Limiting Liabilities Structuring holding to withstand

Virtual Round Table Series Insolvency Working Group 2018 Virtual Series |Limiting Liabilities

IR Virtual Series, issue #35. First published September 2018.

irglobal.com | page 3 Limiting Liabilities Structuring holding companies to withstand insolvency

The concept of is one well A good example of best practice technique, As another example, if a fails to meet known in the international corporate lexicon. is the development of separate corporate its obligations to the authorities for sales tax Companies are organised to minimise their governance, ensuring that different directors sit or employee contributions, the directors of the liability for the actions of related but legally on the board of a subsidiary than sit on the holding can be held personally liable separate entities, be they partners, suppliers or board of a . If it appears that if it can be determined that they influenced customers. the subsidiary is fully under the control of the those decisions. In extreme cases, money used parent company it is harder to resist liability for for mortgage payments or children’s tuition fees These divisions are generally fairly clear, but its actions. has been reclaimed. they become less so when applied to groups of companies, with and holding Another would be the rigorous maintenance of It is clear that correct corporate structuring and companies legally bound to each other via board minutes, financial accounts, and appro- governance are required at the formation of ownership. In these situations, under certain priate documentation of intercompany transac- a company group to avoid any future liability circumstances, a holding company and its tions. This helps to rebuff accusations of prefer- issues in the event of insolvency. The behaviour directors may be held liable for the actions or ential transactions. of directors and responsible employees during performance of a subsidiary despite the fact and immediately prior to an insolvency is also Failure to adhere to these best practices can the subsidiary is a separate . critical to the outcome of any liability claims be easily tested under the insolvency laws of outside the immediate legal entity. Insolvency is one such circumstance when various jurisdictions around the world. The liabilities within a group of companies are Instrumentality Test and the Identity Theory, for The following feature draws upon the expertise examined forensically. The insolvency or bank- example, are used by courts in the US when of five insolvency practitioners from around the ruptcy of a subsidiary will usually leave a range deciding whether to pierce the corporate veil in world who are members of IR Global. Each of out of pocket and practitioners pursuit of damages. of them gives a unique perspective from his employed by those creditors will make every or her jurisdiction on the issues to consider In the event of a subsidiary insolvency, the effort to recover losses, including exploring the when attempting to limit holding companies’ behaviour of holding companies and their potential liability of a holding company and its liability during the insolvency of a subsidiary directors can have a significant bearing on directors. in a company group and further considers liability. In some jurisdictions, related party the possible damages and defences available As a consequence, it is imperative that transactions (between a subsidiary and a should the worst happen. corporate structures are maintained using holding company) made up to five years prior best practice techniques, prior to any future to the insolvency could be examined. If any are insolvency, to make it as difficult as possible found to have been made at an undervalue, the for creditors to ‘pierce the corporate veil’ and holding company can, in some cases, be forced make charges against assets held outside the to repay the entire consideration received by insolvent business. the transferee for distribution to creditors.

The View from IR

Thomas Wheeler Each discussion features just one represent- Founder ative per jurisdiction, with the subject matter Our Virtual Series publications bring together a chosen by the steering committee of the number of the network’s members to discuss a relevant working group. The goal is to provide different practice area-related topic. The partic- insight into challenges and opportunities iden- ipants share their expertise and offer a unique tified by specialist practitioners. perspective from the jurisdiction they operate in. We firmly believe the power of a global network This initiative highlights the emphasis we place comes from sharing ideas and expertise, on collaboration within the IR Global community enabling our members to better serve their and the need for effective knowledge sharing. clients’ international needs. irglobal.com | page 3 Virtual Series |Limiting Liabilities

ITALY ENGLAND CANADA EAST Massimo Boni David Foster S. Fay Sulley Partner, Ferrari Pedeferri Boni Partner, Barlow Robbins Partner, Torkin Manes LLP

 39 02 72 73 061  44 1483 464243  1 416 777 5419  [email protected][email protected][email protected]

