The legal, political and societal assessment of parent responsibility for the actions of affiliated organisations is changing in many parts of the world, including Australia.
Liability is no longer restricted to the typical corporate/parent-subsidiary relationship – it can now extend to financial sponsors and the portfolio companies they invest in (and often control). As the landscape continues to shift, financial investors must come to terms with the risks of controlling entity liability.
For many years, Australian courts have steadfastly upheld the sanctity of the Salomon principle, whereby a corporation is considered to have a separate legal personality, rights and obligations to its shareholders.
As a result, ‘piercing the corporate veil’ (or in other words, when a corporation’s shareholders are held personally liable for that corporation’s actions or debts) continues to require something akin to a sham group holding structure. There are, however, two ways in which the consequences of the Salomon principle have been altered without piercing the corporate veil – liability in the tort of negligence pursuant to a duty of care owed by a controlling entity to third parties dealing with affiliated entities, and legislative intervention.
Parent company duty of care
Australian courts have previously held that a parent company owes a duty of care to an employee or third party affected by the activities of the parent’s subsidiary (and is liable if that duty is breached). Albeit few in number, these decisions have turned broadly on the questions of whether the parent exerted a sufficient degree of control or influence over its subsidiary and whether the harm to the claimant was reasonably foreseeable.
Interestingly, control was also a key factor in a recent UK Supreme Court case determining the scope of parent company liability. In April 2019, the UK Supreme Court unanimously held in Vedanta that there was an arguable case that a UK-domiciled parent company had a duty of care to third parties harmed by its foreign subsidiary’s activities. A key consideration for the Court was the parent’s adoption and communication of group-wide policies on environmental, social and corporate governance (ESG) – by advocating and promoting adherence to high standards, the parent created a duty of care to those impacted by affiliate operations.
A survey of the relevant case law across a number of Commonwealth jurisdictions also suggests that the category of situations where a controlling entity has a duty of care for affiliate operations is not closed. Driven by a combination of ‘deep pockets’ and the ability to seek legal remedy in the controlling entity’s home jurisdiction, it seems novel situations will continue to be presented to the courts.
Considerations for financial investors
As the impact of ESG matters on financial investments continues to grow, it is becoming increasingly necessary for financial investors to re-examine the nature of controlling entity and affiliate liability.
Financial investors should carefully consider the following:
- Promotion of ESG policies and standards. The promotion of ESG policies and standards by financial investors can contribute to establishing a special relationship with those impacted by its portfolio company operations, which helps found a duty of care. By promoting ESG considerations, the investor moves closer to suggesting responsibility for adherence to those standards. This conundrum should not cause investors to resile from promoting ESG as an investment virtue or parameter – rather, investors should ensure that they are genuine about their ESG commitments and that promoting those commitments is not simply a ‘tick-the-box’ exercise.
- The ‘control’ question. This goes to the heart of financial investor liability, and three aspects are worthy of particular consideration:
- First, where a financial investor backs a management or executive team and establishes an incentive scheme, the incentive criteria specified should appropriately incorporate the portfolio company’s performance on ESG matters and impact on third parties – again in a substantive, not tick-the-box, manner. In the right circumstances, we can foresee the adoption of solely financial incentive criteria being used against a financial investor where third parties are impacted by portfolio company operations. In the Australian context, the issue of performance incentive criteria and corporate conduct has become a focus of regulators following the recent Financial Services Royal Commission. Again, where claims are made, we can foresee controlling entities being asked how their incentive mechanisms aligned with (and supported attainment of) their stated ESG goals.
- Second, the concept of ‘superior knowledge’ is one element of control. In both Australia and the UK, where controlling entity liability has been established (or in the case of Vedanta, allowed to be argued on its merits), a common characteristic was the superior operational capacity of the controlling entity in relation to the relevant impugned conduct. The superior knowledge thesis lies at the heart of many financial investments – financial investors acquire and take control of portfolio investments because, for example, they have global expertise in ‘turning around’ the investment based on similar portfolio investments (often on a global scale), and the value proposition they bring to a portfolio investment sits naturally with the idea that they have some form of superior knowledge or capacity. We can readily see this argument being made in future litigation scenarios.
- Third, the absence of control in relation to a portfolio investment (e.g. a minority interest) does not mean the above issues are not relevant. For example, financial investors who are signatories to the United Nations Guiding Principles on Business and Human Rights commit to using and building leverage in their investments to prevent and mitigate harm.
Financial investors must come to terms with the risks of controlling entity liability and grasp the changing landscape – just as holding companies that operate globally in extractive or environmentally sensitive industries (who have been exposed to most litigation to date) have had to.
In the years to come, tick-the-box compliance for portfolio companies will no longer be enough to provide an appropriate level of protection from legal risk.
 See Salomon v Salomon  UKHL 1.
 See Barrow v CSR Ltd (Unreported, 4 August 1988, Supreme Court of Western Australia, Rowland J); CSR Ltd v Wren (1997) 44 NSWLR 463; CSR v Young (1998) Aust Tort Reports 81-468.
 See Vedanta Resources plc and another v Lungowe and others  UKSC 20.