‘Enterprise liability’ for entities of a group?

Allowing creditors of one member of a corporate group to pierce horizontally to reach the assets of other members

Belgian private law is traditionally very distrustful of asset partitioning in the shape of both owner shielding and entity shielding. It has inherited from the 19th century French doctrine (Aubry & Rau) the idea that: (i) only persons have an estate; and (ii) every person has only one estate. An ‘estate’ (‘vermogen’ / ‘patrimoine’) is a pool of assets which serves as collateral for a pool of liabilities. Accordingly, the traditional théorie du patrimoine entails that a person cannot have separate pools of assets which serve as collateral for separate pools of liabilities. This theory betrays a strong distrust of asset partitioning, both internal and external.

In the beginning of the 19th century the rule ‘one person, one and only one estate’ was generally understood as referring to natural persons. The incorporation of legal persons, particularly of legal persons with owner shielding (limited liability), was exceptional and restricted. It was limited to certain types of activities and subject to governmental authorization. As a result, the 19th century doctrine of ‘one person, one and only one estate’, while at face value barely modified, presently has completely different practical consequences. Presently a natural person can easily incorporate, control and benefit from, one or more legal persons.

This raises the important question: Why is the traditional animus against asset partitioning not an issue, or less so,  in case the technique of the corporate form with legal personality is used to bring about such asset partitioning?One of the featueres which explain the liberal approach towards the corporate form is the presence of  ‘corporate creditors’.  Corporate asset partitioning creates a bundle of rights in the estate of the shareholders which serves as collateral for their personal creditors. At the same time the corporate form results in a separate estate with its own creditors, who have priority over the personal creditors. (Technically more correct: corporate creditors are the only creditors who can seize the corporate assets and mandatory rules, such as distribution constraints, limit transfers to shareholders unless the rights of corporate creditors are satisfied or reasonably safeguarded.)

Priority for corporate creditors is a relatively recent feature

For a modern reader, the presence of corporate creditors and their priority over personal creditors is such a self-evident feature that it might seem silly to mention it as a defining characteristic of the corporate form. Yet taking a historical perspective it becomes clear that it was a feature which took time to develop.

The centre of the Napoleontic legislator’s attention were the internal relations among the shareholders themselves; not the external relations between the entity and third parties (including the creditors). This contractual myopia is before anything else revealed by the name given to the relevant title in the Code civil (“on the contract of company”) and its position between other agreements such as the lease and the loan. During the 19th century, the classical French treatises on civil law continued to discuss the partnership and the corporation as part of the “minor contracts” (les petits contrats).

In the same vein, the provisions in the Code civil on the company display a startling disregard for the position of the creditors and the effects of asset partitioning. This disregard is most vividly demonstrated by the lack of any provision (i) on the claims of the entity creditors on the entity assets; (ii) on the claims of personal creditors on the entity assets prior to dissolution; (iii) on the liquidation of the entity (other than one laconic reference in art. 1872 C.c. to the rules on partitioning of the jointly owned inheritancesn which themselves ignored joint creditors).

Criteria for attribution of liability

While today the presence and priority of entity creditors is no longer an issue – at least in corporate forms with legal personality – Belgian law still has not fully settled which creditors qualify as corporate creditors. The rules which attribute claims to corporate entities and/or directors, shareholders or other insiders are an important (and again often underestimated) part of organizational law.

For voluntary creditors (such as contractual creditors) the rules are fairly clear, as the rules of agency are used. A contractual liability is attributed to the company if an agent acted (i) in name of the company and (ii) with authority to bind the company. The main development of the last decades is that third parties can to a large extent disregard any internal limits to the authority of corporate agents if such limits are not part of normal practice with regard to representation (see in particular the First Company Law Directive and the jurisprudence on apparent authority).

The attribution of claims by involuntary creditors (such as tort victims) to a corporate entity was one of the hotly debated issues in 19th century law. While it is fully settled that a corporate entity can be liable for torts (including for damages and penalties resulting from crimes), legal authors still debate which criteria should be used to attribute torts to companies. This seems to be a topic which is more of an issue in legal doctrine and less of an issue in case law.

