Much ado about nothing? Is Chandler v Cape significant?

A recent Court of Appeal in Chandler v Cape plc [2012] EWCA Civ 525 decision has found that a parent company owed a duty of care to its subsidiary employees.

This is the first time an employee has successfully established liability to him from the parent company. Some people are claiming this is an attack on the separate legal personality principles, fundamental to company law. The case of Adams v Cape [1990] Ch 433 affirmed that a group of companies was not one legal entity. Each individual company in a group has its own legal personality. Whilst at first glance one may think this is open to abuse by having a rogue trader set up a number of companies to avoid liability this very rarely happens in practice. On the contrary allowing a group company to have different legal personality is beneficial for reasons such as diversification in business or due to geographical locations. Arcadia may be a good example of this. Furthermore, there are market forces that, at some level, prevent the abuse by parent companies of their subsidiaries, especially if they have similar creditors or suppliers.

Returning to the Chandler case the court found a duty of care was owed by the parent company to the employee of the subsidiary. The court of first instance had applied the test for how a duty of care is established, which is highlighted from the case of Caparo Industries v Dickman [1990] 2 AC 605 that a duty of care is owed if there is:
1) Reasonable to foresee harm
2) Proximity
3) Whether it is fair, just and reasonable for a duty of care to be owed

So, it may not come as quite a surprise that a duty of care was owed by the parent company to the employees of the subsidiary when one looks at this test. If the facts of the case demonstrate this three criteria then stringent rules of separate legal personality should not prevent a duty of care being owed. That would effectively, and excuse my limited knowledge of tort, go against basic principles that developed from Donoghue v Stevenson [1932] UKHL 100. To the effect it would basically imply if the parent company could not be liable then a manufacutrer of goods could not be liable to an eventual purchaser due to an intervening supplier of the goods after production.

And one must argue that the facts of the case do support a duty of care being owed. Here the parent company had superior knowledge of the health and safety of the particular industry; the parent company knew, or ought to have known that the subsidiaries system of work was unsafe; The parent knew or ought to have foreseen that the subsidiary or its employees would rely on its using the superior knowledge for the employees' protection and it was not necessary to show the parent company often interfered with the health and safety practices of the subsidiary. The court will look at the relationship between the companies more widely.

So is this piercing the corporate veil and ignoring the principle of separate legal personality for different companies in a group. The court was emphatic in rejecting such a notion. They note the question was simply whether the parent company owed a duty of care. An article written by Eccles suggest that this does pierce the corporate veil. But his arguments as to why seem to be merely restating the facts and recognised law in relation to duty of care, rather than stating why the veil has been pierced here.

He notes this pierces the corporate veil...'but only on the basis of an existing concept of assumption of responsibility - Caparo Industries v Dickman'. As you can see he merely restates that a duty of care was owed under the existing principles. A person who takes certain responsibility will owe a duty of care if the facts satisfy the criteria above.

I would agree with Eccles though that in practice companies with subsidiaries may want to review any existing insurance policies if this has been overlooked.

For the corporate veil to be pierced one needs to ask if the two separate companies are being treated as one for the purposes of liability. The answer here is no. The parent took on a duty of care through its (in)actions. Thus, the court recognised the parent company's separate legal personality and was not piercing the corporate veil to say the parent and the subsidiary were one. Perhaps further work in light of quite a few new cases, see here here and here, on this topic needs to seek a more accurate definition or categories of when the corporate veil will be pierced.

What are my readers interested in?

OK, I may be turning the blogosphere in to something similar to Primark through this blogpost. But it is inspired from one of the blogs I follow, that of one of my supervisors throughout my PhD. His blog post looked at the stats of his followers, and so I aim to do the same.

So my audience are primarily from English speaking countries: (1) United Kingdom (3503); (2) United States (1295). After these two though there are perhaps surprising results with (3) Russia (457); (4) Germany (161); and (5) Malaysia (113). I would have predicted more results from countries such as Canada and Australia, but neither feature above 50.

So what posts are people interested? Well primarily it appears to be areas of European Company Law or perhaps more accurately the regulation of company law in Europe. Both my articles on the conference on European Company Law have received 352 and 262 views respectively. My post on the Companies Act section 175 makes up the top three posts with 203 views. This may predominately be due to its feature on the Lexis Nexis Community.

