Parent Companies Are Not Parents, Subsidiaries Are Not Children

A recent judgment of the England and Wales Court of Appeal addressed important jurisdictional questions in relation to a parent company’s liability for damages caused by its subsidiaries. The court did not rule on the merits of the claim; rather, it analysed the preliminary issue of whether UK courts have jurisdiction to hear such claims. In determining whether there is jurisdiction, however, the English court did have to examine substantive law issues. This makes the case of great interest to parent company liability, and, as parent company liability overlaps with supply chain liability, also to the latter.

In most of continental Europe, parents are vicariously liable for torts committed by their children – in Belgium, this is known as ‘qualitative’ liability, since being a parent is sufficient to incur liability. Liability of parent companies for their subsidiaries, however, has not been conceived like the vicarious liability of parents. Because the relationship between a parent company and its subsidiary is fundamentally different from the relationship between a parent and a child. There is no a priori reason to assume that a subsidiary cannot do everything its parent can do. It has its own management, and may be better equipped to run operations overseas than its parent. Despite the obvious differences, claimants seem to have been inspired by parental vicarious liability when they argue cases against parent companies for conduct of their subsidiaries.

The UK court judgment discussed in this blog post is a case in point. The first part of this post provides a general introduction to theories of parent company liability. I then turn to the appellate court’s reasoning in dismissing the case. Reviewing both the majority and dissenting opinion, I analyse the ‘test’ to determine whether a ‘duty of care’ exists. In the third part, I discuss the policy considerations of the appellate court’s ruling. Fourth, based on this analysis, I assess under which conditions a parent company can be held liable and attempt to identify those factors that will mitigate against parent company liability.

1. Theories of parent company liability

Under the rule of limited liability, the liability of the shareholders of a company is limited to their contribution to the company’s share capital (i.e. the capital which they have contributed or agreed to contribute). The concept of limited liability applies also to a company that holds (all of) the shares of another company. Limited liability is a “fundamental principle of corporate law” and is generally deemed to be necessary to create incentives for investments in corporations. Limited liability does not create problems as far as voluntary creditors of the corporation are concerned – they are able to protect themselves against the corporation’s potential insolvency before the fact.

There are exceptions to the rule of limited liability, however. Shareholders can be jointly or severally liable – with all of their assets – for their companies’ debts, if they engage in wrongdoing or fraud that results in their company causing damage or avoiding payments, or if they abuse the company’s limited liability for private gain. This type of liability is often referred to as “piercing the corporate veil,” and is generally accepted as a justified exception to the rule of limited liability. Where required, a parent company may have to back up its subsidiary’s obligations – in the Netherlands, for example, a parent company can voluntarily declare itself liable for the debts of its subsidiary (a so-called “403-declaration”). Problems arise where a corporation’s creditors are involuntary tort victims.

To provide relief to such extra-contractual creditors, there is support for additional and broader exceptions to the rule of limited liability. Academics have argued in favour of unlimited liability of parent companies for tort liability of their subsidiaries. NGO’s advocate for broad, unqualified parent company liability for damage caused by their subsidiaries.  At least one legislature has been willing to effectively do away with limited liability in the case of parent companies.  General parent company liability has been implemented in Albania through article 208 of the Law on Entrepreneurs and Companies. Reflecting the concept of ‘enterprise liability,’ this law stipulates that a “parent company” stands surety for both the contractual and extra-contractual claims of the creditors of its “subsidiaries,” if the parent has the right to appoint at least 30 percent of one of the subsidiary’s governing bodies or has at least 30 percent of votes at the General Meeting.

These exceptions to limited liability go beyond the traditional grounds for veil piercing. In many cases arising in this area, there is not necessarily any ‘veil piercing’ involved – rather, the claims are based on direct liability of the parent company. The parent is liable due to its failure to properly control the subsidiary’s conduct so as to avoid the damage. In other words, under the new parent company liability theory, the focus is on the parent company obligations in relation to the creditors of its subsidiary. Irrespective of the subsidiary’s liability, direct liability of the parent company entails an independent duty of care of the parent company – no ‘veil piercing’ is necessary.

