Rules Regarding the Corporate Group Structure

The coursework question is relates with matter of company law review which concern to the Company Act 2006. In 2006 Act there is no new provisions has been introduce to regulate existing corporate group. The law review steering group provides their opinion regarding this issue. According to their view there is no need to introduce new rules or regulations to control group of companies because it would remove the reasonable flexibility of company’s activities. They also provided some evidence regarding their opinion and expressed that there are no evidence of abuse of corporate eminence by parent company. So they are quite satisfied with the existing legal provision regarding regulate corporate group structures. This easy will critically evaluate the statement whether there is need to introduce new laws for corporate structures or not.

Generally one or more investors established a company to achieve a familiar purpose and that is economic purpose. Company is a legal and separate entity which is separate from its investors or shareholders. In UK companies are integrated under the Company Act 2006. There is lots of significant aspect s of a company, such as; company can own assets and liabilities, company can sue and be sued, company have perpetual succession. There are two types of company private and public limited company. Private limited company consists of a single individual to represent the corporate organs on the other hand public limited company consist of large public members and shareholders. Company is a legal entity. It does not have all the rights like natural person but under the eye of law it has a significant recognition [1] , this principle has been discussed in the case of DPP v Dziurzynski [2] . Without any human organs a company cannot perform its activities. So there are need some people to operate the company on behalf of investors or shareholders.

The case of Salomon v Salomon [3] is the most significant case regarding the matter of separate legal entity. “ in the 19th century case Salomon v Salomon, the HL emphasised that the formally separate personality of a company should prevail in the eyes of the law and consequently in the opinion of a court, regardless of any economic or moral considerations that might otherwise justify regarding a registered company as the mere extension of its defacto incorporators or controllers.” [4] In Salomon case court stated that its irrelevant that the members are related or not but once the company incorporated it is a legal entity in the eye of law. “Sec 16(3) of company Act 2006 said that company has a legal standing on its own separate from the people who own it and from the people who manage it.” [5]

Companies have to maintain lots of different activities. Companies spread out with corporate groups because of its legal, administrative and economical ground, such as; to gain economic profit, to reduce legal liability and risk, to raise capital easily, to run the company conveniently, to operate the management or administration properly, etc. There are two corporate group relationships namely; Holding company and parent company. These two relationships deal with section 1159 and 1162 of company Act 2006. “A holding company can appoint or remove directors as well as has the majority voting rights of a subsidiary.” [6] In the case of Gramaphone and Typewriter v Stanley [7] court applied Salomon principle and stated that both holding as well as subsidiary company has the separate legal entity. “When a company has a right from the provisions of its articles to exercise supreme power over another company, such company who exercise the dominant power is considered as the parent company.” [8]

Section 190 of company Act 2006 provides that non cash assets purchasing from a holding company by the subsidiary as a measure of controlling possible abuse. Section 197 of company Act 2006 stated over restriction over directors of holding company where without the approval of its members no loans would be granted. There is another provision under section 201 of company Act 2006 where stated that to grant credit facilities by the subsidiary to a director or holding company there are need approval of the members which is made compulsory. It is submitted that to control for possible abuse by the holding company these provisions such as; 190,197 and 201 provides some important aspect regarding control for possible abuse by the holding company.

The origin of the company can be illustrated by three theories, such as; contractual, communitaire and Concession theory. “Contractual theory deemed as inherent in contractual relationships between the actors. This concept provides explanatory framework of the corporation both politically and judicially.” [9] In this aspect state and judiciary will recognise the concept of separate legal personality. Communitaire theory sees company as a tool of the state to earn political goal. Italy, Spain and China are using this model. Social welfare is the main objective for this system so when necessary the veil could be lifted. Concession theory is in between above two theories. State does not interfere in this aspect so investors are fascinated to provide investment despite of risk. In UK, legislator and courts used their broad approach to solve any problem.

The main aspect of the coursework question is that there is no need to introduce additional law regarding group of companies and existing regulation is enough to control this corporate group structures.

In UK there are many laws towards group of companies but not for corporate structure. According to above discussion about existing laws or provisions regarding the activities of group of companies, this evaluation would provide that there is enough rules and regulation to controlling corporate group structures.

