Liability and Loss from a Comparative Perspective – the Question of Groups of Companies

Mária Rexová

The group has but one option and that is to play according to “the rules of game” of company law as it is set out in the legal texts. However, another position stems from real life. New phenomena always emerge in law requiring new responses. If the law cannot supply them, there arises a gap which can be bridged only by the judge and the doctrine, by relying on the values expressed in the existing positive law – and in the case of company group law, there is evidently a huge loophole.[1]

The economic reality of groups of companies often requires acting on a coordinated group basis, meaning sometimes giving instructions by the parent company beneficial for the group as a whole, but financially risky for the targeted company. Nevertheless, this potentially collides with one of the most important principles rooted in company law, which is the duty of loyalty of directors, managers, and shareholders to their companies. Lots of questions arise. May a director be exempted from liability even if he or she breached the duty of loyalty owed by acting in compliance with the instruction given to him by the parent company? And what other consequences it might trigger? Could the loss be compensated in other ways than usually?

One would vainly look for the solution in European Union law. The Rozenblum concept developed by French case law provides for a unique compromise worth discussing in further details. This concept set an example which was followed by the Czech Republic as well. The question is whether these two countries could also set a standard for European legislation. And is there actually any harmonisation on the European level needed for groups of companies?

The article will first discuss French and Czech law and then it will discuss if this solution is also suitable in the European Union.

1. The general rule

In many jurisdictions, it is a starting point in company law that a director or a manager has a duty of loyalty to its company, which means that it must act in the best interest of the company. As a rule, the general principle is that, if a director breaches this duty and causes loss to the company, the loss must be compensated. The economic reality of the group of companies might, however, reveal that the interest of the group as a whole may need to supersede the interest of an individual company within the group and even to the detriment of such company.

2. Approach to groups of companies in France

France has a long history of unsuccessful legislative attempts to enact rules on groups of companies generally in order to reflect their needs. Eventually the rules on groups of companies with respect to liability and compensation for loss emerged through case law.

The general rule found in Articles L-225 251 and L223-22 of the Code de Commerce is that, if a director or manager causes damage to the company they represent, then they are liable and must provide compensation for the ensuing loss.

For more grave breaches of the duty of loyalty, there are special provisions in the French economic penal law (droit économique pénal) which is a special branch of penal law dealing with economic crimes.

The French economic penal law recognises the crime of abuse of the corporate assets of the company (“abus des bien sociaux[2]) with a penal punishment for e.g. the board chairmen and directors of a public limited company if they act in bad faith and in a way that violates the best interests of the company they represent. Examples of such abuses include acting with respect to one’s own private gain instead of the company’s, favouring the interests of another company in which the director has some stake, etc.

However when a director acts to the detriment of its company because it followed the instructions given by the parent company and such acting was in the interest of the group of companies as a whole, French jurisprudence offers possible exculpation of the director in the name of the interest of the group (“intérêt de groupe”).

2.1 What is “intérêt de groupe”?

In the milestone decision Marc Rozenblum dated 4 February 1985[3]  the chambre criminelle of the Cour de cassation set the outer limits for enforcing group policy in the groups of companies.

Marc Rozenblum was the director of a couple of companies where some capital transfers were made among them. The transfers constituted about three quarters of the social capital of the contributing companies, and moreover, they were being transferred to insolvent companies. Rozenblum based his defence on the fact that the companies involved were in fact forming one group and the transfer of capital was in pursuit of the common goal. La Cour de cassation in Paris rejected Rozenblum’s arguments and provided criteria under which that argument would be admissible. It held that “in order to escape the application of the relevant provisions of….. the law of 24 July 1966, the financial contribution made by the directors……. (1) has to follow the common economic, social or financial interest, (2) it must benefit the policy elaborated for the whole group of the company, and (3) under no circumstances shall it be deprived of economic compensation or shall it break the balance of mutual commitments between the companies concerned.”[4] Also, (4) the links between the companies in the group must be real, the group needs to be structurally firm, and the intervention cannot exceed the financial capacity of the subsidiary.

2.2 What is the contradictory issue here?

It is very rare that the French court finds all conditions set in Rozenblum present.[5] Also, only about 10 out of 75 decisions issued have been published so far.[6] This uncertainty may limit the freedom of the decision-making of the directors of the subsidiary who may be afraid of extensive responsibility for following instructions.[7] On other hand, parent companies may be afraid of potential liability for the caused loss which they are also reluctant to bear. Both sides hence fall victim to the law not being specific and being based only on jurisprudence. Despite this, the French doctrine also became inspiration for the Czech Republic.

3. Approach to groups of companies in the Czech Republic

The currently valid Business Corporations Act of 2012[8] has parted from the previous legislation based solely on the German model of Konzernrecht and established a two-fold system of influence and concern, reflecting both the German and French model.

