Research Handbook on Corporate Liability 1800371276, 9781800371279

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RESEARCH HANDBOOK ON CORPORATE LIABILITY

RESEARCH HANDBOOKS IN PRIVATE AND COMMERCIAL LAW The Research Handbooks in Private and Commercial Law series is a forum for Research Handbooks covering both the traditional private law topics, such as torts, contracts, equity and unjust enrichment, as well as more commercial topics such as the sale of goods, corporate restructuring, commercial contracts and taxation, among others. Reflecting the approach of the wider Elgar Research Handbooks programme they are unrivalled in their blend of critical, substantive analysis and synthesis of contemporary research. Each Research Handbook stands alone as an invaluable source of reference for all scholars interested in private and commercial law. Whether used as an information resource on key topics or as a platform for advanced study, volumes in this series will become definitive scholarly reference works in the field. For a full list of Edward Elgar published titles, including the titles in this series, visit our website at www​.e​-elgar​.com​.

Research Handbook on Corporate Liability Edited by

Martin Petrin Dancap Private Equity Chair in Corporate Governance, University of Western Ontario, Canada

Christian A. Witting Professor of Law, National University of Singapore, Singapore

RESEARCH HANDBOOKS IN PRIVATE AND COMMERCIAL LAW

Cheltenham, UK • Northampton, MA, USA

© Editors and Contributors Severally 2023

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA A catalogue record for this book is available from the British Library Library of Congress Control Number: 2023939462 This book is available electronically in the Law subject collection http://dx.doi.org/10.4337/9781800371286

ISBN 978 1 80037 127 9 (cased) ISBN 978 1 80037 128 6 (eBook)

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Contents

List of contributorsvii Introduction to the Research Handbook on Corporate Liability1 Martin Petrin and Christian A. Witting PART I

FOUNDATIONS

1

The company and its constituents Susan Watson

2

Theoretical approaches to corporate liability Martin Petrin

24

3

Corporate liability: a systems perspective Christian A. Witting

42

PART II

7

CORPORATE LIABILITY

4

Corporate law and statutory liability Deirdre Ahern

62

5

Issuer liability: ownership structure and the circularity debate Martin Gelter

82

6

Corporate criminal liability Samuel W. Buell

100

7

Corporate tortious liability Robert J. Rhee

116

8

Agency liability Tan Cheng-Han

136

9 Attribution Ernest Lim

156

PART III PERSONAL LIABILITY 10

Directors’ and officers’ liability under securities laws Lisa M. Fairfax

v

174

vi  Research handbook on corporate liability 11

Evolution of director oversight duties and liability under Caremark: using enhanced information-acquisition duties in the public interest Jennifer Arlen

12

Fiduciary liability and business judgment Paul B. Miller

221

13

Review of directors’ business judgments Joan Loughrey

237

14

Joint liability Joachim Dietrich

256

194

PART IV VICARIOUS LIABILITY AND EXTENDED LIABILITY 15

Vicarious liability and corporations Paula Giliker

274

16

Toward corporate group accountability Virginia Harper Ho, Gerlinde Berger-Walliser and Rachel Chambers

292

17

Liability in the shipping industry Martin Davies

315

18

Enterprise liability Gregory C. Keating

330

PART V

THE CLAIMS PROCESS

19

Overlapping remedies Bert I. Huang

351

20

Jurisdiction and corporations: identifying an international standard Richard Garnett

365

PART VI THE FUTURE OF CORPORATE LIABILITY 21

The future of corporate criminal liability in the ESG space J.S. Nelson

387

22

Towards corporate digital responsibility Florian Möslein

409

23

Accountability for AI labor Mihailis E. Diamantis

434

24

The company and blockchain technology Kelvin F.K. Low, Edmund Schuster and Wan Wai Yee

