Relational Networks and Enterprise Law1
Relational Networks and Enterprise Law:
Comparative Trends of Network Liabilityin the United States and Europe
René Reich-Graefe
University of Connecticut School of Law
65 Elizabeth Street
Hartford, Connecticut 06105
United States of America
Abstract. Corporate groups and relational networks (with franchising systems presenting a prime example of the latter) share many functional and economic attributes. Due to their paradoxical structures and dialectically opposed strategies for organizational success, they present a complex challenge to the regulatory system. Courts and legislators in the United States and Europe alike have increasingly turned to concepts of enterprise law and – for the externalities of such conglomerates – to principles of enterprise liability in order to better align the still vastly disparate economic and legal realities of these modern-day ‘titans’ of collectivized commercial cooperation. This paper endeavors to investigate and evaluate those international trends – by necessity, in a rather eclectic and essayistic manner – with particular focus being given to the product liability exposure of networks. In synthesis, it concludes that comparative and interdisciplinary network research has become an indispensable, yet largely unfulfilled prerequisite in order to fully grasp the unique nature and impact of the dual phenomenon of corporate groups and relational networks in post-modern economies and, further, that such undertakings may eventually become to be best understood – and best regulated – as a higherlevel form of commercial cooperation, i.e., an organizational structuration and enterprise sui generis, within the evolutionary process of industrial organization.
1Introduction
Corporate groups and what are named here relational networks are both highly integrated, polycorporate economic enterprises. Though their origins lie far back in the nineteenth century, their emergence as a prevalent form of industrial organization in modern market economies only occurred during the second half of the twentieth century. Arguably, it took even longer before they squarely entered the res publica and before their regulation in the public realm began in earnest. To this day, a convergence of the economic and legal realities of group enterprises and relational networks has not been achieved by any significant degree (in neither of such dualities).
Notwithstanding the striking similarities in the functional and structural attributes of both types of networks as well as in their externalities, international comparative study (not to mention uniform, network-specific regulation) is rather rare. However, it is the experience from other network relations and from attempts at their regulation which should give corporate group scholars cause for thought (Teubner 1991, p 118). Are there trends of (regulatory) convergence which perhaps remain imperceptible to the analytical inquiry of only one system (whether the particular network organization or academic discipline)? One such (apparent) trend is made the object of investigation here: the increasing application of principles of enterprise law and theories of enterprise liability to both corporate groups and relational networks. Regarding the former typus of a collectivized commercial undertaking, legal scholarship and regulation on the ‘twin’ topics of group aggregation and group liability are already far advanced (as described in more detail in Part 2 below). They may therefore provide a suitable frame of reference in order to examine more closely the relevance of enterprise law principles in the domain of relational groups (as described in Part 3 below, using franchising systems as a main example).
The objective of this investigation and analysis is to develop a better understanding (and also a more adequate normative perspective) of the current, international trends coalescing within various regulatory frameworks applicable to corporate and relational networks. It presents a conceptual inquiry aimed at identifying – within the limited area of network liability – where network regulation may be headed (‘sharpening the lens’) and, to a similar extent, of where such regulation should be headed (‘calibrating the lens’) (see Part 4 below).
2Corporate Groups and Enterprise Law
Pursuant to traditional, nineteenth century Anglo-American corporation law, each corporate entity within a collective network of companies is recognized as a separate juridical entity with its own legal rights and responsibilities independent of those of its corporate affiliates (i.e., parent and subsidiary companies as well as sidestream affiliates under common ownership and control). The same corporate ‘entity law’ approach (Blumberg 1990, pp 285-87; Blumberg 1993, pp 305-08; Blumberg et al. 2005, pp xii) is firmly established today in each of the corporation laws on the European Continent – a development that can be traced back to the first formulations of limited investor liability in the Napoleonic Code de Commerce of 1807 (see Blumberg 1986, pp 595-96).
