Rules finally address corporate group control

Author: | Published: 24 May 2005
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A new set of corporate rules, enacted under Legislative Decree No 6 of January 17 2003, came into force on January 1 2004.

Among the goals achieved by the reform, the statutory gap concerning corporate groups has been filled, an issue that had been ignored under the previous legal framework.

The new statutory provisions aim to create transparent group management and balance the interests of holding and controlled companies. Rules have been laid down that finally acknowledge the importance of corporate groups and address the main issues raised by the exercise of corporate governance at a group level.

Corporate groups pre-reform

Before the reform, the law dealing with corporate group structures was limited to banking groups and controlling relationships between corporate entities.

The banking regulation, aimed at enhancing the effectiveness of the Bank of Italy's supervision, has a limited scope and provides no guidelines for non-banking groups.

Meanwhile, the legal notion of corporate control does not cover the whole range of group relationships. Section 2359 of the Italian Civil Code (the Code) only maintains that control is regarded to occur when either: (i) a company holds the majority of the voting rights at the ordinary shareholders' meeting of another company; or (ii) a company holds voting rights at the shareholders' meeting of another company, such as to exercise a dominating influence; or (iii) a company is able to exercise such influence by virtue of a contractual relationship (such as the influence enjoyed by credit institutions financing the business of a company, or by the company's main suppliers).

Holding company liability pre-reform

The notion of control, although recalled under several provisions, has not traditionally been recognized as sufficient grounds to infer the liability of the controlling entity for the damages incurred/generated by the companies controlled by a single group management.

At a statutory level, the liability of the controlling entity's directors was only provided for under Section 90 of Legislative Decree No 270 of July 8 1999 (governing the insolvency of large corporations) in the event of insolvency of the controlled companies. This liability was conditional upon evidence of: (i) a single direction (that is, a single managing power exercised throughout the group); and (ii) an abuse of that power, to be assessed on a case-by-case basis. The controlling company could not be held liable for the existence of a dominant influence in itself, as provided under Section 2359 of the Code.

Potential solutions to the issue of holding company's liability have been developed by case law but without enough clear-cut direction about which actions are considered unlawful. On one hand, certain courts maintain that liability should operate as a general principle, not limited to the insolvency of the controlled entity. On the other hand, abuse of single group direction/management has normally been excluded on the basis of the benefits enjoyed by the controlled entities as a consequence of their link with the group, which would offset the disadvantages caused by the holding's actions, (the theory of offsetting benefits).

Corporate groups post-reform

Although no specific definition of corporate groups has been provided, the reform has finally set out principles that should encourage intra-group governance to achieve sound group management and transparency.

Under Sections 2497 and following of the Code, a specific liability of entities (holding companies) with directing and coordinating powers over other companies (directed companies) for damages incurred/generated by the latter is expressly maintained.

Strict publicity requirements must be fulfilled, aimed at ensuring third parties' knowledge of the group's structure.

The reform has also introduced a specific right of withdrawal for minority shareholders of directed companies and has provided for the ranking of intra-group financings.

Liability of holdings post-reform

Under the new Section 2497, paragraph 1, of the Code:

"Companies or legal entities which - in carrying out direction or coordination activities on other companies - act in the interests of their own or third parties' business, in breach of the principle of correct corporate management, are directly liable: (i) vis-à-vis the shareholders of the directed/coordinated companies, for the damages occurred to the profitability and value of their shareholding; and (ii) vis-à-vis the creditors of the same companies, for the damages occurred to the integrity of the corporate assets."

Direction and coordination activities

The liability of holding companies relies on the concept of direction and coordination, which is not further defined.

Italian case law and scholars had typically identified single direction (direzione unitaria) as the management of the group as a whole, where a constant flow of instructions is provided to downstream entities concerning corporate management, account policies and business counterparties' choice. Accordingly, coordination is regarded as a specific means of implementing a single direction by creating links between the management of all the group entities.

Clearly, the notion of direction and coordination does not coincide with that of control. Although, with control there is always direction, the absence of control does not preclude carrying out directing activities. In this respect, under new Section 2497 sexies of the Code, legal entities, either controlling other companies pursuant to Section 2359 of the Code, or bound to accounting consolidation, are legally regarded as directing and coordinating the controlled/consolidated companies, unless they provide evidence to the contrary.

