Defining the corporation itself is of course fairly simple—it is a legal entity possessing the characteristics defined by the corporate law of its state of incorporation, or if beyond the United States, by the law of the jurisdiction in which it is formed. Although what constituencies together form the “corporation” is at times unclear, state corporate law, the terms of the corporate charter, and other contractual mechanisms establish the corporation as a separate legal person and delimit its formal boundaries. Defining the corporate group is a more complicated exercise. In Germany and France, the corporate group is a distinct entity form governed by its own body of law. In the United States, however, there is no entity form corresponding to the corporate group, nor is there a uniform definition. For convenience, academic commenta- tors and the courts use generic terms, such as the firm, the company, and even the corporation to refer to the corporate group. At the outset, any effort to define the corporate group must begin by acknowledging that both the “corporation” and the “corporate group” are “firms” in the Coasian sense. That is, both are economic organizations that emerge when organizing production internally is less costly than coordinating transactions through market ex-exchange. In other words, the corporate form or “hierarchy” is an alternative to markets. The economic boundaries of the firm as an enterprise need not, and indeed, frequently do not, however, correspond in any transparent way to its legal boundaries. The key defining characteristic of a corporate group is typically common ownership. The prototypical corporate group includes a parent company and its direct and indirect subsidiaries, each with a separate legal identity and its own legal rights and obligations. Assets of the corporate group may be held in trusts, special purpose vehicles, and other separate legal entities owned by one or more members of the corporate group. The corporate group may, and in fact typically does, include limited liability companies (LLCs) and other entities that are not formally corporations. Corporate groups can therefore be seen as “hybrid arrangements between contract and organization,” having a “paradoxical character of multiplicity and unity.” Common equity ownership is not the only way for firms to enjoy the benefits of cooperative economic activity. As sociologists John Scott and Gerald Davis point out: “Between market (arm’s length exchange) and hierarchy (vertical integration) lie a range of alternative means of governing exchanges that may be less costly, including hierarchical contracting . . . joint operating agreements, or other hybrid forms,” including franchisees, distributors, licensees, and other independent contractors. Other common arrangements are “strategic alliances” or joint ventures between two otherwise independent companies where no legal entity is jointly established and owned by the joint venturers. In areas of the law where equity ownership is a necessary criterion, a number of these common contractual relationships may lie beyond the boundaries of the corporate group. The contractual arrangement will generally itself indicate whether the parties’ arrangement is intended to create joint rights and obligations or otherwise fall within the bounds of the corporate group. For example, McDonald’s franchisees are not part of the McDonald’s corporate group even though the franchisee has licensed rights to the McDonald’s tradename, trademarks, and other intellectual property that constitute its brand and even though the franchisee is the face of the company to the public. Common ownership more clearly defines where the corporate group begins, but the question of where the corporate group ends is another matter. The answer has to do with the second and related criterion for membership in the corporate group—control. At its most basic, “control” is defined as the ownership of a majority voting interest of the corporation’s shares, which confers the power to select the board of directors,39 although control may also be conferred contractually. Where the shareholder is another corporation, the degree of control exercised by the parent depends primarily on the voting interest of the parent corporation in the subsidiary, which need not be identical to its financial stake. Subsidiaries may be wholly or partially owned by their parent company, and the parent corporation may hold a percentage interest that is also sufficient to exercise indirect control over subsidiaries further down in the corporate structure. Nonetheless, even where a parent corporation holds, directly or indirectly, only a minority interest, it may still have the ability to control the management of the subsidiary corporation through overlapping directorates, operational integration, or other means. Many statutory regimes, including ERISA, follow the eighty percent ownership threshold adopted under the Internal Revenue Code’s definition of a “controlled corporate group” as a bright line mathematical standard. Regulatory statutes often sweep broadly, encompassing the regulated entity and all others “that it controls, is controlled by, or is under common control with.” Because of the wide variation in control arrangements among firms, however, the tests developed in common law for establishing the presence of a “control” relationship are generally based on multiple factors. For example, in cases involving majority shareholder duties, the Delaware courts define “control” to include majority ownership of the corpora- tion’s voting rights and/or the “actual control” of the business and affairs of the corporation.46 The latter inquiry is “highly contextualized.” Relevant factors include the appointment by the parent corporation of its own officers to the subsidiary’s board, the presence of external contracts or other business arrangements that facilitate the shareholder’s control, and a general alignment of interests among the corporate entities through which the ultimate parent may exercise control. Similarly, in veil-piercing jurisprudence, functional control by a parent corporation over its subsidiary may be found based on the degree of economic, financial, personnel, and administrative integration within the group, as well as the use of a common public persona. Courts also look to similar factors in interpreting statutory definitions of “control.” Without control, the corporation’s relationship to an entity whose shares it owns begins to resemble a pure investment relationship. Yet clear lines cannot always be drawn. For example, which definition of “control” is relevant? How much indirect control is sufficient for the investee corporation to be deemed part of the corporate group? Should the distinction be based on formal criteria, a more substantive inquiry, or both?51 At what point is control so attenuated that the corporate shareholder should be considered a passive investor in an unrelated entity rather than a member of the same corporate group? A final factor that has guided courts in the veil-piercing context and in weighing these difficult questions is the consideration of whether related entities function as a single integrated enterprise. For example, in the famous case Walkovszky v. Carlton which involved claims against numerous New York taxi cab companies, the plaintiff sought to impose liability horizontally on ten separate corporations operating under common ownership and control on grounds that they constituted a single economic entity. Although the court in that case rejected plaintiff’s argument, economic and decisional integration remains relevant in determining whether independent entities should be viewed, as a matter of law, as a single integrated enterprise. Indeed, many courts often adopt an enterprise approach only when “control” is accompanied by evidence of financial, operational, or administrative integration. Ultimately, the bounds of the corporate group must often be set within particular regulatory domains or by corporations themselves. Securities regulations and accounting standards give companies some flexibility in determining whether to include minority holdings within the group for consolidated financial reporting purposes. Corporations can also, by charter or otherwise by contract, determine the threshold that constitutes “control” in order to delimit the bounds of the corporate group. V H. Ho
Posted on: Mon, 25 Aug 2014 03:27:47 +0000
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