Secured and unsecured corporate landing in the United Kingdom has been recently reviewed by the regulators, following the credit crunch. However, the English Law still lacks some advanced protection measures for creditors of affiliated companies, making them unable to maintain their position and request adequate security for protecting their interest. The below paper is designed to review the legal loopholes in Great Britain regarding trade creditors’ rights and methods of “finding ways around the corporate veil”.
Thesis: The main assumption of the current research the authors would like to prove is that:
“The protection of corporate creditors and liabilities determined by the legal system in the UK is inadequate, and compared to US provides little loss prevention guidelines, even after the introduction of the bankruptcy reform.”
The research will consist of literature review, legal system research and case study analysis, in order to prove the thesis above and try to find a framework for dealing with the legal discrepancies within the English Law covering creditors’ rights. Determining the way forward in legislation and regulation would provide more security for corporate creditors and reduce the risk of lending to affiliated companies. The suggestions included in the paper would have the potential to better the legal system to be able to accommodate the current needs of the market and securities within the United Kingdom. Finally, the paper will focus on the comparison of legal protection provided for corporate creditors in the United Kingdom and two other countries: Australia and United States. The authors are looking to find the answer to the question: how can we learn from other systems to represent creditors’ interest.
The main question regarding the treatment of affiliated companies is whether which approach is fairer for creditors: treating them as separate entities and with limited liabilities or pooling the assets and obligations. The authors would like to review preventive and jurisdiction methods alike in order to provide informations for policy-makers on the potentially most effective international framework on determining liability of affiliated companies.
Review of Creditors’ Rights in the United Kingdom
There are several legislation covering bankruptcy and insolvency in the United Kingdom: all designed to protect the interest of both parties. The Insolvency Act covers both registered and unregistered companies, even overseas companies. The supervision of insolvency, liquidation and bankruptcy is also regulated. Specific professional regulatory requirements have to be met by insolvency practitioners and liquidators. Insolvency proceedings against UK companies can only be started in the United Kingdom if the main interest of the company is in the country. If this is not the case, the other member state’s law applies to the company. This means that creditors of affiliated companies with their head office outside the country might be disadvantaged due to their lack of influence on the EU legal system. The above is one of the discrepancies the paper is going to examine in further chapters.
While the main guidelines and legal background are provided by the Companies’ Act, there are several sections of the Bankruptcy Law that cover liability.
Armour et al. confirms that the recent changes in the bankruptcy law have modified the level of protection provided for secured and unsecured debtors of companies. Secured creditors until recently had “ex post control”, through the institute of “Receivership” in order until 2003, and this meant that they had more power than unsecured creditors. The introduction of the legal term: “Administration” provides a greater control for unsecured creditors. Secured and unsecured creditors gained extra governing rights provided by the Bankruptcy Law This certainly created a fraction among the firm in financial distress, the secured and unsecured creditors. The authors also mention the UK’s Enterprise Act 2002, providing more power for unsecured creditors and abolishing the automatic right of the secured creditor to appoint an official receiver. This certainly balanced the situation and dealt with the discrepancies of the law: protecting the interest of only one group. The Enterprise Act does still allow secured creditors to appoint an Administration that is committed to protect the interest of all creditors: secured and unsecured alike.
Lifting the Corporate Veil. Provisions. The UK law is aware of some group structures used in order to avoid responsibility and taxation. Corporate forms can be used to defraud stakeholders and shareholders in particular and avoid groupwide responsibility. The more complex and international the structure of a group is the harder it is to establish liability and responsibility. According to the Insolvency Act there are some sanctions that help the public, including unsecured creditors to lift the corporate veil.
- “If in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, the following has effect.”
- “The Court, on the application of the liquidator may declare that any persons who were knowingly parties to the carrying on of the business in the manner above mentioned are to be liable to make such contributions (if any) to the company’s assets as the court thinks” proper.”