Looking at the page views after the last month it is unsurprising to see my recent, more substantial post, on outside directors at the top. However, this is joined by my most popular post on the conference on European Company Law both receiving 34 views in the last month. Based on my own observations on tracking I have noticed some other posts "trending" as it were. My post on derivative claims has received 20 views this month; whilst my posts on how to cite Hydrodan Corby has received 23 and my post on Christmas procrastination has received 33. The latter evidencing people's love for cartoons and procrastination? This post in total has received 126 views since it was first posted.

Dividing the total amount of views by the amount of months since they were posted my top five blog posts would appear in the following order: (1) Conference on European Company Law Stream 1 analysis (32); (2) Conference on European Company Law and employee participation in the SE (23.82); (3) Queen's Bench consider section 175 (13.53); (4) Christmas Procrastination (31.5); and (5) Hydrodan Corby v Hydrodam Corby (13.29). So views per month published Christmas Procrastination jumps to the second most popular with the others all moving down one accordingly except for the European Company Law post staying put at 1.

So what I conclude from this is people seem to be interested in European Company Law and cartoons. The popularity of my post on the case of Hydrodan/Hydrodam also evidences that I was not the only one confused as to how it should be cited and spelt. Perhaps most importantly of all my blog appears as the 10th search result for the phrase "European Company Law". Typing in my own name my blog now appears as the 3rd result. I see this as some sort of achievement as I remember searching before I established this blog and I certainly did not even appear on the first page.

IGLRC 2012

Last week I presented my research at the International Graduate Legal Research Conference 2012 at King's College London. My panel was chaired by Dr Michael Schillig.

The event itself was well organised, engaging and interesting. I was able to meet a number of academics and research students in a variety of fields. I also attended the plenary session given by Professor David Kennedy from Harvard in the evening.

I attended a number of other talks from other research students, but this being my first significant external presentation I felt I gained most by presenting rather than listening.

It was interesting in some cases to note the differences in presentations based on the level of study people where at. Certainly students only just setting out on their PhDs mainly discussed the area they were looking in to and aimed to highlight the problems, whereas people further along where able to evidence firm conclusions or talk about more specific points. This of course was of no gauge as to the quality of the presentations, all of which I found thoroughly engaging although not always in my area.

For an outline of what I discussed in my presentation, please see my previous blog post. If you are interested in reading my paper or looking at my presentation, please do get in touch. I am considering uploading it, or something similar, to SSRN in the near future. I do not plan to do it now since I developed my presentation a bit after completing my paper as I had been able to conduct further empirical analysis.

How do you control outside directors?

The law and regulation of non-executive directors or outside directors has remained elusive. In the UK little is known about their duties and their role can vary.

In the UK the case of The Equitable Life Assurance Society v Bowley [2003] EWHC 2263 opined that non-executives owe the same duties as executives. However, in recognition of their different roles the application of those duties will be different. Bowley concerned section 174 in regard to a director's duty to act with reasonable skill care and diligence. Applying a different application here can be relatively simple. For example in Continental Assurance Co of London plc, Re [1996] BCC 888 the judge recognised that non-executives were expected to have awareness of general accounting standards but not be experts.

But what of the other duties? How would a judge differ in his/her application of say a breach of s176 to not accept benefits from a third party; or s175 to avoid a conflict of interest?

The case of Cambridge v Makin [2011] EWHC 12 (QB) dealt with, albeit in obiter, with the latter duty. Here the judge noted that the meaning of what an "interest" is was not clear, and it was also not clear whether a non-executive was prohibited from competing with the company.

Now the standard of section 175 is very rigid. In its application to executives it is seen that the court will have no consideration as to whether the director acted in good faith, whether the company could actually take the opportunity, they pursued the opportunity in their own time, or the opportunity was not within the company's scope of business. For non-executives, one cannot simply apply the executive standard. As mentioned above, that standard applies to opportunities that fall outside the company's scope of business. This may serve as a severe restriction on non-executives who often hold more than one appointment. If the executive standard is applied, if they gave the opportunity to one principal they realistically could be sued by the other principal.

Determining whether an individual owes fiduciary duties depends on the relationship the parties have. Edelman (2010) 126 LQR 302 submits that they will arise when an individual undertakes a voluntary obligation where a principal will have a reasonable expectation to protection. However, those duties will not be the same in all cases as their extent will depend on the exact nature of the relationship. This is why there is a different application of the fiduciary duties, now imposed by law under part 10, for executives and non-executives. The executive role is much more intimate with the company, which explains the higher standard.