Massimo Boni is the founding partner of FPB David is the of Dispute Resolution at Fay is a partner at Torkin Manes, and head of Legal, an Italian business law firm with offices in Barlow Robbins, a leading UK law firm. His areas the Banking, and Insolvency Group. Milan and Trieste, and focuses his practice on of practice include insolvency, professional negli- She acts extensively for institutional and private three main areas: corporate and commercial liti- gence, commercial litigation, property disputes lenders and borrowers in a wide range of gation; insolvency and corporate ; and inheritance disputes. financing transactions, products, corporate and commercial . arrangements, asset securitisations and David regularly handles cases in the higher securitised loans. Over the years, he has acted for Italian and courts for clients of all sizes, including banks, foreign companies, but also international organ- insurers and educational institutions. He has She advises banks with respect to regulatory isations (either UN or non-UN agencies), before handled more than 200 mediations across the and other issues that may arise under the Bank Italian Courts and arbitrators or prominent inter- UK with a success rate of over 90%. Act, or other similar legislation, including a broad national arbitration institutions. range of issues of , such as cost of David is a member of the Commercial Liti- borrowing disclosures, privacy, identification of Massimo has gained a significant expertise gation Association, the Professional clients, money laundering, electronic banking in the highly specialised field of corporate liti- Lawyers’ Association, the Institute of Directors, and other day-to-day issues affecting banks and gation, handling disputes among and the International Bar Association. other financial institutions. for winning the control of the company or among He is also a member of the standing conference companies and their directors and statutory Fay is involved in corporate , insol- of Mediation Advocates and a mediator member auditors for liability for mismanagement and vency and related litigation of a number of mediation groups including the fraud or among sellers and purchasers following ADR Group, Expedite Resolution and Law South matters of all sizes. She offers expertise under M&A transactions. Mediators. He is actively involved in a number of the and Insolvency Act, Companies Massimo is regularly involved in insolvency charities and organisations, including as trustee. Creditors Arrangement Act, Personal Property matter cases, either defending and representing Securities Act, and Financial Act. A recent independent guide to the UK Legal companies, directors and auditors from claims Profession named him as a ‘very good lawyer’ Fay works closely with other members of her brought by bankruptcy trustees (directors liability, who ‘gets down to the heart of an issue’. Karen firm’s Banking, Finance and Insolvency Group to claw-back actions, parent company liability, Schuman, Counsel of 1 Chancery Lane said that assure clients that someone is always available etc.) or counselling and representing distressed David has a ‘calm authority’ and can ‘find the to provide the advice they need, when they need companies throughout their restructuring phase. solution’ in a difficult case. it. He also assists Italian and foreign investors purchasing and assets from insol- vency procedures.

irglobal.com | page 5 AUSTRALIA U.S – WASHINGTON, D.C. James Conomos Trevor (Ted) Swett Founder and Principal Partner, Member, Caplin & Drysdale, James Conomos Lawyers Chartered

 61 7 3004 8200  1 202 862-5081  [email protected][email protected]

James was admitted as a solicitor in 1987, Trevor (Ted) Swett is a Member in Caplin & Drys- having completed a year in 1986 as associate dale's Washington, D.C., office. He was elected to to the then Chief Justice of the Supreme Court membership in 1989, having joined the firm as of Queensland, The Honourable DG Andrews. In an associate in 1985. Mr. Swett has been recog- his early years, he gained experience in a wide nised as a "Leading Lawyer" by Chambers USA, range of areas but quickly settled into litigation. The Legal 500, and Benchmark Litigation for his By 1990, he was established as a commercial work in Bankruptcy/Restructuring. litigation lawyer with a keen interest in insol- Mr. Swett's practice emphasises bankruptcy vency matters. He established James Conomos litigation related to corporate reorganisations Lawyers on 1 July 1992 as a specialist practice and the prosecution and defence of civil cases in commercial litigation and insolvency. involving allegations of financial misconduct. Since 1990, he has practised as a solicitor He has focused on the issues characteristic of primarily in commercial litigation, dispute reso- complex asbestos-related and lution and insolvency matters. James has acted on asset recovery litigation involving theories in and advised various parties in many insolvency of , successor liability, administrations, both corporate and individual. and piercing the corporate veil. He also has He has advised a range of clients including finan- substantial experience representing financial ciers, insolvency practitioners, creditors and regu- institutions in commercial litigation and taxpayers lators. in litigation against the Internal Revenue Service.

James has also acted in hundreds of litigious In several major Chapter 11 reorganisations, he matters, in a range of disputes from land valu- has acted for tort victims in litigation to impose ation, disputes, breaches of fiduciary liabiilty on the parents or affilates of bankrupt duties, fraud claims, building disputes and debt companies under theories of piercing the veil or claims. He has acted in all courts throughout the like. Australia, and represented his clients in many Caplin & Drysdale is a leading provider of tax, tax cases, some of which have changed the law. controversy, and litigation legal services to corpo- rations, individuals, and non-profits throughout the United States and around the world.

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SESSION ONE – DANGEROUS STRUCTURES How should a holding company structure be implemented in your jurisdiction to minimise liability in case of the insolvency of a subsidiary? What practices would be deemed dangerous?