In contrast thereto, during most of the twentieth century the legal systems in Europe and the United States have progressively crafted competing notions of group or enterprise law (‘Konzernrecht’ in German) within various areas of the law of corporate networks. Such enterprise principles have led to a reattribution of legal rights and responsibilities among the affiliated companies constituting the single economic enterprise and, in their most farreaching configuration, may impose a collective liability of all participants of such conglomerate by way of penetrating the horizontal and vertical ‘corporate separateness barriers’ traditionally accepted, but found anachronistic and dysfunctional in modern polycorporate groups.
2.1The Corporate Group Phenomenon
The corporate group or group of companies (‘Konzern’ in German) is, by no means, a recent (legal) phenomenon. It has long been a reality throughout the world; legal provisions applicable to group enterprises are nowadays legion (Blumberg 1990, p 287; Blumberg et al. 2005; Embid Irujo 2005, pp 67, 81; Forum Europaeum 2000, pp 167-68, 258). The emergence of corporate groups in the United States commenced with a liberalization of state corporation laws that permitted intercorporate stock ownership for the first time, i.e., corporations itself, not only natural person investors, were allowed to acquire and own the shares of (other) corporations. New Jersey blazed the trail in 1889 and, eventually, all other American jurisdictions followed suit (Blumberg 1986, pp 605, 607). Similarly, the legal systems in England (1867) (see Blumberg 1986, pp 608-09), Germany (where groups of companies had been observed already in the nineteenth century and legal discussion of groups of companies began in 1910; see Hopt 1991, p 83) and France (1878) (see Forum Europaeum 2000, p 167 n 2) have long acknowledged the legitimacy of intercompany stock ownership – still the central structural element of group composition today (Immenga 1985, p 13).
The paradigm features of the corporate group are its centralized structure (often a hierarchical pyramid)[1] based, in most cases, on equity participation, and the control exercised downstream in a ceaseless, continual manner from the group’s vertex, i.e., the ultimate parent company at the top of the pyramid, to the lowest, most removed tier of each individual branch of subsidiary entities extending beneath such parent firm. Both such features are designed in order to create the entrepreneurial integration and unity of the collective enterprise. Forms of ‘control’ (sometimes also termed ‘dominance’)[2] may vary but regularly include the ownership of a majority of the issued stock of the controlled entity, the ownership of a majority of the voting rights, the right to determine the composition of such entity’s governing body (board of directors, supervisory board, etc.), the right to influence or direct such entity’s otherwise autonomous decisionmaking process, and any combination thereof (Forum Europaeum 2000, pp 187-91; Kluver 2000, pp 291-93; Nygh 2002, p 52).[3] Furthermore, various legal systems – in particular, Germany – allow for special organizational ‘control agreements’ (‘Beherrschungsverträge’ in German) which permit the then dominant company to exercise far-reaching executive powers over the contractually subordinated corporation and its no longer independent but now group-integrated management (Forum Europaeum 2000, p 233; ReichGraefe 2005, pp 788-90).
Corporate groups are complex, dynamic, multi-tiered and, at the same time, very flexible and adaptable institutions, both economically and legally – but this complexity and intricacy does not, in itself, explain the apparently concomitant necessity felt in many legal systems to regulate groups of companies specifically (i.e., other than indirectly by means of general company laws applicable to, and designed for, singlecorporate businesses). By way of a general explanation, it should be noted that, structurally, the legal position of the corporate group is marked by the tension of its unity as a commercial enterprise and its diversity (or multiplicity) due to the legal segregation and insulation of its constituent member companies (Forum Europaeum 2000, pp 193, 232; Teubner 1990, p 67). Such tension is intentional; the objectives of economic unity and legal diversity –together and simultaneously – cherished goals of the management and operational optimization of modern corporate groups.
Consequently, the integration of group management and the harmonization and coordination of operational group functions by legal means (through the manifestation and continuous application of control over group subsidiaries) are principles aimed at achieving commercial unity as one of the group’s predominant goals. To be effective, those principles have to consciously disregard the legal diversity created by the plurality of component group companies. Diversity, however, is the corresponding goal of a different, if not opposite, principle governing the structural logic and raison d’être of corporate groups – viz., subsidiarity. In a network context, subsidiarity ultimately translates into network decentralization. As a true objective, it would allow each subsidiary corporation to selfgovern, i.e., to autonomously manage core areas of its commercial operations in furtherance of the genuine economic interests of, and the resultant business objectives independently set by, such subsidiary (which interests and objectives may or may not align and coordinate with the identification and promotion of the group’s collective interests and objectives).
