The expression corporate group is not specifically
defined in Australia's Corporations Act but a corporate group is
generally regarded in Australia as consisting of a holding company
and all of its subsidiary companies.
There are many reasons a company may wish to establish one or
more subsidiaries. One reason might be to reduce exposure to its
assets. The principle of limited liability, subject to those
exceptions when the legislature or the Courts are prepared to lift
the corporate veil, ensures that the assets of the parent are
protected from liability incurred by the subsidiary.
The recent Special Commission of Inquiry in New South Wales into
various matters concerning the James Hardie Group of companies
highlights the significance of the corporate group. The Special
Commission examined among other things, the restructuring of the
James Hardie Group in 2001 and the cancelling of certain partly
paid shares in 2003. Two former subsidiaries of the group now do
not have enough assets to meet anticipated asbestos-related
compensation claims.
Some of the submissions made to the Special Commission concerned
the fact that company law in Australia may fail to provide adequate
remedies to those seeking compensation from the corporate group for
the activities of one of its insufficiently capitalized
subsidiaries. At the time of writing, the Special Commissioner, D F
Jackson QC, had not delivered his report.
Background facts
From about 1937 to 1987, the James Hardie Group operated in the
building products industry in Australia and overseas. James Hardie
Industries Limited (Industries) was at that time the holding
company of the group. James Hardie and Coy Pty Limited (Coy) and
Jsekarb Pty Limited (Jsekarb), two wholly owned subsidiaries of
Industries during that period, were engaged in making and selling
certain products containing asbestos.
Claims have been made against Coy and Jsekarb by people who had
contracted asbestos-related diseases as a result of exposure to the
asbestos made and sold by those companies. The volume of these
claims intensified during the 1980s.
In February 2001, the James Hardie Group restructured. A
company, known as Medical Research and Compensation Foundation (the
Foundation), was established as the trustee of "a charitable
private fund for the purposes of medical research into
asbestos-related diseases". Coy and Jsekarb were separated from the
rest of the James Hardie Group and became known as Amaca and Amaba
respectively. They ceased to be subsidiaries of Industries and
became subsidiaries instead of the Foundation.
Amaca and Amaba were left with assets of A$293 million, to meet
the costs of current and future asbestos-related claims. In
consideration for Industries topping up the then current net assets
of Coy and Jsekarb, Amaca and Amaba agreed not to sue and to
indemnify Industries in relation to any such claims. In August
2001, a scheme of arrangement under section 411 of the Corporations
Act was approved by the Supreme Court of New South Wales, whereby
the control of the remaining companies in the James Hardie Group
was effectively moved to James Hardie Industries NV (JHINV),
established in the Netherlands, which became the holding company of
Industries. As part of the scheme, shareholders in Industries
swapped their shares for shares in JHINV. Industries later changed
its name to ABN 60 Pty Limited (ABN 60).
Under the scheme of arrangement, partly paid shares in ABN 60
were created and held by JHINV. The nature of partly paid shares is
such that the unpaid amount can be called up as needed, for
example, to pay creditors should there be a threatened insolvency
or shortfall in the assets. ABN 60 cancelled the partly paid shares
at JHINV's request in 2003.
In late October 2003, Amaca and Amaba published their 2002/2003
financial statements, which revealed that, on then current
actuarial estimates, Amaca and Amaba had a shortfall of assets to
meet future asbestos-related liabilities of over A$800 million.
In February 2004, after some media attention to this estimated
shortfall, Jackson was appointed under the Special Commissions of
Inquiry Act 1983 (NSW) to inquire into, and report on, a number of
matters including the adequacy of current arrangements available to
the Foundation under the Corporations Act to assist it to manage
its liabilities, and whether reform of the law was desirable.
The issues
A number of fundamental issues were raised before the Special
Commission. Some of those issues challenged the ability of the
existing law to provide a remedy that would protect future
claimants from the lack of resources after the restructuring of the
James Hardie Group.
More specifically, those issues included:
- Could the corporate veil that stood between Amaca and Amaba
on the one hand, and ABN 60 on the other hand, be lifted?
- Could the partly paid shares be reinstated? In that regard,
a question that arose for Jackson was: "What is the duty of the
directors of ABN 60, when confronted with the transaction to
cancel the partly paid shares, given they were aware that the
transaction was to the advantage of JHINV?"
Lifting the corporate veil
Traditionally under the law in Australia, if a company commits a
tort, it is the company and not its shareholders or its controllers
that is liable. This is because, at law, the company is a separate
legal entity from its shareholders and the personal liability of
shareholders is limited to the amount of their shares. How then
were the claims made, or to be made, by asbestos sufferers to be
successfully directed against ABN 60 (or JHINV) rather than against
Amaca and Amaba? One way, contended for by the Foundation and
others, in which the protection of limited liability might be
denied to industries given the way it managed its business, is by
the courts or parliament find it appropriate to lift the corporate
veil.