Italy – Massimo Boni (MB) In Italy, as Company Registry, disclose it in their personally liable for the repayment of a general principle, holding companies correspondence and reporting certain them if they do. are not liable for the insolvency of their data regarding the holding company There are several other areas of director subsidiaries and their relevant debts. and intercompany transactions in their liability that need to be planned for More precisely, their liability is limited financial statements. around employees and tax. to the debts they may have vis-a-vis Dangerous practices often regard inter- their subsidiary (company’s capital still With regard to an employee’s remit- company financing and intercompany not paid-in, or commercial debts, etc.). tances, when employees are paid, transactions. However, under certain circumstances, a certain percentage goes to the this limitation of liability can be chal- Under certain circumstances, financing government as a withholding tax for lenged. from holding companies to subsidiaries income tax, unemployment is considered as financing contributions and pension contributions. In order to minimise such , holding then it should not be reimbursed before These are viewed as funds remitted companies should pay particular other creditors are paid. to the government. attention to the following specific topics. In handling intercompany transactions, There is a portion that the employer is The Board of Director should be granted the ‘compensatory advantages’ prin- responsible for as well, and if they are autonomy in their decision-making and ciple should be always kept in mind. not remitted then the director can be held it is opportune, for example, that the The advantages for the subsidiary must personally liable. holding and the subsidiary do not share be actual and objective and its Directors the same persons as Directors. This was a bigger problem a number of must analytically disclose the economic years ago, but now we have a payroll Compliance is also key, in particular: rationale of such transactions. Both service that automatically deducts and i) corporate compliance, since some- parties should be ready to carry out remits the correct amounts. times subsidiaries tend to take it lightly transactions to restore the balance of (e.g. ’ meetings and advantages and disadvantages should Smaller companies do still often have decisions must be timely held and a liability for ‘direction and coordination’ a problem with this though and can get taken as well as timely recorded in the be claimed. cut off from their payroll services if they relevant company’s book); ii) book- are not remitting enough money to cover Canada – Fay Sulley (FS) We set a keeping compliance, especially with everything. company up to minimise director liability regard to intercompany transactions; iii) from the start and we have the shares The other area where we have huge compliance with other kind of provisions of an operating company or subsidiary potential director exposure is VAT or that may bring significant liabilities for the held by the holding company not by sales tax. We have harmonised sales tax company and their Directors if breached, an individual, because it adds a layer in Canada, along with GST and provincial as provisions on data protection (e.g. so of complexity which makes it harder to sales tax in some areas. Any company called GDPR), anti-money laundering, pierce the corporate veil. that collects those should hold corporate responsibility under Law No. them in trust and remit them to the 231/2001, social security contributions, There are certain rules that directors government. If they fail to, they can be etc. have to follow and we have a general held personally responsible which can blanket anti-money laundering regime Furthermore, subsidiaries need to often cause the biggest problem for here in Canada, but it’s not something comply with certain disclosure duties with directors of insolvent companies. that directors are always aware of. regard to the companies that exercise We find that when directors get desperate powers of ‘direction and coordination’ Directors can be held liable for various they use those tax monies for operating under Art. 2497 of Italia Civil Code on offences if they are aware that the purposes. them. Subsidiaries must communicate company is insolvent. They cannot this ‘direction and coordination’ to the declare and could be

irglobal.com | page 7 Directors are also liable for up to one year's The failure of each company in the and don’t do what they should do. It can worth of unpaid wages to employees. to maintain board minutes, also apply where there is an assumption of That can be a problem because a lot of financial accounts, and appropriate docu- responsibility. companies allow vacation to accrue and mentation of intercompany transactions The relationship between a subsidiary carry over year-on-year. We recommend presents a serious hazard, as does the holding company and a third party might that companies don’t allow vacation time to failure of the board of directors to seek indicate that the holding company has be carried over for this reason. out material information pertinent to their assumed some responsibility for the decisions affecting subsidiaries, including If a company is becoming insolvent, we subsidiary and the law will impose sanc- professional advice when needed. advise directors to have weekly meetings tions in that eventuality. to make sure that all the remittances are Red flags include any director’s failure to If the subsidiary is carrying out business in being made. disclose to the board all personal interests the same area as the parent and the parent that conflict or compete with those of the Finally, I would mention that we also advise has superior and specialised knowledge holding company or any of its subsidiaries, directors or companies at the outset to take meaning it should have foreseen that the and to refrain from participating in any out directors and officers insurance. We subsidiary was relying on that knowledge, corporate decision for which he is subject have a lot of clients we recommend that then the parent company might be on the to such a conflict. for and we find that those policies not only receiving end of a claim. handle the legal defence of directors being Any parent-company transaction with a There are also problems for holding sued, but they also pay out to government subsidiary that is or may be insolvent companies if they act as shadow or de and employees. is likely to be troublesome if it arguably facto directors of subsidiaries, so it’s elevates the interests of the parent or its Using funds owed to third parties as important to keep an eye on patterns of directors above those of the subsidiary’s general corporate funds is a huge red flag. behaviour that show automatic compliance creditors. Also paying dividends to shareholders with the holding company’s advice. during times of insolvency is a huge no-no. England – David Foster (DF) First of all, Austrailia – James Conomos (JC) The Any kind of distribution, whether it’s a it’s quite legitimate to have subsidiaries in circumstances in which liability for insolvent shareholder loan or a , would be the UK carry out certain functions and ring- trading is imposed on a holding company the director’s responsibility to pay back. fence assets. A holding company’s liability correspond to those in which a director is is limited to paying any amount not paid out U.S – Trevor (Ted) Swett (TS) We have liable for insolvent trading. Under section in the shares of the subsidiary. 50 states in the US, each of which has its 588V of the Australian Act own , with which the federal Third parties don’t have any recourse to 2001, a which is a holding law intersects. My comments are based the holding company unless the holding company contravenes the section if the on Delaware law, which provides widely company has assumed contractual liability following criteria are met: prevailing (but not universal) norms for such as by guarantee or indemnity, or if the • the corporation is the holding company of corporate matters. subsidiary has merely acted as an agent a company at the time when the company for the holding company. That can occur Like any corporation, a holding company is incurs a debt. where the subsidiary is under the control a presumptively separate from of the holding company and not acting indi- • the company is insolvent at that time, or its subsidiaries. But the law ignores that vidually. becomes insolvent by incurring that debt, distinction and pierces the corporate form if or by incurring at that time other debts necessary to avoid injustice or abuse. A few basic protections to implement including that debt. include having processes to keep records To uphold the separateness of parent and of guarantees and indemnities. It is also • at that time, there are reasonable subsidiary, it may be helpful to have some important to be clear about who can make grounds for suspecting that the company officers and directors at the subsidiary level the arrangements for things like banking is insolvent, or would so become insolvent, who are not also officers or directors of the transactions. as the case may be. parent. But this is a matter of prudence rather than a legal requirement. It is dangerous to have identical boards The circumstances in which the and there is a need to ensure that the of a subsidiary can claim against the A solvent subsidiary is meant to operate subsidiary has its own governance and holding company are: for the benefit of the parent company, and decision making processes. It’s a good directors of a holding company generally • a corporation has contravened section idea to have non-executive directors on are not liable for the parent’s or subsidi- 588V in relation to the incurring of a debt the board to make sure everything is being ary’s obligations (absent personal guar- by a company done properly. anties). Directors do, however, have fidu- • the person to whom the debt is owed has ciary duties of good faith, due care, and In English law we have liabilities coming suffered loss or damage in relation to the loyalty toward the holding company and at us from two angles. The common law debt because of the company’s insolvency can sometimes be held accountable by about piercing the corporate veil applies creditors of an insolvent subsidiary. where people enter existing obligations

