30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 23 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA: A RESPONSE TO THE JAMES HARDIE CONTROVERSY James McConvill* I ABSTRACT In September 2004, a major report into Australia's largest products manufacturer James Hardie's controversial corporate restructuring was handed down by Commissioner David Jackson QC. In the report the Commissioner gave a detailed account of the events leading up to James Hardie's restructuring and movement of corporate headquarters to The Netherlands, and the potential impact this has on victims of asbestos-related diseases caused by James Hardie's once subsidiary companies. One of the implications of the corporate restructuring was that the new holding company in the James Hardie corporate group was shielded from any litigation taken out against the subsidiary companies by asbestos victims due to the establishment of a fund, the Medical Research and Compensation Foundation. This was completely separated from the James Hardie Group. In the report, the Commissioner did not engage in much consideration as to how corporate law in Australia could be reformed to make a holding company liable for the debts of its subsidiary companies resulting from death or personal injury, yet potential law reform has certainly drawn the attention of a number of commentators both before and after the report was handed down. What the majority of commentators, including Counsel Assisting the James Hardie Inquiry, have suggested is that limited liability (a cornerstone principle of corporate law) should be restricted so that a holding company (often the only shareholder of a subsidiary company) will be held liable for subsidiary company liabilities resulting from personal injury or death. According to the author, the broad call for reform to `restrict the limited liability principle' in response to the report into James Hardie's restructuring is misguided and troubling. Limited liability is an important privilege bestowed on shareholders, both large and small, and should only be restricted when there is an overriding justification for doing so. While an obvious effect of subjecting holding companies to liability for debts of its subsidiaries is to restrict the application of limited liability to holding companies (as the largest shareholder in the subsidiary), law reform can achieve * Lecturer-in-Law, Deakin University. 23 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 24 (2005) 7 UNDALR this effect without undermining the general operation of limited liability. In this article, the author suggests that the response to the James Hardie controversy should be more measured, focusing on the specific problems which occurred with James Hardie, and (keeping this in mind) in constructing a law reform proposal designed to achieve the commonly accepted objective in the aftermath of the James Hardie controversy. This is, implementing corporate law reform so that holding companies can be liable for tortious claims resulting from negligent acts or omissions of subsidiary companies when the subsidiary is unable to pay. II INTRODUCTION A Overview Australia's approach to the regulation of corporate groups has been of interest to scholars and practitioners of corporation law worldwide, including in the United States.1 The regulation of corporate groups, and in particular the issue of holding company liability for subsidiary company debts, resurfaced as one of the most reported topics in Australian newspapers and journals during 2004 as a result of controversial corporate restructure carried out by James Hardie Ltd, a large products manufacturer, in 2001. James Hardie established a new parent company in The Netherlands, ostensibly to take advantage of favourable tax laws. However as part of this restructuring it merged two of its subsidiary companies into a new entity, the Medical Research and Compensation Foundation (`MRCF'), with a view to providing compensation to asbestos victims, and completely separating compensation claims from the James Hardie group. Approximately $A300 million was allocated to the fund to provide compensation to victims of asbestos-related diseases, however it soon became apparent that the asbestos claims would well and truly exceed the $300 million allocated. By early 2004, it was clear that a crisis had emerged ­ it was by then estimated that the total amount of compensation to be paid to asbestos victims could in fact draw close to $A2 billion. Accordingly, by setting up a new entity which was completely separated from the James Hardie group to be responsible for asbestos claims resulting from the negligence of its subsidiaries, with such a large shortfall, the James Hardie group would avoid liability, leaving asbestos victims short-changed, unless something was done 1 See, eg, Ian Ramsay, `Allocating Liability in Corporate Groups: An Australian Perspective' (1999) 13 Connecticut Journal of International Law 329; and to a lesser extent Steven R Ratner, `Corporations and Human Rights: A Theory of Legal Responsibility' (2001) 111 Yale Law Journal 443.; David B Noakes, `Reform to the Law of Corporate Groups in Australia to Protect Employees' (2000) 34 The University of British Columbia Law Review 239. 24 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 25 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA about it. In early 2004 due to the emerging crisis facing the MRCF and asbestos victims, the New South Wales Government in Australia set up a Special Commission of Inquiry, chaired by David Jackson QC, to put on the record; how the crisis developed, who was responsible, what went wrong and why. The Commission was established with a view to determine whether imposing liability on the ultimate holding company of James Hardie was an appropriate and reasonable course of action to take. Millions of dollars were spent examining the factual matrix involved in James Hardie's restructuring over a number of months in 2004, with a final report handed down by Commissioner David Jackson in September 2004. Importantly, over 90 per cent of the report gave a detailed account of events leading up, and subsequent to, the establishment of the MRCF and move of corporate headquarters to The Netherlands. In his report, David Jackson QC briefly touched upon possible options/situations in which whereby the holding company could be made liable for the extensive shortfall in compensation, but did not go further and actually propose any models, leaving this to be subsequently debated by governments and commentators. Both prior, and in response, to the Commissioner's report in September 2004, a number of possible options for reform were raised. This included the possible establishment of a statutory fund to compensate asbestos victims, and also reform to principles of negligence to make it clear that in some circumstances holding companies and/or their directors can be held liable for the negligent acts or omissions of subsidiary companies. The main call for reform, which emerged in response to the problems associated with James Hardie's corporate restructuring, was to restrict the application of the limited liability principle to holding companies. The general consensus, amongst commentators pushing for such reform, was that where personal injury or death is caused by a subsidiary company whilst part of a corporate group, there should be a `lifting' of the corporate veil so that liability can be sheeted home to the holding company. This was considered to be a particularly useful reform, considering such circumstances like that of James Hardie and the MRCF. Where the entity responsible for the negligence claim no longer has the funds to meet the claim, the victim in a particular case will lose out. Unless the veil of the company can be lifted to attach liability to the entity which was the major shareholder at the time when the negligent act or omission occurred, the holding company. The wide-ranging calls for `restricting limited liability' were the impetus for my decision to comment on the James Hardie controversy by way of this article. In my view, the principle of limited liability, an important 25 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 26 (2005) 7 UNDALR privilege bestowed upon shareholders, should only be restricted if there is a clear justification for doing so based upon public policy. It is argued in this article that focusing directly on limited liability in the case of James Hardie, and similar scenarios, is unnecessary and undesirable. The same objective can be achieved without directly attacking limited liability. B Purpose of this Article In this article, I will construct and explain a corporate law reform initiative which specifically responds to the James Hardie corporate restructuring, and is designed to meet the present objective in corporate law in Australia of enabling liability to be directed to holding companies for claims imposed when a entity was a subsidiary company at the time that the negligent act or omission occurred. Importantly, my proposal has also been designed to attach liability to a holding company (or what I will later refer to as the `controlling entity') for claims against a subsidiary company (what I will later refer to as the `controlled entity') even if, as occurred with James Hardie, subsequent to the negligent act or omission that company has been completely separated from the corporate group and is thus not a subsidiary company when the debt is `incurred'. I outline a case for amending s 588V-W of the Corporations Act 2001 (Cth) (`Corporations Act'), so that a subsidiary company, or a company which has assumed the liabilities of a subsidiary company, is deemed to incur a debt if it becomes liable for tortious damages or a criminal fine. The effect of this small, but significant, amendment is that in particular circumstances what is essentially the holding company could become liable if the subsidiary company is under funded and cannot afford to pay the debt when the debt is incurred (which will be defined to be the point in time in which the amount is liquidated). As already mentioned, my reform proposal also involves a technical amendment to s 588V to change who is potentially liable from a `holding company' to a `controlling entity'. The change is subtle but again important, for reasons, which will be explored later. As will be explained in the article, the key benefit of my proposal to amend s 588V of the Corporations Act is that it provides an avenue for liability to be imposed on holding companies in a corporate group, including James Hardie in relation to the impending shortfall of funds in MRCF (notwithstanding, as discussed below, that James Hardie reached an agreement to compensate asbestos victims in the short term), without directly undermining the principle of limited liability. A fundamentally important aspect of my proposal is that liability will not be imposed on companies simply as a result of being substantial shareholders in a subsidiary company within a group. Instead liability will be imposed on the basis that the company exerted control over the 26 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 27 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA controlled entity at the time when the negligent act occurred, and on that basis the controlling entity should accept some responsibility if the controlled entity is not in a position to meet tortious claims.2 Again, this difference in approach will be explored in the article. What is also important to make clear at this point is that in constructing a corporate law reform proposal to impose liability on a holding company in particular circumstances, but in a way which does not directly undermine the operation of the limited liability principle, there are some difficulties which confront the proposal. This is particularly the case where a controlled entity is responsible for a `latent' asbestosrelated disease which is discovered, and a claim made in relation to it, after the controlled entity has been wound up. The special nature of asbestos-related diseases, and how the special nature of such diseases may limit the operation of my proposal, will also be explored. C What this Article Does Not Do The purpose of this article is to outline and justify one possible reform initiative which responds to the recent call in Australia for the law to facilitate liability being imposed on holding companies for the debts of its subsidiaries arising from personal injury or death. I expect that the analysis and reform initiative provided in this article will also be of interest to readers in other jurisdictions confronting the issue of how to effectively impose liability in complex corporate group arrangements. The proposal for reform which will be outlined in this article has been designed to deal with the particular issues and difficulties arising from James Hardie's corporate restructuring, and for similar scenarios which occur in the future. This is done, however, in a manner which does not directly undermine the application of the limited liability principle, given the importance of limited liability as a privilege belonging to shareholders (a point which will be expanded upon). Given the difficulties for asbestos victims resulting from James Hardie's restructuring, the scope of this article could have been far more wideranging. Exploring the desirability of the operation of limited liability and separate