So to determine the extent a non-executive owes a duty to avoid a conflict of interest may come down to intimacy of the relationship with the company. The role of the non-executive has continually developed over the past 20 years since the publication of the Cadbury Report on Corporate Governance in 1992. Their role, although part time, is one of supervision, challenge and strategy. Whilst twenty years ago you may have had a stronger argument to say non-executives do not owe a duty to avoid a conflict of interest, or a very low standard, it is unlikely that still holds true.

The case of Aas v Benham [1891] 2 Ch 244 however demonstrates that the conflict duty can be altered in some respects. This case concerned a partnership rather than directors. Here the partner was excused from a conflict because it fell outside the company's scope of business. The Court of Appeal recently rejected a scope of business test for executive directors in Allied Business & Financial Consultants Ltd, Re [2009] EWCA Civ 751 based on the differences in the relationship between partners and executive directors, but it is plausible a scope of business test can still be applied to non-executives.

From this one problem would remain. What exactly is a scope of business test? When Aas v Benham was decided the ultra vires rule was still in effect to restrain directors from acting outside the company's objects to protect the shareholders and creditors. Thus, a company could not act outside what it had set out to do in its constitution.

Now the ultra vires rule has been replaced due to its unreasonable restrictions on business activity and has been replaced by the fiduciary duties. Now a company is effectively allowed to do anything legal.

So interpreting a scope of business test could be wide or narrow. Do we assess it on what the company actually does? or what it has the potential to do? This may ultimately be fact sensitive though. The court may apply a wider test for a non-executive with a more intimate relationship than a non-executive who is less involved. Such an approach can be infered from the case of Langreen Ltd, Re (unreported) 21st Oct 2011 where the court found that whilst the individuals where called non-executives, they were in fact executives and held to that standard.

So, non-executives may be controlled from acting against his principal's interests via fiduciary duties. However, is this enough? Fiduciary duties are rarely enforced. There may also be unexpected legal problems with any claim since the law is not clearly tested. For example, giving an opportunity to a different principal the director personally may have no profit to disgorge which is the usual remedy. Thus the company may only have a claim for compensation which would require the company to show a causal link between the non-executives actions and the company's loss. This was seen in the case of Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244.

Executives, unlike non-executives, receive a complex web of compensation for their role to ensure they remain incentivised. They receive long term performance plans which outweigh significantly any remuneration they receive upfront. This is largely based on agency theory which argues that a director values £1 in the hand more than a promise of £1 in the future. However, as Fama (1980) 88(2) Journal of Political Economy 288 has stated, if you simply pay everything upfront what is to stop an individual consuming more perquisites to the detriment of the company after receiving his remuneration? The result is the mix of ex ante and ex post rewards for the executive to ensure they remain incentivised to prefer the interests of the company over their own.

Non-executives do not have these compensation packages though. In the majority of cases they merely receive a fee for their services and hold a small equitable interest in the company (mean 2010: .041%; median 2010: .008% for independent non-executives)

Applying agency theory to non-executives, what is to stop non-executives assuming more perquisites to the detriment of the company after receiving their fees if they have no long term incentive plans. However, one should not simply jump to the conclusion that non-executives should receive more equity in the company and be paid through long term plans. Non-executives need to be independent. They primarily are meant to monitor the management. To incentivise them too strongly will create a stronger interest in the company, which would bring their independence in to question.

But without controls, non-executives may view additional appointments as a form of perquisite consumption and may continue to accept appointments, and stretch themselves too far to the detriment of the firms who appoint him/her. This may become more of a problem as non-executive fees continually increase to reflect their increased involvement in companies. The mean fees paid to non-executives in 2006 was £817366.67 but by 2010 that figure has risen to £1053295.67. The median is not quite as extreme but still shows an increase from £696500.00 in 2006 to £849500.00 in 2010.

Measuring non-executive additional appointments against external appointments there appears to be a significant relationship.

The correlation is significant at the .01 level with Pearson's Correlation at .513** 

Thus there may be a strong case for introducing restrictions on non-executive appointments since incentive plans are not a reasonable alternative. Some other EU states have restrictions such as Germany which only permits 10 (The German Stock Corporation Act section 100) additional appointments and in France it is 5 (The French Recommendation of Corporate Governance 2011 Part II Para D.2). Anecdotal evidence suggests non-executives or outside directors in the EU accept more appointments than in the UK. Thus a restriction of 10 may be meaningless. It is submitted that a restriction set at no more than 4 or 5 to be more appropriate.