447

Index467

Contributors

Deirdre Ahern is Professor of Law, Trinity College Dublin, Ireland Jennifer Arlen is Norma Z. Paige Professor of Law, New York University, USA Gerlinde Berger-Walliser is Associate Professor of Business Law, University of Connecticut, USA Samuel W. Buell is Bernard M. Fishman Professor of Law, Duke University, USA Rachel Chambers is Assistant Professor of Business Law, University of Connecticut, USA Martin Davies is Admiralty Law Institute Professor of Maritime Law, Tulane University, USA Mihailis E. Diamantis is Professor of Law, University of Iowa, USA Joachim Dietrich is Professor of Law, Bond University, Australia Lisa M. Fairfax is Presidential Professor, University of Pennsylvania, USA Richard Garnett is Professor of Law, University of Melbourne, Australia Martin Gelter is Professor of Law, Fordham University, USA Paula Giliker is Professor of Law, Bristol University, UK Virginia Harper Ho is Professor of Law, City University of Hong Kong, China Bert I. Huang is Harold R. Medina Professor of Procedural Jurisprudence, Columbia University, USA Gregory C. Keating is William T. Dalessi Professor of Law and Philosophy, University of Southern California, USA Ernest Lim is Professor of Law, National University of Singapore, Singapore Joan Loughrey is Head of School and Professor of Law, Queens University Belfast, UK Kelvin F.K. Low is Professor of Law, National University of Singapore, Singapore Paul B. Miller is Professor of Law, University of Notre Dame, USA Florian Möslein is Professor of Law, Philipps-University Marburg, Germany J.S. Nelson is Professor of Law, Villanova University, USA Martin Petrin is Dancap Private Equity Chair in Corporate Governance, Western University, Canada Robert J. Rhee is John H. and Mary Lou Dasburg Professor of Law, University of Florida, USA vii

viii  Research handbook on corporate liability Edmund Schuster is Associate Professor of Law, London School of Economics, UK Tan Cheng-Han is Professor of Law, National University of Singapore, Singapore Wan Wai Yee is Professor of Law, City University of Hong Kong, China Susan Watson is Dean of Business and Economics and Professor of Law, University of Auckland, New Zealand Christian A. Witting is Professor of Law, National University of Singapore, Singapore

Introduction to the Research Handbook on Corporate Liability Martin Petrin and Christian A. Witting

Several months before the Covid-19 outbreak, we began planning this Research Handbook on Corporate Liability. Despite a pandemic that disrupted lives everywhere and much academic work, we proved able to count on a stellar team of international scholars, each a leader in their field, that delivered timely contributions on core aspects of corporate liability. Writing in late 2022 at the conclusion of a sizeable project, we now take the opportunity in this Introduction to reflect on the Handbook’s main themes as well as the broader context. A striking feature of corporate liability is its breadth and complexity. The topic encompasses, among other things: corporate and securities law; corporate governance; tort law; criminal law; administrative law; civil procedure; international law; human rights law; and environmental and sustainability law. Corporate liability contains elements of both hard and soft law and is influenced in no small part by politics and lobbying. It can be viewed through the lens of economic analysis, justice or fairness and other philosophical accounts, as well as historical, sociological, and other perspectives. All this makes the study of corporate liability as fascinating as it is challenging. To mention but one, very simple example of the complexity: If an individual defrauds another person, the law will normally not struggle to resolve the situation. By contrast, if that same fraudster were a corporate participant, many questions would arise. Should the company be liable for the fraudster’s actions? Should the company be liable jointly with the perpetrator, and should other participants be held accountable, perhaps because they failed to prevent the fraud? If so, what should the sanctions be and what does it mean for the entity’s ‘innocent’ stakeholders that would be indirectly affected? If the company is unable to compensate the victim, would it be justifiable to hold a parent company or other shareholders liable? Finally, to go beyond the example of fraud, what should happen if financial loss or even physical injury were caused by automated processes, machines, and/or (algorithmic) software? The corporate liability principles used to resolve these and cognate issues today still tend to be based on old theories and conceptions of the corporate form. We have not yet made up our minds fully as to whether legal entities are artificial, real, or something in between, and how – or through whom – exactly they can be said to act for the purposes of liability. The field of corporate governance appears further advanced in its understanding of corporations’ internal workings and their purpose in society than the field of corporate liability. Insights developed in the former have failed thus far to impact on much of the latter. The law grapples uncertainly with many aspects of corporate liability with respect to even the most basic questions of what the company is, what its constituent elements are, and when and how it can be said to act and form states of mind. This uncertainty means that several different conceptions of the company persist and little coherence arises in their invocation. The law struggles further to get the balance right between corporate and individual responsibility. In part, this is because of unresolved frictions between corporate law principles and their inter1