entity doctrine in the context of corporate groups, the rationale for corporate groups, and the potential for reform in areas 2 3 This basis for imposing liability on the holding company (or `controlling entity'), that is where the holding company clearly shares some responsibility for the subsidiary company's misfortune, rules out other commonly raised reform proposals, such as being able to impose US-style contribution or pooling orders. See in particular the report of the Companies and Securities Advisory Committee, Corporate Groups Final Report (2000), which the reader is referred to gain a better understanding on the nature of corporate groups, the issues in relation to limited liability and separate entity doctrine applied in a group context, and the different 27 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 28 (2005) 7 UNDALR outside corporate law. However, I believe that these issues have been dealt with in sufficient detail in other forums,3 and I leave it to other commentators to explore other possibilities for reform in response to the James Hardie controversy. D Structure of Article The structure of this article is as follows. Part III provides a background report on the James Hardie controversy, looking at; the James Hardie restructuring and the impact this has had on present and future asbestos claimants, the Special Commission of Inquiry examining the James Hardie controversy, and the findings of Commissioner Jackson. Part IV focuses on the calls for corporate law reform both during and after the Special Commission's proceedings, and more specifically the calls to restrict the principle of limited liability in the context of corporate groups. I provide a critical analysis of this suggested approach to law reform. In Part V, I set out in detail and then justify a proposal for law reform, involving changes to s 588V-X of the Corporations Act. I also respond to inevitable arguments that could be made against the proposal. It is explained that the key strength of the proposal is that it is a moderate and balanced response to the problems which arose with James Hardie and which could reoccur in the future. Most importantly it would fulfil the objectives underlying the recent calls for reform, but without directly undermining the principle of limited liability. III BACKGROUND REPORT ON THE JAMES HARDIE CONTROVERSY A The James Hardie Restructuring The significance of asbestos in Australian society, and the dominance of James Hardie as a products manufacturer, certainly gave the problems involving James Hardie and the embattled MRCF particular prominence in Australia. As Commissioner Jackson noted in his report: Asbestos was used in Australia during a large part of the last century in the manufacture of building products (particularly sheeting and roofing), pipes, insulation materials, brake linings and other friction products, and 4 possibilities for reform so that creditors of subsidiary companies can potentially turn to the holding company for payment. The report also includes a rich source of academic references on these issues. The CASAC report is available on-line at http://www.camac.gov.au/camac/camac.nsf/byHeadline/PDFFinal+Reports+2000/ $file/Corporate_Groups,_May_2000.pdf. See D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical Research and Compensation Foundation', (2004) [2.1]. The report is available on-line 28 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 29 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA other materials. Asbestos, however, carries with it problems. Its fibres can give rise to asbestosis, lung cancer, asbestos-related pleural diseases and mesothelioma.4 A research note prepared by the Australian Parliamentary Library in 2004 provides a useful summary of the events involving James Hardie's restructuring and the impact this had on asbestos claims: Between 1937 and 1986 asbestos products were manufactured by two subsidiaries of James Hardie Industries Ltd (JHIL): now known as Amaca (building and construction products) and Amaba (brake linings). Between 1996 and 2001 the assets of Amaca and Amaba were transferred to JHIL (now `ABN 60') then to a Netherlands-based company- James Hardie Industries NV (JHI NV). In February 2001 ownership of Amaca and Amaba were transferred to a new body, the [MRCF], which was given $293 million to fund asbestos injury claims. In October 2001 the Hardie Group assured the NSW Supreme Court that ABN 60 could call on $1.9 billion owed by JHI NV for partly paid shares to meet future asbestos claims ... But in March 2000 ABN cancelled the partly paid shares without informing the court or the stock exchange.5 This separation, and the movement of Group funds away from the entity which assumed the asbestos liabilities, was the cause of the present problems. According to Commissioner Jackson's report, the primary reason given by James Hardie for this separation was to support Hardie's expansion in the more lucrative US market. `The principal purpose of separation was to enable the Group thereafter to obtain capital or loan funding or to use its own share capital for future acquisitions without the stigma of possible future asbestos liabilities.'6 Based on chapter three of the Commissioner's Report (`The Foundation's Present Financial Position'), at the time when the MRCF was set up in 2001, the assets transferred to the MRCF, from various sources, amounted to A$293.5 million. A question was whether the MRCF's financial position was likely to be sufficient to meet its future asbestos-related liabilities in the medium-to-long term. At 30 June 2004, net assets of the companies were A$179.2 million, with this amount since decreasing rapidly due to new asbestos related claims (approximately A$63 million). According to the Commissioner's report, the MRCF's funds were quickly being used to meet current claims, and it 5 6 7 at: See Peter Price, Jerome Davidson and Susan Dudley, `In the Shadow of the Corporate Veil: James Hardie and Asbestos Compensation', Australian Parliamentary Library Research Note No. 12, (2004-2005). Available on-line at: http://www.aph.gov.au/library/pubs/rn/2004-05/05rn12.htm. D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical Research and Compensation Foundation', (2004), [1.6]. D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical 29 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 30 (2005) 7 UNDALR was expected that the funds would be exhausted by the end of 2006 or early 2007, `with no prospect of meeting the liabilities of Amaca and Amaba in either the medium or the long term.'7 What needs to be emphasised very clearly, based on the above facts, is the MRCF's complete separation from the James Hardie Group. It could be presumed from media coverage talking of potential liability for `holding companies,' that the MRCF is a subsidiary within the James Hardie Group, or at least was at the time when the Special Commission of Inquiry was being conducted, and hence the veil should be pierced to impose liability on the holding company. That is an incorrect account of James Hardie's restructuring and the position of the MRCF. The MRCF has been completely separated from the James Hardie Group since 2001, and hence if limited liability were to be restricted in relation to the debts accrued by MRCF, it would not be the parent company in the James Hardie Group that would be subjected to liability. Why the issue of subjecting holding companies to the liabilities of its subsidiaries has come up in the context of James Hardie is not because the MRCF is a subsidiary of James Hardie's holding company now, even though the James Hardie Group were responsible for setting up the MRCF and hence could be said to have exerted some `control' of the MRCF within the meaning of the Corporations Act. Rather it is because the subsidiaries of James Hardie Industries, which were responsible for the manufacturing and use of asbestos-related products (Amaca and Amaba), were joined to become the MRCF. Hence, more precisely what is sought to be done is to impose liability on the holding company for claims resulting from negligent behaviour by companies which were subsidiaries at the time when the negligent act or omission occurred. It is important to understand this difference as it helps to clarify the extent of the difficulties involved in imposing liability on the James Hardie Group. This is due to the shortfall of funds in the MRCF, and does impact on the way in which reform of the Corporations Act should be approached. As will be discussed later, in October 2004, the New South Wales Government were seriously considering introducing general legislation which would have had the effect of unwinding the separation of asbestos-related liabilities from the James Hardie Group. There are specific problems with this approach to reform (which I will discuss later in this article), confirming that the statutory scheme approach is inferior compared to the author's proposed reforms to s 588V-W of the Act. B Establishment of a Special Commission of Inquiry In response to concerns about the impending shortfall in MRCF's 30 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 31 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA resources to compensate asbestos victims, and the impact that this would have on victims of asbestos-related illnesses, on 27 February 2004, following instructions of the NSW Premier, Bob Carr, the Governor of NSW signed letters patent establishing a Special Commission of Inquiry. David Jackson QC was appointed as Commissioner and instructed, by terms of reference, to report on the following matters: 1 The current financial position of the MRCF, and whether it is likely to meet its future asbestos related liabilities in the medium to long term; 2 The circumstances in which MRCF was separated from the James Hardie Group and whether this may have resulted in or contributed to a possible insufficiency of assets to meet its future asbestos related liability; 3 The circumstances in which any corporate reconstruction or asset transfers occurred within or in relation to the James Hardie Group prior to the separation of MRCF from the James Hardie Group to the extent that this may have affected the ability of MRCF to meet its current and future asbestos related liabilities; 4 The adequacy of current arrangements available to MRCF under the Corporations Act to assist MRCF to manage its liabilities, and whether reform is desirable to those arrangements to assist MRCF to manage its obligations to current and future claimants. The first two of the terms of reference are especially relevant for the purposes of this article, and in constructing a law reform proposal which responds to the special issues in James Hardie, as well as effectively dealing with future situations. The date for delivery of the interim report was originally set for 30 June 2004, but was later extended to 21 September 2004. C Commissioner Jackson's Findings Commissioner Jackson's highly publicised report, titled `Report of the Special Commission of Inquiry into the Medical Research and Compensation Foundation' was handed down on 21 September 2004. The first and most important (in particular for the purposes of this article) term of reference of the Jackson Inquiry, which was dealt with in the report, related to `the circumstances in which MRCF was separated from the James Hardie Group and whether this may have resulted in or contributed to a possible insufficiency of assets to meet its future asbestos-related liabilities.' Commissioner Jackson explained in the report that the restructuring of 31 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 32 (2005) 7 UNDALR the James Hardie Group and the separation of the asbestos-liable subsidiary companies from the Group was not illegal, and indeed was a valid arrangement by the company with a view to elevating its share price and attracting US capital. Commissioner Jackson did find, however, that the separation from the Group was a cause of the MRCF's present dilemma, and that on the facts the Group did bear some responsibility for this. According to Jackson, `I find it difficult to accept that management could really have believed that the fund of the Foundation would have been sufficient to enable it to pay all future legitimate asbestos-related claims against Amaca and Amaba.'8 Commissioner Jackson then stated later in the report: ... there was no legal obligation on JHIL to provide Amaca and Amaba, on separation, with any funds in addition to the assets of those companies. Amaca and Amaba were not stripped of assets; they retained them. Indeed they obtained more than those assets by reason of the additional periodic payments. ... But in practical terms, separation was, in my opinion, likely to have an effect of that kind. If separation had not taken place in February 2001, it seems likely that, for the indefinite future, the asbestos liabilities would have been treated, as they had been for years, as one of the annual expenses of the Group.9 D Historic Agreement Despite the fact that it was made clear in the Special Commissioner's report that James Hardie had no legal obligation to make up for the shortfall of funds in MRCF, the company was pressured to do so due to a sliding share price (as a result of community outrage and forecasts regarding the company's future), the implementation of government bans on the purchase of James Hardie products, as well as the threat