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Fay Sulley pictured at the 2018 IR Annual Conference in Toronto

• the debt was wholly or partly unse- Perrine, the second defendants, formed As directors of Perrine Architecture and cured when the loss or damage was Perrine Architecture in 1989 and were of PPL, the Perrine’s were liable for suffered the sole directors and shareholders at insolvent trading under section 588M of all times. the Corporations Act whilst Perrine Archi- • the company is being wound up. tecture would be liable under section PPL was formed in 2007 with the Any such proceeding has a statutory 588W. purpose of marketing a construction limitation period of six years from the system designed by Mr Perrine. The To limit holding company liability, a beginning of the winding up. Perrine’s were directors of PPL from its business should enter into joint venture The 2016 case of Giovanni Maurizo formation along with two other directors. arrangements; or retain a shareholding Carrello (as liquidator of Perrinepod Ltd By 2008, PPL only had three directors, of less than 50 per cent in the subsidiary (in liq)) v Perrine Architecture Pty Ltd two of which were the Perrine’s. PPL was company. [2016] WASC 145 demonstrates the ordered to be wound up in insolvency on application of both sections 588V and 1 March 2012. 588G (liability for directors). The plaintiff asserted that; The Perrine’s The plaintiff was the liquidator of failed to prevent PPL incurring debts Perrinepod Pty Ltd (PPL) and the first while insolvent; and that Perrine Archi- defendant, Perrine Architecture, was the tecture, as holding company of PPL, was holding company of PPL. Mr and Mrs liable for the insolvent trading of PPL.

irglobal.com | page 9 SESSION TWO - DAMAGES AND DEFENCES What kind of damages can be claimed from holding companies or their directors in the event of the insolvency of a subsidiary? What defences are available to mitigate these?

USA – TS Let’s talk first about piercing stemming from losses inflicted on of the benefits and making whole the the corporate veil to get at the parent and subsidiaries. subsidiary. They may also be held liable impose responsibility on the parent. for restitution on equitable grounds in Creditors of an insolvent company may cases of unjust enrichment. First, the subsidiary’s insolvency does bring a suit derivatively in the name and not, in itself, justify piercing, but a classic right of the company to hold insiders It is important not to lose sight that the case for piercing arises when the parent accountable to the corporation. When parent and its directors may also be held has stripped value out of a financially the injured corporation is a subsidiary, its liable if they personally commit a tort troubled subsidiary. creditors may sue the parent company against a or a competitor of a and its directors “double derivatively” in subsidiary. An example might be mali- There will be questions about whether or the name and right of the parent. cious interference with a contract. not, at the time of the contested trans- action, the subsidiary was technically A holding company and its directors Italy - MB In very short terms, there are insolvent, but if the parent strips out inter- may also be held liable for aiding and two kinds of possible liability for parent company accounts, takes dividends or abetting breaches of fiduciary duty at companies under Italian law. removes value when the subsidiary is the board level of the subsidiary, if a The first one is liability for abuse of financially troubled, then the case invites plaintiff can show that these defendants legal personality, which is the liability piercing the veil under predominant tests. knowingly and substantially assisted in that a holding company can be subject breaches of duties that the subsidiary’s A widely recognised test known as to when it exercises such a full control directors owed to the subsidiary. the Instrumentality Theory, allows the on the subsidiary that the later can be piercing of the veil if the parent exercises A key defence for all corporate fidu- considered as a mere tool, or agent, in a high degree of domination and control ciary claims is the Business Judgment the hands of the holding. In this case, over the subsidiary, then uses its control Rule. This is the fundamental principle Italian law foresees a direct liability of to commit a fraud or wrong thereby prox- that courts will not review the merits the holding company for all debts and imately causing injury to the complaining of a business decision honestly made liabilities of the subsidiary. In case the party. by an informed board of directors that subsidiary goes bankrupt, bankruptcy acted in good faith and without conflicts can be extended to the parent company. An alternative might be the Identity of interest. If a plaintiff overcomes that Theory, when the failure to observe the The second one is regulated by Art. standard, then the defendant directors corporate distinction internally is so 2497 et seq. of the Italian Civil Code and can avoid liability only by showing that complete that the court finds there was is not connected to an abuse of legal the contested transaction was entirely fair no distinction in fact, but an integrated personality, but to an abuse of power to the company both in process and in entity responsible for all corporate obli- to direct and coordinate subsidiaries. substance. gations. Such power of direction and coordi- There is a liability on the part of the nation is legitimate and does not allow The take away point is that the limited directors for illegal dividends or stock piercing the corporate veil provided that liability of shareholders is a strong redemptions and capital transactions it is exercised according to: 1) the laws; presumption but not an absolute one. that don’t meet the requirements of the 2) the company by-laws; 3) the principle Courts have power to pierce the veil to corporate law, with respect to main- of correct business . On avoid injustice or inequity. taining the capital of the subsidiary. the contrary, in case of misuse of such There is also the doctrine of breach power, a holding company can be held Those who receive fraudulent transfers of fiduciary duty, where directors may accountable for damages. The holding out of the subsidiary, whether it’s the become liable for breaching duties of company’s directors and other subjects parent itself, or the parent’s principals care, good faith and loyalty owed to their taking advantage of the wrongdoing, are or directors, may be liable on a fraud- corporation. This may involve indirect jointly liable with the holding company. ulent transfer theory for disgorgement harm caused to a parent company