Sound corporate management

The performance of direction and coordination activities is not regarded as unlawful in itself. Following case law, the lawfulness of centralized group management is now recognized at a statutory level, under the assumption that the holding aims to pursue the whole group's interests. So a specific breach by the holding company of the principle of sound corporate management is required to trigger its liability.

The assessment of whether correct management principles have been complied with will be carried out on a case-by-case basis, focusing on the balance between the potentially conflicting interests of the holding and the directed companies.

Entities entitled to action and underlying interests

To be entitled to bring action against the holding, shareholders and creditors of the directed companies must prove that the holding's directing and coordinating powers caused damage to the following interests:

The shareholders' interest to keep the profitability and value of their shareholdings. To be indemnified, shareholders should show that another strategy would have been possible that would have had a less prejudicial impact on their interests.

The interest of the creditors in the integrity of the corporate assets. For the purposes of obtaining compensation for the relevant damages, the creditors should bring evidence that the residual assets of the directed company, after the losses incurred under the management of the holding company, are not enough for the purposes of their repayment.

Shareholders and creditors may not claim damages against the holding company unless they have first claimed them against the directed company.

Actual damage

For the holding company to be held liable, the existence of actual damage is essential.

Under Section 2497, paragraph 1, of the Code:

"In the light of the overall outcome of the direction and coordination activity, the liability of the holding company is excluded if no damage occurs, or such damage is entirely removed/eliminated, including by means of transactions targeted to such purpose."

Clearly, the absence of actual damage excludes any possible liability of the holding. Further, assessment will probably be carried out based on the theory of offsetting benefits, where the prejudicial impact of the holding company's decisions may eventually be offset by the benefits arising from the directed companies' participation in the group structure (such as easier access to financing, participation in cash pooling agreements, and the possibility to share services within the group, as well as to exploit scale economies).

On these grounds, scholars further maintain that the damage relating to a directed company should be compensated at a whole group level, that is, having regard to the overall results achieved by the group. These results should be assessed on the grounds of the plans implemented by all the group companies.

The reasons given by both the holding and the directed companies, as to the final aims of their respective business initiatives, represent a key element of the assessment. In this respect, under the new Section 2494 ter of the Code, corporate resolutions of directed companies, where influenced by the holding company, must be analytically motivated, providing specific reference to the reasons and interests that have influenced the resolution. Consequently, extra attention must be paid to accurate drafting of the minutes.

Other liable persons

As well as the holding comany's liability, Section 2497, paragraph 2, of the Code also provides for the joint and several liability of "any legal entity or individual participating in the damaging action, as well as, any such person which has consciously enjoyed some benefit arising therefrom, within the limits of such benefits".

Unlike the general liability under Section 2497, paragraph 1, individuals can incur liability arising under this last rule of law. This could allow an extension of liability to non-corporate holdings that would otherwise enjoy an unjustified exemption.

Moreover, based on paragraph 2 above, liability may be also charged on the shareholders and creditors of the holding that have required or authorized the implementation of group strategies that were detrimental to the directed companies, and on the holding's shareholders that enjoyed a dividend distribution or an increase in the value of their shareholding because of an abuse of the holding company's ability to provide direction.


The minority shareholders of the directed companies may also have a right of withdrawal if the holding carries out directing and coordinating activities. In particular, minority shareholders are entitled to withdraw when: (i) a resolution of the holding company changes the corporate purpose of the directed company; (ii) a court finds the holding company liable pursuant to Section 2497 of the Code; or (iii) the directing and coordinating activities that modify the risks connected to minority participations in unlisted directed companies commence or end.

Shareholders' financings

Lastly, the reform established that the credits arising from intra-group financings do not enjoy a pari passu ranking with the other credits claimed against the company. If the ratio between the financed company's net worth and indebtedness is widely unbalanced, or the financial situation of the financed company would have required a capital contribution instead of a financing: (i) such financings may be reimbursed only upon full repayment of any other credit claimed against the company, with priority only in respect of the reimbursement of the corporate capital to the shareholders; and (ii) if the financing has been reimbursed in the year before the adjudication in bankruptcy of the financed company, the whole amount must be returned by the financing entity.