Limited Liability for contract creditors when dealing with the subsidiary will mostly be the same. For the majority of contract creditors it is expected that the creditor has dealt with due diligence and care prior to entering in to the contract. Limited liability for the subsidiary would mean that the contract is only with the subsidiary and not with the holding company. If limited liability was not enforced it would enable contract creditors to exploit the holding company when they themselves did not express the due care. In Pioneer Concrete Services Ltd v Yelnah Pty Ltd it was held that the holding company was not a party to the clause in an agreement and it was undertaken by the subsidiary. But under common law it is possible to enforce the lifting of the corporate veil as seen in Smith Stone & Knight v Birmingham Corporation in which Salomon’s principle could not be held because the “subsidiary carried on a business as agent for its holding company”. A clear line must be drawn for subsidiaries when dealing with contract creditors and certain conditions must be satisfied for the subsidiary to be seen as an agent or in a partnership.
Tort creditors have a much larger claim against Salomon’s principle of limited liability. Because tort creditors claims tend to be more compelling than contract creditors and have greater ramifications. Limited liability restricts the tort creditor’s ability to access the required amount of compensation from the corporate group. Brigg’s v James Hardie & Co Pty Ltd has shown how Australian courts are starting to look at lifting the corporate veil when looking at tort claims. Rogers AJA said “the particular employer… has no real input in determining how the business will be conducted and whether reasonable care will be taken for his safety”. The law of negligence may apply in certain cases where there is a high degree of control shown in the running of the subsidiary by the holding company. It may apply directly to employees of the subsidiary because the employee is owed a duty of care. James Hardie created a subsidiary to deal with the compensation victims relating to asbestos and the increasing claims against it have seen it unable to satisfy claims. Limited Liability had been able to protect James Hardie against fully compensating victims.
Disadvantages of Limited Liability, and effect on contract and tort creditors.
CASAC (known now as CAMAC) looked at reform of the limited liability concept relating to corporate groups and was considered in its Corporate Groups Final Report. It was rejected because they felt that making a parent company liable for tort claims should be left to sections 588V and 588X and specific common law principle. The exclusion of certain law relating to the lifting of the corporate veil “do not provide adequate protection for victims of torts committed by insolvent subsidiaries of wealthy holding companies.” Limited liability gives the holding company the ability to hide away from the wrongs committed by its subsidiary. Some of the reasons which promote the lifting of the corporate are that tort creditors do not presume risk through dealing with the subsidiary, the wrong message is sent to the business world if limited liability is fully enforced, and the ethical issue is raised with companies profiteering from wrongful actions.
A tort creditor does not presume all the risks associated with making a deal with a subsidiary. The situation is difficult for tort creditors because they have limited access to information hence when making the decision they are not able to determine the status of the subsidiary. The level of financial information disclosed to major shareholders and contract creditors is quite substantial in comparison to tort creditors. There is no way to monitor the actions of managers because they have no real pulling power and in most cases can not demand or utilize such information. Claims for torts have no relationship to ensure that the corporate is to be liable. Because there is no contractual claims which the tort claimants and their safety is not secured.
For holding companies not to be liable creates the wrong message in the public arena. The public perception of subsidiaries and corporate groups will be frowned upon if the corporate veil can not be lifted for the safety of the public. This sort of deterrence of responsibility gives major companies the notion they are immune to claims against it and can not be in danger. James Hardie knew about the dangers relating to asbestos and continued to undertake this harm causing behaviour and placed in risk the health of the public. Through creating a subsidiary which did not have the cash reserves to pay claimants James Hardie was able to deter themselves from paying the claims.
The ethical problem is raised through having limited liability. Because the holding company is able to receive the benefits from the subsidiary and in turn have no responsibility for claims. The ethical question was faced by James Hardie because in the case Briggs v James Hardie & Co Pty Ltd, he was employed by a subsidiary of James Hardie and suffered asbestos poisoning. While the case was upheld in support of Briggs, the ethical duty of companies must be enforced and limited liability creates an ability to defer this responsibility.