Specific Provisions of Insolvency Law for Affiliated Companies. Reviewing the challenges of recovering debt from affiliated and multinational companies, Mevorach examined international insolvency policies and practices. The first challenge the author found is determining the “home country’ and parent company location. While obtaining guarantees from the local subsidiary or the parent company would be recommended when dealing with affiliated companies, once the default occurs, and there are no securities provided, it is difficult to create an accurate map of multinational enterprise groups, their affiliation, interest and the application of international insolvency regimes effective in such cases. The “global approach” of the problem would involve dealing with the group, instead of one subsidiary. This would certainly reduce the cost of investigation and proceeding. Instead of trying to locate all responsible parties, the holding or head office would be made responsible for the unpaid debt. Still, determining the “home country” of the multinational enterprise is challenging in most cases. This is the challenge that Mevorach is trying to tackle, providing a framework for such instances.
The author describes several related international regulations and proceedings models that can be used by legal experts to determine the home country and apply the most relevant approach. The author also confirms that many international regulations do not provide adequate guidelines for international relations. For example, he mentions the EU’s regulation on Insolvency Proceedings, as well as the UNCITRAL Model Law on Cross-Border Insolvency not providing explicit rules and regulations regarding international enterprise groups. There is one guideline, however, that can be used: this is the ALI Principles, which states that a subsidiary is able to start an insolvency proceeding in the parent company’s jurisdiction, but this is not a rule or obligation, only offered as an option. Some details are still missing regarding the proceedings and legislations to apply.
Review of Creditor’s Rights Around the World
La Porta et al. successfully compared the protection provided for creditors of companies among 39 countries. The authors found similarities among English Law countries. In the United Kingdom, secured creditors are paid first, however, in Australia and US, this rule in not in place. Further, the UK law includes some restrictions for going into reorganization, but none of the countries determine a minimum legal reserve in the percentage of the capital, apart from Thailand. Therefore, compared to German, French and Scandinavian origin legal system, the level of security provided by English law is fairly low. The authors also state that there is a strong link between legal protection of investors and economic growth, as well as the size of the debt and equity markets. Therefore, the paper proves the thesis that common-law countries have the strictest protection of investors and creditors, while the weakest regulation is present in the French – civil-law systems.
According to Armour et al, the US Federal Bankruptcy law has two legal ways of filing a formal bankruptcy: they are determined by Chapter 7 and Chapter 11. Companies can carry out the bankruptcy proceedings by allowing their management and administration to remain in place, or allow the creditors to appoint a Trustee. It is evident that Chapter 11 proceedings do not represent the rights of creditors as well as Chapter 7. In the UK law, there is no option for the management to stay in reorganization. Both in the US and UK, however, shares are not blocked before the meeting.
In France, there is a legislative response to assuming liability of the parent company for the debt of the subsidiary. According to Article L 233-c-cc, parent companies with at least 50 percent of the subsidiary firm’s shares are assumed to have full control over the operation, finances and management. This means that the parent and subsidiary are jointly liable for the financial demands.
In Germany, the preventive measures are in place in order to avoid even the existence of the corporate veil in litigation and insolvency cases. The corporate law of Germany does not allow one person to be the director or owner of another firm. Further, the director of the parent company is regarded as the shadow director of the subsidiary de facto by German law. Directors need to exercise the duty of loyalty and care, therefore, can be made liable for the damages caused by the legal entity. In other European countries, however, the same approach of paying extra attention to groups of companies and affiliated companies is common, based on the German example.
Regarding ECJ, the Treaty of European Communities does not regulate affiliated companies. The presence of the Antitrust law in the European legislation provides a framework, which allows the court to make the parent company liable for the subsidiary’s acts. While the Capital Directive states that: “The parent as a major shareholder could possibly be hold liable for damages in case it breaches its obligation to react in case of inadequate capitalization”, it is not related to insolvency and liability.