Corin Ltd, Re 5th March 2012 (unreported)

A while ago I wrote about de facto directors and the test for determining who one might be. See here and here.

As a quick reminder, de jure directors are those who have been officially appointed, whereas de facto directors are those who have either: (1) been appointed with defect (Canadian Land Reclaiming and Colonizing Co, Re (1880) LR 14 Ch D 660); (2) have since retired but continued to serve (New Par Consols Ltd, Re [1898] 1 QB 573); (3) or have not been appointed at all (Lo-Line Electric Motors Ltd, Re [1988] Ch 477). A further extension of these categories of de facto directors was recently rejected by the Supreme Court in Holland [2010] UKSC 51. The rejected the notion that a natural director of a corporate director of a composite company could be a de facto director of the latter.

As I highlighted previously, the Supreme Court decision was not determining whether Holland was a de facto director based on his status and functions but deciding on whether the categories of de facto directors could be extended to such an instance.

P Watts in his case comment in the (2011) 127 Law Quarterly Review 162 makes this mistake as to what the case was saying and tries to argue that a fact based test of who a director is, is flawed. He states one must look to whether one has assumed the status and functions of a director. It was respectively submitted that these two are actually one in the same. Arden LJ, in Mumtaz, Re [2011] EWCA Civ 610 confirms this belief when she called Holland an 'incidental issue' and confirmed the case of Gemma Ltd, Re [2008] BCC 812 which used a fact based test in determining whether somebody was a de facto director.

This month the decision in Corin Ltd, Re has confirmed this approach of determining whether someone is a de facto director. The case analysis available on Westlaw noted that there was no one decisive test and all relevant circumstances had to be taken in to account, including whether someone had become part of the corporate governing structure and assumed a role which imposed fiduciary obligations on someone.

This latter point is interesting as it begs the question of whether the courts need to look closer as to whether a fiduciary relationship has been established before imposing director liability.

Confirming that assuming the status and functions and a fact based test are effectively synonyms, is where the court established that the important question was whether someone had assumed the status and functions of a company director so as to make himself liable under the Companies Act as if he were a de jure director.

Consultation: European Company Law - What Way Forward?

I was asked to comment on the recent Consultation, that I have been discussing in my previous two blog posts, by Lexis.

My comments have been published on LexisLibrary for those of you with access. The citation is Lexis News Bites 7th March 2012 54.

The Structure of European Corporate Law

Following on from my previous blog post I thought to look a bit further in to what is the structure of European Corporate Law (ECL).

Structure and purpose
The structure and purpose are not something that can be easily ascertained. Purpose can certainly be a thorny issue at European and National level. Take for example the intense debate that surround section 172 of the UK's Companies Act 2006, as to what it means to act in the "best interests" of the company.

Looking at the Consultation released last month, the EU seems to highlight the areas it is most concerned with regarding its "purpose" in regulating company law. From Q5 these areas are protection of employees, creditors and shareholders, the regulatory competition framework, facilitating creation of companies, and improving the environment companies operate in i.e. reducing transaction costs making business efficient.

Structure is also another complicated area. One cannot simply look to a single codified piece of legislative material. A combination of European Court of Justice (ECJ) decisions, which have sought to lay down rules relating to the establishment and movement of Companies under the EC Treaty Articles 49 and 54 ; and a variety of innovative legislative materials in areas including: takeovers, capital maintenance, securities, cross-border mergers, and legal forms all form part of the structure.

Problems with the structure
The difficulties with this structure is, as the Consultation identifies, not "user-friendly". The legislation ranges from maximum harmonisation to "soft-law" recommendations. Further harmonisation has become increasingly difficult and a number of aspects of ECL have opt-out provisions or allow for an a la carte approach. This is perhaps most noticeable in the Takeover Directive. As such, it can often be difficult to ascertain what the law of any particular State will be without looking at its national laws. There are also practical problems with such an approach in that the judicial system may have different attitudes to aspects of ECL. Thus, even where two States appear to have implemented similar regimes cultural attitudes may cause unforeseen differences. This can create significant difficulties for smaller companies looking to expand or international investors.

