When is a Parent Company Liable for the Actions of Its Subsidiary?
From a purely legal perspective, a parent company and its subsidiary constitute separate legal entities. Still, a question arises as to whether the legal fiction of the juridical entity of each company is always strictly adhered to. In other words, may the legal separation between a parent company and its subsidiary be disregarded so that the former may be liable for the actions of the latter? If yes, in what circumstances should a court pierce the corporate veil?
It is a widely held view by lawyers, judges, and legal commentators that the general rule should be that the limited liability of a parent company as a separate legal entity should be upheld. Exceptionally, however, courts have pierced the corporate veil to deny a parent company the limited liability for the actions of its subsidiary. Yet, no clear principle has thus far been discerned from court decisions to give guidance on when a parent company may be liable for the obligations of its subsidiary. The lack of clarity regarding this question exists in many jurisdictions. (Ian M Ramsy & David B Noakis, Piercing the Corporate Veil in Australia’ (2001) 19 Company and Securities Law Journal, 250-271.)
It follows that the extent of liability of a parent company for its subsidiary is determined on a case-by-case basis depending on the established facts of each particular case. For instance, in jurisdictions other than Jordan, the corporate veil was pierced where it was demonstrated that the relevant parent company was a guarantor for its subsidiary or if the later had acted as the agent of the former. Furthermore, where a parent company effectively makes the decisions issued in the name of its subsidiary, the former may well be found liable for the actions of the latter. Fraudulent transfer of the assets of one company to another affiliated company is another good justification for treating the relevant entities as jointly liable.
The Supreme Court of Jordan has considered the issue of piercing the corporate veil in a recent case involving a holding company and its subsidiary. Affirming a decision of the Court of Appeal of Amman, the Supreme Court held that a holding company was jointly liable with its subsidiary for the actions of the latter. While the facts of the case showed that the subsidiary was wholly owned by the holding company, the decision of the court was couched in general terms that are apparently tantamount to pronouncing a general principle.
The Decision of the Court of Appeal of Amman in the case number 7516/2014
On 1 July, 2014, the Court of Appeal of Amman entered a judgment to the effect that a holding company was liable for the actions of its subsidiary on the ground that the subsidiary was wholly owned by the holding company. On the facts of the case, AL Qabas for Real Estate Development Ltd (Qabas) agreed to sell to the plaintiffs a piece of land within the Aqaba Special Economic Zone. Qabas received a sum of money from the plaintiffs as part of the price of the land. Yet, the parties failed to record the sale at the Lands Department, which is a legal requirement to perfect the sale under Jordanian property law. Consequently, the plaintiffs brought an action against Qabas and Taameer Jordan Holdings (Taameer) which owns Al Qabas to recover the paid amount.
Taameer argued that there was no privity between it and the plaintiffs as Qabas alone was the signatory to the agreement for the sale of land. Accordingly, Taameer asked the court of first instance to dismiss the action against it. The court of first instance rejected Taameer's motion to dismiss the case. Affirming the judgment of the trial court, the Court of Appeal rested its decision on the fact that Taameer owned and managed Qabas.
The Decision of the Supreme Court of Jordan in the case number 3186/2014 dated 22 January, 2015
Taameer and Qabas appealed the decision of the Court of Appeal before the Supreme Court. Upholding the ruling of the appellate court, the Supreme Court reasoned that Taameer owned all the shares in Qabas, the proceeds of Qabas's business devolved ultimately to Taameer, and Qabas was but the instrument through which Taameer carried on business. Interestingly, the Supreme Court went as far as suggesting that both the holding company and its subsidiary were jointly liable for each other's actions.
Assessment of the Ruling of the Supreme Court
The structure of a group of companies aims, among other things, to reduce the risks of doing business, to ensure limited liability for the shareholders, and to realize tax benefits if possible. These aims cannot be achieved without the legal recognition of the members of the group as separate legal entities; hence, piercing the corporate veil is the exception. This applies to group of companies in general, including subsidiaries owned by a holding company.
However, the Supreme Court of Jordan pronounced in general terms, as if it were stating a point of law, that a holding company was liable for the actions of its subsidiary. Since the court relied upon a legal element, namely the ownership of the shares in the subsidiary, the ruling appears to adopt a general rule of liability denying a holding company the limited liability for the actions of its subsidiary. Indeed, the decision of the Supreme Court suggested that the joint liability was a two-way result: each of the holding company and its subsidiary was liable for the actions of the other. (The reference to the liability of the subsidiary for the actions of the holding company was an obiter dictum since the point of law at issue was the liability of the holding company.)
Moreover, the decision of the Supreme Court paves the way for possibly unintended consequences relating to arbitration agreements. An arbitration agreement signed by a subsidiary may be binding on the relevant parent company. It remains to be seen whether the doctrine of "group of companies" adopted by French courts to extend the effect of an arbitration agreement to non-signatory members of the group will be embraced by Jordanian courts.
However, interpreting the decision of the Supreme Court as rendering a holding company automatically liable for the actions of its subsidiary is untenable. The legislator recognizes that a holding company is legally an independent juridical person. Thus, paragraph (c) of section 205 of the Companies Law provides that a holding company may extend loans and guarantees to its subsidiaries. By necessary implication, section 205 assumes that a holding company is not liable for the actions of its subsidiary unless the holding company has assumed liability as a guarantor.
It is true, as indicated by the Supreme Court, that a parent company may be liable for the obligations resulting from a contract made by its subsidiary if the latter was in fact a mere instrument fully controlled by the former. However, the "instrumentality" of the subsidiary, quite like allegations of fraud, must be established by positive evidence – presumptions based solely on the ownership of shares are capable of undermining the economic utility of the structure of a group of companies.
Founding the decision of the Supreme Court on the ownership of shares implicates the sole shareholder in a "one-man company." It also raises doubts about the extent of the liability of a holding or parent company that owns part of the shares in a subsidiary, unlike Qabas that was wholly owned by Taameer.
A better interpretation of the decision of the Supreme Court, it is submitted here, is that it was based on the fact that Qaba was wholly owned by Taameer and that the directors of Qabas were themselves memberBoard of Directors of Taameer, as may be found through the public record of both companies. In other circumstances, piercing the corporate veil should be supported with positive evidence establishing to warrant the liability of the holding or parent company for the actions of its subsidiary and, for that matter, the liability of a sole shareholder in a "one-man company."