irglobal.com | page 9 Virtual Series |Limiting Liabilities

A company is considered a controlling In particular with regard to the liability You can defend a preferential trans- company under Art. 2497 when has the for unlawful ‘direction and coordination,’ action claim, if it was not made at the power to control the decision-making there is also the compensatory advan- relevant time, which is generally six of the subsidiary, or can exercise a tages defence. The holding company months before an insolvency, or two dominant influence on it, either in force or its directors are not liable even in years for a connected person. Where a of its participation in the subsidiary’ case certain intercompany transactions transaction is being made at an under- company capital or through a specific or decisions can be judged as detri- value, it should have been entered into contractual power (e.g. particular agree- mental for the subsidiary, if the overall within two years of the onset of insol- ments between the parent company result of the direction and coordination vency if it is going to be challenged. and the subsidiary) or even de facto. activity brings advantages that fully Canada – SFS Our biggest defence compensate the disadvantages. Liability for unlawful ‘direction and coor- here is Canada is the Legitimate dination’ is not a direct liability for the England – DF We don’t have the Business Decision defence. Directors indebtedness of the subsidiary, but compensatory advantages rule in the have to show there is a legitimate for the (indirect) damages the holding UK, but we do have section 212 of the business reason for a decision and company caused to the creditors and Companies Act 1986, which allows a any other business person would have to (other possible) shareholders of the liquidator, contributor or creditor to the made the same decision, whether it’s subsidiary. company’s capital to bring a misfea- to continue in business, order goods, sance claim against a subsidiary or a pay employees, pay the rent, or enter Shareholders are entitled to claim parent. The court can order repayment into new contracts. If you go through damages for loss of value and of remu- and restoration on account of misap- a whole litany of things, the court and neration of their participation. The exact propriated money or property and can creditors will take a look at whether they content of these general concepts is compensate the misfeasance or fidu- were all legitimate decisions under the debated; however, the underpinning ciary breach of duty by contributing to circumstances. idea is that the shareholders are the company’s assets. damaged because of the loss of value I will highlight fiduciary duties at the and dividends of their participation in Pursuing directors, including de facto subsidiary level and at the holding the subsidiary due to the illegitimate and shadow directors can be done in company level. transfer of money, assets or the likes the following cases; Our fiduciary duties are owed to share- from the subsidiary to the holding • misfeasance or breach of fiduciary holders. There was a case in Canada without proper consideration. duty claims against anyone in the about 15 years ago called the People’s Creditors can claim damages under Art. company. Jewellery Case, where the court held 2497 when a transaction between the that directors do not have a fiduciary • by any person who holding company and the subsidiary duty to creditors. Despite this, we still was party to the fraud of creditors. diminishes the subsidiary assets, have remedies in provincial statute. since, under Italian law, the latter • , where a successful There is the Derivative Remedy are considered a general guarantee wrongful trading action can impose which Ted highlighted and also the granted to the creditors by the personal responsibility on directors Oppression Remedy. If any shareholder (the subsidiary in this case) for the reim- if they knew there was no reasonable or creditor or otherwise proper person bursement of its debts. chance of avoided insolvency. thinks the business of the company In the case of bankruptcy of the Unjust enrichment principles enable was carried on in a way that was preju- subsidiary, the bankruptcy trustee is disadvantaged subsidiaries to be dicial to their interest, they can sue the entitled to sue holding companies, its protected since the personal assets of directors personally. directors and auditors for the aforemen- directors can be attacked and tracing I was involved in a recent case where a tioned kind of liabilities. can occur. In such cases, a spouse’s lawyer was named as a party defendant assets need to be protected. The main defences against these in the case of oppression, where the kind of actions are based on the affir- As a defence, if the directors can show lawyer helped carry out the director’s mation of the substantial autonomy of they took every step to minimise loss to orders. The judges held there was no the subsidiary and the denial of liability creditors they can often be allowed to way the law firm could be held respon- because the parent company and its continue restructuring a business. sible for what happened. directors acted in compliance with There are also defences available under The idea that the lawyers could be the law, the bylaws and relevant deci- misfeasance claims, if an officer can grouped in with directors in the actual sions were reasonable according to the show they acted reasonably. Otherwise, law suit is important, so we have to be business judgement rule. having good accountants and financial careful what legal advice we give to advisors is advised, as is a good directors after insolvency. with forecasts.