Reform
Although other areas are mentioned the two areas that seem to receive significant attention are assisting small and medium sized enterprises (SMEs) and regulatory competition.

Regulatory competition
After a series of ECJ decisions the law relating to the mobility of companies in the EU has remained unaltered for a few years since the decision in Cartesio C-210/06. The position currently is that companies have freedom of establishment anywhere in the EU. States are to treat companies establishing in their State equally unless there are genuine reasons, such as public policy, not to.

The importance of this is that where a company establishes itself, the laws of that State will govern the company. States adopt two different theories as to what binds the company to its State's national laws. Real Seat Theory requires companies to have their headquarters and place of incorporation in the same States. Incorporation Theory insists that the place of incorporation will determine the applicable laws but does not require the headquarters to also be located in the State.

As such, when a company has tried to move its seat of incorporation or headquarters questions as to whether a State can restrict the movement of the company have arisen. The restrictions have been challenged as infringing freedom of establishment, however the ECJ has recognised the need to protect interested parties from companies wishing to move State and thus the applicable laws governing the company.

Currently, the ECJ allows restrictions for companies moving out of a State. A rationale behind this is shareholder and creditor protection.

The European Commission (EC) have previously discussed whether a Directive on jurisdictional mobility was necessary. However, in 2007 they concluded that it was not since there were already instruments in place to facilitate movement such as the European Company and cross-border mergers. They also expected that the ECJ would further extend its decision from Cartesio. Whilst the former is true, the latter is unlikely to happen. The ECJ are not in a position to lay out a system of protection for shareholders and creditors to facilitate easier mobility. They can effectively, only have a binary approach that either restrictions are allowed or they are not. The ECJ seems to have firmly settled on the former and it should be a matter for the EC to develop a clear system for mobility if they wish to prevent restrictions on movement.

Even if the EC adopts measures to facilitate easier movement, it is likely only to serve as a real benefit for larger companies. Again, practical problems such as culture, judicial attitudes and language may serve as barriers to movement for SMEs.

SMEs
The European Private Company (Societas Privata Europaea SPE) although not agreed to after three years demonstrates the EC's desire to broaden its scope of regulation to assist SMEs in Europe. Certain reforms seem to focus on creditor protection. As SMEs can be more susceptible to default, insolvency or liquidation organisations and practitioners will need to be aware of any proposed changes.

The failure to agree to the SPE however leaves this area as to how the EC shall proceed a bit unclear. Its likely aim is to be similar to that of its approach to large public companies of reducing transaction costs and facilitating trade in Europe.

The European Company Model Act
The European Company Model Act is a current project being undertaken by academics. It sets out as an alternative to the current approach taken by the EC to regulate corporate law. The Model Act is only advisory with the aim of setting a "European standard", which they hope States will implement giving it binding force.

I for one am very sceptical about how successful this will be. The group's rhetoric, that States will find it difficult to deviate from a European standard, goes against years of contrary evidence and the failure of States to agree on a variety of issues. Deviation may not necessarily be for better or worse but States are still likely to do so, if given the freedom, based on their national interests.

Furthermore, since it will not replace any of the existing framework it is only going to serve as another element to the regulatory jigsaw that is ECL. In fact it is likely to result in 27 new pieces as States may choose to adopt the Act to varying degrees. It also brings it back to practical problems faced by the EU, which such a Model Act will not address. Even if all 27 States adopt the Act, different cultures and judicial attitudes may result in different national interpretations and application leaving ECL no better off in terms of understanding it.

Conclusion
ECL has certainly come a long way. After a series of reforms, further harmonisation dropped off with States failing to agree. However, Armour and Ringe have recently highlighted the the economic crisis in the West has given ECL a much needed boost with a rush of reform activity.

It is difficult to see what is going to happen in the future but it is likely that the EC will continue its aims of facilitating growth and reducing transactions costs. This author certainly believes the EC will make efforts to assist SMEs. But reform elsewhere may be difficult as national interests in some States, probably most notably in the UK, may make uniformity in how to proceed difficult as States may be reluctant to concede powers that are not in the national interest of the State. The UK's veto on a new Treaty and Fiscal Treaty goes to show that it may be difficult under the current regime to further improve ECL. As business becomes more global it is likely that more uniformity in EU will be needed to compete with States such as America and China. Reform may just be a question of when rather than if.