of specific legislation being introduced to in effect unwind the company's 2001 restructure so that liability could be imposed on the parent company. Accordingly, over thirteen weeks following Commissioner Jackson handing down his report, James Hardie entered into negotiations with the New South Wales Government and the Australian Council of Trade Unions (`ACTU') to find a mutually satisfying way to resolve the impending funding crisis. The willingness of James Hardie to agree to negotiations was significant, given that the predominant reason for its move to The Netherlands in 2001 was to avoid having to fund the asbestos claims. On 21 December 2004, an agreement between James Hardie, the ACTU and the New South Wales Government was announced. The agreement 8 9 Research and Compensation Foundation', (2004), [1.4]. D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical Research and Compensation Foundation', (2004), [1.1.4]. D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical 32 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 33 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA detailed the way in which James Hardie would compensate asbestos victims for at least 40 years. James Hardie agreed to make annual payments to a special purpose fund, capped at 35 per cent of its free cash flow. Initially, James Hardie agreed to inject into the special purpose fund three years worth of funding (approximately A$240 million).10 The value of the agreement was estimated to be as high as A$4.5 billion.11 While the decision by James Hardie to negotiate a settlement obviously was designed with shareholder interests in mind, with the agreement seen as a way to improve the company's economic and share price performance (indeed, on the day of the announcement the company's share price rose by six per cent and a number of boycotts on James Hardie products were lifted), and it was in effect the lesser of two evils (the other option being specific legislation), commentators also emphasised that there was a moral element to the agreement. One commentator described the James Hardie episode as `One of Australia's most protracted and bitter fights for moral justice ended [by] James Hardie Industries signing the nation's largest compensation settlement, worth up to A$4.5 billion.'12 Indeed, James Hardie CEO Meredith Hellicar described the agreement as a `compassionate' outcome. Another commentator stated: This year's Special Commission found there was `no fundamental legal impediment' to what Hardie did before it moved offshore; divorce itself from subsidiaries that had manufactured building products and brake linings containing the deadly fibre. Hardie therefore gets some credit for negotiating a new funding deal and not relying on the letter of the law to try to avoid its moral responsibility. Only some, however, because it had next to no choice.13 James Hardie's agreement with the NSW Government and the ACTU was certainly historic, and provides some degree of comfort for asbestos victims. However, the agreement does not put to rest the need for legislative intention to deal with similar scenarios to James Hardie which may arise in the future. This was recognised by prominent corporate law experts (including Professor Jennifer Hill and Professor Ian Ramsay) at a panel discussion on James Hardie held at Sydney Law School in February Research and Compensation Foundation', (2004), [1.23]. 10 See Anthony Marx, `Accord Fires Up Hardie', The Australian, (Sydney) 22 December 2004. 11 See `James Hardie Signs Compo Deal', The Australian, (Sydney), 21 December 2004. 12 See Roz Alderton, Bianca Wordley and Kaaren Morrissey, `Hardie Agrees to $4.5bn Payout', The Age, (Melbourne) 22 December 2004. 13 Malcolm Maiden, `Cost of Asbestos Exposure Does Not End Here', The Age, (Melbourne) 22 December 2004. 14 See Fiona Buffini, `Call to Widen Company Liability', The Australian Financial 33 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 34 (2005) 7 UNDALR 2005 as part of the annual Corporate Law Teachers Conference.14 Indeed, it is submitted that legislative intervention in relation to the James Hardie controversy itself is still warranted to back up the agreement that has been reached. Also to provide even further certainty and comfort for victims by covering any `gaps' that may surface over time in the agreement, and to `strike while the iron is hot' in legislating to protect victims once the term of the historic agreement comes to an end. IV RESTRICTING THE PRINCIPLE OF LIMITED LIABILITY: LAW REFORM MOVEMENT IN AUSTRALIA IN RESPONSE TO THE JAMES HARDIE CONTROVERSY In this section, I discuss how restricting the application of limited liability to holding companies in relation to tortious claims against subsidiary companies was the major call for corporate law reform in Australia in response to the James Hardie controversy. I then explore some of the problems with approaching law reform in this way. Before engaging in this analysis, however, I first provide a brief explanation of limited liability, including a discussion why I consider the limited liability principle to be a fundamentally important shareholder right. A Explanation of Limited Liability In a recent article published in the Yale Law Journal, David A Skeel Jr, explained that limited liability means `that the shareholders of a corporation generally do not have any liability beyond the capital they have contributed to the corporation in return for their shares', and that limited liability is `the attribute most people associate with the corporate form.'15 Further, in his report into James Hardie's restructuring, Commissioner Jackson explained that: The principle of limited liability, that shareholders of a limited liability company are not personally liable, as shareholders for the debts of that company, except to the extent of any unpaid capital on their shares, was originally introduced by the Limited Liability Act 1855, which was soon replaced and incorporated into the Joint Stock Company Act 1856.16 In Australia, the limited liability principle is given practical effect under s 516 of the Corporations Act, as part of the provisions regulating the winding up of a company. Section 516 provides that: Review, (insert place of publication) 9 February 2005. 15 See David A Skeel Jr, `Corporate Anatomy Lessons' (2004) 113 Yale Law Journal 1519, 1525. 16 D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical 34 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 35 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA Subject to s 518 and s 519, if the company is a company limited by shares, a member need note contribute more than the amount (if any) unpaid on the shares in respect of which the member is liable as a present or past member. Limited liability is a consequence of the separate entity principle established in the much cited House of Lords decision of Salomon v Salomon & Co Ltd,17 that a company is a legal entity separate from its members. Limited liability and the separate entity principle are often considered to be interchangeable concepts, but this is not technically correct.18 The two concepts are given practical effect through two separate parts of the Act.19 The operation of exceptions to the separate entity principle (operating to `lift' the corporate veil) do not necessarily unwind the limited liability principle.20 What I wish to emphasise at this point is that rather than limited liability being purely a commercial device, it also operates as an important Research and Compensation Foundation', (2004), [1.51]. 17 [1897] AC 22, (`Saloman'). 18 See Annexure T to the D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical Research and Compensation Foundation', (2004), `The Concept of Limited Liability ­ Existing Law and Rationale', where Counsel Assisting the Commission explains that: The separate entity doctrine is not only a fundamental legal principle but a commercial expectation entrenched within commercial investment practice. Coupled with limited liability it stimulates investment. The revenue from such investment allows further research and development. See also H A J Ford, R P Austin and I M Ramsay, Ford's Principles of Corporations Law (11th ed, Sydney: Butterworths 2003), [4.160], where a good point is made as to why separate entity doctrine and limited liability cannot be considered interchangeable concepts: The separate entity doctrine does not itself import limited liability. It is still possible for a company to be registered as an unlimited company. But most companies are companies limited by shares in which each shareholder's liability is limited under the Corporations Act ss 514-529 to the amount they, or earlier holders of their shares, agreed to pay for the company for the issue of their shares. 19 The principle of limited liability is given practical effect by s 516 of the Corporations Act 2001 (Cth), under the winding up provisions of the Act, whereas the separate entity doctrine is given practical effect under s 124(1) of the Act, which provides the company with the capacity and powers of an individual and the powers of a body corporate, and s 119 which provides that, on registration, the company comes into existence as a body corporate. 20 See Susan Watson, `Who Hides Behind the Corporate Veil? Finding a Way out of "The Legal Quagmire"' (2002) 20 Company and Securities Law Journal 198, 201: [What] was the significance of Salomon? The first major point is that it did not in fact establish that shareholders have limited liability since the battle for limited liability had been won some 40 years earlier [in 1855 under the Limited Liability Act] ... In short, the case sets out the principle that a company is at law separate from its subsidiaries/members.' See also at 206 highlighting that there is a distinction between the two concepts: Of course, [the case of Williams v Natural Life Health Foods [1998] 1 WLR 830] ... is not (or should not be) a reference to limited liability. It is a reference to the fact that the director in carrying out the acts is separate at law from the 35 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 36 (2005) 7 UNDALR shareholder right, given that limited liability generates a number of privileges for shareholders. It is rarely the case that corporate law texts and commentaries label limited liability as a shareholder right, however the direction of corporate law and governance is shifting to give greater recognition to shareholder rights, and limited liability is beginning to be expressly recognised as a shareholder right. For example, in the Organisation for Economic Co-operation and Development's (`OECD') revised Principles of Corporate Governance21 released in April 2004, when discussing shareholder rights, limited liability is given centre stage: Equity investors have certain property rights. For example, an equity share in a publicly traded company can be bought, sold or transferred. An equity share also entitles the investor to participate in the profits of the corporation, with liability limited to the amount of the investment.22 Accordingly, with limited liability expressly and impliedly recognised as an important right which corporate law operates to provide shareholders, it is reasonable to expect that limited liability will be upheld and protected given the present `shareholder rights movement'.23 Indeed, I will discuss below that limited liability should only be restricted if there is a fundamental justification for doing so. The economic advantages associated with the operation of limited liability, raised by law and economics commentators, further emphasise the importance of limited liability as a privilege providing certain rights and benefits for shareholders. The most commonly cited work outlining the importance of limited liability to shareholders from an economic perspective is Easterbrook and Fischel, The Economic Structure of Corporate Law, liability: who cite the following advantages with limited · Limited liability reduces the need of shareholders to monitor their agents, such as directors and employees of the corporation; · Limited liability also reduces the cost of monitoring other shareholders; · Limited liability provides an incentive to managers to act in an efficient manner by promoting the free transfer of shares; company. 21 OECD Principles of Corporate Governance (revised ed, Pariscedex: OECD 2004). 22 OECD Principles of Corporate Governance (revised ed, Pariscedex: OECD 2004) 32. This publication is available on-line at: 23 For a discussion of the elevated place of shareholder rights shareholder participation in contemporary corporate governance, see Jean Du Plessis, James McConvill and Mirko Bagaric, Principles of Contemporary Corporate Governance (Sydney: Cambridge University Press 2005) Ch 14. 