Introduction
Liability of controlling company
Territorial scope
Relevance of indirect control
The limitation of shareholder liability is one of the fundamental pillars of modern company law and it is recognised in most jurisdictions.(1) Therefore, shareholders generally cannot be held liable for the debts and losses of the company in which they own shares. This principle has been accepted in Portugal and, as a result, the company types that are most commonly used to engage in commercial activities and as "vehicles" to acquire other companies are those that provide for a limitation of the liability of shareholders
Furthermore, to carry out an M&A transaction to buy a certain company, it is common for the buyer to be a company. This ensures that the risk of the investment and the future performance of the target company will not contaminate the buyer's other assets. However, in Portuguese law there are situations that may jeopardise the limitation of shareholder liability, which is unusual compared with the legislation in other jurisdictions. Such situations, therefore, should be remembered when structuring M&A transactions, especially in light of case law developments on these matters.
Liability of controlling company
Despite its general acceptance in Western legal systems, the limitation of shareholder liability may be set aside in certain situations. These situations are usually exceptional and allow the shareholder to be held liable for the losses and debts of the company.
Under Portuguese law, one clear and direct exception from the principle of limitation of liability is in groups of companies(2) and in relationships of full control. This is, in other words, when a company (the controlled company) is held (directly or indirectly) by a single company (the controlling company). In those cases, on the understanding that a group of companies is a form of organisation of a sole enterprise, the Portuguese legislation(3) has determined that the controlling company may be held liable for the debts of the controlled company and even for the losses that the company may incur during the period of control. The rules on the liability of the controlling company are a corollary of the right to give binding instructions to the controlled company (power of management). They are also a consequence of the primacy that the legislature recognises for the interests of the controlling company and of the group over those of the controlled company, which must comply with the instructions of the controlling company, even if they are detrimental to it.(4)
The liability of the controlling company for the debts of the controlled company is, as the Supreme Court of Justice has demonstrated,(5) impressively summarised, direct, unlimited, objective, joint and several,(6) and automatic. Further, it is maintained even if the relationship of control ceases in the meantime.
Moreover, the liability of the controlling company for losses of the controlled company has also been analysed by the Supreme Court of Justice.(7) The Court held that liability for registered losses is objective. In other words, regardless of whether the losses are caused by decisions of the controlling company, the controlled company must be compensated for them when the control relationship ceases.
The mechanisms for holding controlling companies liable for the debts and losses of the companies they control are, in general, well established. However, doubts still remain as to their territorial and material scope of application, and this may have an impact on the risks arising from the structures of takeovers of companies by other companies.
Under Portuguese law, group relationships (specifically of full control) are only established between companies that have their seat in Portugal. Thus, at first glance and literal interpretation, if a company with its seat outside Portugal holds the entire share capital of a Portuguese company, it could not give disadvantageous instructions to the Portuguese company and it would not be liable for its debts and losses.
This interpretation has been a topic of discussion, as it calls into question the constitutional principle of equality. This is because if a Portuguese company controls another company based in Portugal, it will be liable for its debts and losses. However, if a company based in another country wholly owns a Portuguese company, it will not be subject to that burden. Thus, seeking an interpretation that conforms with the Constitution and its principle of equality, some have argued that foreign companies that are the sole shareholders of Portuguese companies must also be liable for the debts and losses of the controlled companies.
The Constitutional Court has also passed judgment(8) on a similar issue, although it was based on employment credits. The Court analysed the compliance with the principle of equality, enshrined in article 13(2) of the Constitution, of the rule that:
[prevents] the joint and several liability of companies established outside Portugal for claims arising from employment contracts, or their breach or termination, by employers with whom they are in a reciprocal shareholding, control or group relationship.
The Court concluded(9) that there was no "reasonable, rational and objectively founded" reason, in light of the equality principle, for a Portuguese controlling company to be held jointly and severally liable for employment debts of a Portuguese controlled company and a controlling company based outside Portugal not to be held liable for the employment debts of a Portuguese controlled company. The Court, therefore, held that such an unequal treatment was inconsistent with the Constitution.