irglobal.com | page 11 We don’t have fraudulent trading, but from the holding company under the • that a competent and reliable person there is case law where directors have following circumstances. was providing information in respect of been sued personally for ordering the subsidiary company’s solvency • a corporation has contravened goods and services when they knew section 588V (1) • the holding company director did the company would have no funds not take part in the management of available to pay for those ordered. • the person to whom the debt is the subsidiary company because of owed has suffered loss or damage If I have a meeting with clients who illness or some other good reason in relation to the debt because of the are concerned about the viability of company's insolvency • the holding company took all their company I will say, if you order reasonable steps to prevent the goods and services after today, please • the debt was wholly or partly unse- subsidiary company from incurring the set aside funds to pay for it. Share- cured when the loss or damage was debt. holders don’t necessarily get involved suffered; and in insolvency, since they are bottom of Section 588GA also creates a ‘safe • the subsidiary company is being the list of creditors. If a company goes harbour’ for directors to protect them wound up insolvent, unless directors have wrongly from personal liability, and from the enriched themselves, shareholders • When the requirements are satisfied, potential civil penalty exposure if don’t often sue directors. the liquidator may recover from the section 588G (2) applies. holding company an amount equal We have the same look back rules as The provision protects directors from to the amount of the loss or damage the UK – once a company is insolvent personal liability for debts incurred by suffered as a debt due to the subsidiary under our statutory law, we will look an insolvent company if, after a director back 12 months to see what was • Any proceedings to recover loss in ‘starts to suspect’ that the company done. Any intercompany payments in this manner have a limitation period of may become or is insolvent, the that period will be reviewed and could six years. director starts developing a course of be clawed back. For related company action that is ‘reasonably likely to lead The measure of compensation liability transactions, we can go back as far as to a better outcome’ for the company to which a holding company is exposed five years. than the immediate appointment of an is expressed as the amount of the loss administrator or liquidator. We have a section of our income tax act or damage suffered in relation to the that is very harsh on unpaid taxes. In debt, because of the subsidiary’s insol- In order for the safe harbour to apply, Section 160 of the income tax act, if the vency, by the person to whom the debt the debt incurred by the company government believes a director didn’t was owed. needs to be ‘directly or indirectly’ in pay withholding taxes or other taxes, connection with that course of action Where a payment order is made against they can go after directors personally. taken by the director. a holding company under section 588 They can also look at what happened to W and the court is satisfied that, at the The provision sets out several factors the director’s money, and, if they used time the subsidiary incurred the debt, that may be considered when deter- it to pay living expenses or a mortgage the person who suffered the loss or whether the steps taken by the they can recoup the money. damage knew that the subsidiary was director were reasonably likely to lead There are cases now where govern- insolvent or would become insolvent to a better outcome for the company. ments have gone after students for the by incurring that or other contempora- repayment of tuition fees that directors neous debts, the court may order that have paid for their children to go to the compensation paid to the subsidiary university. This has become a real area is not available to pay that debt unless of concern for directors in Canada all the company's unsecured debts during the last few years. have been paid in full.

Australia – JC Section 588V of the There are defences provided under Australian Corporations Act 2001 is section 588X of the Corporations Act, not a civil penalty provision and does being: not trigger any compensation remedies • the holding company directors had under Pt 9.4B (or any other provision reasonable grounds to expect that of that Part). Further, a company that the subsidiary company was solvent contravenes it is not guilty of an offence. (able to pay its debts when due and However, section 588W provides that a payable) when it incurred the debts liquidator may recover for loss resulting from insolvent trading by the subsidiary

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SESSION THREE - BANKRUPTCY TRUSTEES If a subsidiary goes bankrupt, can a receiver or bankruptcy trustee pierce the corporate veil and sue the holding company, making it liable for a subsidiary’s debts, or even claim for damages?