In Briggs v James Hardie & Co Pty Ltd, Justice Rogers
expressed the view that different considerations should apply when
deciding whether to lift the corporate veil in tort cases compared
to actions such as in contract. Recent Australian research by the
Centre for Corporate Law and Securities Regulation has found that
in the 1990s about 16% of the applications made to the courts to
lift the corporate veil were successful. When those applications
were made in the context of prejudice to tort creditors, about 40%
of cases were successful. It should be said, however, that the
sample size of the research was small and the applications were
mainly brought by small proprietary companies.
In Australia, the prospect of an argument to lift the corporate
veil succeeding is impossible to predict confidently. Many reasons
have been put forward for this, including:
- the separate legal entity doctrine is not only a
fundamental legal principle but it is also a commercial
expectation and is entrenched within commercial investment
practice;
- making a parent company liable for the liabilities of a
group company would commercially weaken the central economic
foundation for other group companies;
- lifting the corporate veil may give rise to increased
litigation, particularly against larger corporate groups;
and
- the common law can accommodate the interests of individual
justice if justified by the circumstances of a particular
case.
The Foundation argued that the general tort rules for corporate
groups should be changed to rely on specific "see through"
liability legislation, which would "lift the corporate veil and
impose direct liability on the holding or other group companies for
negligence or other tortious acts of a specific group company where
this was considered necessary in the public interest".
The James Hardie Group submitted to the Special Commission that
there was no legal basis for piercing the corporate veil or holding
ABN 60 or JHINV directly liable for the activities of Amaca or
Amaba. That submission is consistent with the final report on
corporate groups of the Australian Companies and Securities
Advisory Committee (CASAC), issued in May 2000, which considered
the appropriateness of introducing a general tort liability for
parent companies of corporate groups, but concluded such liability
is undesirable as it would undermine the separate legal entity
principle unless dealt with by specific legislation. However, as
the directors of ABN 60 also contended that they were entitled,
both under the company's constitution and under the Corporations
Act, to take into consideration, and to act in, the best interests
of the parent company, it remains to be seen whether Jackson will
go further than CASAC and recommend specific legislative reform in
this area of the law. Any such reform would no doubt be
controversial, its precise nature uncertain, and might take some
time to carry out.
The cancellation of the partly paid shares
In March 2003, ABN 60, by resolution of its directors, cancelled
the partly paid shares that had been issued to JHINV as part of the
2001 restructure.
One of the questions considered by the Special Commission was
whether the directors of ABN 60 acted consistently with their
duties of care and diligence/good faith in resolving to cancel
those shares. That question involved consideration as to what
extent, if at all, the directors of ABN 60 are able to act in the
best interests of the parent, JHINV, before they might fall into
breach of their fiduciary obligations to ABN 60.
The effect of the cancellation of the partly paid shares was to
prevent them from being able to have access to the funds which
would have been raised by ABN 60 calling for payment of the partly
paid shares, to satisfy any judgment that the asbestos sufferers
might obtain against ABN 60.
The Foundation alleged that the duties of the ABN 60 directors
included a duty to act bona fide in the best interests of
ABN 60, to use their powers for proper purposes and to avoid a
conflict of interest, all standard duties of directors of
Australian companies. The Foundation further alleged that by voting
in favour of the cancellation of the partly paid shares, the
directors were in breach of their fiduciary obligations to ABN 60
because such a step could not reasonably be supposed to be in the
best interests of ABN 60, but rather was solely an advantage for
JHINV.
In making the allegation the Foundation submitted that the
directors of ABN 60 were aware that the actuarial advice, at the
time of the cancellation, was that the original funding was
unlikely to be enough and that the Foundation was seeking
additional funding. Given that awareness, the Foundation alleged
that it was likely that a claim would be made against ABN 60,
perhaps by the Foundation, perhaps by asbestos sufferers directly,
being a claim which, at some point in time, ABN 60 would be unable
to meet. In those circumstances, alleged the Foundation, the
prudent director would have either asked JHINV to pay the likely
amount of such claims or to indemnify ABN 60, before agreeing to
cancel the partly paid shares.
Against this, however, the evidence of the directors was that,
at the time of the cancellation of the shares, each of them
considered that they were free to make and did make their own
decision. Further, the Corporations Act allows the ABN 60
directors, where the constitution of the company is appropriately
drafted as it was here, to make decisions that are in JHINV's
interests. The directors argued that this meant that they were to
be taken to have acted in good faith and in the best interests of
ABN 60 even though their decision was in the interests of the
parent, in circumstances where ABN 60 was not at the time insolvent
and did not become insolvent because of the cancellation of the
partly paid shares.