Recent court cases raised this issue of direct parent liability – under which conditions does a parent company have a duty of care under tort law vis-à-vis the victims of damage caused by their subsidiaries? In Okpabi et al v Royal Dutch Shell (“RDS”), the England and Wales Court of Appeal issued a judgment that illustrates well how one should conceive of direct parent company liability. Mr. Okpabi et al. sought damages from RDS for environmental damage caused by leaks of oil from pipelines operated by Shell’s Nigerian subsidiary (“SPDC”) in the Niger Delta. In first instance and on appeal, the UK courts dismissed the case based on lack of jurisdiction. In doing so, however, the courts analysed the substance of the claims, focusing on RDS’ control over its Nigerian subsidiary and its duty of care in that regard. Simultaneous with the English case, similar claims against Shell were brought before the Dutch courts. In 2017, The Hague Court of Appeal ruled the claims admissible. After the English court’s ruling, however, the Dutch case looks less promising.

2. Duty of care-test

In first instance, the court did not find jurisdiction and thus rejected the case. The claimants, including Mr. Okpabi, appealed the judgment. As noted, although the courts ruled only on jurisdiction, they had to engage the merits of the claims against RDS because that is what the test to determine the court’s jurisdiction requires. Pursuant to Article 3.1 (3) of Practice Direction 6B of the Civil Procedure Rules, for the court to have jurisdiction, there must be “a real issue” between the claimant and the defendant that is “reasonable for the court to try”. The existence of “a real issue” is construed as a “realistic prospect of succeeding on the merits” of the claim. Since the claims against RDS were based on negligence, and negligence implies breach of a duty of care, the key question for the court’s jurisdictional analysis was whether RDS had an arguable, relevant duty of care – in other words, there should be a colourable argument to the effect that RDS breached its duty of care vis-à-vis the claimants.

Following the landmark ruling in Caparo v Dickman, the courts applied a three-step test to establish whether RDS has a duty of care vis-à-vis the plaintiffs:

(1) the duty of care must relate to a harm that is reasonably capable of being foreseen;

(2) it must concern a ‘relationship of proximity’ or ‘neighbourhood’ between the plaintiff and defendant; and

(3) the attachment of liability for harm occurred must be ‘just and reasonable’.

The first prong was met: since oil spills had occurred regularly in the past, the damage resulting from these spills was found to be foreseeable – this was not contested by RDS. While the court in first instance paid considerable attention to the third prong, the court discussed it only briefly, finding the claimants’ arguments unpersuasive (see below). The appellate court’s focus came to lay on the second requirement of “proximity”.

Proximity

To determine whether there was a relation of proximity between RDS and the claimants, the courts noted that there is little precedent from which guidance could be gained. The only tort case they cited, in which a parent company was found liable, is Chandler v Cape plc. The case involved a parent company’s employment of a medical officer to oversee the health and safety of the employees of its subsidiary, who were exposed to asbestos. By employing a medical officer responsible for monitoring the subsidiary’s employees, the parent company assumed responsibility for the health of the employees of its subsidiary. Proximity in this case seemed rather straightforward, and the court found a duty of care. In Thompson v Renwick plc, however, the Court of Appeal found that a parent cannot be held to have assumed a duty of care to employees of its subsidiary in health and safety matters “by virtue of that parent company having appointed an individual as director of its subsidiary company with responsibility for health and safety matters.” The reason was that the defendant parent company was a holding company and did not at any time carry on any business at all apart from that of holding shares in other companies.

(i) Formal tests of proximity 

Given the scarcity of precedence, the appellate court in Okpabi et al v Royal Dutch Shell relied chiefly on “common sense and practicality.” In contrast, the court in first instance had focused heavily on formalities of corporate law to reject the necessary “proximity”. It noted, first, that RDS “was not a direct parent of SPDC, in the sense that it did not hold shares in SPDC; and nor did it conduct operations itself, in contrast to the position of the defendant in Chandler v. Cape Plc.” As Justice Simon writing the majority opinion for the Court of Appeal stresses, this point seems relevant only in terms of differentiating the present case from precedent case law – Justice Simon “would accept the facts of the Chandler case with the parent directly engaging someone to address the relevant risk strongly favoured a relationship of proximity in contrast with the present case.” According to Simon, shareholdership is not of importance to establishing proximity; rather, one must look at the day-to-day operations.

The second formal consideration of the court of first instance centred on the directors: “the executive officers of RDS (the CEO and CFO) who sat on Executive Committee (‘ExCo’) were in a minority”. Justice Simon discounts this point as well, since “ExCo carried out functions on behalf of RDS”, meaning ExCo functions under RDS’s control regardless of the composition of its board. Once again, according to the Court of Appeal, the corporate formality is not unrelated to the reality.

A third factor to which the court of first instance gave weight, related to authority to conduct operations. As this court observed accurately, RDS was not itself permitted to carry out operations in Nigeria, and was not a party to the joint venture agreement, pursuant to which the operations were carried out. Again, the Court of Appeal was unimpressed and notes that the fact that RDS was not authorized to operate pipelines on Nigerian soil does not mean it did in fact refrain from doing so.