2  Research handbook on corporate liability action with general torts, criminal law, and regulatory and statute law. The fact that efficiency and fairness considerations sometimes work at cross-purposes makes the task of reconciling principles even more difficult. Yet, a balance between entity and individual liability is required because, for example, when compensation is needed only the company might be able to pay. Further, when reform and/or deterrence are called for, only individuals such as directors and senior managers can ensure that the appropriate measures are taken. Difficulties in designing corporate liability rules are probably greatest in criminal law owing to (1) the fear that criminal liability brings with it a particular stain on reputation (for both companies and individuals), which might not always be warranted, and yet (2) the company’s own liability can only lead indirectly to reform – via the board and managers – and (3) the company itself cannot be jailed in the way that is the usual mark of criminal punishment. Law and economics suggests that there is little point in maintaining a system of corporate criminal liability, although this underestimates criminal law’s ability to adapt to corporate defendants as well as the importance of its signaling effects. Questions arise about the extent to which outside directors are both truly responsible for corporate misdeeds and in the best position to ensure that reform and deterrence objectives are met. Although these individuals are the subject of considerable attention in the literature, rarely are they sued successfully. On the other hand, senior managers, who oversee the day-to-day operations of firms, are seldom thought of as responsible parties. Further, when thinking about both directorial and managerial liability the problem of risk and risk-shifting arises. First, an argument can be made that business risks should be primarily borne by entities, not the individuals that act for them. Second, corporate law, especially in the US, contains devices that insulate senior officials from liability to a great extent based on the notion that socially optimal risk-taking should be encouraged. While sensible in theory, difficulties lie in defining and achieving the correct level of risk-taking, especially considering climate change and other modern, societal challenges, which might necessitate rethinking current approaches. The question of strict versus negligence-based liability also remains open. The most usual types of corporate liability include vicarious liability for employee wrongs, products liability and general negligence liability (the latter often imposed without clarity on the mechanisms of attribution). In many jurisdictions, vicarious liability (certainly) and products liability (or parts thereof) bring strict liability – so that prima facie strict liability is wide. However, products liability rules are cut down in various ways, including through the operation of development risks defenses, which assume importance in an age of rapidly evolving new technologies. Advantages of strict liability include the facts that (1) companies will know in advance, with a degree of certainty, where responsibility for wrongs will fall, which means (2) that they are encouraged to plan their activities in advance and (3) claimants are spared much of the cost of bringing lawsuits because they do not have to prove fault. Characteristics (1) and (2) mean that significant corporate liability rules are forward-looking rather than backward-looking. They place pressure upon companies and their managers to be vigilant and to put in place appropriate policies and procedures for avoiding wrongdoing. On the other hand, there is the danger that broad rules result in liability that is potentially costly and unfair. Much of the impact might be felt by shareholders. As mentioned, liability rules will be effective only when both entity-level and individual responsibility are catered to and reinforce each other. As part of this balance, going forward, there could be a stronger focus on the corporate ‘system’ and its activities as a collective whole, including internal company policies, procedures, routines, and cultures. Individual

