Accountability of Parent Corporation for the Tortious Acts of Foreign Subsidiary

This article was written by Pallavi Singh and Shubham Singh a student of Amity University U.P. 

Abstract

Parent Corporation derive several benefits from the Subsidiary Corporation such as cost and tax benefits. The principle of limited liability gives room to use subsidiary in a manner which can externalize the Human Rights and environmental concerns. In the case of foreign subsidiary the victims are left without remedy because the claims cannot be brought against the parent corporation. Sometimes the laws in the host country are liberal to promote investments and thus the victims are rendered helpless. In such cases the Parent Corporation should be held vicariously liable for the acts of its subsidiary in the jurisdiction where it is incorporated so that adequate claims can be brought against them, which is not possible in the host country. This would not only check the abuse of liberal laws in host country and ignorance of human rights and environment but would also provide remedies to the victims. The logic behind imposing liability upon the Holding Corporation is that it is the one who owns or finances the subsidiary to transact any business in other country. Therefore, it has the knowledge about the conditions in the host country and the effects of the business. The profits earned by the subsidiary are when unified are ultimately enjoyed by the Parent. Hence, when adequate claims cannot be raised against the Subsidiary Corporation the Parent Corporation should be held responsible to provide adequate remedies to the victims.

Introduction

The connection between Parent and Subsidiary Corporation has always been the bone of contention in corporate law. Under what circumstances the separate legal entity of both can be disregarded, so as to treat them as a single entity? In what scenario will the parent corporation be held liable for the acts of the subsidiaries? What is the extent of control that holding corporation exercises over its foreign subsidiaries. The main question here arises is the jurisdiction over the foreign subsidiary. If a foreign corporation doesn’t performs any business within the territory it cannot be held liable for its acts. The subsidiary enjoys a separate legal entity independent from that of its holding corporation.[1] The concept of separate legal entity emerged in England in 1867 from the case of Saloman v. Saloman & Co. Ltd.[2]. In the case of Cannon Mfg. Co. v. Cudahy Packing Co.[3] the question which was considered by the U.S Supreme Court was that whether the use of subsidiary corporation to transact any business would subject parent corporation to the jurisdiction. The court observed that the organization of both entities are separate and the business of subsidiary is separate from that of holding corporation. The court emphasized that the parent corporation would not be subjected to the jurisdiction of the state merely for conducting business by its subsidiary. A line of distinction was drawn by the court between the cases which have a jurisdictional issue from the cases which impose liability on Parent Corporation for the acts of its subsidiary. A subsidiary transacting any business within a state has a separate legal entity from that of Parent Corporation by whose instrumentality it exists in a foreign state.

The parent corporation cannot be deemed to be performing any business through its subsidiary is an important theorem of company law. It is a methodological principle for the practical objective of protection of foreign corporation from the injudicious actions of the states. Hence, the accountability of foreign corporation for its subsidiaries is a completely different matter from imposing liability upon the Parent Corporation created within the state.

Concept of Limited Liability

The corporations exist by the permission of the state and not as a matter of legal right^[4]. In the 17^th century as the incorporation of corporates increased the states started formulating statutes to regulate the establishment of the corporations.[5] Emphasis was laid on making such procedure for corporation enactment that it didn’t require individualized permission, it only required filling of articles and other documents with the state. Along with the development of statutes the concept of limited liability of shareholders emerged. The objective of the concept was to promote investments in corporation thus enhancing economy and business activities[6]. The limited liability of shareholders protects them from the claims of creditors and they are liable only for the amount they invest[7].

Corporations, in the initial phase were not allowed to acquire shares in other corporations[8].  In the year 1888 for the first time corporations were allowed in New Jersey to invest in shares of other corporations[9]. These changes were brought in the late 18^th and early 19^th century and brought revolution in the parent- subsidiary structure[10]. Corporations stated using subsidiaries for conducting business for various reasons including to have various financing options, to avoid difficulties and impossibilities of qualifying the parent corporation as a foreign corporation in the concerned state, to avoid formalities required for the purchase of physical assets, to preserve the goodwill of an established business unit from being tampered in new venture, to avoid taxes, to avoid complexity in the management of business, and to benefit from limited liability.

