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Liability of a Holding Company for the Debts of Its Insolvent Subsidiary

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Liability of a Holding Company for the Debts of Its Insolvent Subsidiary LIABILITY OF A HOLDING COMPANY FOR THE DEBTS OF ITS INSOLVENT SUBSIDIARY By Johanna Barbara Cilliers BA LLB H Dip Co Law LLM Submitted in fulfilment of the requirements for the degree of Doctor of Philosophy from the University of Western Australia Law School University of Western Australia Year of submission: 2002 PREFACE I gratefully acknowledge a grant received from the University of Western Australia, which was applied towards the research for this thesis. My supervisor, Professor Jim O'Donovan, has offered invaluable guidance and assistance which I sincerely appreciate and for which I would like to thank him. I would also like to thank my family, especially my husband, both for acting as a sounding-board and for his encouragement and motivation. I declare that the thesis is my own composition, substantially completed during the course of enrolment in this degree at the University of Western Australia and has not previously been accepted for a degree at this or another institution. INDEX 1 INTRODUCTION 1.1 Separate entity principle and limited liability 1 1.2 Extension of limited liability to corporate groups 6 1.2.1 Automatic extension inappropriate 6 1.2.2 Risk of creditor prejudice 8 1.2.3 Creditors are less efficient risk-bearers 14 1.3 Scope of investigation 16 1.3.1 Comparison with other jurisdictions 16 1.3.2 Limitation of topic 18 1.3.3 Roadmap 23 2 THE MEANING OF CONTROL AND THE REGULATION OF CORPORATE GROUPS 2.1 Background 25 2.2 Various applications of the control concept 28 2.2.1 Subsidiary/holding company relationship 29 2.2.1.1 Test of controlling the composition of the board 30 2.2.1.2 Voting control test 31 2.2.2 Consolidated accounts 35 2.2.3 Related party transactions 38 2.2.4 Cross share-holdings 41 2.3 Evaluation of position of group creditors 44 2.3.1 CASAC recommendations 45 2.3.1.1 Regulation by general control test 45 2.3.1.2 Wholly-owned groups to choose whether enterprise principles 46 apply 2.3.2 Critique of CAS AC recommendations 49 2.3.2.1 Regulation by general control test 49 (a) Replacement of 'holding/subsidiary' with 'control' 50 (b) Preferred definition of 'control' 52 2.3.2.2 Wholly-owned groups to choose whether enterprise principles 57 apply 3 PIERCING THE CORPORATE VEIL 3.1 Background 60 3.2 Fraud 61 3.2.1 Limited to exceptional cases 61 3.3.2 Further restriction on lifting the veil 66 3.3 Agency 3.3.1 Extent of control 70 3.3.2 Authorisation to contract 72 3.4 Single economic unit 74 3.5 Evaluation of position of group creditors 95 4 DIRECTORS' DUTIES: GENERAL PRINCIPLES 4.1 Background 98 4.2 Fiduciary duty to act in interests of company 99 4.2.1 Objective test laid down in Charterbridge 100 4.2.2 Subjective test laid down in Walker v Wimborne 102 4.2.3 Implied recognition of Charterbridge test after Walker v 105 Wimborne 4.2.4 Express recognition of Charterbridge test after Walker v 109 Wimborne 4.3 Nominee directors: notion of 'dual loyalty' 112 4.3.1 Traditional approach 113 4.3.2 Pragmatic approach 114 4.3.3 Notion of 'dual loyalty' similar to Charterbridge test 118 4.4 Duty of care, skill and diligence 121 4.4.1 Scope of duty 121 4.4.2 Statutory formulation of duty 126 4.4.3 Overlap with fiduciary duty 130 4.4.4 Overlap with insolvent trading provisions 133 4.5 Evaluation of position of group creditors 134 4.5.1 Fiduciary duty to act in interests of company 134 4.5.2 Nominee directors 136 4.5.3 Duty of care, skill and diligence 137 5 DIRECTORS' DUTIES: CAPITA SELECTA 5.1 Background 139 5.2 Particular difficulties in intra-group transactions 139 5.2.1 Downstream, lateral and upstream transactions 139 5.2.2 Restructuring a group 142 5.2.3 Uncommercial transactions 146 5.3 Duty to take into account interests of creditors 153 5.3.1 Extension of duty 153 5.3.2 Insolvency as condition established 155 5.3.3 Concept of'insolvency'delineated 157 5.3.4 Duty to future creditors 159 5.3.5 No direct duty to creditors 162 5.4 Statutory duty to act in interests of company 164 5.4.1 Interests of the company and proper purpose 164 5.4.2 Specific provision for corporate groups 167 5.5 Evaluation of position of group creditors 173 6 INSOLVENT TRADING: HOLDING COMPANY AS SHADOW DIRECTOR 6.1 Background 182 6.2 Addressing the problem 188 6.2.1 Position in the United Kingdom 188 6.2.2 Position in Australia 192 6.2.3 