Armour et al. examined 348 bankruptcies in the United Kingdom, comparing the legal protection provided by English Law before and after 2003. The findings include that while the realizations during the legal procedure were increased, the costs have gone up, as well. As a result, creditors were unable to recover more debt than when “Receivership” was in place instead of “Administration.” This means that instead of allowing secured lenders to appoint an official receiver, they can appoint an administrator. An administrator needs to work on recovering secured and unsecured debt, as well. The study focused on the differences of bankruptcy cases before and after the reform. While gross recoveries increased, net recoveries remained the same, due to the higher legal and administration costs, according to the research.
The administration procedure, introduced in 2003 clearly defines the responsibilities and legal duties of the official administrator. Further, the law outlines the priorities and objective hierarchies related to administration. The official administrator needs to seek the highest return (recovery of funds) for unsecured creditors. The administration institution is also aiming to provide better results for unsecured creditors than liquidation. Still, the author notes that several experts doubt that the increased regulation results in improvement of protection.
Mentioning the Enterprise Act, the author summarizes that while it increased the control provided for unsecured creditors, it also decreased the rights of secured ones at the same time. Still, this seems like a more democratic and fairer approach, as the legal duties of the procedure apply for all creditors, and the demands, proceedings and decisions have to be approved by a creditors’ meeting.
The study was based on an interview with corporate finance experts, involved in UK bankruptcy proceedings. Two main hypotheses were confirmed based on the interviews and data collection about bankruptcy cases:
- “Realisations were on the average larger in administrations than in administrative receiverships among the cases examined”
- “Bankruptcy costs were larger in administration than previously in administrative receivership”
Padilla and Requejo reviewed the theories of creditor rights’ protection. Interestingly, the authors do not automatically conclude that a higher level or regulation would mean a greater protection. They review different financial approaches: debtor-oriented and creditor-oriented legislation. They examine the relationship between the level of creditors’ rights provided by the legal system and economic efficiency. The study also concludes that equality in the distribution of assets should be exercised. Starting with the review of the so called “Orthodox View” This view concludes that while it is recommended that lenders obtain collateral agreements, if this is not possible, a higher interest is charged to reflect the higher risk. This means that the financial world should have their own regulation and rules, which cannot be fully controlled and overseen by the legal system. Further, the existence of collateral agreements should be providing enough protection against non-payment.
Critical theories regarding strict regulation of creditors’ rights protection include claims that this approach would slow down economic growth, as creditors would not allow debtors to restructure their finances and continue operation to try and turn their financial situation around. Some defaults are the result of short term liquidity problems, and if the company changes their financial plans, the debt can be paid within a short period of time. Projects might not be funded as a result in a decreased risk-taking incentive of entrepreneurs, and consequently slower economic growth. There is, however, a great inequality between different types of lenders. Banks, however, have more provisions and tools in place to eliminate and identify risks, complete background and financial checks. In the case of an exporter dealing with a company that has their head office outside of the borders, there is little information available, and even if the company does check their potential or new partners, it is creating a cost burden for the management.
The final answer the authors provide is to take La Porta et al.’s research and add two dependent variables: default rate and interest rate, as well as two different explanatory variables: inflation and the surplus of the government. The study proves that the cost of external finance is reduced when strict creditor protection is present. However, lending volume is not affected by the level of creditor protection built in the legal system. Strong creditor-oriented provisions, however, did not prove to be effective in reducing the rate of defaults.
Thinking through the theories above, as well as the research findings, the authors of the current study can assume that there are two potential explanations for the results:
- strict provisions are hard to apply in the legal system and are not effective
- prevention and pre-contract risk analysis support would be needed to supplement the provisions to protect creditors’ rights.