The concept of limited liability originally was for contractual liability and did not gave protection against tortious liability.[11] Several scholars have made claims that the concept of limited liability was not for tortious liability but covered only contractual claims so as to increase the investments in the corporate sector.[12] Tortious acts cannot be covered under the concept of limited liability because that would render the society and community left with no remedy against the actions of corporations.

Logical Hypothesis behind Parent Corporation Liability

The strongest argument for parent corporation liability is that the subsidiary is financed or incorporated by the parent corporation. The Parent Corporation has complete knowledge about the conditions in the host country where the subsidiary would be operating its business, about the nature of business and most importantly it must have analysed the consequences of the business and what rights of people would be violated. When a company commits a tort the community and society is rendered without any remedy and the sufferers have to absorb the costs themselves.  Though allowing people to seek claims against the parent corporation for petty harms may be impractical. However, if the harm caused by the subsidiary is significant or of such nature that its remedy cannot be recovered from the subsidiary in such case the claims may be brought against the Parent Corporation[13].

Need For Parent Corporation’s liability for the actions of its subsidiary in certain circumstances:

Abuse of Financial Benefits

While contemplating as to whether impose liability of subsidiaries acts upon the parent corporation it is important to analyse that parent corporation enjoys several significant financial benefits by transacting business though subsidiary corporation. These benefits may entitle the corporation to take exceptions from statutes like rebates in taxes. The other cost benefits at managerial level include reduced labour cost, less expenditure in management of affairs etc.[14].

Holding corporations benefit from the incomes of foreign subsidiaries as shareholder dividends, as they can receive such dividends.[15] Further Parent Corporations benefit from establishing overseas subsidiaries as they are deferral of income earned by Subsidiary Corporation and transfer pricing manipulation provide significant tax benefits.

Transfer pricing is one of the most important dimension in the international taxation laws which is used to reduce tax liability by shifting it from higher tax jurisdiction to lower tax jurisdiction by use of subsidiaries. Transfer pricing is a phenomenon where the corporation tries to evade tax by transferring goods and services among the related corporations. For Example, if the subsidiary transacts business in a lower tax jurisdiction then the parent corporation may concentrate larger share of profits to that jurisdiction so that the tax on the profit is comparatively less.

Violation of Fundamental Rights by transnational business enterprise

The parent corporations buy or establish subsidiaries in a foreign company to benefit from the conditions of that host country like lower labour or manufacturing cost, liberal laws, etc. These transnational overseas subsidiary corporation establish such a network that can evade national laws like labour laws or even environment norms. Such countries may have a liberal legal system or inefficient to protect the Human Rights or other laws to be bypassed by such corporations.[16]

Inability of host country to provide remedy

If the host country is not able to provide remedy to the victims against the actions of Subsidiary Corporation, then the victims should be able to claim remedy against the parent corporation in the country in which it is incorporated. If the victims are not allowed to claim remedies against the parent corporation then they would be left without a remedy. This will not only impart injustice but would also pave a path for corporations to randomly violate rights of others for their benefits or even to exploit environment.

It can be presumed that all the countries must have judicial system that could protect the rights of its people from such corporations. But this is not the case many countries have liberal approach and loosen the legal system to attract the foreign investments in the form of transnational business. Sometimes the judicial system is not able to award proper claims or remedies due to corrupt system of lack of statutes to bring up such claims. If all these factors are compiled together there is only one hypothesis that the victims are helpless in the host country.

Judicial Approach

In the year 1986, remedies were claimed against the Union Carbide Corporation based in New York in the U.S Federal Court[17] by the Indian Government and the victims of 1984 Bhopal Gas Tragedy. The factory in Bhopal was owned by the subsidiary of Union Carbide Corporation named   Union Carbide India Ltd. The U.S Federal Court refused to entertain the petition for tort claims and stated the Indian Judicial System to take cognizance of the matter as they are in a better state to deal with the matter and also directed the Union Carbide Corporation to abide by the directions of the Indian Courts.

