According to the government bill to amend the Commercial Companies Code, a parent company could issue binding instructions to a subsidiary if justified by the interest of the corporate group and not barred by specific regulations. The new powers of a parent company are balanced by provisions regulating its liability for injury caused in connection with issuing binding instructions.
What is a binding instruction?
The proposed provisions would help bring corporate law into line with business reality. Under the proposal, a parent company and a subsidiary participating in a corporate group would be guided not only, as they are now, by the narrowly defined interest of each company, but also by the interest of the corporate group (more on this amendment in the article “Holding law: Proposed amendment to the Commercial Companies Code”). According to the proponents, allowing a parent company to issue binding instructions to its subsidiaries would streamline the operations of undertakings using complex corporate structures.
Under current law, the ability of a parent company to issue binding instructions is excluded when the subsidiary is a joint-stock company, and at least questionable when the subsidiary is a limited-liability company. The new powers of a parent company are to be counterbalanced by provisions taking into account the interests of the subsidiary, its creditors, members of its corporate bodies, and minority shareholders.
To be valid, binding instructions would have to be issued in written or electronic form, and would have to indicate at least:
- The conduct expected by the parent company of the subsidiary in connection with execution of the binding instruction
- The interest of the corporate group justifying the subsidiary’s compliance with the instructions of the parent company
- The expected benefit or detriment to the subsidiary resulting from compliance with the instructions of the parent company, if any
- The method and timeframe for compensating the subsidiary for injury suffered as a result of complying with the instructions of the parent company.
Refusal to comply with a binding instruction
Execution of a binding instruction by a subsidiary participating in a corporate group would require a prior resolution of its management board, and the parent company would be notified of the resolution. According to the bill, members of the subsidiary’s management board would not be liable under the Commercial Companies Code for injury caused by execution of a binding instruction.
However, there are circumstances in which such a subsidiary could not only disobey a binding instruction, but would even be required to pass a resolution refusing to execute it. In principle, such a situation would occur when execution of the binding instruction would lead to insolvency or a risk of insolvency of the subsidiary.
Moreover, all other subsidiaries, other than a single-member company, would have a duty to refuse to comply with a binding instruction of the parent company if there was a justified concern that compliance would be contrary to the interests of the subsidiary and could cause injury to it that would not be remedied by the parent company or another subsidiary participating in the corporate group within two years after occurrence of the injurious event. But in determining the amount of the injury, the subsidiary would also take into account the benefit derived by it from its participation in the corporate group during the last two financial years. Finally, the articles of association of a subsidiary participating in a corporate group could provide for additional grounds for refusing to comply with a binding instruction.
According to the explanatory memorandum to the bill, a decision should always be backed by responsibility. Thus the proposal provides for the parent company to be liable for the consequences of issuing a binding instruction subsequently executed by a subsidiary. This liability would extend to the subsidiary, its creditors, and minority shareholders.
Liability of the parent company to its subsidiary
Under the proposed law, a parent company is to be liable to a subsidiary for injury caused by execution of a binding instruction and not remedied within the time specified in the binding instruction, unless the parent company was not at fault.
The liability of a parent company is to be determined taking into account the duty of loyalty towards the subsidiary when issuing and carrying out a binding instruction. The content of this duty would be interpreted on the basis of existing case law and legal doctrine.
In this case, the time limit for remedying the injury should be understood to mean the time limit specified in the binding instruction. Thus, until that time, the subsidiary would have no due and payable claim. If, on the other hand, no such time limit was specified for a particular injury, it should be assumed that it should be remedied immediately. Only in the case of a single-member subsidiary, the liability of the parent company would apply exclusively to a situation where execution of a binding instruction led to insolvency or a threat of insolvency of the subsidiary. If the subsidiary did not bring an action seeking damages within one year after the time limit specified in the binding instruction, that right would also pass to the shareholders of the subsidiary.
A claim for damages arising from execution of a binding instruction would become time-barred under the general rules, i.e. on the last day of the calendar year following the expiry of six years from the date of the event causing the injury.
Liability of the parent company to the subsidiary’s shareholders
The parent company would also be liable to the shareholders of the subsidiary for reduction in value of the subsidiary’s shares, if it resulted from execution of binding instructions of the parent company. In this respect, the proposal adopts the construction of liability for consequential (indirect) damages, which under Polish law is of an extraordinary nature.
This liability would apply to minority shareholders of a subsidiary, where the parent company could independently (directly or indirectly) adopt a resolution to participate in a corporate group and amend the articles of association of the subsidiary. In other words, this legal protection is extended to shareholders deprived of any real influence over the company’s articles of association.
Another provision facilitating pursuit of claims by shareholders would be a presumption that the parent company holds a majority of votes enabling it to adopt a resolution on participation in a corporate group and amend the articles of association of the subsidiary if it directly or indirectly represented at least three-quarters of the share capital in the subsidiary.
A claim for redress of injury resulting from a reduction in the value of shares would become time-barred three years from the date when the shareholder became aware of the injury, but in any case no later than five years after the event causing the injury.
Liability of the parent company to the subsidiary’s creditors
As regards the creditors of a subsidiary executing binding instructions of the parent company, the bill does not adopt the notion of “piercing the corporate veil,” whereby the parent company would be liable to the creditors of the subsidiary as a guarantor. The explanatory memorandum to the bill asserts that this concept of liability is undesirable from a systemic perspective, as it would violate a fundamental principle of corporate law, namely the lack of personal liability of a shareholder for the obligations of a company. According to the proponents, adoption of a different concept could discourage businesses from using the structure of corporate groups and thus hinder them from competing on the domestic or international market.
As a substitute for piercing the corporate veil, the bill provides for compensatory liability of a parent company to creditors of a subsidiary in a situation where enforcement against the subsidiary proves ineffective and the injury to the creditors of the subsidiary arose as a result of the subsidiary’s execution of a binding instruction of the parent company and as a result of circumstances for which the parent company is at fault. A presumption is also introduced that such injury includes the amount of the unsatisfied claim against the subsidiary.
The liability of a parent company to creditors of a subsidiary would cover all types of subsidiaries participating in a corporate group, i.e. single-member companies and other subsidiaries. Such a claim would become time-barred under general rules, i.e. on the last day of the calendar year following the expiry of six years from the date of the event causing the injury.
According to the bill, the amending act would enter into force six months after publication.
Aleksandra Drożdż, Jakub Gerula, M&A and Corporate practice, Wardyński & Partners