Introduction  3 responsibility can and should arise from discrete acts that directly cause harm, but it might also be appropriate when there is unjustified failure to ensure that entities avoid or mitigate harms. To some extent this is now reflected, albeit in different ways, in the trend towards broader and stricter oversight or monitoring duties (with Delaware leading the charge), carrot and stick approaches in Anglo-American corporate criminal law, and various failure to prevent and due diligence type statutory obligations (imposed on both entities and individuals, especially in European countries). Still, regulation and common law corporate liability rules have failed to settle on clear, overarching principles of corporate liability. Instead, the law follows a piecemeal approach. To be sure, the issue of how best to formulate and model rules is a difficult one. Although law and economics proponents, in particular, have worked intensely to offer answers, questions remain. In the future, it might be wise in the development of rules to seek assistance from more sophisticated, data-driven computer-modeling. Although not an easy task, this would cut down on the guesswork that legislatures and regulatory agencies currently have to employ in working out which rules and combinations thereof work best. A final, important factor influencing corporate liability is that many modern corporations are multi-jurisdictional and multi-national actors, with extensive webs of subsidiaries, suppliers, and other contractual partners. This creates questions of both group and supply chain liability not to mention complications due to lobbying activities and consequent regulatory arbitrage that leads to a feared ‘race to the bottom’ with the (ostensible) continual loosening of standards for company operations. To the extent that this is a problem, more coordination among lawmakers is required. While this can be seen, to some extent, among EU member states, it is less apparent elsewhere. In a similar vein, the growing presence, reach, and spread of business can lead to procedural challenges. Corporate activities can affect numerous parties in different locations at different times, creating difficulties when it comes to deciding where claims can be brought and how to coordinate regulatory sanctions and judicial remedies. Again, a key to solving these challenges appears to lie in coordinated frameworks. The six Parts that make up this Handbook pick up and elaborate on various facets of these and related issues. Part I (Foundations) is dedicated to fundamental questions of corporate theory and structure, with a higher-level focus on implications for corporate liability law and policies more generally. Among other issues, it looks at the nature and composition of corporate entities (Chapter 1, Susan Watson: ‘The Company and its Constituents’), the impact of theories new and old on the recognition and design of corporate liability (Chapter 2, Martin Petrin: ‘Theoretical Approaches to Corporate Liability’), and explores the idea of examining the company and its liability through the lens of systems theory (Chapter 3, Christian Witting: ‘Corporate Liability: A Systems Perspective’). Part II (Corporate Liability) focuses mainly on the liability of the entity itself, although some overlap and interactions with individual liability are inevitable and necessary. In doing so, this Part first discusses corporate liability based on statutory causes of action (Chapter 4, Deirdre Ahern: ‘Corporate Law and Statutory Liability’) and the specific instance of the liability of issuer corporations for misstatements under securities law (Chapter 5, Martin Gelter: ‘Issuer Liability: Ownership Structure and the Circularity Debate’). It then moves to examine the ‘large’ topics of corporations’ general liability under criminal law (Chapter 6, Samuel W. Buell: ‘Corporate Criminal Liability’) and tort law (Chapter 7, Robert J. Rhee: ‘Corporate Tortious Liability’). The Part concludes with chapters on agency (Chapter 8, Tan Cheng-Han:

4  Research handbook on corporate liability ‘Agency Liability’) and various problems of attribution (Chapter 9, Ernest Lim: ‘Attribution’) in the context of corporate vehicles. Part III (Personal Liability) is dedicated to exploring the accountability of individuals that act for corporations. It includes discussions of managerial liability under securities laws (Chapter 10, Lisa M. Fairfax: ‘Directors’ and Officers’ Liability Under Securities Laws’), fiduciary duty liability and, in particular, a fresh take on Delaware’s evolving framework for managerial monitoring (Chapter 11, Jennifer Arlen: ‘Evolution of Director Oversight Duties and Liability Under Caremark: Using Enhanced Information-Acquisition Duties in the Public Interest’), as well as judicial deference to board decisions from a US perspective (Chapter 12, Paul B. Miller: ‘Fiduciary Liability and Business Judgment’) and a UK perspective (Chapter 13, Joan Loughrey: ‘Review of Directors’ Business Judgments’). This Part also explores various instances of private law liability imposed on companies together with their individual participants (Chapter 14, Joachim Dietrich: ‘Joint Liability’). Part IV (Vicarious Liability and Extended Liability) examines more closely instances of entity liability for ‘others’, be they human agents (Chapter 15, Paula Giliker: ‘Vicarious Liability and Corporations’) or legal persons such as subsidiaries and contractually affiliated entities (Chapter 16, Virginia Harper Ho, Gerlinde Berger-Walliser and Rachel Chambers: ‘Toward Corporate Group Accountability’). This Part also explores the fascinating world of corporate liability under maritime or admiralty law (Chapter 17, Martin Davies: ‘Liability in the Shipping Industry’) and provides an encompassing discussion of enterprise liability (Chapter 18, Gregory C. Keating: ‘Enterprise Liability’) for corporate torts. Part V (The Claims Process) delves into two selected issues of a procedural nature. The first chapter in this Part (Chapter 19, Bert I. Huang: ‘Overlapping Remedies’) analyzes problems about, and offers novel solutions for, the issue of judicial remedies for harm caused by business entities. The second chapter (Chapter 20, Richard Garnett: ‘Jurisdiction and Corporations: Identifying an International Standard’) provides a comparative account of the question of when foreign corporations may be subject to the jurisdiction of national courts. Part VI (The Future of Corporate Liability), finally, turns to emerging issues in corporate liability. It reflects the movement of corporate liability towards an increasing concern with defining two societal challenges: digitalization and (broadly defined) sustainability or ESG (environmental, social, and governance) issues. A first chapter explores corporate responsibility for decisions, disclosures, and impacts concerning ESG factors (Chapter 21, J.S. Nelson: ‘The Future of Corporate Criminal Liability in the ESG Space’), while others explore the broader issue of corporate accountability in a world of digital transformation (Chapter 22, Florian Möslein: ‘Towards Corporate Digital Responsibility’) and liability for harm caused by artificial intelligence (Chapter 23, Mihailis E. Diamantis: ‘Accountability for AI Labor’). The last chapter in this Part of the book is dedicated to exploring distributed ledger technology and its impact on corporations, including their liabilities (Chapter 24, Kelvin F.K. Low, Edmund Schuster, and Wan Wai Yee: ‘The Company and Blockchain Technology’). Ultimately, the Handbook’s aim is to contribute to an improved understanding of the nature and operations of the company in the context of liability and the challenges presented by the corporate form to corporate liability. The more clarity we have on these issues, the better our liability rules and outcomes for society will become. We thank those who have helped us in this undertaking, especially: our committed contributors; Laura Mann and the excellent team at Edward Elgar for initiating and supporting a valuable project; Benson Fan, Research Assistant at NUS Law (funded by an NUS Start-Up Grant awarded to Christian Witting), for his research

Introduction  5 assistance and technical production of the chapters; our home institutions, National University of Singapore and University of Western Ontario; and, last but not least, our families.

PART I FOUNDATIONS

1. The company and its constituents Susan Watson

I. INTRODUCTION The ‘corporateness’ of modern companies has two possible sources. Companies may derive their corporateness primarily from the people who comprise them. Alternatively, the company may derive its corporate status from the state in some way. After incorporation therefore the company is either based on the shareholder collectivity, or exists separately from its shareholders. The fundamental basis of the company in turn determines the legal and economic relationship of the company to its constituents. Those constituents include the company’s shareholders and its directors, with some arguing that constituents extend to stakeholder groups like employees, consumers, the Government and even the environment. Contested areas of corporate law, which include issues concerning the appropriate liability of corporate constituents, relate to these contested models of the company. Former Delaware Chancellor William T. Allen described the two long-standing conceptions that dominate contemporary thinking about what a modern corporation or company is as the property conception and the social entity conception.1 In this chapter they are referred to as the contractual model and the entity model. In the contractual model, the company is the private property of shareholders. This model is favoured by many law and economics scholars. ‘The corporation’s purpose is to advance the purposes of these owners (predominantly to increase their wealth), and the function of directors, as agents of the owners, is faithfully to advance the financial interests of the owners.’2 The company itself is no more than a nexus of contracts between constituents. Writing in 1992 Allen noted that this model was at the time the dominant academic paradigm of the corporation. ‘In its most radical form, the corporation tends to disappear, transformed from a substantial institution into just a relatively stable corner of the market in which autonomous property owners freely contract’,3 with shareholders the residual owners of the firm. With the increasing attention on ESG (environmental, social, governance) externalities and the impact of the company on the world, the entity model may be gaining favour. In the entity model, the modern company is not the private property of shareholders. The company is a social institution that is not wholly private as it also has a public purpose. Its existence depends on government concurrence through the act of incorporation. The attributes of a corporation – juridical or legal personality, limited liability and perpetual life – are derived from the state rather than privately acquired through contract. This conception provides ballast to arguments that a company depends on a social licence to operate and is under a duty in some sense to all those interested in or affected by the corporation. 1 William T. Allen, Our Schizophrenic Conception of the Business Corporation, 14 Cardozo L. Rev. 261, 264 (1992). 2 Id. at 265. 3 Id. (footnotes omitted).

