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Group of Companies Insolvency

Posted on 14 November, 2014 at 9:50

The principle of “limited liability” of a company is well entrenched in most legal systems. The main effect of limited liability is that the company as a legal body is responsible for the debts it incurs. If a company is insolvent, the shareholders will lose their invested capital in the company, however in most cases they will not be liable for payments in respect of any remaining company debts.

This essay will condiser to what extent the principle of limited liability applies in the event that the shareholder is a Company rather than an individual. As an outline the essay will examine how case law across some jurisdictions has evolved in this regard and how EU insolvency law treats liability within a group of companies. To conclude, the essay will assess if indeed adequate protection is afforded to creditors or do coporate shareholders of the parent company escape liability by hiding behind an impenetrable “Corporate Veil“.

In the Re Sothhard case, it was established that , if the shareholder is not an individual, but rather another legal entity, “ the parent company and other subsidiary companies prosper to the joy of the shareholders without any liability for the debts of the insolvent subsidiary”

The ruling of this case highlights that treating the company group as individual and separate legal personalities may place creditors at a disadvantage . This may be the case when the related parent company was responsible for the management of the of the subsidiary or was responsible for incurring the liabilities towards the creditors. The parent company may drain the subsidiary assets to cover financial problems or satisfy shareholder demands for dividends that ultimately affect share prices if the company shares are publicly traded. Creditors may also be deceived by transferring assets from the subsidiary to the parent at unrealistic low values. Therefore, if control is exercised by the parent company, it is unjust not to distinguish between controlling shareholders and passive individual investors.

From the Shareholders perspective, if companies are not treated as separate legal entities, building a “firewall” against risk would increase uncertainty , affect the cost of borrowing , provide a cautious approach to drawing dividends that would make investment unattractive. This would lead to an over cautious business environment that would hamper growth and development.

Globalisation and the EU – group companies:

Insolvency becomes more complicated with globalisation and the increasing number of countries joining the European Union. This is , in part as a result of the principal of freedom of establishment of companies and free movement of goods. Many group structure companies have developed, with the parent company being registered in one Member State and owning several subsidiaries across other Member States. This has created complexity and uncertainty where insolvency arises within a subsidiary. In the UK House of Lords debate of whether the UK should adopt the European Convention on Insolvency Proceedings,( this later ater became the European Council (EC) Regulation on Insolvency Proceedings (“ The Regulation“) Lord Hoffmann had commented on the omission of the Convention to deal with insolvencies in groups of companies.

The Regulation which was adopted in 2000, primarily functions as a regulatory framework to address “conflict of law“ issues between the Member States . Some academics are surprised that it has taken more than 40 years to have a unified approach towards insolvency, and in addition does not deal with groups of companies. Within the EU there are about 200,000 corporate bankruptcies filed each year with about 1.7 million job losses. Despite this, the only member states which cover through legal provisions for the regulation of groups and parent to subsidiary relations with regard to liabilities are Germany, Portugal, Poland and Slovenia.

The Regulation has been developed on the principle of universality, meaning that there will be one core insolvency proceeding against one debtor. Jurisdiction and applicable law will be governed by where the debtor’s main economic interests take place . The court decisions are recognised throughout the Member States of the EU. There is a presumption that the COMI is defined as per the registered office of a Company, “the mere fact that its economic choices are or can be controlled by a parent company in another Member State is not enough to rebut the presumption” .

Some Jurisdictions:

UK

As companies grow around a group structure, the Salomon principle may be abused. Lord Denning had argued in DHN Ltd v Tower Hamlets that when considering a group of companies, these should be treated as one economic entity. However in Woolfson v Strathclyde RC the House of Lords held that the corporate veil of a group structure should be maintained unless it was a mere front.

In Adams v Cape Industries plc (1990), the court concluded that the court could not show disregard for Salomon “merely because it considers that justice so requires“ . This case defined three situations where the piercing of the veil is allowed. The first relates to the interpretation of a statute or a document, the second in case of a façade company and finally in the event where the subsidiary has an agent relationship with the parent company.

The approach to Adams has changed in recent years as is evident by the rulings of some cases. In Samengo-Turner v J&H Marsh & McLennan (Services) Ltd , the Court of Appeal applied an EU regulation as a basis to interpret and treat a group of companies as a single entity. The Court of Justice (ECJ) has taken a similar view that if a subsidiary is supervised by the parent company and has no freedom, it is deemed to be a single economic unit.