24 See Frank H Easterbrook and Daniel R Fischel, The Economic Structure of Corporate 36 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 37 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA · It is said that limited liability also allows for more efficient diversification by having a portfolio of investments in a number of companies; and finally, · Limited liability is seen as facilitating optimal investment decisions through the diversification of investment in a number of different corporate entities.24 B Limited Liability and Corporate Groups There is no precise statutory definition of `group' in the Corporations Act, however in High Court of Australia's decision in Walker v Wimborne,25, Mason J said: The word `group' is generally applied to a number of companies which are associated by common or interlocking shareholdings, allied to unified control or capacity to control assets and liabilities and meeting claims.26 Thus, in the context of corporate law, even in relation to corporate groups, each company remains a separate legal entity at law. The James Hardie controversy is an important recent example of the use of separate companies to avoid certain liabilities through the protection of the corporate veil for each company forming part of a group. While the MRCF was established with a view to being completely separate from the James Hardie Group, a discussion of corporate groups is still relevant as: · The companies responsible for the asbestos claims were group companies when they negligently used dangerous asbestos materials in their building and manufacturing ventures; · The usual situation is that the responsible subsidiary companies will still be part of the corporate group when the debts are incurred; and · While MRCF is completely separate from the James Hardie Group, James Hardie has some control over MRCF's operations in the sense that it can inject further funds where necessary to ensure the entity's continued solvency. Under a strict application of the Salomon principle, the reality of a Law (2nd ed London: Harvard: University Press 1996) 47-48, cited in Roman Tomasic, Jane Jackson and Robin Woellner, Corporations Law: Principles, Policy and Process (4th ed, Sydney: The Federation Press 2002) 141. 25 (1976) 3 ACLR 529 26 Walker v Wimborne (1976) 3 ACLR 529, 532. 27 As stated in the report of the Companies and Securities Advisory Committee Corporate Groups Final Report (2000), [1.48], In Australia, the corporate veil has been lifted if the corporate form has been used improperly, or if one company is the agent, trustee or partner of another company. However, control or domination of a subsidiary by a parent, or other forms of close economic integration within a corporate group, has not sufficed to 37 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 38 (2005) 7 UNDALR corporate group is not recognised, instead each company is recognised as a separate legal entity, and this can be taken advantage of by each company within the group. The use of a group structure is not a basis for `lifting' the corporate veil to restrict the application of limited liability.27 Indeed, one of the key reasons for setting up group structures, with a number of different companies operating within the group, is to take advantage of limited liability. In his report, Commissioner Jackson stated: `One of the rationales for a group structure is to lower the risk of legal liability by confining high liability risks, including environmental and consumer liability, to particular group companies, with a view to isolating the remaining group assets from this potential liability.'28 From my research, it is submitted that there are two main possibilities to approaching regulation of corporate groups: one way which respects justify disregarding the separate legal personality of each group company. 28 See D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical Research and Compensation Foundation', (2004), [1.8]. See also Annexure T to the Special Commission of Inquiry's report, where Counsel Assisting the Commission notes: The separate legal entity principle does not of itself `impose' limited liability. However, the formulation of the company as a separate entity capable of acquiring obligations separate from its members makes it possible for the members to derive the privilege of limited liability; limited in the sense that recourse by the company's creditors is only to the company's assets rather than the totality of the member's personal assets. Applied to corporate groups, the principle means that they can determine the size and choose the limits of their legal responsibility by the relatively simple mechanism of making one company a member of another company or companies in the group. (at 415) (emphasis added). 29 See Companies and Securities Advisory Committee Corporate Groups Final Report (2000), [1.44]: Each company in a corporate group is a separate legal entity with its own rights and duties, even when controlled or wholly-or-partly owned by another company and collectively engaged in the business of the group. This has various consequences including ... the debts incurred by each company are debts of that company, not of the controllers of that company or of the corporate group collectively. The assets of the group cannot be pooled to pay for these debts. It is stated in the CASAC's report on corporate groups that the separate entity approach involves three inter-related principles, originally developed for single companies, but subsequently applied to corporate groups, namely: (a) separate legal personality of each group company (corporate autonomy), (b) limited liability of shareholders of each group company, and (c) director's duties to the separate group company. 30 The Companies and Securities Advisory Committee Corporate Groups Final Report (2000),, provide the following explanation of the `enterprise entity approach' to the regulation of corporate groups: This approach recognises and attaches considerable legal significance to economic integration within a corporate group. In its pure form, it treats the corporate group as a unitary economic enterprise functioning to further the interests of the group as a whole, or those of its dormant corporate body.' Under 38 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 39 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA and upholds the principle of limited liability as an important consequence of separate legal personality (the `separate entity approach'),29 and one which recognises the reality of the group structure, so that it cannot be abused (the `single enterprise approach').30 In upholding and respecting the principle of limited liability, I prefer the separate entity approach. However, I also believe there are circumstances based purely on legal responsibility where some flexibility in the operation of the separate entity approach is required and that will be reflected in my approach to law reform outlined below. 1 Chorus for Reform post-James Hardie What needs to be made clear is that the specific objective commonly raised in response to the James Hardie controversy was to implement corporate law reform so that holding companies (and not just James Hardie) could be liable for subsidiary company debts arising from claims based on personal injury or death. The main impetus for this specific call for law reform was a paper by Counsel Assisting the Special Commission of Inquiry examining the MRCF discussing limited liability and its rationale (forming Annexure T to Commissioner Jackson's report). In that paper, Counsel Assisting proposed that: The Commission should recommend reform of the Corporations Act so as to restrict the application of the limited liability principle as regards liability for damages for personal injury or death caused by a company that is part of a corporate group, confining the benefit of limited liability to members of the ultimate holding company.31 Interestingly, in an Australian Parliamentary Library note commenting on this recommendation to restrict limited liability, it was explained that: If applied to the James Hardie case, this would mean the personal assets of JHI NV members would still be protected, but the company's assets would be available to asbestos compensation claimants.32 In the Australian Labor Party's (`ALP') corporate governance policy package, released on 30 September 2004 in time for the 2004 Federal Election, the party adopted Counsel Assisting's recommendation for this approach, assets of the group could be pooled so that the assets of the holding company could be used to fund the liabilities of the subsidiary companies. [1.59]. 31 Annexure T to the D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical Research and Compensation Foundation', (2004), [27]. 32 See Peter Price, Jerome Davidson and Susan Dudley, `In the Shadow of the Corporate Veil: James Hardie and Asbestos Compensation', Australian Parliamentary Library Research Note No. 12, (2004-2005). 39 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 40 (2005) 7 UNDALR reform of limited liability. While the ALP subsequently lost the election, it is useful to restate the ALP's campaign position on reforming limited liability: At a Federal level, an incoming Labor Government is committed to law reform and will consider all of the options for reform including Counsel Assisting's recommendation for reform of the Corporations Act so as to restrict the application of the limited liability principle, in respect of claims for damages for personal injury or death, to members of the ultimate holding company.33 In his report released on 21 September 2004, Commissioner Jackson did not have any specific position in relation to reforming limited liability but did make the following comment in relation to Counsel Assisting's recommendation: The most wide-ranging reform suggested would have imposed limits on the operation of the doctrine of limited liability. In a detailed submission, Counsel Assisting recommended reform of the Corporations Act so as to restrict the application of the limited liability principle, in respect of claims for damages for personal injury or death, to members of the ultimate holding company.34 [T]he proposed reform is limited in that it does not seek to remove limited liability from all shareholders, only from parent companies. It would, therefore, have no impact on the liability of individual investors (whether corporations or natural persons), and should not impact on their willingness to pool their investment capital by resort to incorporation.35 Instead, Commissioner Jackson supported the introduction of a statutory scheme to guarantee that asbestos victims would be compensated According to Jackson: The best long-term solution for satisfying the asbestos liabilities of Amaca, Amaba and ABN 60 would be a scheme, for which that proposed by JH NV might be a starting point.36 B Issues Regarding the General Chorus for Reform In my view, a law reform initiative restricting limited liability, even if it is confined to the application of limited liability in the context of holding companies, is unwarranted. It is submitted that the same outcome, in terms of shifting liability to holding companies for certain debts of subsidiaries where the subsidiary is not in a position to be able 33 Australian Labor Party, `Labor's Approach to Corporate Governance and Financial Services: Creating a Culture of Accountability', 30 September 2004, 17. 34 D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical Research and Compensation Foundation', (2004,), [30.69]. 35 D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical Research and Compensation Foundation', (2004, [30.72]. 40 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 41 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA to pay, could be achieved without specifically reforming limited liability. `Restricting limited liability' so that holding companies can be liable for the debts of a subsidiary, while not imposing liability on individual shareholders, creates the (negative) impression that the privilege of limited liability can be modified or even abolished in particular circumstances. In order to protect the interests of other company stakeholders (in the case of James Hardie, asbestos victims i.e. creditors) that is the interests of other stakeholders are deemed to take precedence over the interests of the company's shareholders. At a time when shareholder participation and the protection of shareholder rights are such important objectives in corporate law and governance, restricting the application of limited liability should be approached with extreme caution. Furthermore, there is also a question as to how precisely `restricting limited liability' to make holding companies liable would be achieved, and also, just as importantly, when restricting the application of limited liability would be justifiable. In other words, lifting the protections offered by the corporate law to holding companies seems like a reasonable and appropriate initiative in the context of asbestos victims missing out on compensation, however more generally such an approach to reform lacks detail and therefore legitimacy. There are a number of questions which remain unanswered. For example, would holding companies be automatically liable for subsidiary debts, or would some responsibility for the incurring of debts first need to be established? Further, would there need to be some knowledge or involvement on the part of the holding company? Would the holding company be potentially liable for all debts of the subsidiary companies, or more specifically debts arising from personal injury or death? If so, what is the rationale for this? Would liability only arise when there is a shortfall in the funds of the subsidiary available to compensate victims, or otherwise? Given that there are important economic and rights-based justifications for the continued operation of the limited liability principle, it is extremely important to determine the scope of what is being proposed. While it is desirable to protect the rights and interests of asbestos victims who may otherwise miss out on compensation, it is also important to recognise that limited liability is itself a right bestowed upon shareholders as a consequence of investing their funds into a particular company. V RESPONDING TO THE JAMES HARDIE CONTROVERSY: A MODERATE PROPOSAL FOR LAW REFORM A Preliminary Points 41 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 42 (2005) 7 UNDALR At the outset, it is important to re-emphasise that with this article, I am not intending to raise every possible avenue for reform to impose liability on holding companies for subsidiary company debts, but one specific reform proposal. There have been numerous potential reforms raised to deal with how liability could be imposed on a holding company in a corporate group for the debts of its subsidiaries. In particular reforms of the voluntary administration and winding up rules under the Corporations Act, as well as changes to the principles of negligence in group arrangements, however I leave these reforms to be explored by other commentators.37 Further, I have tried to construct this reform proposal specifically in response to the factual scenario involved in the James Hardie controversy, as not only does this give the proposal some contemporary relevance, but also provides law reformers with a model which could actually be implemented to deal with the shortfall of funds in the MRCF by imposing liability on James Hardie's parent company, as the company most responsible for the problems which have transpired. B Section 588V-W of the Corporations Act 36 D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical Research and Compensation Foundation', (2004, [1.38]. 