England – DF You need to be fairly The other interesting principle we have in Under the Bankruptcy Code, case law cautious about saying yes in a situation the UK is called the Duomatic Principle, also recognises that the bankruptcy court like this: there are a lot of questions that where there can be a defence to director may decree substantive consolidation of need to be considered in some detail. liability if it can be shown that share- the bankrupt company and other entities. The main area to focus on is around holders who have a right to attend and In rare cases, this can include merging the area of directors’ responsibility in vote in a general meeting, would have a non-bankrupt parent company into the various companies and, broadly, or did consent to what was happening. a bankrupt subsidiary, thus effectively there are six or seven particular areas of If the shareholders have actually ratified forcing the assets and liabilities of the misfeasance that the directors may have the relevant misfeasance or breach of parent into the bankruptcy estate. fallen foul of. fiduciary duty, then that is quite an inter- This extraordinary remedy is available esting defence. They are; only if (1) the parent and subsidiary so If they fail to act within their normal In terms of foreign multi-jurisdictional disregarded their separate identities that powers claims, the Principle of Comity exists creditors relied on the two companies as If they haven't promoted the success of between states around their accepted one, or (2) the companies’ assets and the company rules of mutual conduct. This means liabilities were so thoroughly co-mingled If they haven’t exercised independent practically, that if you issue in one juris- that disentangling them would be prohib- judgment diction there is often no point in issuing itively expensive and would harm the If they haven’t exercised reasonable in another which is really beneficial for creditors of both companies. care and diligence creditors not to waste time and money The bankruptcy trustee also has special If they haven't avoided in issuing in other jurisdictions. As powers under the Bankruptcy Code to If they have accepted benefits from third such, it may be appropriate to go for pursue avoidance claims and clawback parties an injunction in the foreign jurisdiction remedies against insiders for preferential If they have not declared any interest in to stop those second proceedings and transfers made up to one year before the the proposed transaction ask for recognition of process where you bankruptcy. This includes loan repay- have started proceedings. ments and of inter-company There is relief and a defence is possible, U.S – TS The trustee, which in the US accounts, by which the parent gained particularly where the director has acted is usually the bankrupt company itself, advantage as a creditor outside of the honestly and reasonably, and, if the may prosecute for the estate any claims ordinary course of business. circumstances of the case mean it's fair belonging to the bankrupt subsidiary to excuse them from liability. These avoidance powers also apply to against the parent company and its fraudulent conveyances, or transfers One particular case showing how a directors. These include such causes of made by the insolvent subsidiary to court can apply this defence was that of action as restitution for unjust enrichment the parent without receiving reasonably D’Jan of London, where a director had and recouping illegal dividends. equivalent value in exchange, or ones failed to properly fill in an insurance form In some states, this category also intended to hinder, delay, or defraud the as a result of which the company lost includes a claim by the subsidiary to subsidiary’s creditors. money. The director held 99 per cent of remedy abuses of the parent by piercing the shares and the court felt that he had A holding company and its directors the subsidiary’s own veil, so as to hold failed in his duty and yet, while they did cannot avoid suit merely because that the parent responsible for the subsidi- make an order against the director, they company is not incorporated or otherwise ary’s debts. In other states veil-piercing reduced the amount due which would go present in a district where the bankruptcy claims belong to individual creditors, not to the company’s creditors. is filed or because the directors reside to the subsidiary. elsewhere.

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A summons and complaint for a bank- ‘You know in the last two months prior to a receiver will liquidate the assets and ruptcy adversary proceeding may be bankruptcy you were paid CAD100,000 collect the money from the insolvent commenced by personal service or first- while nobody else got any money, so you company before a bankruptcy trustee class mail anywhere in the United States. have to give us that money back.’ can become involved. Service outside the US is also permitted There are a lot of lawsuits for return of There are, however, two claims that a by various means, including interna- what we call unjust preference claims to can pursue for the tionally recognised procedures. creditors. benefit of the estate and not just for the Canada – FS Trustees in Canada are benefit of the . A trustee will also look to reclaim any appointed either by a creditor, who money paid to directors or related parties One is the unjust preferences I just talked brings an application to court to appoint within a year of bankruptcy. They can about and the other one is fraudulent a receiver, or, sometimes, under a look at contracts between a company conveyance actions, where some of the general security agreement or debenture and any related party, including lease assets of the company were conveyed, saying that the company is insolvent. and rental arrangements. prior to the insolvency or bankruptcy, at An can bring an appli- an undervalue. Trustees see rental arrangements as a cation for bankruptcy and a third-party possible way of stripping money out of a A trustee in bankruptcy could assert trustee will be appointed and, of course, company. They can go after the company that claim independently of the secured the company can make a voluntary that owns the real estate and force them creditor, since fraudulent conveyance assignment to bankruptcy in which case to pay back some of the money if the claims and fraudulent preferences claims the company chooses the trustee. rental wasn't on the same terms as it are seen as representative actions for the Canadian trustees can prosecute would have been if it was a third party benefit of all creditors, not just secured anything, if they think that there was arrangement. creditors. an unfair advantage given to directors, One thing to highlight, is that the rights I'd like to wrap up by saying that we also shareholders or creditors of the company. of bankruptcy trustees are subordinate have something in our Bankruptcy and We have preference claims that are very to the rights of the secured creditor. Insolvency Act called Section 38 claims. similar to unjust preference claims in the So, if you are a secured creditor who UK and the US, where a trustee in bank- has appointed a receiver for example, ruptcy can go to a creditor and say;