With the fourth factor the court of first instance considered the policy implications of finding a duty of care. Specifically, the court considered that imposing a duty of care on RDS would potentially impose “liability in an indeterminate amount, for an indeterminate time, to an indeterminate class”, citing Cardozo CJ in Ultramares Corporation v. Touche. This argument received favourable reception by the Court of Appeal. The court reasoned that a parent company would become liable for damage unlawfully caused by its subsidiaries around the world, since “much of the claimants’ argument was designed to show that the Shell Group imposed a wide-ranging degree of direction from the centre.” As Justice Simon put it, this argument “proved too much, in the sense that what it in fact showed was standardisation of policies and practices across all the operations and in all the countries in which the Shell Group operated.”

(ii) Substantive tests of proximity

Thus, the Court of Appeal did not endorse a formal approach to determining “proximity”. Rather, the appellate court opined that as a prerequisite to establishing the necessary level of “proximity”, RDS must be shown to have either (i) assumed responsibility for the relevant aspect of the business of their subsidiary (i.e. the operation of oil pipelines), or (ii) exercised a sufficient degree of control over the operations of the subsidiary.

• With respect to the first test, according to the claimants, the imposition by RDS of mandatory policies, standards and manuals regarding the safe operation of pipelines on its subsidiaries established the requisite ‘proximity.’ To the extent these requirements were mandatory, Justice Simon argued, they were mandatory across all Shell subsidiaries – there was no indication of specific control of or responsibility for the Nigerian subsidiary. In emphasizing the uniform application of these policies, the court of appeal thus suggested that a showing of a particular divergence or discrepancy from the safety requirements in relation to the Nigerian subsidiary would have had more relevance.
• With respect to the second test, the claimants’ argued that the systems of supervision and guidance in implementing RDS’s standards testify to RDS’ control over the subsidiaries’ operations. The appellate court rejected this reasoning since it found that “the concern was to ensure that there were proper controls and not to exercise control.” In other words, RDS’ policies did not result in RDS taking over the operation of its subsidiaries’ operations; they merely ensured that the subsidiaries exercised control in accordance with the policies. Furthermore, the appellate court reasoned, insofar as RDS’ policies were mandatory for its subsidiaries, “this is hardly surprising since it affected Shell’s general reputation.” It is only fair to expect a company to care about its reputation abroad and thus to make sure its guidelines are followed.

Dissenting from the majority, Justice Sales took a different approach to establish a duty of care of a parent company. First, he determined that RDS’ subsidiary had a duty of care vis-à-vis the claimants according to the Chandler test under English law. He then argued that because of the likely proximity due to practical control of management or generalized joint control, this duty of care may be imputed to RDS as the parent company. The majority rejected Justice Sales’ analysis, however, because no sufficient degree of control had been established, as discussed above.

Fair and reasonable

Since the Court of Appeal had already concluded that the proximity test was not met, it quickly disposed of the claimants’ reasoning regarding the “fair and reasonable” requirement. The claimants argued that it is fair, just and reasonable to impose a duty of care on RDS in the present circumstances on several grounds.

First, they asserted it is important to make sure multinational enterprises comply with international standards such as Corporate Social Responsibility (“CSR”). As the appellate judge Simons points out, however, this is true as an “abstract principle”, but a “doubtful” basis for imposing a duty of care. Indeed, subject to a few exceptions, international CSR standards are set out in non-binding soft-law instruments.

Further, they argued that it would be fair, as there is “only limited enforcement of environmental regulations in Nigeria.” Justice Simon does not engage this point specifically, but finds the argument as a whole unpersuasive.

Lastly, the claimants contended that because RDS makes “billions of pounds of profit” from its subsidiary’s operations, it is neither unreasonable nor unfair to impose a duty of care on RDS. Justice Simons characterizes this reasoning as assuming that which must be proven.

Policy considerations

The judgment of the court in Okapi raises two sorts of policy considerations. First, there is the issue of parent company liability’s effect on the behaviour of corporations. Second, parent company liability has an influence on corporate headquarter or holding company location decisions.