37 The author refers the reader to the panoply of reforms contained in the Companies and Securities Advisory Committee Corporate Groups Final Report (2000). 38 An excellent summary of the general operation of s 588V, and the defences under s 588X, is provided in the Companies and Securities Advisory Committee Corporate Groups Final Report (2000) See [6.11]: Under s 588V of the Corporations Act, a holding company contravenes the Corporations Act if: · It was the holding company of a subsidiary at a time the latter incurred a debt; · That debt caused, or was incurred during, the insolvency of the subsidiary company; and · There were reasonable grounds to suspect that the subsidiary company was then insolvent or would become insolvent by incurring that debt (or debts including that debt) and either · The holding company or any of its directors was aware of the reasonable grounds for suspecting the subsidiary's insolvency; or · Having regard to the nature of the holding company's control over the subsidiaries, it was reasonable to expect that a company in the circumstances of the holding company, or any of its directors, should be aware of these grounds for suspicion. And in terms of possible defences under s 588X, it is noted by the Companies and Securities Advisory Committee Corporate Groups Final Report (2000) [6.13] that the holding company has various defences including: · Where at the time when the debt was incurred the company or its directors: · Reasonably expected that the subsidiary was solvent (taking into account the relevant debt and any other concurrent debt); · Reasonably believed that a competent and reliable person was responsible for informing the holding company of the solvency of the subsidiary and that person 42 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 43 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA As has already been discussed, my proposal involves implementing a number of important reforms to s 588X-W of the Corporations Act (which comprise Part 5.7B, Division 5 of the Act, entitled `Liability of Holding Company for Insolvent Trading by Subsidiary').38 To appreciate the proposed reforms which I outline below, it is useful to reproduce s 588V-W here. 588V When holding company liable (1) A corporation contravenes this section if: (a) the corporation is the holding company of a company at the time when the company incurs a debt; and (b) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and (c) at that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as the case may be; and (d) one or both of the following subparagraphs applies: (i) the corporation, or one or more of its directors, is or are aware at that time that there are such grounds for so suspecting; (2) (ii) having regard to the nature and extent of the corporation's control over the company's affairs and to any other relevant circumstances, it is reasonable to expect that: (A) a holding company in the corporation's circumstances would be so aware; or (B) one or more of such a holding company's directors would be so aware; and (e) that time is at or after the commencement of this Act. A corporation that contravenes this section is not guilty of an offence. 588W Recovery of compensation for loss resulting from insolvent trading (1) (2) Where: (a) a corporation has contravened section 588V in relation to the incurring of a debt by a company; and (b) the person to whom the debt is owed has suffered loss or damage in relation to the debt because of the company's insolvency; and (c) the debt was wholly or partly unsecured when the loss or damage was suffered; and (d) the company is being wound up; the company's liquidator may recover from the corporation, as a debt due to the company, an amount equal to the amount of the loss or damage. Proceedings under this section may only be begun within 6 years after the beginning of the winding up. 588X Defences (1) (2) This section has effect for the purposes of proceedings under section 588W. It is a defence if it is proved that, at the time when the debt was incurred, the corporation, and each relevant director (if any), had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time. 43 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 44 (2005) 7 UNDALR (3) Without limiting the generality of subsection (2), it is a defence if it is proved that, at the time when the debt was incurred, the corporation, and each relevant director (if any): (a) had reasonable grounds to believe, and did believe: (i) that a competent and reliable person was responsible for providing to the corporation adequate information about whether the company was solvent; and (4) (5) (6) (ii) that the person was fulfilling that responsibility; and (b) expected, on the basis of the information provided to the corporation by the person, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time. If it is proved that, because of illness or for some other good reason, a particular relevant director did not take part in the management of the corporation at the time when the company incurred the debt, the fact that the director was aware as mentioned in subparagraph 588V(1)(d)(i) is to be disregarded. It is a defence if it is proved that the corporation took all reasonable steps to prevent the company from incurring the debt. In subsections (2), (3) and (4): relevant director means a director of the corporation who was aware as mentioned in subparagraph 588V(1)(d)(i). An important point regarding s 588V, is that under s 588V(1)(d) you can have regard to the nature and extent of the corporation's control over the company's affairs and to any other relevant circumstances in determining whether the holding company should be held liable. Thus, it does not actually (necessarily) need to be established that the holding company, or any of its directors, were actually aware of the subsidiary company's insolvency. In an article published in the Connecticut Journal of International Law, Professor Ian Ramsay explains that the objective of the main provision, s 588V, is to `make a holding company liable for the debts of an insolvent subsidiary where the holding company was aware or should have been aware of the insolvency.'39 Importantly, the report of the Companies and Securities Advisory Committee (`CASAC') on corporate groups published in 2000 noted some limitations with ss 588V, and 588X which would need to be addressed if a law reform proposal was to be carried into effect. The main limitations suggested by the CASAC in its report are that the provisions: · Rely upon the legal definition of holding/subsidiary companies. Business activities that pose higher than usual risk of failure can be organised to avoid the creation of that relationship; was fulfilling that responsibility; or · Had taken all reasonable steps to prevent insolvent trading by the subsidiary. 39 See Ian Ramsay, `Allocating Liability in Corporate Groups: An Australian Perspective' (1999) 13 Connecticut Journal of International Law 329, 368. 44 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 45 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA · May require an express and expensive investigation of the company's financial situation at the time of incurring specific debts to determine whether it was then insolvent (although I believe that this problem would be minimised in relation to tortious claims if the ultimate debt is incurred after winding up of the company commences or the company enters into voluntary administration, as the company would clearly be insolvent at the relevant time). · Do not cover any debts incurred by a subsidiary whilst solvent, but which remain unpaid, and for which there are insufficient funds, after the insolvency.40 C Overview of the Reform Proposal: Amending s 588V/W of the Corporations Act As is discussed in more detail later in this section, I believe that limited liability as a privilege belonging to shareholders should be protected and corporate law should not unduly interfere or restrict the ability of companies to structure their arrangements to take advantage of the various benefits (tax, financing et cetera) that group structures provide, simply as a reaction to claims of a particularly vulnerable group in the community. In weighing up the benefits of limited liability with the public policy considerations of ensuring that companies can be held liable if victims would otherwise not have an avenue to pursue their rights, I believe that a specific reform initiative should be implemented to impose liability on controlling entities for such debts only when a controlled entity is not in a position to pay the debt. The controlling entity can be held partially responsible through its control over the subsidiary, not for the personal injury or death per se, but for the controlled entity incurring the debt (the claim for damages) when it is not in a position to pay. It is important to make clear that the problem, arising from James Hardie, which is now sought to be addressed is not the actual incurring of tortious damages for personal injury or death due to the negligence of the subsidiary companies per se, as unfortunate as this is. It is rather the inability of the subsidiary company to actually fund the debt once it arises and working out a way that liability can be imposed on the holding company within the group. Under my proposal, s 588V will be amended so that a `controlling entity' (rather than a holding company, a distinction explored further below) will potentially be liable for any debts arising from tortious claims against a subsidiary company. The most important aspect of my proposed reform is to expressly define `incurring a debt' so that it includes involuntary debts incurred through tortious (or indeed criminal) claims. I will explain below why the meaning of `debt' for the purposes of this provision is presently not considered to encapsulate damages arising from compensation for torts. There will be an express definition of `incurring a debt' for the purposes of s 588V to include 45 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 46 (2005) 7 UNDALR incurring tortious damages from personal injury or death (not all tortious claims) which invokes a positive duty based on public policy. If it can be satisfied on the evidence that the controlling entity or its directors at that time had reasonable grounds to suspect that the controlled entity would not be able to pay the debt once it was `incurred' (which could be satisfied with reasonable certainty in James Hardie given the actuarial reports which have been prepared over time to indicate that there would be a shortfall in funds to compensate victims), then it would again be reasonable for liability to be imposed on the controlling entity. This is due strictly to the control it exerted over the controlled entity and hence its ability to do something so that the subsidiary companies and the victims of the company's negligence would not be placed in such an undesirable position. My specific reform proposal is not in fact a new idea, other commentators have in the past pointed out that s 588V does not apply to tortious damages incurred by a subsidiary, and that the section could provide an avenue for extending the liability of holding companies in particular circumstances to tortious claims against subsidiary companies.41 However, as far as I can tell, this is the first time that a proposed new s 588V has actually been drafted and explained. It is also the first time in which some of the potential difficulties and issues relating to a such a reform have been explored and addressed, so that we can be confident that the faith placed in a revised s 588V to adequately fulfil the present objective in corporate law is deserved. Furthermore, given the potential for this reform proposal to actually be adopted to impose liability on James Hardie if it does not honour its agreement with the NSW Government and the ACTU (or after the agreement transpires), I deal with the special nature of asbestos-related diseases and how a revised s 588V could actually be drafted to directly accommodate the unique position of asbestos diseases which may not surface until many years after the claimant came into contact with the asbestos, and the difficulties that may accordingly arise in the holding company being held liable in this situation. I also deal with the specific situation in relation to James Hardie, in which asbestos liabilities have been assigned to an entity which is completely separated from the corporate group so that it cannot be described as a subsidiary company. The construction of a statutory corporate law provision to allow for liability for asbestos-related diseases (and similar `latent' diseases) to be directed to the holding company, but in a way which is not designed to 40 See Companies and Securities Advisory Committee Corporate Groups Final Report (2000), [6.28]. 