Types of Protection
Guarantees. Regarding guarantees, the legal system seems to be extremely confusing in the United Kingdom. Those relating to partners of affiliated companies and international corporations are explained and reviewed by Ashurst LLP. The summary provided by the company is used to simplify the explanation of the legal system covering creditors’ rights. Guarantees are classed into two different types: “surety” and “indemnity”. A guarantee is only a secondary obligation, as the guarantor only needs to pay if the indebted is unable to. A corporate finance agreement can be obtained with, and without a guarantor supplement: it is determined by the agreement. From the perspective of the creditor, it is important to understand the difference between indemnity and guarantee. Indemnities can have different conditions based on the individual agreement, however, guarantees usually replace obligor’s liability with the guarantor’s. This means that the liability’s extent is exactly the same as the one stated in the original credit agreement. Further, guarantees need to be in written form, signed by the guarantor themselves. Indemnity agreements can be made in a verbal form. This means that their existence is harder to prove in court. However, guarantees can be challenged in court in case a legal insolvency proceeding is started.
Performance Bonds, Demand Guarantees and Letters of Credit. These measures and provisions are in place to provide security of payment and unconditional undertakings to pay a set amount to the beneficiary. All the above documents are called “documentary credits” and payment can be demanded upon the presentation of these documents. In case of performance bonds, there is a need to attach the proof of default in order to demand payment. A commercial letter of credit are commonly used in international trade. When starting a new import-export relationship, the lack of trust from the exporter would call for this institution. While credit cannot be provided for the company, upon the letter of credit, the bank of the debtor secures the amount of the price of goods ordered, upon delivery. This is a successful and effective preventive measure that is not used commonly by UK companies. Reviewing the conditions of a commercial letter of credit, it can be an effective way of protecting creditors’ interest in international trade.
Comfort letters are written statements, usually of a non-binding nature. They are set up for companies that are unable to provide guarantees or letters of credit. There is usually a confusion among companies regarding the nature of these letters. Only international legal experts might be aware that comfort letters including statements: “binding by honour only”, “by way of comfort only” or “it is our policy that” are not legally binding. As comfort letters do not provide adequate protection for companies providing credit, they are not suitable to reduce risk associated with international trade.
Demand guarantees. Guarantees become “demand guarantees” when the responsibility of the guarantor starts: usually when the obligor defaults on the payment. Therefore, the obligor’s responsibility to pay is transferred to the guarantor, as, according to Ashurst Quickguide, “the guarantor’s liability is triggered at that point”. An important feature of this type of guarantee is that “no defences to payment are left open to the guarantor – once demand in the appropriate form has been made”. This provides creditors extra security, while it creates clarification regarding liability of the guarantor.
Wrongful Trading and Liability of Directors. Keay examines whether the Wrongful Trading provision in the UK legal system provides extra measures to protect creditors’ rights and increase directors’ responsibilities. Reviewing the Insolvency Act, he finds that the Act indeed provides an option for creditors to initiate an action against company directors. Their liability, however, can only be confirmed, according to §214 of the Insolvency Act, if there is a proof that there was a way of avoiding liquidation and the director was aware of both the situation and the potential solution. If the director can prove that they took every measure to avoid or minimise loss, they would not be charged with “wrongful trading”. While this bill is created to prevent bankruptcies and emphasize directors’ liabilities, control corporate activities, it is an effective provision. It is not included in the Canadian and US corporate law, but is present in Ireland, New Zealand and Australia. It is a measure that helps preventing directors from running up debt when they find the company in financial difficulties. Indeed, when directors are not disciplined by the law, creditors can lose out. Still, Keay finds some crucial problems with the paragraph. One of the major ones is the difficulty to prove wrongful trading: the company’s books might not include the information the Court is looking for, or got erased. Another potential effect of the provision would be to make directors take fewer risks, resulting in lower profits and slower growth. Further, the author quotes several experts who state that courts are unable to deal with these cases effectively as there is no “beaten track” and judges have no experience in the legal proceedings of “wrongful trading”. This results in a lack of evidence and the release of directors almost automatically. Further, the provision might result in a higher number of liquidations and administration cases, as directors will make a decision more prematurely. While the fairness and effectiveness of the above mentioned provision has not been proven by the author, this provides an alternative preventive measure to corporate liability, which should be further examined and researched in order to make a judgement on its benefits or disadvantages.