In the theme of lifting the veil, it is necessary to consider when the veil is lifted and how it applies to corporate group structures. Usually courts use this process where there is dishonesty, fraud or other unacceptable functions exist. In Salomon case which discussed earlier, Lord Halsbury said that “ if the company or individual have some fraudulent or improper intention then they cannot enjoy the privilege of using corporate personality as a shield.” [10] In Gilford motor Co. Ltd v Horne [11] , court held that if there is if there is found any deliberate evasion of contractual obligation or found any evidence of ‘sham’ or ‘device’ then veil may be lifted which explained in Yukong Line v Rendsburg Corp [12] also in the case of Jones v Lipman [13] . Statutory regulations like sec 399 of Company Act 2006, provides veil can be lifted to determine if the company is part of the group. In the case of Augustus Barnett & Son Ltd [14] , court held that even though parent has misled creditors, the behaviour of parent would not treat as fraudulent trading by parent.

Fraudulent trading generally deal with sec 213 and 214 of Insolvency Act 1986.section 213 states that if the director has the actual knowledge of the fraud and knowingly continue the business then he will be liable as well as he has to contribute towards asset of the company. But it is quite difficult for the court to identify the actual knowledge about fraud and courts don’t wants to pierce the veil. so there is a chance for abusing corporate status by parent. Section 214 brought a flexible approach to liable the real wrongdoer. This section states that court may treat a director liable if he commits wrongful trading. To establish the negligence is enough when company is at a loss although he continue the business. Now directors are more concern about their duties regarding any improper activities. So sec213 and 214 of Insolvency Act 1986 are two important provisions to regulate group structure because it provides some obligation towards directors not to perform anything against company interest.

On this matter A J Boyle [15] states that insolvency law is quick and reasonable regarding regulate corporate group structure. In Re Augustus case where court didn’t lift the veil when it is disadvantage for company but if it is advantageous to company then veil can be lifted. Lynn Gallagher [16] stated that the procedure of lifting the veil is not clear bur he point out some area such as; sham, fraud, dummy etc Where courts opt to lift the veil in their judgement. So lifting the veil is another equipment of judiciary to regulate group of companies.

In the case of DHN Food Distributors Ltd v Tower Hamlets London Borough Council [17] , court has taken a different view regarding separate legal entity. This is a land mark case where court recognized realities of the company’s position and allowed pierce the veil according to the situation of the group of companies. “Lord Denning argued that for the present purpose, the group of companies was in reality a single economic entity and should be treated as one” [18] . Professor Gower [19] said that to prevailing situation court consider the group of a single economic unit and ignored separate entity. Apthorpe v Peter Schoenhofen Brewing Company Ltd, [20] this case relates with agency principle where parent company was liable for its subsidiary company because parent company has the head brain and controlling power. “The assertion that the Salomon principle would be destroyed if the agency principle was held to apply will consecutively apply between corporate groups which will effectively reduce the doctrine of separate legal personality and destabilize the underlying principle of corporate groupings.” [21] The first successful case for agency principle was Smith, Stone & Knight Ltd v Birmingham Corporation [22] , “Atkinson. J. lifted the veil to enable a subsidiary company operating business on land owned by the holding company to claim compensation on the ground of agency and the evidence was the degree of control exercised by the parent company.” [23] This case provides some principle such as; parent treated as head brain of subsidiary, parent company has the controlling power over subsidiary, parent company has the deciding power regards capital in subsidiary etc. [24]

In the case of Woolfson v Strathcyde Regional Council [25] , court didn’t follow the DHN case. Court said that if a company is linked with any facade or some other wrong activities the court can departure from Salomon principle and should consider special circumstances.The court tends to find some separate legal entities regarding group economic or enterprise entity. In DHN case where it was held that the group of company’s should be treated as one single economic unit. Nonetheless the courts treat the parent company and its subsidiary as single unit according to European Community Competition Law. This issue explained in Viho Europe BV v Commission [26] .

The veil lifting argument re-examined in the case of Adams v Cape Industries [27] , this case mainly concern with the matter of agency principle. Court applied Salomon principle and held that a group of companies as separate legal entities. This case provides some criteria to identify whether the economic unit treated as one or not. Court said that “the veil will be lifted in following three situations;

(1)Where the court is interpreting a statute or document

(2)Where the company is a mere facade

(3)Where the subsidiary is an agent of the company” [28]

Kevin wardman [29] expressed his view regarding Adams case and states that courts are trying to solve the agency principle and don’t want to suggesting for new laws concerning corporate structures. John P Lowry [30] stated that “the companies Act 1985 allowed courts to pierce the veil where the membership falls below the minimum while stating the possibility of courts to lift the veil on its own to prevent breach of contract.” Schulte [31] stated that “as the law states the parent company is given considerable latitude to act in a deter mental manner towards its subsidiaries.” Adrian Walters [32] points out regarding the desire of courts related to veil lifting. He also provides some case example such as Ord v Belhaven Pubs Ltd [33] and Williams v Natural Health Foods Ltd [34] on behalf of his view. However section 1159 and 1162 of Company Act 2006 treated corporate group as single economic entity.