41 See Ian Ramsay, `Holding Company Liability for the Debts of an Insolvent Subsidiary: 46 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 47 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA directly undermine the limited liability principle, has been a task which required considerable thought and reflection. My solution as to how s 588V could specifically deal with asbestos-related claims which arise years after the subsidiary company has been wound up, is unique and will be presented and explained in detail below. D Constructing a Reform Proposal 1 Considerations Arising from James Hardie Responding to the problems arising with James Hardie needs to be done in a way that continues to respect the important commercial benefits which derive from companies having this freedom to structure their affairs, but recognises that there are circumstances in which this freedom can be abused. This potential for abuse has been described as the `capital boundary problem'.42 2 Details of the Proposal To begin with, what follows is how s 588V-W of the Corporations Act would look if my proposed reforms were implemented, followed by a detailed explanation of some of the key components of my reform proposal, including discussion of the rationale behind each key component. I will also briefly analyse the strengths and weaknesses of the proposal, but await a response from other commentators. If my proposed reforms are implemented, s 588V-W would read as follows: 588V When controlling entity liable (1) A corporation contravenes this section if: (a) the corporation is a controlling entity of a company at the time when the company incurs the debt, or is the controlling entity of a company which caused the debt at the relevant time that the debt was caused; and (b) the company which incurs the debt is insolvent at the time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and (c) at that time, there are reasonable grounds for suspecting that the company which incurred the debt is insolvent, or would so become insolvent, as the case may be; and (d) one or both of the following subparagraphs applies: (i) the corporation, or one or more of its directors, is or are aware at that time that there are such grounds for so suspecting; (ii) having regard to the nature and extent of the corporation's control A Law and Economics Perspective` (1994) 17 University of New South Wales Law Journal 546. 42 According to Hugh Collins, the capital boundary problem which arises consists of this: because the firm dictates its own size, it also chooses the limits of its legal responsibility, which in turn provides an open invitation for the evasion of mandatory 47 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 48 (2005) 7 UNDALR (2) (3) over the affairs of the company which incurred the debt, or the company which caused the debt, and to any other relevant circumstances, it is reasonable to expect that: (A) a company in the corporation's circumstances would be so aware; or (B) one or more of such a company's directors would be so aware; and (e) that time is at or after the commencement of this Act. A corporation that contravenes this section is not guilty of an offence. For the purposes of this section, in determining whether a corporation is a controlling entity of a company, refer to the definition of control in s 50AA of the Act. (4) For the purposes of this section, incurring a debt includes a liquidated amount of damages against the company which is determined by a court, tribunal or regulatory body, and a criminal fine. 588W Recovery of compensation for loss resulting from insolvent trading (1) Where: (a) a corporation has contravened section 588V in relation to the incurring of a debt by a company; and (b) the person to whom the debt is owed has suffered loss or damage in relation to the debt because of the company's insolvency; and (c) the debt was wholly or partly unsecured when the loss or damage was suffered; and (d) the company is being wound up; the company's liquidator may recover from the corporation, as a debt due to the company, an amount equal to the amount of the loss or damage. [Deletion of six-year time limitation for bringing claims under subsection (2)] 588X Defences (1) (2) (3) This section has effect for the purposes of proceedings under section 588W. It is a defence if it is proved that, at the time when the debt was incurred, the corporation, and each relevant director (if any), had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time. Without limiting the generality of subsection (2), it is a defence if it is proved that, at the time when the debt was incurred, the corporation, and each relevant director (if any): (a) had reasonable grounds to believe, and did believe: (i) that a competent and reliable person was responsible for providing to the corporation adequate information about whether the company was solvent; and (4) (ii) that the person was fulfilling that responsibility; and (b) expected, on the basis of the information provided to the corporation by the person, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time. If it is proved that, because of illness or for some other good reason, a particular relevant director did not take part in the management of the corporation at the time when the company incurred the debt, the fact that the director was aware 48 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 49 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA as mentioned in subparagraph 588V(1)(d)(i) is to be disregarded. (5) (6) It is a defence if it is proved that the corporation took all reasonable steps to prevent the company from incurring the debt. In subsections (2), (3) and (4): relevant director means a director of the corporation who was aware as mentioned in subparagraph 588V(1)(d)(i). (a) `Incurring' a Debt (i) General The phrase `incurring a debt', which is used in s 588V, is not actually defined in the Act, however it is generally considered that by `incurring' being associated with `debt', the phrase probably does not encompass damages arising from tortious claims (or indeed criminal fines). However, this is in relation to s 588G which contains a positive duty upon company directors to prevent insolvent trading, it may not in fact be relevant to s 588V which does not contain such a positive duty. According to one of Australia's leading texts on corporation law, Ford's Principles of Corporations Law, the word `incur' by itself does not appear to be limited to voluntary debts ­ based on the dictionary definition of the word (from the New Shorter Oxford Dictionary), `incur' can mean running into or meeting with something or it can mean bringing something upon itself.43 Importantly, this would seem to accommodate non-voluntary debts, however the word needs to be applied consistency with the context in which it is used and statutory purposes.44 In relation to s 588G, the context suggests against involuntary debts incurred by way of tortious damages or criminal fines, however the legal rules. See Hugh Collins, `Ascription of Legal Responsibility to Groups in Complex Patterns of Economic Integration' (1990) 53 Modern Law Review 731, 736737. 43 See H A J Ford, R P Austin and I M Ramsay, Ford's Principles of Corporations Law (11th ed, Sydney: Butterworths 2003), 871: s 588G ... seems to use `incur' in a sense requiring some act or omission of the company. The heading to Div 3 of Pt 5.7B, which is part of the Corporations Act, refers to `Director's Duty to Prevent Insolvent Trading'. The actus reus in the operative part ... is failure to prevent the company from incurring the debt. Precisely on point is the case of Geraldton Building Co. Pty. Ltd. v Woodmore (1992) 8 ACSR 585, 590, in relation to the duty to prevent insolvent trading in s 588G, rather than s 588V- in that case Master Bredmeyer said: `A director is not liable for damages. Debts and damages are quite distinct. ... Incurring a liability for damages does not constitute the incurring of a debt for the purpose of s 592.' 44 See, eg, Hawkins v Bank of China (1992) 26 NSWLR 562 at 572; See also Antico (1995) 18 ACSR 1; Shepherd v ANZ Banking Group (1996) 20 ACSR 81. 45 Ian Ramsay, `Allocating Liability in Corporate Groups: An Australian Perspective' (1999) 13 Connecticut Journal of International Law 329 49 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 50 (2005) 7 UNDALR context may be considered different to s 588V. That said, the general consensus among commentators on s 588V, including one of Australia's leading corporate law experts Professor Ian Ramsay, is that the meaning of `incurring a debt' in relation to s 588V is similarly confined to voluntarily incurred debts45 and therefore the present author proceeds on this basis. Under my proposal, in light of the James Hardie controversy, there would be an express definition of `incurring a debt', whereas currently there is not one, so that the concept includes involuntarily incurred debts, such as tortious damages and criminal fines. The circumstances, which resulted in the recent Special Commission of Inquiry, can be said to have arisen from the negligence of James Hardie's subsidiaries.46 As has already been stated, the proposal to extend s 588V so that it captures debts incurred from tortious claims is not new. A number of commentators has suggested reform in the past, including Ian Ramsay. In an article published in the Connecticut Journal of International Law, Professor Ramsay based his suggestion for an extension of s 588V on a law and economics analysis of the provision. In that article, Professor Ramsay argued: A tort claimant is the creditor least likely to be able to protect him or herself against the risk of harm by a company. There are a number of reasons why this is so. First, unlike other creditors, a tort claimant or victim is not in a contractual relationship with the company. Because of this, he or she cannot contract to be compensated for assuming the risk of injury, nor can the tort claimant contract around the rule of limited liability the way other creditors do. Second, the tort claimant cannot assess the creditworthiness of the company before the tort occurs. Other creditors do have this opportunity prior to entering into a contract. Third, the tort claimant will be an inefficient monitor of managers compared to other creditors. ... The problem is particularly serious in the context of corporate groups. This is because a company can establish subsidiaries, each with minimal assets, for the purpose of conducting hazardous activities that may result in tort claims. The purpose is to minimize the exposure of the assets of the corporate group to tort claims.47 (ii) At What Point Should the `Debt' Be Deemed to be Incurred? 46 In the D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical Research and Compensation Foundation', (2004) [12.3], Commissioner Jackson said that: [The asbestos liabilities] were based on tortious conduct of James Hardie Group companies - usually negligence in the manufacture or distribution of asbestos products - which had occurred in 1987 or earlier. 47 See Ian Ramsay, `Holding Company Liability for the Debts of an Insolvent Subsidiary: A Law and Economics Perspective` (1994) 17 University of New South Wales Law Journal 546., 372-373; see also Annexure T to the D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical Research and Compensation Foundation', (2004), 418. 