Position in New Zealand 196 .3 Liability of holding company 199 6.4 Evaluation of position of group creditors 218 6.4.1 Meaning of 'directors of the body' 218 6.4.2 Meaning of 'accustomed to act' 221 6.4.3 Meaning of directions or instructions' 222 7 INSOLVENT TRADING: HOLDING COMPANY AS SHAREHOLDER 7.1 Background 225 7.2 Addressing the problem 226 7.3 Liability of holding company 230 7.3.1 Criteria to be satisfied for contravention 230 7.3.1.1 'Incurs a debt' 233 (a) General 233 (b) Narrow approach - directors may easily escape liability 235 (c) Flexible approach - more difficult for directors to 238 escape liability (d) Voluntary and involuntary debts 240 7.3.1.2 'Insolvent' 243 7.3.1.3 'Reasonable grounds for suspecting' 247 7.3.2 Defences 250 7.3.2.1 Reasonable grounds to expect insolvency 251 7.3.2.2 Reliance on another 256 7.3.2.3 Illness or some other good reason 257 7.3.2.4 Reasonable steps to prevent incurring a debt 264 7.4 Evaluation of position of group creditors 265 7.4.1 Disadvantages as a result of intermingling 265 7.4.2 Other disadvantages 266 8 CONTRIBUTION AND POOLING: THE CURRENT POSITION 8.1 Background 272 8.2 Indirect pooling by the regulator 274 8.2.1 Shortcomings of Deeds of Cross Guarantee vis-a-vis creditors 276 8.2.1.1 Multiple insolvencies 276 8.2.1.2 Release from obligations 280 (a) Revocation 280 (b) Sale 281 8.2.2 Shortcomings of Deeds of Cross Guarantee vis-a-vis directors 282 8.2.2.1 Breach of fiduciary duty 282 (a) Committal 283 (b) Revocation 285 8.2.2.2 Breach of insolvent trading provisions of the Corporations Act 286 8.3 Indirect pooling by the courts 287 8.3.1 Schemes of arrangement and compromises/arrangements with 287 creditors 8.3.2 Other avenues 292 8.3.2.1 Rights of contribution and subrogation under inter-company 292 guarantees 8.3.2.2 Section 447A of the Corporations Act 296 8.3.2.3 Section 510 of the Corporations Act 303 8.4 Evaluation of position of group creditors 312 8.4.1 Indirect pooling by the regulator 312 8.4.2 Indirect pooling by the courts 315 9 CONTRIBUTION AND POOLING: THE CASAC RECOMMENDATIONS FOR A MODIFIED NEW ZEALAND MODEL 9.1 Background 318 9.2 Harmer Report recommendations 320 9.2.1 Contribution 320 9.2.2 Pooling 323 9.3 Legislative provisions relating to contribution and 325 pooling in New Zealand 9.4 Case law on contribution in New Zealand 328 9.4.1 'Such other matters as the Court thinks fit' 328 9.4.2 'Just and equitable' 330 9.5 Case law on pooling in New Zealand 334 9.5.1 'As if they were one company' 334 9.5.2 'Just and equitable' 337 9.6 Evaluation of position of group creditors 341 9.6.1 CASAC recommendations 341 9.6.1.1 Contribution orders 341 9.6.1.2 Pooling orders 343 9.6.2 Critique of CASAC recommendations 346 9.6.2.1 Uncertainty exists also in respect of pooling orders 346 9.6.2.2 Uncertainty exacerbated by confusing contribution and pooling 348 9.6.2.3 Summary 351 10 PROPOSALS 10.1 Inadequacy of existing law 352 10.1.1 Piercing the corporate veil 353 10.1.2 Directors'duties 354 10.1.3 Insolvent trading 355 10.1.4 Contribution and pooling 356 10.2 Proposed model 358 10.2.1 Pooling: To be used as a last resort 358 10.2.2 Contribution: Presumption of abuse based on control 361 10.2.2.1 Liability based on status versus liability based on fault 361 10.2.2.2 Substantive aspects 364 10.2.2.3 Procedural aspects 368 10.2.2.4 Contribution with a difference 374 10.2.2.5 Advantages of proposed model 378 10.3 Conclusion 381 SUMMARY 383 TABLE OF CASES 384 BIBLIOGRAPHY 395 ABBREVIATIONS 416 1 INTRODUCTION 1.1 Separate entity principle and limited liability 1 1.2 Extension of limited liability to corporate groups 6 1.2.1 Automatic extension inappropriate 6 1.2.2 Risk of creditor prejudice 8 1.2.3 Creditors are less efficient risk-bearers 14 1.3 Scope of investigation 16 1.3.1 Comparison with other jurisdictions 16 1.3.2 Limitation of topic 18 1.3.3 Roadmap 23 1 INTRODUCTION 1.1 Separate entity principle and limited liability Anthropomorphism, prevalent in religion and politics since the Middle Ages, also found its way into law.1 In the eighteenth century the anthropomorphic idea inspired lawyers to regard every company as an 'artificial body' or legal persona, which was in turn the impetus for the development of the principle of separate legal personality of a company.2 This principle and the other principles of our company and insolvency law were developed in England in the nineteenth century, culminating fin de siecle in the doctrine of limited liability in respect of companies.
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