The Canadian Court in a case imposed claims for $69 million on the parent corporation based in Canada. The Subsidiary Corporation was based in Guyana where it caused severe environment damages due to totality of its activities. The court stated that it has significant jurisdiction to entertain the matter because the Parent Corporation based in Canada controlled the affairs of its subsidiary in Guyana and is also liable for environment damages.[18]

The legislature of France introduced the bill that creates presumption of liability of Parent Corporation for the acts of its overseas subsidiary. The tortious liability arising from the acts of its subsidiaries can be imposed upon the Parent Corporation for protection of human rights. Switzerland legislature adopted the similar approach and called for motion that requires corporations to take due care of Human Rights and Environment while transacting their business.

The decision of U.S Supreme Court in the case of Kiobel v. Dutch Royal Shell[19]  added another barrier in these litigations by presumption against extraterritoriality. In order to claim remedy against Parent Corporation it is not sufficient to overcome the limitation of limited liability but also it must be proved that there must be some action on behalf of the Parent Corporation in the county where it is based that has led to violation of international customary laws.

Suggestive Methods to impose liability upon Parent Corporation

Piercing of Corporate veil is the most common approach that can be used by the judicial bodies to look behind the corporate personality of the corporation to bring forward the actual guilty people. By lifting of corporate veil both Parent and Subsidiary Corporation can be treated as single entity due to absence of limited liability and corporate structure. Thus, Parent Corporation can be held liable for the tortious acts of its subsidiaries. But the doctrine of piercing through the corporate veil is rarely used[20] and can only be brought into picture when it is proved that the parent corporation was directly involved in the act, which very difficult to prove.[21] However, there are several other approaches that can be used for this purpose.

Agency Theory approach can be used to impose the liability upon the Parent Corporation.[22] Under the Agency Theory approach parent can be held liable for the acts of its agent which acts within its authority. Similarly as the Subsidiary Corporation is owned or incorporated under the authority of Holding Company for transacting a particular business.

Enterprise Liability Theory is the most persuasive and convincing approach that can be implied to make Parent Corporation liable for the acts of its subsidiaries. This approach presumes Parent Corporation responsible for the functioning its Subsidiaries because ultimately they are a network of corporation with unified benefits and economic gains from their respective business. Parent Corporation also has control over the affairs of the Subsidiaries as it appoints the board of directors, incorporated the corporation, defined the objective, etc.[23]

The due diligence approach presumes it the duty of parent company to monitor the activities of the subsidiary and to ensure that the acts of its subsidiaries are within the sphere of Human Rights. The theory is however unclear and doesn’t lays down any standards for Due Diligence.

The theory of Parental Duty of care it is duty of the Parent Corporation to monitor the activities of its Subsidiary. If a subsidiary violated any of the International customary Law, human rights or performs any such act for which claims can be brought against the corporation. It would be considered failure of Parent Corporation to perform its duty to check such actions of its subsidiaries. Therefore, the Parent Corporation is held liable for its own breach of duty that it owed to other parties.[24]

CONCLUSION

The Parent Corporation derives many benefits by transacting business though subsidiary like reduction in taxes, lower labour cost, etc. In the urge to earn maximum profits the Subsidiary Corporation ignore the factors like Human Rights, environment etc. In such cases when the Subsidiary cannot provide adequate remedy or when the claims against such acts cannot be brought against the subsidiary the Parent Corporation should be help vicariously liable to ensure that the harmed victims are provided adequate relief. The parent Corporation should not be allowed to dodge the claims by raising the plea of limited liability else the victims would be rendered helpless.

Liability should be specially imposed when the Parent Corporation directly gives assent to such act for earning more profits by exploiting the liberal conditions in the host country at the cost of Human Rights, environment, etc.