50 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 51 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA There is no express definition of `debt' in the Corporations Act, however commentary speaks of the need for there to be a `liquidated amount' before a debt can be incurred under the insolvent trading provisions. According to Ford's Principles of Corporations Law, a debt is liquidated when its amount is fixed or can be calculated positively.48 Thus, even though the tortious act or omission by which the claim materialises may have occurred well beforehand, the debt would still not be incurred until the amount of a claim is determined by the relevant court or tribunal. This position derives support from the case of Shepherd v Australian and NZ Banking Group Ltd,49 in which Bryson J rejected the argument that a debt which accrued later was in fact incurred at the earlier stage when the contractual time for performance passed, leaving it in control of the payer to make an election which would actually create a debt. When we see that `debt' has been defined in this way, there are potential problems which emerge if the meaning of debt is to be extended to cover involuntarily-incurred amounts, namely tortious damages. If a debt is not `incurred' until the amount of a claim is liquidated through determination of a court or by some other body, there is the potential for the parent company to place the subsidiary company under `voluntary administration', or use its authority as the dominant shareholder in the subsidiary to voluntarily `wind up' the company (I provide below an explanation of the law of voluntary administration and winding up in Australia). This approach could be pursued so that the subsidiary company is not capable of incurring the debt, and the holding company can therefore avoid liability. As a result, the victim who is seeking compensation against the subsidiary company would have no recourse to s 588V to obtain compensation. This is especially a problem with `latent' asbestos-related diseases, which may arise many years after the company responsible for the debt has been wound up. This problem was indeed raised by Commissioner Jackson in his report: ...An injured plaintiff's ability to sue for damages in respect of the injury will not be effective if there is not a financially substantial defendant available and responsible for the damage. ... A reflection of this is that in theory JHL might have caused the subsidiary to be put into liquidation, in which case future claimants, not having contracted an asbestos-related disease, or been exposed to asbestos, would have no one to recover against once the company's assets had been distributed.50 The main concern is whether it is a possibility for holding companies to organise for the winding up of the subsidiary company in complete 48 H A J Ford, R P Austin and I M Ramsay, Ford's Principles of Corporations Law (11th ed, Sydney: Butterworth 2003) [20.090]. 51 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 52 (2005) 7 UNDALR disregard of the impending claim of the victims to avoid the operation of s 588V in its proposed amended form. That is, would subjecting holding companies to potential liability lead to a so called `phoenix' company arrangement whereby the directors of a failed company transfer all the assets to a newly-formed company to avoid liability. While this is an important issue that does require attention, a review of insolvency law in Australia demonstrates that the concerns raised about the potential reform are unfounded. Entering the company in voluntary administration, or commencing winding up of the company would not automatically prevent liability being imposed on the ultimate holding company, and it is unlikely that the subsidiary company could be wound up if there were impending claims for tortious damages arriving in the future. I will deal first with voluntary administration, and then with winding up. (iii) Voluntary Administration Under Part 5.3A of the Corporations Act, if a company is insolvent or nearing insolvency, the directors of the company can pass a resolution causing for the company to appoint an administrator (an independent qualified person) to take control of the company, with the view to ensuring that the company continues in existence.51 Usually the company's creditors will meet to approve a deed of company arrangement dictating how the administrator is to manage the affairs of the company.52 The important question, which arises in relation to voluntary administration, is whether a debt can be `incurred' for the purposes of s 588V once the subsidiary company has been placed under voluntary administration. This question arises because under the Corporations Act, once a company enters into voluntary administration, there is a general suspension (or `moratorium') on the rights of claimants against the company under administration, until the outcome of the creditor's 49 (1996) 20 ACSR 1. 50 See D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical Research and Compensation Foundation', (2004), [12.13]-[12.14]. 51 The objects of Part 5.3A are expressed in s 435A of the Corporations Act. The section provides that: The object of this Part is to provide for the business, property and affairs of an insolvent company to be administered in a way that: · Maximises the chance of the company, or as much as possible of its business, continuing in existence; or · If it is not possible for the company or its business to continue in existence- results in a better return for the company's creditors and members than would result from an immediate winding up of the company. 52 For an explanation of the law of voluntary administration in Australia, see Colin Anderson and David Morrison, Corporate Voluntary Administration Law (3rd ed, 52 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 53 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA determination as to the company's future.53 Section 440D of the Act provides that no proceeding in a court against a company under administration can be commenced by any person except with the administrator's consent or the leave of the court. The purpose of this suspension or moratorium is to provide the subsidiary company with some breathing space, ensuring that the funds of the company are not dissipated through meeting new claims, and that the task of the appointed administrator is not made unnecessarily difficult. Accordingly, I believe that this suspension places no barrier on instituting proceedings against a holding company/controlling entity under s 588V, if it is made clear that the reason for establishing that there is a debt is to take action against the holding company/controlling entity. Rather than, to directly target the subsidiary company and potentially reduce the pool of assets available to the administrator. Under these circumstances, I am confident that in most, if not all circumstances, either the administrator or the court would provide its approval for a debt to be pursued during administration. It should also be said that the consequences of placing a company under voluntary administration are different for s 588V compared to the director's duty to prevent insolvent trading under s 588G. In relation to the duty under s 588G, placing a company under voluntary administration can operate as a defence under s 588H(6) on the basis that the director took all reasonable steps to appoint an administrator. Pursuant to this provision, if a director seeks to prove the defence, the court must consider any action the director took with a view to appointing an administrator, the time when that action was taken and the results of that action. Appointment of an administrator would provide no defence for a tortious claim against the subsidiary. As the negligent act giving rise to the claim would have arisen prior to the company actually entering into voluntary administration, that is the administration can play no role in preventing the debt being occurred, so why should it actually operate as a defence? (iv) Voluntary Winding Up Rather than utilising the voluntary administration regime, another option that could be pursued by the holding company is to utilise its control as the majority shareholder of the subsidiary to voluntarily wind up the company. There is a procedure for voluntary winding up by members under Part 5.5, Division 2 of the Corporations Act. Like with voluntary Sydney: Thomson 2002). 53 See H A J Ford, R P Austin and I M Ramsay, Ford's Principles of Corporations Law (11th ed, Sydney: Butterworths 2003), [27.040]. 53 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 54 (2005) 7 UNDALR administration, once a company commences winding up and a liquidator is appointed, there is a stay of proceedings against the company between the time of filing for winding up, and the order for winding up.54 This would again protect the company from claims, unless the courts grant leave. However, while it is a possibility for the holding company to utilise the voluntary administration regime once there is an impending claim(s) for tortious damage(s), as all that needs to be established is that the subsidiary company may become insolvent in the future, voluntary winding up by members would not be available under these circumstances. This is because this form of winding up can only be used when the company is solvent, and when the company is sure that the company will be able to pay its debts in full within a period not exceeding 12 months after the commencement of the winding up.55 Obviously, if there are outstanding and impeding debts against the company based on claims of tortious damages against the company being successful, the company clearly could not satisfy this key requirement, and hence voluntary winding up would not be available. There is a further avenue for the holding company, as the majority shareholder in a subsidiary, to apply to the court under s 459A (in reliance on s 459P) for the winding up a company on the basis that it is insolvent. However, it is unlikely that the company will actually be insolvent (based on the definition of solvency in s 95A, that is the ability to pay debts as and when they become due) before incurring the debt of a liquidated amount of damages, as it is the actual incurring of the debt which usually renders the subsidiary company insolvent. Accordingly, this would not be a useful mechanism for the holding company to avoid the application of s 588V. 54 See s 471B of the Corporations Act. 55 Section 494 establishes as a prerequisite to voluntary winding up that a majority of the company's directors provide a written declaration to the effect that they have made an inquiry into the affairs of the company, and that they have formed the opinion that the company will be able to pay its debts in full within a period not exceeding 12 months after the commencement of the winding up. While the section use the word `may', case law has established that the declaration is a compulsory rather than discretionary requirement: Re Kyra Nominees Pty Ltd (1980) 5 ACLR 60. According to Simon Fischer, Leanne Wiseman and Colin Anderson, Corporations Law (2nd ed, Sydney, Butterworths, 2001 [23.2.3]: The object of the declaration of insolvency is to prevent a company from abusing the voluntary winding up procedure where it is, in fact, insolvent. Importantly, s 494(4) provides that it is an offence if a director makes such a declaration without having reasonable grounds for believing that the company will be able to pay its debts in full. Section 494(5) provides that there is a presumption against the director having reasonable grounds if the debts are not paid in full within the 54 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 55 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA Therefore, it appears to be suitable to retain the existing position in Australia that a liquidated amount needs to be determined before a debt is said to be `incurred'. (b) Substituting Control Test for Holding Company/Subsidiary Test At present, s 588V imposes liability on a `holding company' of a `subsidiary' if the subsidiary incurs a debt while insolvent. A `subsidiary' company is defined under the Corporations Act, s 46: A body corporate is a subsidiary of another body corporate if, and only if: (a) the other body: (i) controls the composition of the first body's board;56 or (ii) is in a position to cast, or control the casting of, more than one-half of the maximum number of votes that might be cast at a general meeting of the first body; and (iii) holds more than one-half of the issued share capital of the first body. What can be seen with the definition of subsidiary is that it is fundamentally based on the level of shareholding, or voting power in relation to shares, that one company has in relation to another company. Thus, imposing liability on a holding company directly attacks and undermines the operation of the limited liability principle. Due to this rather strict, narrow definition of subsidiary in the Act, there have been proposals in the past (both generally in relation to the Corporations Act as a whole, and more specifically in relation to s 588V) for the holding company/subsidiary test to be changed to a control test. In most cases, it has been suggested that the present definition of `control' under s 50AA could provide the basis for the general control test. `Control' is defined in s 50AA in terms which extend to practical influence and which take account of practices and patterns of behaviour, rather than just embodying a strict de jure test for control, which applies in relation to the subsidiary/holding company test.57 Section 50AA(1) states that for the purposes of the Corporations Act, an entity controls a second entity if the first entity has the capacity to determine the outcome of decisions about the second entity's financial and operating policies. Subsection (2) goes on to provide that in determining whether the first entity has this capacity; 1 2 the practical influence the first entity can exert (rather than the rights it can enforce) is the issue to be considered; and any practice or pattern of behaviour affecting the second entity's financial or operating policies is to be taken into account (even if it period stated in the declaration. 