3.1 The first degree – influence

The legal provisions for the first degree of control, influence, set out that an entity that influences (the parent company)[9] in a decisive and significant manner the behaviour of the company (subsidiary)[10] is responsible for ensuing loss or damage to the subsidiary.[11]

The Act further specifies that the parent company guarantees payment of the debts of the subsidiary to its creditors if this inability to pay the debts was caused by the interventions of the parent company.[12] Some scholars even suggest that this provision is moving towards the doctrine of piercing the corporate veil. However, as this provision applies also to concerns, where this doctrine is generally not accepted, such an interpretation should be taken with a grain of salt.[13]

3.2 The second degree – concern

The concern constitutes the second form of control and means a uniform direction of management.

In concerns, the parent company is liable to the subsidiary company in the same way as in the case of influence. However, as opposed to pure influence, the rules of exemption according to the Rozenblum doctrine apply. If the parent company proves that the damage occurred as a result of the uniform management of the concern and in the interest of the concern and that it will be settled and balanced within the concern with adequate consideration or other provable advantages, it will result in the exemption of the parent company from liability and obligation to compensate for the damage in the traditional sense of the word. [14]

As opposed to influence, where the law strictly speaks about compensating the loss, in the case of concerns, Czech law speaks about the possibility of settlement of the damage.

 3.3 How does settlement of damage differ from compensation in the traditional sense of the word?

In comparison to compensation, settlement means that the value provided does not have to be equal to the damage. It may be distributed over time, provided that it is within a reasonable period of time and has various forms (adequate consideration or other demonstrable benefits arising from membership in the concern, such as better intra-group loans, access to know-how, cash pooling).[15] The basic principle here is that it is not necessary to settle every singular damage (even though it is not excluded), but rather to check on a regular basis that the interests of the subsidiary are in balance with the interests of the concern as a whole and its other entities.[16]

With respect to influence, the influential entity must compensate the loss to the subsidiary by the end of the accounting period at the latest.[17]

3.4 The directors’ liability

Apart from a parent company’s liability for causing damage, there is one more issue in terms of responsibility, namely whether directors of the subsidiary concerned might be held liable for carrying out instructions given by the parent company.

With respect to the first degree, the influence, the directors of the subsidiary must act with the due managerial care[18]. However, it should be noted that the business judgment rule is applicable in this situation. It provides the directors with some leeway in making their decisions whether to follow instructions of the parent company or not.[19] The more so, if no concern is being involved since in those scenarios there is no obligation to follow such instructions at all.[20] Hence, the general business judgment rule is the only possible way how the subsidiary’s directors may escape from liability regardless of the loss which indisputably occurred.

Within one concern, the directors of a subsidiary may be exempted from liability and related obligation to provide compensation for any loss suffered by the subsidiary itself if they can prove that they could have reasonably expected the fulfilment of conditions for acting in search of benefits for the concern. At the same time, they must attest that the loss will be redressed within the concern.[21] If the opposite is true, they should rather refuse to follow such an instruction. Otherwise, their liability might be engaged. In the regime of concerns, this constitutes a so-called modified business judgement rule.[22]

The directors of the parent company are also obliged to act with the requisite degree of due care. Consequently, they are subject to the same assessment as to whether they act in the best interests of the concern. Otherwise, they are equally exposed to the regime of the duty of due managerial care and liable to the parent company.[23]

By the same token, establishing this liability as regards the parent companies is not an easy issue either.

The introduction of the Rozenblum rules into the Czech legal system might bring an important competitive advantage to the Czech Republic over other European states. As a result, more holding companies could be attracted. Its introduction at the European level has also the potential to identify European Union as a key player in the global markets, if the European legislator ever decides to follow the French, and now also Czech example.

4. Approach to groups of companies in European Union law

Efforts to harmonise EU law with regard to the issue have been underway for a couple of decades now. The little progress the EU bodies have made in this area can be mainly attributed to two reasons.

Firstly, there is a question of whether the issue needs to be regulated at all. Be it a complex set of harmonised rules known as Konzernrecht in Germany or fragmented legislation of France, the attitudes of Member States differ in this aspect. Some countries merely recognise the notion of group companies.[24]

Secondly, there has been a lot of discussion as to which model should prevail on a substantive basis.[25] A key concept here is the German one, which does not recognise the interest of the group. Another one is rooted in French case law and suppresses the individual responsibility of subsidiaries in favour of its parent undertakings. [26]

 4.1 A bit of history…Which way to go

The first most significant proposal was the draft proposal of the 9th company law directive[27] introduced in December 1984. The draft was a reflection of the rigid rules of Germany, and as a consequence, lacked support for its enactment.

