4.1.2 Corporate groups

Creditors and minority shareholders of the members of corporate groups are arguably more vulnerable to the opportunism or negligence of controlling shareholders than the creditors of (and minority shareholders in) independent companies.1? This circumstance has led a few jurisdictions—most notably, Germany—to develop a specialized law of corporate groups (Konzernrecht in German law)20 and many other jurisdictions to address group-related issues pervasively in their company laws.

u See Julian R. Franks, Kjell G. Nyborg and Walter N. Torous, A Comparison of U.S., UK, and German Insolvency Codes, 15 FINANCIAL MANAGEMENT 86 (1996); Julian R. Franks and "Walter N. Torous, Lessons from a Comparison of U.S. and UK Insolvency Codes, 8 OXFORD REVIEW OF ECONOMIC POLICY 70 (1992); David A. Skecl, An Evolutionary Theory of Corporate Law and Corporate Bankruptcy, 51 VANDERBILT LAW REVIEW 1325 (1998).

13 In the UK holders of floating charges {a security available only to creditors of limited liability

entities) were, until the adoption of the Enterprise Act 2002, allowed to appoint a receiver to replace

the board as soon as there was an event of default. See Paul L. Davies, INTRODUCTION TO COMPANY

LAW 73-5 (2002).

14 Large cases excepted, creditors of U.S. companies commence less than 1% of all bankruptcy

cases: sec Charles J. Tabb, THB LAW OP BANKRUPTCY 92 (1997). This contrasts with a more active

filing role by creditors of EU companies.

17 This follows from the 1999 Civil Rehabilitation Act (providing somewhat simple proceedings

for reorganization of individuals and firms). The Corporate Reorganizaton Act of 1952 (providing

more formal and rigid proceedings for joint-stock companies) was amended in 2002 to recognize the

debtor-in-possession schemes.

18 On management turnover, see for the U.S.: E. Hotchkiss, Post-bankruptcy Performance and

Management Turnover, 50 JOURNAL OF FINANCE 21 (1995); Stuart C. Gilson, Management Turnover

and Financial Distress, 15 JOURNAL OP FINANCIAL ECONOMICS 241 (1989).

19 Minority shareholder protection is an essentia! aspect of group regulation. We address it infra

5.2 and 6.2.2.2.

20 For a discussion of German 'Konzernrecht', see Volker Emmerich, Jlirgen Sonnenschein and

Mathias Habersack, KONZERNRECHT (7th ed. 2001); Klaus J. Hopt, Legal Elements and Policy

Decisions in Regulating Groups of Companies, in Qive M. Schmitthoff and Frank Wooldridge

(eds.), GROUPS OF COMPANIES 81 (1991); Herbert Wiedemann, The German Experience with the

Corporate groups are multi-company structures dominated by 'controllers,' or powerful insiders, who may be the shareholders of a dominant company, coalitions of shareholders, or even cliques of influential managers. A group structure might adversely affect creditors in two ways. First, such a structure might reduce transparency by blurring divisions between the assets of group members, and by suggesting—often wrongly—that the entire group stands behind each member's debts. Second, a group structure allows controllers to set the terms of intra-group transactions, and thus to assign (and reassign) value within the group. Sometimes an intra-group transaction is designed solely in order to extract value from the creditors or minority shareholders of a group member. More often, however, creditors are injured by transactions that are undertaken for other reasons. For example, the entire group might gain a production, distribution, or tax advantage by shifting assets from one member to another, even though this shifrmakes the transferor's debt far riskier and thus injures its creditors (absent explicit guarantees from other group members).

Identifying corporate groups is sometimes difficult. 'Control' over the policies of group members—a necessary prerequisite of groups—is hard to define;21 voting agreements that create control blocks often go undisclosed; and simple rules based on a putative controller's voting rights can be misleading. For example, the control of a closely held company might require 51 % of its voting rights, while control of a publicly held company might only require 10%-20% of its voting rights.22 Moreover, the law has difficulty recognizing some classes o f corporate groups. Some kinds of groups are obvious: for example, holding company structures, including the U.S.-style public company with wholly-owned subsidiaries, and the family- or state-owned company with multiple subsidiaries that is common in continental Europe; and dominant shareholder strttctures, in which companies are tightly linked together by cross-shareholdings and the largest company appears to lead (typical in Germany). Other groups are harder to identify, including coalition structures, in which several companies dominate a larger set of firms linked by cross-shareholdings (typical in France, Italy, and the Netherlands); and managerial structures, in which top managers exercise group-level control without a controlling shareholder coalition (said to occur in Japan).

Although there is little consensus among jurisdictions as to how to regulate corporate groups as such, no country goes so far as to prohibit them outright.

Law of Affiliated Enterprises, inKlaus J. Hopt (ed.), GROUPS OF COMPANIES IN EUROPEAN LAWS II21 (1982). The major jurisdictions other than Germany to include group-specific sections in their company statutes arc Brazil and Portugal.

21 A good example of how complex these legal definitions can be is provided by the Seventh

Company Law Directive [1983] OJ L 193/1.

22 Fabrizio Barca and Marco Becht (eds.), THE CONTROL OF CORPORATE EUROPE (2001); Rafael

La Porta, Florencio Lopez-de-Silanes and Andrei Shleifer, Corporate Ownership around the World, 54

JOURNAL OF FINANCE 471 (1999).

Indeed, even problematic structures such as corporate 'pyramids'—groups controlled by minority shareholders through partly-owned holding companies23—are generally allowed, despite the fact that they are the functional equivalent of super-voting stock, which is often prohibited outright.2'' Such general acceptance suggests widespread appreciation of the possible efficiencies of group structures. In different settings, corporate groups can minimize taxes, efficiently allocate monitoring and risk-bearing costs among creditors, and safeguard transaction-specific investments.23 In addition, at least one category of corporate group, a family holding company with a controlling interest in an operating company that also has minority shareholders, is the sole form of public ownership in much of the world.

But if groups are not prohibited anywhere, they are heavily regulated in some— if not most—jurisdictions. At one extreme, Germany devotes both a specific section of its company law and substantial judicial attention to groups of companies.26 At the other extreme, U.S. courts largely ignore group structures.27 The UK, France, and Japan fall between these extremes, since they lack an express law of corporate groups, but nonetheless have many statutory provisions and cases that address group-related issues.28 Finally, all major jurisdictions (including the U.S.) require at least a subset of corporate groups to prepare consolidated financial statements for the benefit of creditors and minority shareholders.