The concurrent pursuance of the dual goals of commercial unity and legal multiplicity within corporate groups may accordingly be considered a structural paradox: Disparate legal strategies are utilized in order to structure the group internally (integration of management to attain internal unity on the one hand and segregation of asset spheres to realize external ‘owner shielding,’ i.e., a decentralization of liability to third parties, on the other hand) and in order to position the collective enterprise to develop optimal legal and economic frameworks for market success. Such success objectives, however, are obviously set in a ‘group-immanent’ and autopoietic manner, i.e., they are self-referentially generated from the inside of the group without reflection of the ‘outside’ world. In the legal literature, Teubner (1990, p 67) has described the autopoiesis aspects of such constitutive group functions as “closed networks of self-producing decisions.” As we know, however, corporate groups do not operate in a hermetic, closed world. Whatever introvert reclusion (and operation of disparate legal strategies) may be functional within corporate groups for purposes of generating a unified organizational system, groups are also ‘group-transcendent’ and effluent institutions in constant interaction with their outside environment. Such interaction and “openness toward the environment” (Teubner 1990, p 67) is, among other things, characterized by a necessary actualization of group-extraneous interests (i.e., those of outside, non-group parties that the enterprise comes in contact with) and an often reflexive externalization of the cost of network risks (for example, network mismanagement, operational hazards, and the undercapitalization of individual network units) which may give rise to contract and tort claims by outside creditors of the group’s subsidiary firms.
Put briefly: Groups may be best understood as structural hybrids, and hybrid systems often, by their very nature, generate (societal) friction and externalities which bring regulators to the table. Groups collectivize action without simultaneously collectivizing responsibility; they increase and externalize risks to outside parties without taking adequate measures to ensure their absorption (see Collins 1990, p 737; Teubner 1991, p 106; 1993b, p 230).[4]
2.2Corporate Networks and Enterprise Law
Historically, the phenomenon of corporate groups was preceded in the nineteenth century by an almost universal acceptance of two fundamental doctrines on the subject and juridical status of companies: First, that an entity once incorporated and, thus, sanctioned by the state became an independent legal subject, separated in personam and in rem from its residual owners (i.e., its shareholders), and, next in chronological sequence, that the personal liability of equity investors to the creditors of such incorporated entity was limited (Blumberg 1986, p 607; Blumberg 1993b, pp 58-60; Buxbaum 1974; Easterbrook and Fischel 1985).[5] As the rule to this very day and as one of the cornerstones of modern market economies, entrepreneurial liability of residual owners (NB – to the corporation, not to its creditors) is strictly limited to the respective subscription or investment amount undertaken by each such owner – and is further limited to a ‘call liability,’ i.e., the amount of such agreedupon capital contribution which has not yet been paid to the corporation (if any). The concept of limited liability and the legal separation of the residual owner’s personal assets from those of the firm is sometimes also described as ‘owner shielding.’ Such entity law approach – the ‘atomistic’ notion of the separate juridical personality of each individual corporation with its rights and responsibilities (i.e., its jural relations) rigorously confined by the legal and capital boundaries of such personality – is one of the fundamental concepts of corporation law common today to all Western legal systems (Blumberg 1990, pp 286-87, 297; Blumberg 1993b; Collins 1990, Forum Europaeum 2000, p 169).