The first real breakthrough was the detailed opinion with the title “Concern law for Europe” elaborated by a group of company-law academics and leading practitioners from the then EU Member States called Forum Europaeum Konzernrecht in 1998.[28] In contrast with its predecessor, this opinion reflected mostly the developments in French case law rather than rules in German law.

 4.2 The recent initiatives…Should the subsidiary follow the instructions of the parent?

With respect to the possibilities of the parent company to give instructions to its subsidiary, two interesting recent initiatives which reflect the ambiguity of the European legislator in this issue can be tracked. The European Model Companies Act[29] is a particular effort not to harmonise rules on the EU level, but rather at the national level. It also contains a chapter on groups. It holds that if the instructions which a parent company issues do not fulfil the conditions of the Rozenblum test, directors and managers should not follow them, otherwise they may be held liable.

One step further was taken by the currently negotiated Directive on Societas Unies Personae (SUPs).[30] Though it recognises the notion of the interest of the group, the rights of the parents to give instructions to its subsidiaries has been paradoxically removed from the text.

Meanwhile, the involvement of SUPs in cross-border group structures might open a Pandora’s box with respect to the (parental) liability schemes. For instance, the recent decision Impacto AZUL of the CJEU [31] denied the creditors of subsidiaries in the EU cross-border context the right to invoke joint and several liability of parent companies located in the other Member State.

Fresh out of the oven is the October 2016 Proposal for reforming group law in the European Union – Comparative observations on the way forward[32], which is a paper of the ECLE (European company law experts) independent group and not for profit organisation. It advocates the pursuit of group interest, and it defends a position that the further work should be done on individual issues such as related party transactions in the revised Shareholder Directive rather than enacting “a full-fledged law on groups of companies”.[33] With respect to the discretion of a subsidiary to follow the instructions of the parents, it points out that all directors of a subsidiary are inevitably faced with a dilemma about choosing to either breach the duty of loyalty or face termination of contract from the parent company.[34]

In my opinion, adopting harmonised rules at the EU level reflecting the Rozenblum doctrine might be beneficial to all Member States. It would certainly clarify some of the uncertainties caused by different treatment of the group of companies in different Member States. On the other hand, some Member States prefer having very flexible case law, which can always be interpreted in the light of the most recent developments.

 Conclusion

Groups of companies remain an under-regulated issue in many EU Member States and also at the EU level. The answer to the question how to balance the duty of loyalty with the overarching interest of the group is not satisfactorily solved on a unified basis either.

The solution offered by the French landmark case Rozenblum provides for a test under which it shall be deemed acceptable that the interests of the group are to outweigh the interests of its subsidiaries. The Czech provisions of law inspired by the Rozenblum rationale contain possible grounds for directors’ exculpation once they acted in breach of the duty of loyalty for reason of obeying the parent company’s instructions. The Czech law also newly encompasses flexible rules for providing compensation or rather offsetting the loss suffered in the aggregate by such concerns which is expected to reflect better the needs of group of companies. However, this approach certainly has its pitfalls. The directors of both the parent company as well as the subsidiaries are required to assess critically and ex-ante the situation to ascertain whether the conditions are fulfilled. For the sake of completeness, it should be emphasized that these benefits are not available in relation to group of companies not officially recognized by law as concerns.

Apart from substantive issues, there is also the question of the suitable form of the rules. In this aspect, Czech law has moved one step ahead of the French legislator by actually enacting the rules of French case law. In Europe, even though recent academic, legislative, and case-law developments remain reserved on the question of enacting hard law in a sensitive area of substantive company law, it is nevertheless clear that they all go in the direction of recognition of the interest of the group.

And this, in my opinion, seems to be the right direction.

 

Maria Rexova graduated from Law Faculty of Charles University. Her particular area of interest is the European Company Law which she studied also at Université Pantheon Assas in Paris as an Erasmus student. Previously she has worked at the Ministry of Finance of the Czech republic and currently she is on her sabbatical year, teaching English and French.

 

[1]Druey, J.N. (2003). Pour la protection des mères. A quoi bon un droit sur les groupes de sociétés ? In: Mélanges en l’honneur de Yves Guyon. Paris: éditions Dalloz, p. 350. Translated by the author.

[2]Articles L. 242-6 paragraph 4 Code de Commerce (for the public limited companies) and article L. 242-6 paragraph 3 Code de Commerce (for private limited companies).

[3] Cass. Crim. dated 4.2.1985, no.1985-000537.

[4] Cass. Crim. Dated 4.2. 1985, no. 1985 – 000537.