Contract creditors are in a more debatable situation because they have a nexus with the company. When a contract is signed it is expected the due car and diligence was observed by both parties prior to the signing of the contract. Making the holding company liable for discrepancies in the contract would be more controversial. Because when a contract is entered in to it is between the two parties involved hence each party understands the position of the opposing party. If limited liability is not enforced for contract creditors it would cause the holding company to have a more controlling influence on the day to day business of the subsidiary. This would see subsidiaries acting as agents or partners with the holding company as seen in Smith Stone & Knight v Birmingham Corporation.
The reform and change to Salomon’s separate legal entity principle has been proposed but was rejected. “CASAC’s May 200 Corporate Groups Final Report was whether the regulation of corporate groups should be based on;
- the separate entity approach, or
- the single enterprise approach, or
-
a combination of these approaches.”
This would have seen holding companies being more responsible and accountable for the unlawful actions placed upon the public. But it continues that Salomon’s principle is still upheld.
Shareholders Interests v Tort Victims
Directors have a duty of care to place the shareholders interest at the forefront when making decisions for the company. Limited liability encourages directors to make decisions which can benefit the parent company. It can be said that limited liability places the shareholders interests first because the parent company can exercise risky investment decisions that have high payoffs. “The facilitation of optimal investment decisions by managers by pursuing projects with positive net present values rather than being concerned with the risk to shareholders that such projects may bring” the dangers of negative investment is not felt by the shareholders. Limited liability allows the shareholder to monitor performance of managers and “the increased incentive to managers to act efficiently and in the interests of shareholders by promoting the free transfer of shares;”. The corporate veil places the interests of shareholders in front of the tort victims. Because with the pursuing of risky investment decisions there is a danger those shortcomings will eventuate and in certain cases safety will be compromised. This was seen in Briggs v James Hardie & Co Pty Ltd because they knew about the dangers of asbestos but they continued having business dealings with asbestos because it was profitable. The Corporations act does not really consider the tort victims because under section 588 V the holding company only becomes liable when undertaking insolvent trading.
If a company is a member of a corporate group and if they are liable for the debts incurred by the other companies in the group it would mean that the shareholder’s interests are placed after that of tort victims. This will be the ethical and responsible way of making holding companies, deferring the responsibility of controlling a subsidiary. Tort creditors are in the position where under the current limited liability concept they are unable to receive the full compensation which was owed to them. James Hardie created a subsidiary which was unable to meet the compensation of victims. But if holding companies were liable for the debts of the subsidiary tort victims would be able to receive the full compensation which is owed to them. The James Hardie case shows how they placed the needs of the shareholders of the company in front of the tort victims because they created a subsidiary to refrain from being liable. Hence making holding companies liable would mean the tort victim’s needs are placed before the needs of the shareholders.
The making of a company in a corporate group liable for the debts of the other companies defeats all the benefits from having this sort of structure. But at the same time it becomes evident that this sort of structure destroys the ability of tort victims to receive the full compensation owed to them. It gives the perception that companies can conduct operations which are irresponsible and they can not be held liable. I believe it would be best to keep the statute and common law they way it is relating to holding companies. But a law must be made which protects the needs of the tort victims, this could be done through an extension of needs “The Commission should recommend reform of the Corporations Act so as to restrict the application of the limited liability principle as regards liability for damages for personal injury or death caused by a company that is part of a corporate group”. But in no way should a holding company be fully responsible for the actions of the subsidiary because this would destroy the advantages of having such a structure. Hence shareholders interests would still be paramount but more flexibility is given to tort victims.
Lipton and Herzberg, “Understanding Company Law”, pg 31
(ANNEXURE T The Concept of Limited Liability - Existing Law and Rationale)
Lipton and Herzberg, “Understanding Company Law”, pg 39
(ANNEXURE T The Concept of Limited Liability - Existing Law and Rationale)
Lipton and Herzberg, “Understanding Company Law”, pg 41
(ANNEXURE T The Concept of Limited Liability - Existing Law and Rationale)
(ANNEXURE T The Concept of Limited Liability - Existing Law and Rationale)
((ANNEXURE T The Concept of Limited Liability - Existing Law and Rationale)