7

8  Research handbook on corporate liability In the entity model, the corporation is capable of bearing legal and moral obligations: The corporation comes into being and continues as a legal entity only with governmental concurrence. The legal institutions of government grant a corporation its juridical personality, its characteristic limited liability, and its perpetual life. This conception sees this public facilitation as justified by the state’s interest in promoting the general welfare. Thus, corporate purpose can be seen as including the advancement of the general welfare. The board of directors’ duties extend beyond assuring investors a fair return, to include a duty of loyalty, in some sense, to all those interested in or affected by the corporation.4

As Allen concludes, ‘To law and economics scholars, who have been so influential in academic corporate law, this model is barely coherent and dangerously wrong.’5 The two dominant models of the company have both historical and theoretical underpinnings. Herbert Hovenkamp explains how, historically, the jurisprudential concept of the modern corporation developed along the lines of three broad perspectives: an ‘associational’ perspective, a ‘fictional’ view that developed during the nineteenth century, and a ‘personal’ or ‘entity’ view that became important at the end of that century.6 The personal or entity perspectives relate to the incorporated form, with the general incorporation statutes of the nineteenth century preceded by incorporation through the Crown and later Parliament by charters, letters patent or discrete statutes. The associational perspective relates to unincorporated forms based on shareholders that were significant in the period before the enactment of the general incorporation statutes. The association of shareholders was permitted to transact as if it were a recognised legal person – the legal fiction referred to by Hovenkamp. These three perspectives and how they relate to the two models of the company that prevailed at certain points in the development of the modern company are expanded on in the following section. The chapter then sets out how the entity model ultimately prevailing at the end of the nineteenth century was short lived, with a discussion of the revival of the contractual model in the twentieth century. Section IV considers the consequences of the models on the relationship of the company with its corporate constituents and section V considers the impact of the two models on the liability of corporate constituents. Section VI concludes.

II.

THE ORIGINS OF ASSOCIATIONAL, LEGAL FICTION AND ENTITY PERSPECTIVES

A.

The Origin of the Associational Perspective

Societates, or simple partnerships based on the partners who comprised them, operated in parallel with the universitates or corporations of the Middle Ages that are discussed in the following section as the source of the entity model. Partnerships that used double-entry book-

Id. Id. 6 Herbert Hovenkamp, Enterprise and American Law, 1836–1937 14 (1991). Despite a divergence in the history of the development of the United States’ corporation from the English company after American independence, and despite the more rapid re-emergence of the modern form in the US, conceptions of the modern company shifted in similar ways in both jurisdictions. 4

5

The company and its constituents  9 keeping to separate for accounting purposes the partnership fund, known as Joint Stock, from the partners, emerged in England in Elizabethan times. In terms of capital lock-in, the utilisation of Joint Stock was an intermediate step between simple partnerships and modern companies. Shareholders gave up the right to withdraw their capital, but only for a limited period. Although legally a form of partnership, these private partnerships were called Joint Stock Companies. They were not incorporated. To distinguish them from chartered corporations, the form is described in this chapter as the contractual Joint Stock Company. A variation of the contractual Joint Stock Company form, where Joint Stock was separated by settling corporate assets in a trust, became significant in the eighteenth century during the period when the Bubble Act 1720 restricted access to incorporation.7 Chancery was more efficient than the common law courts in dealing with the concept of funds, with the equitable rights of the members as beneficiaries firmly established.8 Though legally a partnership, this form was designed to mirror incorporated business corporations as much as possible. 9 This was done, as the legal historian F.W. Maitland put it, ‘without troubling King or Parliament, though perhaps we said we were doing nothing of the kind’.10 This variation of the contractual Joint Stock Company form was known as the deed of settlement company. B.