The states must introduce such legislations that hold Parent Corporation responsible for the actions of its Subsidiaries. The essential factor to be considered is that these subsidiaries come into existence only by the permission of the Parent Corporation for particular objective.

Adopting the suggested approaches in this article would ensure that the victims of the acts of corporations are not rendered helpless. Especially when their rights are being violated by a Subsidiary Corporation which is owned by an international corporation and the host nation is not capable enough to provide adequate remedies.

[1]  Mills v Menifee [1915] 237 U. S. 189

[2] Saloman v Saloman & Co. Ltd [1867] AC 22

[3]  Cannon Mfg. Co. v Cudahy Packing Co. [1925] 69 L. Ed., Adv. Ops. 308

[4] Meredith Dearborn, ‘Enterprise Liability: Reviewing and Revitalizing Liability for Corporate Groups’ [2009] 97 CAL. L. REV. 195, 203

[5] E. Merrick Dodd, ‘Statutory Developments in Business Corporation Law’ [1936] 50 HARV. L. REV. 27, 28

[6]  Anderson v. Abbott [1944] 321 U.S. 349, 362

[7] Stephen M. Bainbridge, ‘The New Corporate Governance in Theory and Practice’ [2008] Oxford. Univ. press LTPC 20. 79

[8]  Nelson Ferebee Taylor, ‘Evolution of Corporate Combination Law: Policy Issues and Constitutional Questions’ [1998] 76 N.C. L. REV. 687, 698

[9]  Jodie A. Kirshner, ‘Why is the U.S. Abdicating the Policing of Multinational Corporations to Europe? Extraterritoriality, Sovereignty, and the Alien Tort Statute’ [2012] 30 BERKELEY J. INT’L L. 259, 263

[10] William Douglas & Carol Shanks, ‘Insulation from Liability Through Subsidiary Corporations’ [1929] 39 YALE L.J. 178

[11]  David W. Leebron, ‘Limited Liability, Tort Victims, and Creditors’ [1991] 91 COLUM. L. REV. 1565, 1566-67

[12]  Robert B. Thompson, ‘Unpacking Limited Liability: Direct and Vicarious Liability of Corporate Participants for Torts of the Enterprise’ [1994] 47 VAND. L. REV. 1, 4, 29-39

[13]  David Shea Bettwy, ‘Human Rights and Wrongs of Foreign Direct Investment: Addressing the Need for an Analytical Framework’ [2012] 11 RICH. J. GLOBAL L. & BUS. 239, 243, 249-51

[14] Daniel Chow, ‘Counterfeiting As an Externality Imposed by Multinational Companies on Developing Countries’ [2011] 51 VA. J. INT’L L. 785, 816-17

[15]  Julie Roin, ‘The Grand Illusion: A Neutral System for the Taxation of International Transactions’ [1989] 78 VA. L. REV. 919, 938

[16]  George T. Ellinidis, ‘Foreign Direct Investment in Developing and Newly Liberalized Nations’ [1995] 4 J. INT’L L. & PRAC. 299, 313

[17] In Re Union Carbide Gas Plant Disaster at Bhopal, India in December [1984] 634 F Supp. 842

[18]  Recherchés Internationales Quebec v Cambior Inc. [1998] Q.J. No. 2554.

[19] Kiobel v. Royal Dutch Petroleum Co. [2013] 133 S. Ct. 1659

[20] Berkey v. Third Ave. Ry. Co. [1926] 155 N.E. 58 61

[21] Doe v. Unocal Corp [2001] 248 F.3d 915, 926

[22]  Bigio v. Coca-Cola Co [2012] 675 F.3d 163, 175

[23] Henry Hansmann & Reinier Kraakman, ‘Toward Unlimited Shareholder Liability for Corporate Torts’ [1879] 100 YALE L.J., 1916-19

[24] Mendez-Laboy v. Abbott Laboratories, Inc. [2005] 424 F.3d 35, 37