There is another regulation regarding corporate group structure that is corporate manslaughter. Corporate manslaughter and corporate Homicide Act 2007 provides some rules and provisions to find out the guilty mind or mens rea situation where any disaster caused by corporate groups. In Tesco Supermarkets Ltd v Nattrass [35] , where the court emphasised on ‘directing mind and will’. But to determine the real guilty mind is quite difficult in group of companies. In the case of R v Kite and OLL Ltd, [36] it was difficult to find out the real guilty mind in corporate group because of its size. Under this new Act there are some provision regarding this problem such as; section 9 and 10 of this Act stated that action can be brought against guilty individual company from group of companies. However the main loophole of this Act is it cannot bring any action against individual directors.

The board of director and the shareholders in general meetings are the principal organ of management of a company. Board of directors have the managerial powers of a company which stated in Articles 3 of both for private and public companies. [37] Directors are the main object of the management area. There are three of director, such as; executive director, non-executive director, shadow director. Under common law directors duties are two type, namely; fiduciary duties and care, skill and diligence.

Directors owe fiduciary duties which relates with trust and confidence. In the case of Percival v Wright [38] , court said that director owes duty to company not to individual shareholders. The first fiduciary duty is ‘duty to act bonafide’ in the good interest of company where a company. Where a company is part of a group, the interest of the company seems problematic for director. In Lindgreen v L & P Estates [39] , it was held that director must protect their own company which they are appointed. So it was an implication of Salomon principal. This similar principal applied in Facia Footwear Ltd v Hinchcliffe [40] , court held that by having the parent ratify their conduct the subsidiary right protected themselves where decisions are taken for the group to a specific subsidiary disadvantage. In the case of West Mercia Safety wear v Dodd [41] , court held that in insolvency situation directors can’t protected by shareholder ratification. In Kuwait Asia Bank EC v National Life Nominees Ltd [42] , it was held that director must protect company’s interest even their decision goes against their shareholders. Second fiduciary duty is director must ‘act their power for proper purposes’. In Howard Smith Ltd v Ampol Petroleum Ltd [43] , court held that director will be liable for abuse of power if he has any mixed motive or intention. Third fiduciary duty is ‘not to make secret profit’. In the case of Aberdeen Railway Company v Blaikie Bros [44] , court provided general principal where director should not have any personal interest which will conflict with the company’s interest.

A director must exercise reasonable care, skill and diligence. It is an equitable duty. In Re City equitable fire Insurance [45] , this case court emphasised on reasonable directors’ activities during the time of any improper situation. So it is basically depends on subjective test whether director is liable or not for negligence or other improper activities. In Norman v Theodore Goddard [46] , the court held that to liable any director both subjective and objective test must be considered which is also applied in Re D’ Jan of London Ltd [47] . Under new Companies Act 2006 all of these fiduciary and common law duties incorporated between section 171to 177. [48]

Section 171 stated that a director must follow the constitution of the company and use their power which they are conferred. So the case of Howard Smith must be fall in these criteria. A recent case for this point is West Coast Capital (Lios) Limited [49] . According to section 172, a director must act to promote the success of the company. So a director must have a bonafide or good intention to promote the success. The classic case for this section would be Percival v Wright [50] . A recent case is for this aspect would be Re Southern Counties Fresh Foods Ltd [51] Section 173 provides that a director must exercise his judgement independently as well as he must take the reasonable and responsible decision towards own subsidiary company. This point discussed in the case of Kregor v Hollins [52] . But different situation occurred in Fulham FC v Cabra Estates Plc [53] . A more recent case emphasised on this section. In Re Neath Rugby Ltd [54] , the point of independent judgement discussed. Section 174 discussed about duty to exercise skill, care and diligence. In a recent case of Gregson v HAE Trustees Ltd and others [55] , it was held that section 174 merely codified the existing law. In the case of Lexi Holdings v Luqman [56] , court drew on City Equitable case and further discussed about directors duty regarding reasonable skill, care and diligence. Section 175 provides that a director have a duty to avoid any conflict with company interest. In the case of Industrial Development Consultants Ltd v Cooley [57] , all of the material of conflict of interest laid down there which is now in that section. Section 176 stated that a director have a duty not to accept benefits from third parties. The case of Attorney-general for Hong Kong v Reid [58] , explained about the point of accepts benefits from third parties. Section 177 provides that a director have a duty to declare interest in proposed transactions. There are few more sections of the Companies Act 2006 which imposes some obligation as well as duties on directors to regulate group structures. Such as; section 182 provides that a director must declare any interest over existing transaction. It will be a criminal offence if he failed to do so. Section 190 to 195 [59] states that there is needs an ordinary resolution regarding the matter of property transaction to and from a director. So above sections of the Companies Act 2006 reduces abuse of power regarding corporate structure by parent or holding companies because now there are some direct obligation to the director and parent or holding company.

