Supreme Court ruling reinforces corporate veil

Introduction
De facto management
Facts
Supreme Court's ruling
Comment

Introduction

The concept of de facto management makes it possible to hold a parent company liable for its subsidiary by requiring that it make up any shortfall in its assets if the subsidiary is insolvent. This ultimately leads to a piercing of the corporate veil.

An October 11 2016 Supreme Court ruling points to a shift in case law towards a more restrictive interpretation of de facto management, thereby reinforcing the corporate veil.

De facto management

The Commercial Code distinguishes between de jure managers and de facto managers. A 'de jure manager' is defined as a person holding a corporate office and designated by the company's bylaws to manage the company. No statutory definition of a 'de facto manager' exists.

Conversely, while a de facto manager does not hold a corporate office, it does manage the company.

According to the Supreme Court, a party is a de facto manager of a company if it engages, continuously and regularly, in free and unfettered positive acts of management and administration which bind the company.(1)

In other words, a de facto manager exercises all of the privileges which a de jure manager enjoys. The courts use their discretion to assess the existence of de facto management, based on the facts of each particular case. More often than not, they consider a range of factors when determining whether a party is a de facto manager.

There was a general impression that a parent company becomes a de facto manager if it abnormally interferes in the management of its subsidiary. However, the Supreme Court's ruling limits the situations in which a parent company can be held to be a de facto manager of its subsidiary.

Facts

In the case in question, Molex Inc restructured its group – in particular, by closing down the plant operated by its indirect subsidiary, Molex Automotive, which it held through its wholly owned subsidiary Molex International Inc. Molex Automotive was then placed in liquidation. The liquidator sued Molex Inc for payment of the shortfall in assets on the grounds that it was the de facto manager of Molex Automotive.

The Paris Court of Appeal found that Molex Inc could not be considered to be the de facto manager.

Supreme Court's ruling

The Supreme Court upheld this ruling on the following grounds:

• Holding an indirect subsidiary through wholly owned entities does not in itself lead to "the absence of autonomy of the indirectly-held subsidiary". The specialisation of production within the group put in place by the parent company "did not lead the parent company to determine the purchase and sale prices" practiced by the indirect subsidiary and "there was no joint management of personnel".
• The managers of the indirect subsidiary "continued to control the management of the company within the framework of group policy" and their close relationship with the parent company, of which they were employees, was "part of the normal control by the parent company of the activities of its direct and indirect subsidiaries, which is inherent to the existence of a group of companies".
• The restructuring of the group involved the indirect subsidiary ceasing its activity, but the parent company "did not get involved in the process of closing the plant" operated by the indirect subsidiary "or in managing the staff redundancy programme", which it merely financed.
• The parent company's decision to impose a distributor on its indirect subsidiary for its output "was part of the implementation of a new distribution policy covering the group", and the agreement with the distributor was negotiated and signed by the indirect subsidiary's production manager.
• The decision to replicate the indirect subsidiary's production facility at the parent company's site in order to continue production of parts previously made by the indirect subsidiary did "not confer the status of de facto manager on Molex".

Consequently, while it was clear that Molex Inc had significant influence over its subsidiary's future, the Supreme Court did not consider Molex Inc to have engaged, continuously and regularly, in free and unfettered positive acts of management and administration which bound the subsidiary. This ruling has put paid to the view that a parent company's abnormal intervention in the management of its subsidiary is sufficient to lead to a finding of de facto management.

Comment

In short, provided that the subsidiary retains some degree of autonomy and remains, at least officially, under the control of its de jure corporate officers – even if such control is exercised only within the limits of group policy and directives – the corporate veil continues to protect the parent company.

For further information on this topic please contact Rhidian David or Cyrille Gaucher at Cabinet Hughes Hubbard & Reed by telephone (+33 1 44 05 80 00) or email ([email protected] or g[email protected]). The Cabinet Hughes Hubbard & Reed website can be accessed at www.hugheshubbard.com).

Endnotes