Discrepancies in the UK Legal System Regarding Creditors’ Rights
There are several loopholes in the legal system: no matter if it is based on English or French law. It is the result of the ever-changing facet of the financial world, globalization and the internal regulation of the financial world. Below, the authors would like to review three of the most challenging problems in the United Kingdom: dealing with international companies, dealing with trustees and the difference in corporate structures.
The Question of Trustees. The Trust Law Committee Report summarizes the problem of creditors’ dealings with trustees and trust funds. The legal problem is that a trust is not considered to be a legal entity, similarly to a company. It cannot have an agent, therefore, the authority of trustee might be questionable, so would their legal responsibilities and liabilities. Still, if the contract is signed by the trustee (no matter if it is a person or company), they become liable for the commitment and the obligations described in the contract will be enforceable upon them.
International insolvency is one of the major challenges, as methods to determine the “home country’ of the company are little known. While Mevorach confirms that in some cases there are several approaches, determining the validity and effectiveness of each one is hard. The four approaches are as below:
- Looking for the home country of each legal entity involved in the group of companies, then determining the one that has a strong connection with the management and other members of the group
- Venue corresponding legitimate expectations
- Choosing based on the predictability of the venue
- Venue determined by the group handing the insolvency.
Different Corporate Structures
The variety and complexity of corporate structures is challenging for legal experts dealing with insolvency and bankruptcy cases. Further in the paper, the identification of the parent company will be examined as a solution, as well as the procedure of handling a holding or group as one legal entity, instead of starting a case against a subsidiary. While this would extend parent companies’ legal responsibilities and liabilities, it would at the same time provide effective solution for creditors, reduce the time and money spent on cases, maximizing recovery of funds. According to Elkin the court often disregards the separateness of the legal entities in order to speed up the case and make the legal system more effective in insolvency and bankruptcy cases. While many parent companies “back up” their subsidiary companies with a guarantee, when this is not in place, it is extremely hard to recover debt. As corporate structures and allocated liabilities in each country differ, it is hard to determine the level of responsibility in multinational cases, especially when the affiliated company has a complicated structure. Therefore, there is a need for an EU and international regulation that relates to every existing form of incorporation and holding, group of company. Unfortunately, the majority of European Company laws do not even deal with the liability of affiliated companies separately: not to mention holdings, trustees and multinational enterprises.
Until there is a standard for international insolvency cases that clearly defines when can the court assume full control of the subsidiary by the parent company (i.e.: a percentage of share, ownership structure, funding), it will remain extremely hard to lift the corporate veil and represent unsecured creditors effectively. There is also a need for an international agreement on ways to determine the “home country” of the company, personal and group responsibilities. These regulations need to be incorporated in the international Antitrust and Trade laws, in order to become effective and enforceable.
Lifting the Veil
Elkin describes the challenges of “lifting the veil” in her research article. The paper is designed to try and find ways of overcoming the hurdles of starting and successfully carrying out insolvency cases, maximizing the asset value and the recovery rate. The offered solution would be to provide more control for creditors before the company becomes insolvent to review the corporate structure, financial information and portfolio of projects, therefore, be able to make an informed decision about financing the company. Cutting through the corporate veil, however, has its own legal challenges.
Elkin confirms that there is a controversy in the United States (and English-law countries) regarding assets, liabilities and creditors’ interest. One of the major obstacles of creditors’ interest protection is the institution of limited liability of corporate shareholders. This can also mean that finding the person or legal entity responsible for the loss is only possible after a long and costly investigation, while parties are pointing fingers on each other. According to the author43, “Veil piercing is an equitable doctrine through which a court holds a shareholder liable for the obligations of its corporation”.
