthermore, the creation of an MNE corporate structure is often motivated by tax reasons or compliance with local requirements in order to enter the relevant market22. In Adams v Cape23, Slade LJ presiding in the Court of Appeal asserted that evasion of such rights of third parties that “may in the future be required” was not covered by corporate veil exception and therefore the deliberate structuring of the US operation of Cape Industries to limit liability under the pre-existing group structure for future asbestos claims did not justify piercing the corporate veil24. Similarly, in the ReSilicone Gel Breast Implants actions, the same rationale as propounded in Adams v Cape was relied on to assert that piercing the corporate veil was only applicable “upon a showing of improper conduct or that the corporation was either formed or some illegal fraudulent or unjust purpose25”. Another situation where the corporate veil is lifted is where the dominant corporation ignores the formalities of separate corporate personality of the subsidiary within the MNE structure26. This was evidenced in the case of Scottish Co-operative Wholesale Society v Meyer27, where the House of Lords found that economic reality of a group relationship was such that the corporate veil of the holding company’s subsidiary should be lifted to create one economic entity for the purpose of determining liability. Although in this case the subsidiary company was not wholly owned by its holding company, the holding company did control the corporate policy of the subsidiary. Furthermore, the concept of control was considered in the case of DHN Limited v Tower Hamlets28,where Lord Denning argued that group companies and MNEs should be treated as one single economic unity under the law when justice so requires29. However, the validity of this rationale was called into question in the House of Lords decision in Woolfson v Strathclyde RC,30 which again undermines the efficacy of the law as a tool for regulation of MNEs by the inconsistent ad hoc approach to piercing the corporate veil. The most likely circumstances where the veil will be lifted is where the subsidiaries are wholly owned, however this is again inconsistent, as arguably the “justice” element of lifting the corporate veil was satisfied in the case of Adams v Cape, where the NAAC was a wholly owned subsidiary of Cape31. However, it seems that the mere fact of being wholly owned is not sufficient per se and there are other requirements. Indeed the fundamental consideration that seems to be taken into account when determining one economic entity is the question of control32. For example, in the case of Adams v Cape itself, the Court of Appeal admitted that Cape had overall control of the policy directives of the NAAC, however refused to equate this with “control” for the purpose of piercing the corporate veil. The Court of Appeal suggested that the NAAC had ability to enter into its own contracts without the need to seek approval, however while theoretically the case, Cape would have clearly had control over ability of NAAC to ignore Cape policy proposals and Cape controlled contracting policies33. If we consider this in context of the group company structure, it would suggest that whilst in reality the holding company would clearly exert “control”, the mere fact that theoretically the subsidiary had apparent autonomy over contractual and business decisions effectively takes MNEs outside the scope of judicial intervention in piercing the corporate veil in meritorious cases. The other method utilised through the law in order to act as an accountability check on an MNE is via the agency relationship between holding the company and its subsidiary, which will facilitate a finding that the holding company is responsible for the actions of it subsidiary34. The notion that a company was an agent of its shareholders was rejected in Salomon, however in the case of Smith Stone and Knight Limited v Birmingham Corporation,35 Atkinson J pierced the corporate veil to enable a subsidiary company operating business premises from holding company land to claim compensation under the principles of agency. If we consider this by analogy in context of separate entities within an MNE, one could regard the agency relationship as the relationship based on implied and express consent of both subsidiary and holding company that the former will act on the latter’s behalf, and as such, it is subject to the holding company’s control36. However, the courts appear to use this rationale to acknowledge the “control” concept as a reason for piercing the corporate veil whilst simultaneously using it as a justification for avoiding doing so in practice37. For example, in Adams v Cape, the Court of Appeal held that the veil of incorporation could be pierced if there was an express agency agreement between the parent and subsidiary. However, this relied on express agreement and in the absence of an agreement there does not appear to be any room for presumption of an agency in such cases38. As such, whilst acknowledging the “control” concept in theory, in the Cape case it was determined that the subsidiaries were independent of each other and had autonomy over day to day control of Cape with no general power to bind the parent. As such, the apparent autonomy rendered piercing of the corporate veil inapplicable. The core issue in the Cape case was whether default judgments in Texas could be enforced against the defendant English company in England. The Court of Appeal refused the appeal and rejected the “presence” issue argument of the Plaintiff. Slade LJ acknowledged that the subsidiary structure could clearly act as a façade, however, he rejected the single economic entity argument. Nevertheless, somewhat paradoxically, Slade LJ acknowledged that there could be “control” of subsidiaries. However, the circumstances did not justify piercing of the corporate veil. Furthermore, the subsidiary companies were separate and not therefore English companies answerable to UK jurisdiction. The circular rigidity of the Cape rationale clearly calls into question where, if at all the corporate veil will be lifted and ignores the reality that many MNEs will effectively be a single economic unit under the “control” of the holding company. Whilst acknowledging the need to lift the corporate veil in cases of control and fraud, there is a distinct dichotomy between this rhetoric and practical implementation. As such, the reluctance to depart from the Salomon principle has resulted in inconsistent, circular judicial opinions highlighting the inadequacy of the law to act as a tool to regulate MNEs. Indeed, Adams v Cape decision emphatically rejected lifting of the veil based on justice. However, in Creasey v Breachwood Motors Limited39 it was held that the court had the power to lift the veil “to achieve justice where its exercise is necessary for that purpose”, compounding the current uncertainty surrounding regulation of MNEs. As such, the current system whilst acknowledging the need to “achieve justice” arguably results in unjust decisions, broadening the scope for an MNE to abuse its corporate structure and unfairly prejudice innocent third parties. Bibliography N Bourne., (2007). Bourne on Company Law. Routledge-Cavendish. Dignam & Lowry (2006). Company Law.4th Edition Oxford University Press. Farrar (1999). Farrar’s Company Law. 4th Edition Butterworths. Brenda Hannigan (2003). Company law. 5th Revised Edition. Oxford University Press Keenan (2005). Company Law. Pearson. Peter T Muchlinski., (2007). Multinational Enterprises and the Law. 2nd Edition Oxford University Press. Peter Nygh., (2002). The liability of Multinational Corporations for the Torts of their subsidiaries. European Business Organisation Law Review Volume 3: 51-81 Asser Press. L.Sealey., & S.Worthington., (2007). Cases and Materials in Company Law. 8th Edition Oxford University Press. Read More