However, as Blumberg (Blumberg et al. 2005) has most convincingly and systematically demonstrated,[6] the once hallowed principle of entity law has been eroded during the course of the twentieth century and has been supplanted in many areas of corporate, tax and business regulatory law by modern notions of what may be designated as ‘enterprise law.’ Today, there is hardly a single developed jurisdiction in which the specific risks within corporate groups to minority shareholders, to creditors of individual group member companies, to the group’s labor relations, to market competition, etc.[7] and, thus, the specific demands of corporate group regulation are not taken seriously (Forum Europaeum 2000, p. 173; Kluver 2000, p 291). As a result, the legal fiction of the separate juridical personality of each constituent group company as well as the insulation of its jural relations from all other member companies of the group are more and more frequently disregarded while, at the same time, the larger picture – the aggregate group enterprise – becomes the focus and subject of regulatory attention today.
Faced with the modern reality of “highly intertwined operational and economic relationships between parent and subsidiary corporations” (Blumberg 1993b, p 92), courts and legislators have developed a variety of conceptual approaches leading, in essence, to a reascription of legal responsibility for subsidiary acts and defaults to the parent company as well as (sometimes) to the group at large. The segregated spheres of corporate personality and (in-)action of individual group members pursuant to entity law principles, and, likewise, the radii of influence and consequence of their individual (in-)action, thus begin to converge into the legal (i.e., no longer only economic) recognition of a single actor: the group in toto. In particular in the realm of statutory law (originating, in the United States, with the New Deal legislation), traditional entity law strictures have been set aside, and comprehensive ‘control’ concepts have been adopted by legislators – both in the United States and in Europe[8] – in order to bring not only the regulated company but also its ‘controlling’ corporations (and often also its ‘affiliated’ corporations and corporations under its ‘common control’) within the ambit of the regulatory program (Blumberg 1990, pp 288-89, Blumberg et al. 2005). American common law, today, equally recognizes the inadequacies of nineteenth-century entity law paradigms in dealing with the profound problems presented by the modern-day corporate group and its complex, multi-tiered (and often also multinational) operation and governance structures (Blumberg 1990, pp 288-89). Pursuant to these – for traditional corporate law paradigms, revolutionary – legal techniques applied by legislators and judges alike, the entire economic enterprise is suddenly transposed into the bright spotlights of political and regulatory scrutiny.
A detailed discussion of these enterprise law techniques is beyond the scope of this paper (though an example of the same in the area of product liability will be discussed more specifically in the following part).[9] But what is important to note here are the critical policy issues – the ‘common threads’ – fueling the application of enterprise principles in various areas of the legal systems in Europe and the United States. The first of such group-specific policy issues must obviously be perceptual: Since the group as a whole becomes the subject of regulatory activity (and inevitable perception), perceptual factors like the extent of the interrelationships between the group and its controlled companies, the extent of organizational direction (i.e., the exercise of intragroup control), the economic, administrative and financial interdependence and integration of group companies, and the use of a common public persona (see Blumberg 1990, p 291; Blumberg et al. 2005) become vital aspects of (legal) policy-making. As regards the substance of those common policy threads, the obvious starting point is the prevalence and size of corporate groups in today’s global marketplace. Very large corporations (whose revenues rival or even exceed the gross national products of many Western economies) dominated the economic system. Legal fragmentation and decentralization among group companies (and further political and regulatory fragmentation in the case of multinational groups) does not correspond to the economic reality of centralized corporate decisionmaking within a single, integrated (worldwide) enterprise, and to the magnitude of the collective, highly concentrated socioeconomic impact such enterprise may have in each country of its operations.
In summary, corporate groups represent legitimate entrepreneurial structures whose interests are to be recognized and protected by the regulatory system. However, having said this, it is equally evident today that the legal regime of corporate groups often proves insufficient, and hence unable, to ensure the safety of their members as well as the orderly pursuit of their interests in balance with those of group-extraneous parties, in particular, creditors and external minority shareholders of component group companies (Embid Irujo 2005, pp 74, 90; Forum Europaeum 2000; Winter et al. 2002). This reality has created irresistible regulatory pressures to ensure effective group responsibility and accountability, and to impose more effective societal controls through the development of new legal rules in the regulatory dimension of unity (i.e., the commonality of the collective group enterprise) and, simultaneously, the abandonment of the traditional corporate law dimension of diversity (i.e., the multiplicity of the separate corporate ‘parts’ constituting the group) (Blumberg 1990, p 285).