Describing the process of “veil piercing”, the author determines different factors to be considered. It is, however, important to note that the paper is designed to fit the US legal system and there might be variations in the processed between United States and United Kingdom courts. To determine that the parent company is closely related to, and therefore, responsible for the subsidiary firm’s debt, one of the following signs should be spotted by the court, investigators and professionals responsible for the insolvency case:
- overlapping in company directorship or ownership
- capitalization of the subsidiary being inadequate
- shared office space or facilities
- financial statement consolidation
- shared bank accounts
- level of control over subsidiary assets, finances by parent company
- history of the relationship: has the parent company previously paid off debt for the subsidiary?
- use of corporate fiction
Any of the above present in the case can be the foundation of an argument in court to disregard the corporate structure. This would result in the court handling the group as a single legal entity. Still, the piercing of the veil should be based on the totality of circumstances, therefore, up to the court’s discretion to disregard corporate structure. In some cases, however, when the subsidiary firm goes into administration or undergoes a re-structuring process, this is the only method creditors can use to get their money (or a part of it) back.
The solution the author finds lies in substantive consolidation. This means that bankruptcy court in the United States can disregard the legal separateness of the parent company and the debtor. The pooling of the liabilities would also help eliminating duplicate cases and financial claims, making the process simpler and faster. The institution of substantive consolidation is also an effective way of making parent companies more responsible when setting up, managing and organizing subsidiary companies. It can certainly act as a preventive measure, when it is in place in the legal system to protect the interest of creditors. Unfortunately, the UK legal system does not permit the pooling of assets and judges are reluctant to apply the legal practice.
The authors also set some simple standards for determining substantive consolidation. Originated from the US Bankruptcy Law, and Rule 1015 in the Federal Rules of Bankruptcy Procedure, which states that separate debtors’ estates can be administered as a joint asset in court cases. Still, there are some guidelines to be created for this “pooling method”, based on the author’s list. While it is important to note that the guidelines were created in the US legal environment, they are still easily adaptable in other English law systems.
- common ownership or control
- same or overlapping directors, shareholders, officers
- consolidated tax return
- inter-affiliate debts and the existence of guarantees
- commingling assets or business functions
- lack of maintaining corporate formalities (no borders)
- fraudulent transfers or preferential transactions
- fraudulent use of an affiliate
- consolidation has economic benefits
The above list seems to be more comprehensive than Elkin’s description of closely related and affiliated companies when examining liability, however, in this case, when trying to adapt the system in a new country, there is a need for finding all the determinants, and it is recommended that all the variables are examined from the perspective of efficiency and relevancy.
Another solution might be the introduction of “tailored limited liability” proposed by Millon. The rethinking of the responsibilities of corporate shareholders is important to make the legal system covering insolvency fairer for all. The management of risk is also an important aim of the proposal. The only trouble with the idea is that there are several countries with different liabilities assigned for various incorporation forms, therefore, unifying the system and harmonizing corporate governance guidelines with regulations and the law can be challenging. The idea needs to be embraced by politicians, policymakers and most importantly, in international cases, by the European Union’s legislation. Still, in order to sanction corporate opportunism.
While the tailored limited liability would extend the owners’ and investors’ risk, it would limit it up to the amount of the original investment. Therefore, it is a balanced approach, which, according to Millon, can increase the popularity of entrepreneurship, and might also be tested. The main purpose of corporate law should be to balance the protection of debtors and creditors, while minimizing risk for both. This balanced approach would shift the focus of the institution of “limited liability” from protecting the interest of companies to protecting both parties.
Some cases will be quoted from the literature to demonstrate the drawbacks and difficulties courts need to face when making a decision about lifting the corporate veil.
One of the classical veil lifting cases in the United Kingdom is the Salomon v Salomon case. The court made a decision in 1897, when the first documented practice of the “lifting of the veil” appeared. According to Hudson,
“Whereas previously a business organised as a partnership could only create contracts in a very complicated way – involving each partner becoming a party to that contract, and involving the hidden nature of the rights and obligations of individual partners – as soon as it is recognised that a company is a distinct, legal person in itself then the company can create contracts in its own name. as a result, the process of creating contracts with businesses became much simpler.”