Moreover, if a holding company makes a subsidiary distribute funds to the holding company in an unlawful manner, then the holding company could be liable to repay the subsidiary. Furthermore, loans provided by a holding company in favour of the subsidiary are potentially voidable during an insolvency if the repayment is considered to discriminate against other creditors in an unlawful manner.

On a statutory level, the CA 2006 of the UK sets responsibility for directors to take into consideration all stakeholders, including creditors. This stance is also reflected in UK case law

Ireland

Before presenting the Eurofood case, an indication of how group insolvencies were handled, the case such as that of KPN Quest is a good example to be considered in order to underline the contrast and effect of Eurofood. During this insolvency, many jobs were lost and heavy losses were incurred by creditors and shareholders owing to the Dutch holding company’s failure. Many subsidiaries were obliged to file for protection since there was no authorised party to coordinate the proceedings. The losses and affected stakeholders could have been minimised through coordination of all the subsidiaries.

In the Eurofood case, a different approach was taken. Eurofood which was a registered company in Ireland and a wholly owned subsidiary of Parmalat SpA, an Italian registered company. Eurofood main activities were to secure finance for the holding company ’s other subsidiaries in Venezuela and Brazil. When the holding company went into liquidation, the Italian courts opened insolvency proceedings against Eurofood, arguing COMI in Italy. The Dublin High Court found however that Eurofood COMI was in Ireland due to its registered offices. The ECJ position considered the key element to COMI is the locality from where the subsidiary manages and administers its interest. Therefore, since the Eurofood subsidiary had the registered office in Ireland and conducted business in Ireland, the decision reached was correct. The fact that strategic economic decisions were directed by the holding company in another Member State did not reverse the presumption. Proof that the actual management and supervision is located elsewhere is required in order to reverse this presumption.

Following the Eurofood decision, in 2012, the Commission published a proposal for the amendment of the Regulation. These suggested amendments include inter alia , proposals relating to insolvency, including rules that address the insolvency of companies which are subsidiaries or members of a group of companies. Furthermore , it was suggested allowing for a coordinated restructuring plan that will prevent job losses and the coordination of information and cooperation between all courts and appointed liquidators.

 

One legal commentator has suggested that the Commision :

“proposal confirms the solution reached in the Eurofood and Interedil cases; so that a group of companies that is highly integrated may still request a single jurisdiction to open a main insolvency proceeding to the benefit of all of its companies in order to favour either the implementation of a global reorganisation plan”

Germany

In the Autokran case , the evidence of control of the subsidiary allowed the court to rule for the full liability of the majority shareholder on the basis of contractual groupings. In the Tiefbau case , the German Federal Supreme Court (GFSC) took this ruling further where it declared that only financial control is necessary for the same outcome as the Autokran case, however it held that a causal link was required between the effects of control and the damages incurred by the subsidiary. In the Video case the German Federal Supreme Court developed a new requirement of conduct that was prejudicial on behalf of the parent company towards the subsidiary.

In the TBB ruling , there was a change in direction as it also introduced the requirement of abuse of power by the directors.In the Bremer Vulkan case the GFSC viewed that since the cashflow of the group was centralised and controlled by the parent company , it had a responsibility towards the subsidiary to provide liquidity and to manage its assets so that the subsidiary could meet its maturing liabilities. The majority shareholder will therefore be liable for depriving the subsidiary of assets it needs to meet its liabilities.

 

Conclusion:

This essay has considered if creditors are protected in the event of insolvency occuring within a company in a group structure. It has shown that It is in the interests of all stakeholders that they are protected in the event of an insolvency by providing an opportunity for re organisation and survival of the company, if it is to pay off debts rather than creditors taking only what is salvaged . The reforms introduced by the revision of the EU Insolvency Regulation on the 5th February 2014,goes some length in addressing this . Article 3 of the Regulation also provides for the principle of “main economic interests”, allowing a focus on interests of the creditors and so companies cannot hide behind a network of subsidiaries in other Member States to overcome problems of overlapping claims.

UK and other Member Sate Case law highlighted above, introduce an element of piercing the corporate veil by treating group companies as single entities, therefore creditors are being favoured, since the holding company cannot hide behind the priciple of limited liability.

 

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