56 See s 47 of the Corporations Act, for an explanation of what is meant by controlling the composition of the first body's board. 57 See H A J Ford, R P Austin and I M Ramsay, Ford's Principles of Corporations Law 55 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:48 AM Page 56 (2005) 7 UNDALR involves a breach of an agreement or a breach of trust). In its report on corporate groups released in 2000, the Companies and Securities Advisory Committee of the Australian Parliament suggested that the substitution of a control test for the holding/subsidiary test was preferable. It was considered that the control test would be much more flexible and of much wider scope. Accordingly, the CASAC recommended that the ... control test is preferable to the holding/subsidiary and related company tests. The former test may better identify all forms of de facto control, as it is not limited to control through majority shareholding or control through composition of the board of directors. The control test should apply in all circumstances.58 Professor Ramsay has also proposed that in relation to s 588V, the application of the holding company/subsidiary test is not entirely desirable. In his article published in the Connecticut Journal of International Law,59 when discussing s 588V, it was explained that there are problems associated with using the definition of subsidiary, which would not arise if a broader and more flexible definition of `control' were used. According to Ramsay, as there is a strict and rather narrow definition of subsidiary under s 46 of the Act, companies can avoid liability under s 588V by adjusting their shareholding or level of voting control so that the relationship is not one of holding company/ subsidiary. Such specific avoidance of the operation of s 588V would not however be possible if the more flexible test of control, based on practical influence rather than strictly levels of shareholding or voting power, is adopted. As Ramsay states, `It is now possible to see why s 588V presents obvious strategies for evasion.'60 Due to the holding company/subsidiary test directly undermining the limited liability principle by imposing liability strictly for holding shares or having voting power in relation to shares, rather than more broadly attaching liability based on control, and the difficulties associated with using the holding company/subsidiary test, my proposed reforms abandon the holding company/subsidiary test for the control test. Liability would be imposed on a `controlling entity' of a `controlled entity' with the meaning of control for this purpose based on the definition of `control' under s 50AA of the Act. However, when looking specifically at the facts involved with James Hardie, this change would not adequately respond to the particular situation in that case of the subsidiary companies responsible for the asbestos-related diseases being (11th ed, Sydney: Butterworths 2003), [23.080]. 58 Ian Ramsay, `Allocating Liability in Corporate Groups: An Australian Perspective' (1999) 13 Connecticut Journal of International Law 329, [1.39]. 59 Ian Ramsay, `Allocating Liability in Corporate Groups: An Australian Perspective' 56 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:49 AM Page 57 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA separated from the Group prior to the claims for tortious damages being determined. Under this situation, liability could not be imposed on the James Hardie Group under s 588V, as it would no longer be the controlling entity when the debt is actually incurred (at the time of liquidation). Indeed, this situation may not be limited to James Hardie. If a holding company could escape liability under s 588V by ensuring that the company is separated from the corporate group before the debt is incurred, then this would present a major gap in the operation of s 588V and undermine the effectiveness of the provision. Accordingly, in order to directly respond to the factual scenario relating to James Hardie, and to overcome the potential for a major gap in the law to develop, it is proposed that s 588V would also attach liability to a company that was a controlling entity at the time when the debt was caused (i.e. the negligent act occurred). Also the company, which has assumed that debt becomes insolvent when the debt is incurred, or is already insolvent when the debt is incurred, and none of the defences under s 588X are available to the controlling entity. (c) Change to Heading of Part 5.7B, Division 5 Part 5.7B, Division 5 of the Corporations Act, which encompasses s 588V-X of the Act, is currently headed `Liability of Holding Company for Insolvent Trading by Subsidiary'. This would no longer, however, adequately reflect the contents and rationale of the provisions under this Part if my proposed reforms were implemented. As part of my reforms, it is therefore proposed that the heading of Part 5.7B, Division 5 be changed to `Liability of Controlling Entity for Insolvent Trading of Controlled Entity.' E Critical Analysis of the Proposal What follows is a brief analysis of the strengths and weaknesses of my proposal. However, the author invites other commentators to further critique the effectiveness of the proposal in responding to the James Hardie asbestos affair, and the specific problems arising from the James Hardie controversy of imposing liability on holding companies for certain debts incurred by subsidiaries when the subsidiary is unable to pay. 1 Key Benefits of the Author's Proposal In my view, the proposed reform package is a sophisticated and effective response to the specific problems arising out of the James Hardie controversy, and involves very moderate reform ­ rather than unwieldy reform based `restricting the principle of limited liability', which would unduly undermine the rights of shareholders. 57 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:49 AM Page 58 (2005) 7 UNDALR The primary benefit of my proposal is that liability will only attach if on the facts it can be said that an entity which has control over another entity (according to the definition of `control' under the Act) has taken responsibility for the second entity not being able to pay a debt which is incurred resulting from a successful tortious claim for personal injury or death. While obviously the controlling entity will usually be a holding company of a subsidiary based on having a substantial shareholding in the company, and hence such a reform would affect the operation of limited liability, it is important to understand that this would be an indirect effect rather than a direct attack on the limited liability principle. The impact on limited liability would be in an indirect manner, in the process of assigning responsibility based on control, rather than in a direct manner. Importantly, from a symbolic level at least, the proposal protects and upholds the rights of shareholders in general terms as under the proposal, rather than imposing liability on the holding company on the basis that they are a major shareholder in the company (and thus restricting the application of the principle of limited liability) the reform proposal would sheet home liability to the holding company on the basis that it is a controlling entity vis-à-vis the subsidiary entity, with this control not necessarily deriving from being a major shareholder in the company. In this sense, my proposal does not seek to directly undermine the principle of limited liability. Rather it provides a very limited situation where companies within a group arrangement will not be treated strictly as separate entities at law. 2 Responding to Potential Weaknesses in the Proposal One potential criticism of my proposal is that it may be unduly harsh on holding companies. However the obvious response is to emphasise that the proposal would not make holding companies (or what would be `controlling entities') liable unless they knew or should have known that the subsidiary was insolvent or would become insolvent by incurring the debt. It needs to be made clear that the basis for liability would be that there is some clear responsibility upon the controlling entity. Furthermore, on this point it is important to emphasise that the reforms would not be too indeterminate or uncertain, as once there is a valid claim presented, the holding company can actually raise one or more defences under s 588V (such as that there were reasonable grounds to expect solvency, or that the relevant company took reasonable steps to prevent incurring the debt). Thus, if those defences are not available on the facts to protect the controlling entity, then it is reasonable that it be subjected to liability. Another issue that relates to the last point is why in fact liability is being 58 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:49 AM Page 59 REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY COMPANY DEBTS IN AUSTRALIA imposed on the controlling entity ­ clearly the controlled entity does not have sufficient assets to pay the debt, but is this any reason to impose liability on a separate legal entity at law? Is there anything that the holding company/controlling entity could have done? In my view, the responsibility comes from `control' ­ control over the financial and operational affairs of the company. In exercising control over the company, there are a number of things that the controlling entity could do to prevent the problem of victims being left out of pocket. A consequence of exerting such control, is a duty to ensure that the company would not continue to operate whilst insolvent. But would not this injection of capital by the holding company be in breach of the directors of the holding company's duty to act in the best interests of that particular company, rather than the group as a whole? In other words, is it reasonable, and consistent with public policy, that the directors need to breach their fiduciary duties, and face potential personal liability, in order to avoid the holding company /controlling entity being liable for the debts of the subsidiary company under s 588V? While the general position is that directors of a particular company must act in the best interests of that company, rather than the group for which the company forms a part, there are circumstances in which assisting another group company may be consistent with their fiduciary duties to the first company. This was made clear by Mason J in the High Court of Australia decision of Walker v Wimborne,61 and there has been support for this view in a number of subsequent decisions.62 In the context of the James Hardie controversy, it is certainly clear, as highlighted in Commissioner Jackson's report, that it would have in been in the best interests of James Hardie's parent company to have made extra funds available to the MRCF to place it in a better position to compensate asbestos victims, and to prevent the later public scandal which transpired and damaged the reputation of the James Hardie (1999) 13 Connecticut Journal of International Law 329. 60 Ian Ramsay, `Allocating Liability in Corporate Groups: An Australian Perspective' (1999) 13 Connecticut Journal of International Law 329, 375. 61 (1976) 137 CLR 1. In that case, Mason J said (at 6-7) that: ... [The] payment of money by company A to company B to enable company B to carry on its business may have derivative benefits for company A as a shareholder in company B if that company is enabled to trade profitably or realize its assets to advantage. 62 See, eg, Equiticorp Financial Services Ltd v Bank of New Zealand (1993) 11 ACSR 642. 63 See D F Jackson QC, `Report of the Special Commission of Inquiry Into the Medical Research and Compensation Foundation', (2004) [12.23], in which Commissioner Jackson suggested that as a practical matter James Hardie's parent company should 59 30877 NOTRE DAME -MCCONVILL (2):30877 NOTRE DAME -MCCONVILL (2) 6/07/09 9:49 AM Page 60 (2005) 7 UNDALR Group.63 Accordingly, it is appropriate that responsibility be assigned (and indeed extended under my proposal) to the holding company/controlling entity under s 588V. VI CONCLUSION It was pointed out in the introduction that the main issue arising from the James Hardie controversy is how and when to make holding companies liable for tortious damages resulting from personal injury or death, and for which the subsidiary company is responsible. It was explained that the recent focus for proposed corporate law reform in Australia has been on restricting the operation of the limited liability principle, so that it does not apply to holding companies when a subsidiary company is unable to meet claims for personal injury or death. I have responded to this call for reform in this article, with what I believe to be a moderate, and effective, proposal which is consistent with the recent focus for reform, but in a way which is not designed to directly undermine the principle of limited liability. Rather, my proposal seeks to impose liability according to whether a controlling entity bears some responsibility for the specific problem highlighted with James Hardie. The specific problem being that a subsidiary company is incurring debts, involuntarily incurred, but is unable to pay. As a legislative response to James Hardie potentially draws closer to being realised, I hope that the merit in this reform proposal is recognised, and that the proposal is adopted in the Corporations Act to deal with similar such problems which may arise in the future. 60