The offence of “fraudulent trading” was introduced, and the Salomon principle was introduced into the English legal system. Today, there are several civil provisions contained in the Insolvency Act. This was followed by an interventionist approach of the court: including the case of Adams v Cape Industries Plc in 1990. This case represented a challenge because it related to the enforcement of a foreign judgement in the United Kingdom. The court needed to make a decision whether to regard the legal entity of Cape Industries as one belonging to US or UK jurisprudence. In this case, the court rejected the claims that the company should be treated in front of the law as one entity: the principles set by the Salomon v Salomon case were disregarded. While the court took the “veil lifting” approach and found that the company used subsidiary companies to minimize the amount of tax paid in the United States. Finally, the “agency” argument and approach was tried by the court, which meant that if the subsidiary company acted as the agent of Cape, and they had the authority to do so, the parent company would need to accept liability.
Another famous case regarding the lifting of the corporate veil was Creasey v Breachwood Motors in 1993. In this case, there was a strong relationship between the two companies: they had common shareholders and directors. While after Breachwood Welwin ceased trading Breachwood Motors paid off the creditors of the company. However, Mr Creasy had an unfair dismissal case against Breachwood Welwyn Ltd, and the court ruled that it was Breachwood Motors’ responsibility to pay the compensation to Mr Creasy. A more important side of the case was, however, that the assets of Breachwood Welwin were automatically transferred to Breachwood Motors, without discussing the issue with stakeholders and this proved that the two companies were to be treated as one entity by the court. This was an effective justification for lifting the corporate veil.
The third case to be examined is Ord v Belhaven Pubs ltd from 1998. The company went under reorganization, and the parties claimed that Belhaven Pubs did not have any liabilities and assets that would be used in the legal action about a lease. The court ruled that the reason for the group’s reorganization was reasonable and did not have an ulterior motive. The group did not try to conceal the facts and eliminate liabilities.
Determining the reason for the reorganization of the group when financial and legal claims are made against the company in administration or litigation is the court’s main task. Once this is determined, the decision needs to be made whether there is a justifiable reason to lift the corporate veil and handle the group as one legal entity in the present case.
The above review of literature, cases and international policies regarding the effectiveness of legal systems in protecting trade unsecured creditors has provided the current research with adequate insight into the difficulties and challenges of lifting the corporate veil. Looking at the three different legislations regarding sanctions for trying to avoid liabilities has identified some measures. However, looking at some cases, the recovery rate of assets and success rate of different administration processes, it is evident that these provisions are not adequate.
While several steps have been taken in order to harmonize the law, the regulation of companies and international trade law, the success rate is still low. There is, indeed a need for advanced, simple and adequate policies, practices to enable judges to justify lifting the corporate veil.
While the US legal system in the current study has appeared to be somewhat more effective in determining responsibilities, it is far from being perfect. The study has found several measures that should be used more and publicized among legal experts: the principle of “wrongful trading” and the above mentioned sections from the Insolvency Act.
The main findings of the research can be summarized below:
- The main challenges of unsecured creditors recovering debts from companies lie in corporate structures, international trade and the particularities of multinational enterprise groups.
- Several ways are available for courts to be able to “lift the corporate veil”, and as the Salomon v Salomon case shows, it is possible to do so. However, there are no official guidelines and sample cases to be used: the decision whether to treat the group of companies as one entity or separate ones is usually down to the court’s discretion. This creates a great level of discrepancy in the legal system.
- Using Merovach’s guidelines in determining the group’s home country would make insolvency cases simpler, faster and more effective. However, there are no published guidelines that provide information for legal policy makers on choosing the right approach.
- The greatest level of discrepancy is originated from international cases, and without the work of harmonizing international trade, European Union and UK corporate legislation, it is hard to provide creditors the protection they need.