An important step was taken in 1999 on the occasion of the introduction of criminal liability for corporate entities (including non-profit entities and partnerships without legal personality). At that time a statutory criterion for the attribution of crimes was inserted in article 5 al. 1 of the Belgian Criminal Code: “A legal person is criminally liable for crimes which are intrinsically linked with the pursuing of the objectives of the legal person or the safeguarding of its interests or which are, based on the particular circumstances, perpetrated on account of the legal person”.

We argue that this criterion for the attribution of crimes should be used, and in practice is being used by courts, for the attribution of other kinds of torts. (This results in an attribution criterion for torts not unlike the one in the Dutch “Kleuterschool Babbel”-case: HR 6 april 1979, NJ 1980/34.)

A striking difference between the attribution of liabilities towards voluntary and involuntary creditors is the use of a formal criterion (‘in the name of the legal entity’) versus a substantive criterion (‘on account of the legal entity’). Such a difference is justified. Voluntary creditors can in principle choose whether or not they accept the company as their creditor. If they do not like the outcome of a formal attribution criterion, they can refuse to contract, change the conditions of the contract or bargain for additional contract partners (e.g. through guarantees by shareholders or directors). A distinction must be made in this respect between voluntary / voluntary creditors (with effective bargaining power) and involuntary / voluntary creditors, being creditors who conclude contracts with the company but have no real bargaining power in doing so. While both types of creditors are voluntary creditors, the latter category is only so from a theoretical point of view. Involuntary / voluntary creditors are entitled to special protection.

Another striking difference is that the attribution of a tort liability to a legal entity does not exclude the attribution of liability for the same activity to another legal entity or to physical persons within the organization involved with the activity. Contract liability, on the other hand, lies only with the entities or persons identified as contract party in the agreement. It does not, at least not automatically, extend to legal entities which benefit from the contract or to physical persons involved as agents in negotiating, consenting to or performing the agreement.

The seeds of entreprise liability in a Belgian group

The traditional analysis of entity shielding and limited liability focuses on a legal entity with one business and many shareholders. The reality however is different: arguably the most important business form is the corporate group. The corporate group has one business with many legal entities; most of the entities will only have one shareholder (if not formally, then at least in substance). This ‘interal asset partitioning’ (see H. Hansmann and R. Squire, External and Internal Asset Partitioning: Corporations and Their Subsidiaries) affects the creditors of the group. Voluntary creditors – at least in theory – can anticipate this when contracting with entities of the group. Involuntary creditors have to undergo it without the possibility to withhold consent.

One answer to this problem is “entreprise liability”.  This remedy, using the words of Hansmann and Squire, “allows the creditor of one member of a corporate group to
pierce horizontally to reach the assets of other members.”

Belgian tort law holds the seeds of such entreprise liabiliy. The substantive nature of the criterion to attribute torts implies that tort liability has de-partitioning features. The attribution of torts follows the economic reality, not necessarily the way that reality has been structured through legal entities.

The criterion for attribution holds the possibility of a type of enterprise liability in practice. This will never amount to an automatic tort liability merely by virtue of being part of a group. Such an automatic tort liability would go against the very idea of asset partitioning.

But in an integrated group it is possible to argue that an activity which wrongfully caused damages can be attributed to several entities of the group because it is intrinsically linked with the pursuing of the objectives of all the entities or the safeguarding of their interests or are perpetrated on their account based on the particular circumstance. The mere fact that formal elements associated with the tort point at one legal entity (e.g. as the employer of the employees involved or as owner of the assets involved), is not sufficient to get other legal entities off the hook.

Joeri Vananroye

Asset partitioning (limited liability and entity shielding) is the subject of the annual meeting of the Netherlands Association for Comparative and International Insolvency Law on 15 November 2018 in Amsterdam. The topic is:  Limits to Group Structures and Asset Partitioning in Insolvency. Contributors are prof. R. Squire (Fordham University, New York), prof. J. Vananroye (University Leuven), A. van Hoe (University Antwerpen), Dr. Gillis Lindemans (University Leuven), prof. F.M.J. Verstijlen and A. Karapetian (University Groningen) and A.L. Jonkers Univer(sity of Amsterdam).

Author: Joeri Vananroye

Professor of economic analysis of law (KU Leuven), attorney (Quinz)

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