In relation to the incentives for corporations, it should be noted that the proximity requirement as construed by the Court of Appeal is entirely a function of decisions made by the parent company. The parent company can decide not to implement specific policies and standards, and not to take control of or intervene with its subsidiary’s operations abroad. As Justice Simon suggests in the majority opinion, this presents a risk of counter-productive judicial decisions. If courts were to impose liability in cases like Okpabi et al. v Royal Dutch Shell, this would mean that companies without strong, centrally-directed corporate management programs would not risk liability, but responsible companies with excellent prevention programs would be exposed to liability. Thus, imposing parent company liability for damage caused by their subsidiaries based on strong corporate programs would create perverse incentives for a parent company to adopt a hands-off approach.

In terms of the attractiveness of the country for corporate investment, the judges may have had parent company liability’s potential adverse effects in the back of their minds. Needless to say, imposing parent company liability in these kinds of cases would render the UK less attractive for companies to establish their headquarters or holding companies. Of course, if companies were to pull out of the UK, this would negatively impact the UK economy. While judges rarely explicitly discuss these kinds of effects, we should not assume that they have no influence on their decisions.

4. Indicators of potential parent company liability

In the Okpabi judgment, the court, although it does not develop a full framework, gives some useful indicators of potential parent company liability. As the analysis above suggests, there is balancing involved and companies need to walk the line between responsible management of their subsidiaries and taking control of their operations resulting in liability exposure. Based on the court’s dicta, the following indicators would appear to be relevant:

• In principle, a parent company may design and implement corporate programs and policies applicable to its subsidiaries without incurring liability.
• Such programs and policies are best presented as guidance, even though ignoring such guidance may have consequences at some point. To the extent policies are mandatory, this might increase the risk of liability exposure, depending also on how the policies are actually enforced.
• The scope of corporate policies should be defined objectively, and apply generally to all subsidiaries that fall within their scope. Where corporate policies are not applied to a subsidiary’s operations, such decisions should be objectively justified. If policies are not applied without adequate justification, the liability risk increases. For example, if RDS had a corporate policy that all pipelines must be protected by fences, and decided that this policy should not be applied by its Nigerian subsidiary, this would harm its case.
• To avoid parent company liability, corporate policies should be aimed at pushing subsidiaries to exercise adequate control over their subsidiaries, not at taking control over subsidiaries’ operations. The latter, of course, increases a parent company’s liability risk. Avoiding operational, in particular day-to-day, control is key.
• If a parent company controls the operations of its subsidiary, e.g. because it serves as the subsidiary’s director, this might increase its liability exposure – in the form of director’s liability. Overlap in membership of the board, however, will not have much weight in analysing the liability risk. Likewise, other formal indicators, such as a parent company holding all shares, even if it behaves like a controlling shareholder (rather than like a director of officer), will not have significant impact on the risk of liability for its subsidiary’s torts.
• Compliance with corporate formalities may help to avoid the impression of a parent company assuming actual operational control. However, the reality of actual operational control prevails over mere formalities.
• Conduct “consistent with international standards, including those relating to corporate social responsibility and oil production” is a “doubtful foundation for the imposition of a duty of care”. To the contrary, in some cases, compliance with international standards can help mitigate parent company liability.
• It is fine to make profit. The profits struck up by the parent company from its subsidiary do not affect the parent company’s exposure to liability.

The English court’s judgment thus helps parent companies to identify factors that may reduce or increase their exposure to liability for damages caused by their subsidiaries.

5. Conclusion

The Okpabi judgment of the England and Wales Court of Appeal is another milestone in the evolution of parent company liability and, thus, supply chain liability. Because the court had a keen eye for the broader implications of its ruling, it stayed clear of finding RDS liable for the environmental damage caused by its Nigerian subsidiary. Incidentally, the court identified factors that are relevant to the design and implementation of centrally-directed corporate programs and policies applicable to subsidiaries.  Going forward, actual operational control, rather than formal factors, are likely to dominate the analysis of a parent company’s potential liability.

Unlike the English Court of Appeal, the Dutch courts apply a lighter test to find jurisdiction. The UK Court of Appeal’s judgment, however, will make it harder for the Dutch courts to rule in favour of the plaintiffs on the merits for two reasons. First, if RDS does not owe a duty of care to this class of claimants under English law, Dutch tort law is less likely to impose such a duty. Second, the Dutch government just abolished the dividend tax to please corporate groups such as Shell and keep them headquartered in The Netherlands. If the courts now impose onerous, group-wide tort liabilities, there will be a huge disincentive to stay in The Netherlands, despite the tax benefit.

In any event, it will be a while before parent company liability will be settled in Western Europe. In Okpabi, the Court of Appeal has given a strong signal that England will not lead the way in opening up new avenues to get into the ‘deep pockets’ of parent companies to address harms around the world.

Penelope Bergkamp
Student Master of Laws, KU Leuven