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If a trustee in bankruptcy does not have being a shareholder, is subordinated to case of Re Edelsten ex parte Donnelly, funds in the estate to pursue claims all the other creditors of the subsidiary. but was ultimately unsuccessful. against directors or related parties, or Damages that bankruptcy trustees can The trustee of Dr Edelsten’s estate in even third parties, they can ask the claim from the holding company and its bankruptcy commenced an action courts for an assignment of that claim directors generally include the surplus claiming that certain property owned under Section 38 and creditors can of indebtedness generated in case the by the VIP Group of companies had pursue those claims independently of parent company worsened the subsid- been obtained by Edelsten before the the trustee. iary’s financial situation, for example bankruptcy had been discharged. The Italy – MB Discussing this topic, two through unjustified intercompany trans- trustee argued that the companies had preliminary observations should be actions, or keeping the subsidiary oper- been incorporated and used for the made. First, some recent legislative ative without taking care of, or delaying, purpose of evading a legal obligation reforms in Italian bankruptcy law have a proper restructuring. or perpetrating a fraud. made it harder for the bankruptcy Bankruptcy trustees can also claim Subsidiaries may typically fall under the trustee to start clawback actions. damages connected to a specific ground of ‘group enterprises’ where the Second, the economic and financial wrongdoing, for example, if money parent company and subsidiaries are crisis that still affects the Italian were funnelled upward to the holding operating in such a manner as to make economy, often leaves the insolvent company via a certain unjustified trans- each individual entity indistinguishable. subsidiaries with few, if no, assets. action, or if the subsidiary sold goods, An argument that a subsidiary and These two factors, inter alia, constitute services or other assets at below parent company form a ‘group enter- a big push for bankruptcy trustees market price to the holding company, prise’ can be made where there are to look to other possible sources for or to another company in the same overlapping directors, officers, and recovering money and pay the debts of group. employees or where there is a part- the bankrupt company. nership between companies in a group. Australia – JC Ordinarily a trustee One of the main strategies of bank- cannot sue a holding company unless A court may pierce the corporate veil ruptcy trustees for doing this is filing the court is prepared to pierce the on the grounds of ‘group enterprises’ claims for liability of directors’ and corporate veil. where there exists a sufficient degree auditors, while another option is of common ownership and common claiming liability of holding companies. One issue with the historical position enterprise. is the tension between the use of the As mentioned before, in the case of phrases ‘lifting the veil’ and ‘piercing Courts will typically not pierce the abuse of legal personality, a holding the veil’. While the principle of lifting veil on the grounds of control alone. company could be considered the veil had an established set of Rogers AJA, in Briggs v James Hardie directly responsible for subsidiary common law principles, the courts are & Co Pty Ltd (1989) 16 NSWLR indebtedness and the bankruptcy rather disinclined to describe a set of 549 examined a ‘group enterprises’ be extended to it. These claims can principles for the act of piercing the argument that the plaintiff (a former lead to very complicated legal issues, corporate veil. Hence the case law is employee of a subsidiary company especially if the holding company is relatively piecemeal and is not rigid who had contracted asbestosis) was a foreign company because there are in its application being more fact than entitled to pierce the corporate veil to also issues with regard to jurisdiction principle based. sue the parent company, because it and applicable law. had the capacity to exercise complete Australia adopted the UK veil piercing In the case of liability for direction and dominion and control over its subsidiary laws in Electric Light and Power Supply coordination, the damages that the and had in fact exercised that capacity. Corporation Ltd v Cornack (1911) 11 bankruptcy trustee can claim are the This argument was dismissed as SR (NSW) 350. This was developed ones suffered by the other shareholders entirely too simplistic. in the cases of Lipman v Jones and (loss of value of their participation) Adam v Cape which established three Rogers CJ, in Qintex Australia Finance and the creditors (loss of subsidiary’s different grounds on which a court may Ltd v Schroders Australia Ltd, noted assets as guarantee of payment). elect to pierce the corporate veil: fraud, that the development of the rigid appli- With regard to intercompany financing, agency and group of companies. cation of the separate legal entity all monies remitted to the holding principle to corporate groups is prob- The most relevant ground for trustee’s company within one year prior to the lematic, often resulting in a divergence seeking to pierce the veil to claim debt declaration of bankruptcy must be between the realities of commercial life will be the group of companies’ ground. refunded by the holding company, and the applicable law. The ground of fraud was raised in the while, in general, the holding company,

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Contacts

UK HEAD OFFICE KEY CONTACTS CONTRIBUTORS

IR Global Thomas Wheeler S. Fay Sulley (FS) The Piggery Founder Torkin Manes LLP – Canada East Woodhouse Farm [email protected] www.irglobal.com/advisor/s-fay-sulley Catherine de Barnes Lane Rachel Finch Trevor (Ted) Swett (TS) Catherine de Barnes B92 0DJ Channel Sales Manager Caplin & Drysdale, Chartered – U.S - Washington, D.C. Telephone: +44 (0)1675 443396 [email protected] www.irglobal.com/advisor/trevor-swett-iii www.irglobal.com Nick Yates James Conomos (JC) [email protected] Editor James Conomos Lawyers – Australia [email protected] www.irglobal.com/advisor/james-conomos

David Foster (DF) Barlow Robbins. – England www.irglobal.com/advisor/david-foster

Massimo Boni (MB) Ferrari Pedeferri Boni – Italy www.irglobal.com/advisor/massimo-boni

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