Corporate groups are a prominent feature of today’s commercial world, with the vast majority of such groups in Australia being wholly owned. Within Australia, the majority of laws regulating corporate groups are reflective of, or are premised upon, the entity approach. Based on the entity principle, Australian corporate law considers each company within the corporate group to be a separate legal entity, concentrates on the particular issues that face each individual company in the group and, in the main, requires directors to act in the best interests of the particular company to which they have been appointed. The application of the corporate form, specifically legal separation and accompanying limited liability of corporate group members, where the group is managed and controlled as a single enterprise, however, encourages opportunistic activity by debtors. Furthermore, the greater separation of ownership and control within a corporate group gives rise to additional conflicts of interest which do not arise within a single independent company and are not addressed by the current creditor protections under the Corporations Act 2001 (Cth).
Within the group, controlling shareholders or directors may pursue risky projects utilising intra-group financing to enable assets to be siphoned from, or additional liabilities to be incurred by, a group member knowing that creditors will bear the costs if these projects fail. Lack of adequate accounting records within the group may allow the commingling of assets so that the undercapitalisation of member companies is disguised. Creditors, unable to distinguish between the assets and liabilities of each corporate group member may inaccurately perceive, and thus price, the riskiness of contracting with the corporate group member incurring losses when such risk manifests.
Although creditors are generally left to self-protect against the risk of non - or partial payment, the Australian corporate law regime does provide a number of ex ante and ex post creditor protections. This thesis argues that the majority of conventional creditor protections only apply ex post, when the debtor company is or nears insolvency such that such protections neither actively prevent debtor opportunism within the group nor provide an early warning system of debtor opportunism directly to creditors.
This failure to identify or prevent debtor opportunism is exacerbated in those corporate groups where there may be an accepted pattern of behaviour to continue to run a member company at a deficit for the benefit of the wider group. Transactions which ultimately 3 contribute to the insolvency of the member company remain unchecked and creditors are overlooked, until the insolvency of the member is assured.
The conclusion drawn from this analysis is that the present regulation of corporate groups encourages debtor opportunism within the group and contributes to the creditors’ inaccurate identification and pricing of the risks of transacting with a corporate group member.
As a means of overcoming the limitations of existing creditor protections, the thesis argues for the adoption of enterprise liability whereby corporate group members would be liable for the unsecured debts of other corporate group members, within those groups managed and operated as a single enterprise.
It is suggested that the level of debtor opportunism within such corporate groups would be reduced as enterprise liability would:
• protect against phoenix activity;
• deter group shareholders from establishing undercapitalised subsidiaries;
• create an incentive for earlier identification of transactions detrimental to creditors; and
• make asset-shifting intra-group transfers or financing arrangements to defeat creditors’ claims redundant.
The adoption of enterprise liability for those corporate groups operated and managed as a single enterprise may cause the cost of capital for such group members to rise. However, despite the possible negative impact on investment, it is argued that the adoption of enterprise liability is an efficient means of protection to creditors:
• it operates ex ante and thus would more effectively deter debtor opportunism;
• its implementation is restricted to those groups run as single enterprises;
• it can be adapted easily into the existing corporate law regime;
• it does not disturb the corporate group members’ separate legal entity status and it is reflective of the manner in which such groups are managed and operated.