Abuse of corporate group structure can be prohibited by shareholders implement of control over the management of the company. The control can be executed by many ways, such as; voting power in the board, to change the articles or memorandum and exchange their shares. But according to section 1159 and 1162 of Companies Act 2006 which discussed earlier provides that parent company have the power to appoint director and sometime declare itself or acting as director to the subsidiary. So it is quite difficult for the minority shareholder to get remedy against any abuse of power. According to section 994 of Companies Act 2006, minority shareholder can get statutory remedy. “(ss 994 to 999) of CA 2006 gives the court a wide-ranging power to remedy conduct of a company’s affairs ‘that is unfair prejudicial to the interest of its members generally or of some part of its members.” [60] There is no case regarding this matter but this issue explained in Rackind v Gross [61] . However minority shareholders right are controlled by common law rules which supported by the case of Foss v Harbottle [62] . It was held that no individual share holder or member can bring action for company’s improper activities because the majority have the voting power and their wrong activities could be ratified. So it was unjustified for any aggrieved member or shareholder. There is some exception of Foss case which shows shareholders control over the company’s affair.

Firstly, a member can bring action if his personal rights have been violated which explained in the case of Pender v Lushington [63] . Secondly, if there is need special majority agreement regarding the transaction but it achieved by ordinary resolution, it explained in Edward v Halliwell [64] . Thirdly if in transaction there is present any ultra vires or illegal form then any member can bring personal claim against those activities. It was explained in Smith v Croft [65] .

Derivative action is another provision by which a minority shareholder can bring action on behalf of the company against a wrong activity done by management. It explained in the case of Burland v Earle [66] . If majority shareholder or the board carried out any ‘unfairly prejudicial conduct’ then this claim can be precede. [67] Section 260 of companies Act 2006 states a member can bring a claim in relation with some cause of action. So claimants need a court order before they proceed. Before permit court will assess some criteria, such as; applicant good faith, interest of the company, alternative remedies, whether wrong can be approved by the company etc. Section 994 of Companies Act 2006 states that any minority shareholder can seek remedy which discussed earlier.

There is another part of regulation which administrate the conduct of directors and that is Company Directors Disqualification Act (thereafter CDDA) 1986. Section 10 of CDDA 1986 states that because of wrongful trading if any director is liable under insolvency act then he will be disqualify for the relevant post for 15 years. Section 14 of CDDA 1986 states senior management of the company will be liable if he does not abide by the constitution of the company. So this provision also creates some impact and obligation to the management not to abuse corporate structure.

In conclusion it is submitted from the above discussion that there is lots of rules, regulation and provisions regarding the corporate group structure. Company Law Review Steering Group(CLRSG) examined the existing rules regarding law applicable to corporate groups but they doesn’t supported to introduce more provisions regarding group of companies. Lowry and Edmunds [68] state that company law review steering group doesn’t provides anything to improve the issue of corporate group structures. They also emphasised on multinational and enterprises as well as possible harm to the subsidiary with technological aspect. Keith Walmsley state that new companies act brings lot of significant aspect such as; “enhancing the shareholder engagement and a long term investment culture, ensuring better regulation and a think small first approach, make it easier to set up and run a company, providing flexibility for the future.” [69]

In this essay the main highlighted issues are whether parent companies abuse their power towards its subsidiary using the corporate status and whether existing law is sufficient to prevent those abusing activities. After considering all of the these discussion about existing laws regarding corporate structures, it is clearly evident from the discussion that legislature doesn’t intend to introduce new law regarding this issue but companies Act 2006 make a significant impact on this matter. So it is true that there is no need to introduce new provision to regulate the group of companies.