[5] Boursier, M.-E. (2005). Le fait justificatif de groupe dans l´abus de biens sociaux: entre efficacité et clandestinité.Analyse de vingt ans de jurisprudence criminelle », Rev. sociétés 2/2005, 273 à 314. Azzi, R.(2006). L’unité économique dans les groupes de sociétés. Memoire online [online]. Available at: http://www.memoireonline.com/08/08/1461/m_l-unite-economique-dans-les-groupes-de-societes15.html [Accessed 11 Dec. 2016].

[6] Azzi, R., ibid.

[7] Boursier, M.-E., op.cit., note 5.

[8]Act no. 90/2012 Sb, the Business Corporations  Act (“the Business Corporations Act”; zákon č. 90/2012 Sb., o obchodních společnostech a družstvech).

[9]The parent company is understood in accordance with Section 74 (1) in conjunction with Section 74 (2) of the Business Corporations  Act as “[…] an entity which can directly or indirectly exercise decisive influence on a business corporation.

[10]The subsidiary company is understood in accordance with Section 74 (1) in conjunction with Section 74 (2) of the Business Corporations Act as “a company controlled by a controlling entity.”

[11] Section 71 (1) of the Business Corporations Act.

[12]Section 72 of the Business Corporations Act.

[13]Lasák, J., Pokorná, J., Čáp Z., Doležil T. a kol. (2014). Zákon o obchodních korporacích. Komentář. 1st Ed. Praha: Wolters Kluwer, p. 596.

[14] Sections 72 and 79 of the Business Corporations Act.

[15]Explanatory memorandum to Act no.90/2012 Sb. the Business Corporations Act, p. 30 [online]. Available at http://obcanskyzakonik.justice.cz/images/pdf/Duvodova-zprava-k-ZOK.pdf [Accessed 19 Sept. 2016].

[16]Lasák, J., Pokorná, J., Čáp Z., Doležil T. a kol., op.cit.11, note 15, p. 602.

[17] Section 71 (2) of the Business Corporations Act.

[18]   Štenglová I., Havel B., Cíleček R., Kuhn P., Suk P. (2013). Zákon o obchodních korporacích. Komentář. 1st Ed. Praha: Charles Beck, p. 175.

[19] Sec. 71(5) in conjuction with Sec. 51 (1)of Act No. 90/2012; the Business Corporations Act.

[20]  Sec. 195 (2) of Act No. 90/2012; the Business Corporations Act.

[21] Sec. 81 (2) of Act No. 90/2012; the Business Corporations Act.

[22] Štenglová I., Havel B., Cíleček R., Kuhn P., Suk P. op.cit., p.194.

[23] Štenglová I., Havel B., Cíleček R., Kuhn P., Suk P., ibid, p.194.

 

[24] For more information, see Conac,H. (2015).The Concept of Group Interest and the Possibility of Implementing Group Interest in Europe [online]. Available at: www.oi.ut.ee/sites/default/files/oi/pierre_henri_conac.ppt. [Accessed 12 Dec. 2016] e.g. Member States recognising the interest of the group include the Netherlands, Luxembourg, Belgium, Poland, and the UK. Member States that do not recognise the interest of the group are Germany, Austria, and Finland.

[25] Bohlhoff, K., Budde J.(1984). Company Groups – the EEC Proposal for a Ninth Directive in the Light of the Legal Situation in the Federal Republic of Germany. Journal of Comparative   Business and Capital Market Law [online] No. 6/1984, note 2, p. 173. Available at: https://www.law.upenn.edu/journals/jil/articles/volume6/issue2/BohlhoffBudde6J.Comp.Bus.&Cap.MarketL.163(1984).pdf [Accessed 19 Sept. 2016].

[26]Conac, H., op.cit., note 16, p. 3.

[27]The text of the draft proposal has not been officially distributed, though the 1974-75 pre-draft was made public.

[28]Forum Europaeum Konzernrecht, Konzernrecht für Europa, ZGR 4/1998.

[29]The text of the draft proposal has not been made officially public yet.

[30] The text of the draft proposal is available online at http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=COM:2014:212:FIN [Accessed 12 Dec. 2016].

[31]Case C-186/12 Impacto Azul Lda v BPSA 9 [2013]
ECLI:EU:C:2013:412, paragraphs 35-37.

[32] A proposal for reforming group law in the European Union- Comparative observations on the way forward. 2016 [online]. Available at: https://europeancompanylawexperts.wordpress.com/papers/reforming-group-law-in-the-eu/ [Accessed 17 Sept 2016].

[33]Directive 2007/36/EC of the European Parliament and of the Council of 11 July 2007 on the  exercise of certain rights of shareholders in listed companies.

[34] A proposal for reforming group law in the European Union- Comparative observations on the way forward, op.cit., note 29.