Dispute resolution

Liability creep | Are the parents to blame?

Published on 1st Oct 2020

With corporate groups covering an increasingly diverse range of activities and geographies, 'liability creep' is becoming an important risk management consideration for corporates, as well as their shareholders and directors.

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Liability creep can arise in a number of ways. For example, there has been a trend in recent years of overseas claimants bringing mass tort claim proceedings in the English courts against UK parent companies for the actions of their foreign subsidiaries. "Economic torts" are also being used more and more in commercial disputes to seek to impose liability on shareholders, directors and parent companies, as a means of circumventing the "corporate veil".

Regulatory liabilities, along with 'follow on' claims, can also extend beyond the legal entity directly involved. That is because in some circumstances, for example, under competition law, little regard is paid to the distinct legal status of companies within a group structure, or the distinction between a business and its investor/shareholder.

We summarise below some of the risks that can arise and how they might be avoided or mitigated.

Mass tort claims

These claims are primarily claims for negligence in relation to the safety of employees or environmental claims by local residents affected by the business operations. Overseas claimants often wish to bring claims in England, rather than in their jurisdiction of domicile, where for a variety of reasons they may consider that there is no real prospect of recovering significant damages.

The Supreme Court in Vedanta Resources v Lungowe emphasised that there are no special principles for establishing parent company liability for the conduct of a subsidiary; the usual test of foreseeability, proximity and reasonableness applies.

As a result, the legal separation of companies in itself is not enough to avoid parent company liability – or at least the realistic prospect of it, which can be enough to enable the claimants to pursue their claim in the English courts.

The crucial question is whether the parent had sufficiently intervened in the management of the subsidiary to have assumed a duty of care to the claimants. In essence, a parent company is at greater risk of owing a duty of care where it is closely involved with the management of its subsidiary's business (or purports to be). Imposing group-wide policies on subsidiaries and taking active steps to ensure that those policies are implemented can increase the risk that such a duty exists.

However, the risk of liability being imposed has to be carefully balanced against the corporate governance interest to implement policies and practices in overseas subsidiaries in order to prevent acts that may give rise to a claim in the first place. Group-wide policies and reporting can also play an important part in ensuring that core business values are being upheld across the group's global footprint.

Economic tort claims

The tort claims of procuring a breach of contract, conspiracy to cause injury and unlawful interference are being used more and more in commercial disputes as a means of circumventing the 'corporate veil'.

These sorts of claims often arise where a trading subsidiary is unable to pay its debts or refuses to comply with a contractual obligation and the contractual counterparty or lender wants to seek recourse from a parent company, director or shareholder.

In practice, problems arise for businesses because the nature of competition is that decisions are often made which will cause detriment to someone else. Simply causing harm will not be enough to give rise to a claim. But if there is use of some unlawful means (which might include a breach of contract), combined with a sufficient degree of intention, a claim may arise.

A particular area which may raise risks is where a group's finances or assets are ordered in a way that might impact on third parties. A refusal to fund a subsidiary will not amount to the tort of procuring or inducing a breach of contract, but deliberately dissipating the subsidiary's funds might.

The risk of attracting liability can be minimised by recording the rationale behind a decision taken by a parent company or shareholder that might impact on the ability of the company/subsidiary to fulfil its contractual commitments. The appropriate corporate decision-making structure should be followed and individuals in one company should avoid having direct control over the decisions of another group entity.

Where contracts are entered into with third parties, it is important to make clear on which company's behalf the person signing the contract is acting. Furthermore, shareholders exercising control should do so by way of shareholder resolutions rather than by acting as de facto directors.

Regulatory liabilities

Regulators are increasingly able to target their actions at the top of the corporate structure. Competition law, for example, pays little regard to the distinct legal status of companies within a group structure, or the distinction between a business and its investor/shareholder. Under competition law, group companies and/or shareholders can be treated as being part of the same undertaking where they form a 'single economic unit'. Accordingly, where one company commits a competition law offence, there is a risk that closely connected group companies will be held jointly and severally responsible for the infringement.

Fines may well be determined by reference to the turnover of the company fined, which incentivises regulatory authorities to pursue the largest company in the undertaking. Private damages claimants are also likely to pursue the legal entity with the deepest pockets.

In determining this, it is now settled in case law that where a parent company exercises "decisive influence" over the conduct of its subsidiary, the two entities constitute a single undertaking. They may thus be held jointly and severally liable for the antitrust violation in question and the imposed fine.

Furthermore, there is a rebuttable presumption that a parent company exercises decisive influence over the conduct of wholly-owned subsidiary, and that subsidiary's own wholly-owned subsidiaries. There is no set proportion of shares that will trigger this presumption. This can be a difficult issue to determine in practice because to some degree shareholders always have some say in the management of a company via shareholder resolutions.

This approach by the European Commission may also be adopted in other areas of European law enforcement, in particular in relation to GPDR, which uses the same concepts of 'undertakings', 'single economic unit' and 'exercise of decisive influence'. This is important, as fines for non-compliance with the GDPR can be very hefty indeed, up to the higher of EUR 20 million or 4% of an undertaking's global annual turnover.

Bribery and corruption is another area where liabilities may spread throughout a group of companies, irrespective of precisely where the wrongdoing occurred. Under the Bribery Act, for example, a foreign subsidiary of a UK company can cause the parent company to become strictly liable when the subsidiary bribes someone for the benefit of the UK parent (although it will be a defence if the UK company had in place adequate procedures to prevent the subsidiary's misconduct).

Managing risks

A holistic approach to managing risks within corporate groups needs to take into account the potential for liabilities to creep up the corporate chain, and how those legal risks can be mitigated – and balance those considerations against the myriad ethical and reputational considerations.

This can be difficult to get right: in some contexts, less direct involvement of the parent company in the business of a shareholder is a safer way forward to avoid the risk of liability creep. But in other areas, such as bribery and corruption, parent companies increase the risk of liability if they do not play a sufficiently active role in the supervision of a subsidiary's business. And with ethical, social and governance factors increasingly important for investors, customers and other stakeholders, the reputational implications of getting it wrong can be important as the legal risks.

All too often though, the risks of liability creep are not properly understood or managed because of a siloed approach to risk and compliance. In a world of increasingly active regulators and more group/class action litigation, a joined up approach is essential.

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* This article is current as of the date of its publication and does not necessarily reflect the present state of the law or relevant regulation.

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