Put another way, the issue for the directors of ABN 60 was
whether they should be considered to be in breach of their duties
for not having had regard to claims that might, in the future, be
brought, not against ABN 60, but against its former subsidiaries,
being claims not only not yet made, but also in relation to damage
not yet suffered. On the other hand, the Foundation contended that
such claims would be made, that damage had been, and would continue
to be, suffered and that the former subsidiaries would be unable to
pay those claims when they were made.
It is unrealistic to require directors to ignore the group
structure within which their company operates, but the better
approach might be to review a director's decision by an objective
standard of benefit to the separate entities.
In that regard, as was said by Pennycuick J in Charterbridge
Corps Ltd v Lloyds Bank Ltd, one might apply the following
test, whether "an intelligent and honest man in the position of [an
ABN 60] director, could, in the whole of the existing
circumstances, have reasonably believed that the transactions [that
is, the decision to cancel the partly paid shares] were for the
benefit of the company".
Awaiting Jackson's decision
The report of the Special Commission of Inquiry has not yet been
published. It will need to deal with the difficulties, created for
the asbestos sufferers by the undercapitalization of Amaca and
Amaba and it will need to address the tension between, on the one
hand, traditional company law principles (the separate legal entity
doctrine) and, on the other hand, commercial reality and the need
for transparency, accountability and fairness by corporate groups
in their dealings with those that suffer loss in their dealings
with an individual group member.
The duties of the directors of group subsidiaries, and to whom
they owe their loyalty, as well as the prevalence of rigid legal,
but perhaps commercially dubious, distinctions between different
group companies may well prompt Jackson to recommend reform of
current company law in the form of specific legislation as
advocated by the Foundation.
Jackson's recommendations are likely to be of significance in
the evolution of the law as it applies to corporate groups in
Australia. It will be interesting to see whether those
recommendations are for the wholesale abandonment of the principle
of limited liability in a corporate group context, whether there is
a carve-out from the principle of limited liability only in those
circumstances when the subsidiary is engaged in socially fragile
activities, or whether, like CASAC, Jackson recommends against
changing the existing laws for the commercial reasons discussed in
this article.
Author
biographies
John Elliott
Clayton Utz
Partner John Elliott has had extensive experience over many
years advising boards and senior management of public companies. He
regularly advises on the duties of directors of public companies in
complex commercial transactions and situations and has extensive
experience in dealing with government and other regulatory bodies
in Australia.
As a partner in the firm's mergers and acquisitions practice,
John has a strong record in mergers and acquisitions, specifically
in the sector of the securities industry concerned with public
company shares, takeovers, corporate acquisitions and
restructuring, and company law generally.
John has been involved in some of Australia's largest and most
complex takeovers, including Cable & Wireless' sell-down of its
majority shareholding in C&W Optus (leading to the A$17 billion
($20.8 billion) takeover offer by SingTel), Advance Bank's merger
with St George Bank, BHP's bid for Tubemakers, Campbell Soup's bid
for Arnotts, BTR Nylex's takeover of ACI International, Coca-Cola
Amatil's takeover of Neverfail Springwater, Stockland Group's
takeover of the AMP Diversified Property Trust, Boral's bid for
Adelaide Brighton, MP Global's bid for Anaconda Nickel and numerous
gold sector takeovers by Harmony Gold Mining
Company.
Dean Jordan
Clayton Utz
Partner Dean Jordan specializes in complex corporate and tax
litigation and compliance matters. He has a wealth of litigation
experience running major litigation, often as lead advocate, both
in the higher State and Federal Courts in Australia as well as in
the Administrative Appeals Tribunal. He works closely with our
taxation and corporate advisory teams on the litigious aspects of
their matters.
He has also advised many clients as to their regulatory
obligations under Chapter 7 of the Corporations Act, the Australian
Securities and Investments Act and the Superannuation Industry
(Supervision) Act and their respective regulations.
Before re-joining the firm in 2000 (Dean was a partner with the
firm from 1990 to 1998), he was special counsel at the Australian
Securities and Investments Commission (ASIC) responsible for high
level advice and advocacy. Dean represented ASIC in many matters
before the Federal Court of Australia, the Supreme Courts of New
South Wales and Victoria, the AAT, the Companies Auditors and
Liquidators Disciplinary Board, as well as acting as a delegate of
the Commission.
Clayton Utz
Sydney
Levels 19 - 35
No 1 O'Connell Street
Sydney NSW 2000
Australia
Tel: +61 2 9353 4000
Fax: +61 2 8220 6700
Melbourne
Levels 17-19
333 Collins Street
Melbourne VIC 3000
Australia
Tel: +61 3 9286 6000
Fax: +61 3 9629 8488
Web: www.claytonutz.com