British company law

The recent investigation into accounting irregularities at Hollinger International has reportedly,1 "focused upon the $5. 5m of so called "non-compete payments" to senior executives purportedly arising from a deal with a wholly owned subsidiary… Investigators are… asking Lord Black, Hollinger's former chief executive, and others how they were supposed to refrain from competing with themselves… " Whilst any allegations of wrongdoing are yet to be substantiated, it is doubtful as to whether British company law will be able to provide an appropriate mechanism with which to deal with any irregularities which may arise.

This essay will evaluate a number of the provisions contained within British company law intended to deal with the problems posed by purely groups of companies. It is contended that such provisions have so far proved to be inadequate. The case of Salomon v A Salomon and Co Ltd establishes as a fundamental principle of company law that; "When the memorandum is duly signed and registered… The company is at law a different person altogether from the subscribers… "2

Thus, a company which has complied with the provisions contained within s13 of the Companies Act 1985 (CA 1985), is to be regarded as a distinct legal personality, giving rise to the notion of a 'veil of incorporation'. A fundamental consequence of this is that the company itself, as opposed to its members, is liable upon its debts. An advocate for economic efficiency might welcome the encouragement that this gives to public investment. Fletcher however raises several concerns;

"Companies are allowed to own other companies, and the ownership of the shares of another company has led to the creation of… the corporate group. The evolution of the corporate group has generated the multinational group… The multinational that wholly owns subsidiaries has created a number of relevant problems. For example, when a subsidiary is trading in a host country… which national court should assume jurisdiction over the parent company for the multinational group… Further, should the parent be liable for the debts of the wholly owned subsidiary?

"Where the 'veil is lifted' in respect of groups of companies, the Court; 'ignores the separate personality of each company in favour of the economic entity constituted by a group of associated companies. '4 It was held by the Court of Appeal in the case of DHN Food Distributors Ltd v Tower Hamlets London Borough Council5 that the group of companies concerned constituted a 'single economic unit'. The facts involved the mandatory sale of premises owned by a subsidiary company from which the parent company operated.

The decision of the Court appeared to be based primarily upon a consideration of corporate policy. "If each member of the group is regarded as a company in isolation, nobody at all could have claimed compensation in a case which plainly calls for it… Why then should this relationship be ignored in a situation in which to do so does not prevent abuse but would on the contrary result in what appears to be a denial of justice. "6 The Court may be commended for making a common sense business judgement responding appropriately to a problem faced by purely groups of companies.

Subsequent case law however, has demonstrated a retreat from the 'single economic entity' principle. This is illustrated in the case of Bank of Tokyo Ltd v Karoon,7as per Lord Goff; "Counsel suggests beguilingly that it would be technical for us to distinguish between parent company and subsidiary in this context; economically, he said, they were one. But we are concerned not with economics but with law. The distinction between the two is in law, fundamental and cannot here be abridged. "

The doctrine of limited liability attainable through incorporation, whilst offering protection to shareholders vis a vis the company's debts, also has the consequence of restricting the extent of recovery which unsecured creditors may obtain. Section 227, CA 1985, seeks to offer greater protection to potential creditors by imposing a 'duty to prepare group accounts'; "(2) Group accounts shall be consolidated accounts comprising- (a) a consolidated balance sheet dealing with the state of affairs of the parent company and its subsidiary undertakings.

" For the purposes of section 227 and the preparation of financial statements, section 258 CA 1985 draws a distinction between "parent and subsidiary undertakings". Sub-section 2 contains the five criteria for establishing when; "an undertaking is a parent undertaking in relation to… a subsidiary undertaking. " The distinction between parent and subsidiary company in section 258 was developed specifically as a means of implementing the Seventh Company Law Directive (83/349).

Consequently, section 736 differentiates between; 'Subsidiary', 'holding company' and 'wholly-owned subsidiary', which is to apply to statutory provisions, other than those relating to financial statements. Davies comments; "While it is a pity that it was thought necessary to have different definitions for what are essentially the same concept, there is no doubt that both are considerable improvements on the previous definition since they recognise that what counts is "control"… "8 The case of Adams v Cape Industries plc9 appears to have severely limited the ability of the courts to lift the corporate veil.

Council for the plaintiff raised several arguments for the imposition of liability against Cape, the parent company of a defendant subsidiary (NAAC) involved in a mass personal injury case in Texas, U. S. The first of the plaintiff's arguments was based upon the notion that the group of companies constituted a "single economic unit". Slade LJ rejected this argument, upholding the dictum of Roskill LJ in the Alberzero10 case: "There is no general principle that all companies in a group of companies are to be regarded as one. On the contrary, the fundamental principle is that 'each company in a group of companies…

is a separate legal entity possessed of separate rights and liabilities"11 Whilst the "single economic unit" appears to have been severely limited in its scope by Adams, support for Davies' contention that 'what counts is "control"', is offered by Griffin; "… the fundamental reason for removing the veil from the subsidiaries so as to create one economic entity would seem to be dominated by the question of 'control'. Is the subsidiary merely a puppet manipulated by its master or does it at least have control over a few of is own strings?

"A second argument for the plaintiff in Adams was that, "an agency relationship existed between Cape and NAAC. "13 This was rejected by the court on the basis that the companies concerned were distinct legal personalities. Griffin comments; "… to label an entity as part of an agency relationship is in fact to illuminate the existence of two entities as opposed to one. If a court lifts the corporate veil it fuses the subsidiary into the holding company, it does not recognise the separate identities of both companies. " 

When then is the veil to be lifted with respect to company groups? Ottolenghi observes that; "Notwithstanding much endeavour, no conclusive answer has yet been given to the question of when the courts will lift the corporate veil. Indeed the plea is often made… that the legislature should lay down definite rules. "15 Further provisions to protect unsecured creditors in the event of a company's insolvency are contained within the Insolvency Act 1986. Section 214 of the Act grants the Court power to impose a personal liability against a company's director for 'wrongful trading'.

This will result when there is a failure to minimise the losses of a company which the director knew, or ought to have known was going into liquidation. In its review of Company Law entitled, "Modern Company Law for a Competitive Economy: Completing the Structure", the Steering Group identifies the major problem facing parent companies as being the preparation and auditing of accounts; "These can be burdensome for a large group, in many cases without adding valuable information or protection for creditors or shareholders, at least of the parent company.

"16 The Steering groups suggestion for reform on this issue is the adoption of an "Elective regime"; "whereby, in exchange for a guarantee by the parent company of he liabilities of a subsidiary… the subsidiary should be exempted from the requirements under the Act relating to annual accounts and audit. "17 Despite the benefits such reform would offer to parent companies, the reform proposals must be criticised for their failure to deal sufficiently with the problem concerning the circumstances in which the courts ought to 'lift the veil'.

Boyle remarks; "The Final Report, in this respect, may fairly be described as an evasively inadequate treatment of an issue of major importance in the reform of any systems of company law. "18 In conclusion, it is my contention that whilst statutory attempts have been made to circumvent the problems posed by purely groups of companies, the restriction placed upon these provisions by the common law has rendered them highly unsatisfactory.

The case of Adams v Cape Industries is demonstrative of the judiciary's unwillingness, in the absence of unambiguous statutory provisions to contrary, to depart from the notion of a 'distinct legal personality',. Whilst an adherence to the Salomon principle may be desirable both as a matter of legal certainty and economic efficiency, the need for further, unequivocal, statutory reform has become self-evident. The proposals of the Steering Group offer little hope of the desired reform emmenating any time within the near future.