- It has also been noted that while the institution of administration was introduced to provide more protection for unsecured creditors, the new system means longer cases, higher costs, and therefore, creditors lose out on the additions funds recovered, as they are “eaten up” by legal fees and costs.
Further, the authors have found several discrepancies in the protection of banks and corporate lenders. While the same measures and tools in risk assessment are not available for all, there will be no equality provided for creditors. As secured corporate lending is usually safer, as there is an asset guarantee, there is also more information available for lenders prior to signing the agreement.
Based on the research of international policies, case studies and UK law, it is important to deal with the question of responsibility in case of affiliated companies. While several authors have been quoted in order to structure a proven to work and efficient framework to determine the liability of persons and affiliated companies, the real challenge is to do so without a lengthy legal procedure while using preventive methods. The author’s recommendations are detailed below for consideration by legislators and researchers.
- Application and publication of Sections 213 and 214 of Insolvency Act. Revising of the Act based on current and recent cases, typical outcomes and the percentage of secured and unsecured recovery.
- The institution of “wrongful trading” principle needs to be publicized in the corporate world, in order to caution managers of affiliated companies and multinational enterprises of the possible legal consequences.
- Consideration of the introduction of substantive consolidation in the United Kingdom, based on case studies, court case statistics and research based on the US legal system. This institution would certainly strengthen the court’s power in lifting the corporate veil and represent the interest of secured and unsecured creditors alike. While this is not currently present in the English law, it would be a regulation that sets standards for judges for future cases.
- Introduction of the institution of “tailored limited liability” and researching studies in order to determine how this would influence the rate of investments, growth of the economy and the risk-taking rate of entrepreneurs.
- The education of companies and managers about risk assessment procedures, provisions in place: such as guarantees, parent company performance bonds, demand guarantees and letters of credit, background checks, some of the insolvency cases that account for several hours of court proceedings and thousands of pounds in legal fees can be avoided.
- Further, there is a need for the harmonization of the parent company’s liability for the acts of the subsidiary, in order to create a clearer, easier to see through and more effective system for member states. In the comparison part of the study, it has been proven that the discrepancy does not only exist between European and American corporate law systems, but within the EEC as well. A joint effort has to be made to revise and restructure the Insolvency Regulation currently in place in the European Court.
While the above study has attempted to reveal some of the effective measures that would help the UK legal system in protecting creditors (most importantly unsecured creditors) of subsidiary companies, it is far from being a comprehensive research. Some of the examples, ideas and international solutions presented in the paper might not be suitable for the UK legal system. The feasibility of the different methods was not a part of the current study, and a separate paper needs to be created in the future to measure and test the effectiveness of the examined approaches.
Some of the current measures in the English law regarding the protection of unsecured creditors have been examined, and the authors found that they need to be publicized and strengthened by -possibly – new regulations and legal recommendations. Still, one of the main findings of the paper was that preventive methods are usually both more effective and more cost-effective than long court cases. Therefore, focusing on the enhancement of preventive law. For example the institution of “wrongful trading” and creating a questionability of corporate structures from taxation and liability perspective at the same time might call for the reconsideration of the Corporate Law.
As the general knowledge of companies about trade law, international regulations of insolvency and the determination of the group’s “home country” is at a low level, and there are not many judges with adequate experience in finding ways of “lifting the corporate veil”, there is a need for revising the system, incorporating the above recommendations and measures put in place for the protection of creditors into different sections of the law. This way, the English corporate legal system can be a fairer one for all: secured, unsecured creditors, debtors and entrepreneurs alike.
Armour, J., Hsu, A., Walters, A. (2006) The Costs And Benefits Of Secured Creditor Control In Bankruptcy: Evidence From The UK. Centre for Business Research, University Of Cambridge. Working Paper No. 332
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Saloman v. A. Saloman & Co. Ltd  A.C. 22