The Constitutional Court's decision is close to the doctrinal position referred to above. However, this case involved employment claims, which, as the Court stated, are "supported by a constitutional rule". Recently, the Court declared the unconstitutionality, with mandatory general force, of the set of rules that:
[prevents] the joint and several liability of a company with its seat outside Portugal, in a reciprocal shareholding, control or group relationship with a Portuguese company, for debts arising from a subordinate employment relationship.(10)
As mentioned above, the liability of the controlling company for debts and losses of the controlled company results from the understanding that, when a company is wholly owned by another, they form a single enterprise. That is why the power of management and the subordination of the interests of the controlled company in relation to the controlling company are enshrined in law. Apparently, the Portuguese legislature considered(11) that the existence of a single enterprise could only be assumed in the relationship of a group of companies when that company had an unequivocal connection with Portugal. At present, due to technological developments and the intensification of the globalisation of the economy, which has occurred since the approval of the rule in question, it is harder to understand why the concept of a company should be bound to a territorial notion. Thus, the duplicity in treatment of the liability for debts and losses of the Portuguese controlling company and the foreign controlling company, and its compliance with the equality principle, must be analysed from that perspective. In other words, the question is: can a multi-company undertaking located in two countries be treated differently from a multi-company undertaking located in Portugal?
In any case, in light of the positions of legal scholars and the trend in case law, today, there is still the risk that a foreign controlling company can be held liable for the debts and losses of its Portuguese-based controlled company. Therefore, this must be considered when structuring the acquisition of Portuguese companies, especially when the operation targets the entire share capital.
Another relevant factor in measuring the risk of debts and losses of the controlled company, which may result from the structure adopted for acquisition operations, is the determination of which controlling companies may be liable in a group of "multi-level" companies. For example:
- scenario one – company A holds 100% of company B and company C which, in turn, each hold 50% of company D; or
- scenario two – company A holds 100% of company B, which in turn holds 100% of company D.
In both scenarios, due to the relevance of indirect shareholdings to determining the existence of control, it could be considered that company A would be responsible for the debts and losses of company D. Some(12) have held that only in scenario one could this direct liability of company A for company D's debts occur. The logic behind this is that it is only in this case that company A (albeit indirectly) is the first company that owns all the capital of the controlled company and, therefore, the only one that can exercise the power of management. In scenario two, company A has indirect control, but does not have the power to give instructions to company D, because this right is reserved to the company that is the first to hold all of company D's share capital, which is company B.
Despite this understanding, the letter of the law is ambiguous. Therefore, when structuring acquisitions of Portuguese companies, it is necessary to consider the risks of liability of companies in multi-level group situations, and to avoid situations that increase those risks. These include, for example, the risk of the company with full indirect control making use of its management power.
The Portuguese rules on groups of companies depart from the usual rules on limiting the liability of shareholders. Therefore, they must be considered when structuring M&A operations. The trend is towards allowing controlling companies to be held liable regardless of where they are based. As a result, it is not possible to rule out the risk of liability for debts and losses being assigned to companies which, despite not having direct control, are in a chain of holdings that leads to the conclusion that they have total indirect control.
For further information on this topic please contact Diogo Perestrelo or Guilherme Seabra Galante at PLMJ by telephone (+351 213 197 300) or email ([email protected] or [email protected]). The PLMJ website can be accessed at www.plmj.com.
Endnotes
(1) The limited liability of commercial companies has its origin in the Limited Liability Act of 1855, which was approved by the UK Parliament. It is sometimes likened to other landmark achievements of the industrial revolution. For further details, see Pettet's Company Law Third Edition, page 39.
(2) Whether the application of the limited liability rules to corporate groups is correct has been widely debated. Further information is available here.
(3) Strongly inspired by the German rules on groups of companies and by a draft of the ninth directive, which was never approved. For further details, see J Engrácia Antunes, Os Grupos de Sociedades, page 272 and following and Ana Perestrelo de Oliveira, Manual de Grupos de Sociedades, page 14.
(4) J Engrácia Antunes, Os Grupos de Sociedades, from page 718.
(5) Judgment of the Supreme Court of Justice of 31-05-2005.
(6) This is not a true situation of joint and several liability, but rather an ancillary liability Ana Perestrelo de Oliveira, Manual de Grupos de Sociedades, page 211.
(7) Judgment of the Supreme Court of Justice of 31-05-2011.
(8) Judgment of the Constitutional Court no. 227/2015.
(9) Even with the dissenting votes.
(10) Judgment of the Constitutional Court no. 272/2021.
(12) Ana Perestrelo de Oliveira, Manual de Grupos de Sociedades, page 52.