The Origin of the Entity Perspective

Corporations were mechanisms by which the Crown granted powers to cities, churches and universities as legal persons. Only legal persons were capable of bearing rights and duties11 but legal persons did not need to be natural persons or (eventually) even be comprised of natural persons. By the sixteenth century corporations could be persona ficta or artificial legal persons. Maitland was careful to term persona ficta ‘the Italian Theory of the Corporation’. He recognised that, despite earlier glimmerings in the English Year Books, the persona ficta concept was not transplanted into English common law until 161212 by Coke CJ in The Case of Sutton’s Hospital.13 Coke CJ said that the corporation was ‘invisible, immortal and rest[ing] only in intendment and consideration of the law’.14 Business corporations chartered by the Crown and later Parliament emerged in the same period. Business corporations were initially a hybrid form. Members of business corporations like the English East India Company could choose to subscribe to a series of terminating Joint 7 Andreas Televantos, Capitalism Before Corporations: The Morality of Business Associations and the Roots of Commercial Equity and Law 35–36 (2021). 8 Id. 9 See Armand B. DuBois, The English Business Company after the Bubble Act, 1720–1800 216–18 (1938); William W. Bratton Jr, The New Economic Theory of the Firm: Critical Perspectives from History, 41 Stan. L. Rev. 1471 (1989); Jane Gleeson-White, Double Entry: How The Merchants of Venice Shaped the Modern World – and How Their Invention Could Make or Break the Planet 216 (2011). 10 Frederic W. Maitland, Trust and Corporation, in 3 The Collected Papers of Frederic William Maitland 283 (1911). 11 Patrick W. Duff, Personality in Roman Private Law 1 (1971). 12 Otto Gierke, Political Theories of the Middle Age xiv (F.W. Maitland trans., 1913). 13 The Case of Sutton’s Hospital (1612) 10 Co Rep 23a, 77 ER 960. 14 Id. at 973.

10  Research handbook on corporate liability Stocks linked to single voyages, or series of voyages. Permanent capital replaced discrete Joint Stocks in the English East India Company by 1657. The business corporation, as an artificial legal person created by the state, was a separate legal entity from its shareholders that had permanent capital. A consequence of separate legal entity status was that commentators mostly concur that shareholders of business corporations with permanent capital had limited liability to the corporation.15 Payments by shareholders beyond instalments as part of subscriptions could not be required,16 nor could governing bodies of corporations be forced by creditors to make calls on shareholders for debts owing by the corporations.17 C.

The Origin of the Fictional Perspective

1. Prior to the general incorporation statutes In the eighteenth century all forms of company were understood by commentators like Kyd and Blackstone to be associations of shareholders that were legal fictions. It did not matter whether the company was unincorporated and therefore contractually formed (the deed of settlement and contractual joint stock companies discussed in II.A above), or incorporated by Parliament as a business corporation (discussed in II.B above). For example, in Kyd’s 1793 treatise, corporations were considered to be ‘a collection of many individuals … with the capacity of acting, in several respects, as an individual’.18 Similarly, in 1803 in Blackstone’s Commentaries, corporations were characterised as individuals consolidated and united into a corporation, with those individuals and their successors considered to be one person at law.19 As a legal fiction, the company is considered to be comprised of its shareholders. It is treated as if it were a single person by the law, meaning that the association of shareholders could transact in the same way as an individual natural person. The fiction of legal personhood is therefore a type of collective noun for the constituent shareholders. The legal fiction concept differs from the persona ficta concept where the law creates an artificial legal person that need not be comprised of natural persons. The persona ficta concept was not favoured by commentators in the eighteenth century. Kyd opined that the parts of the corporate body were bulky and visible and seen by all but the blind, and ‘[w]hen, therefore, a corporation is said to be invisible, that expression must be understood, of the right in many persons, collectively, to act as a corporation, and then it is as visible in the eye of the law, as any other right whatever’.20 Apparently referring to The Case of Sutton’s Hospital,21 Kyd concluded: [O]n this principle we may account, in a satisfactory manner, for many of the incapacities attributed to a corporation aggregate, without having recourse to the quaint observations frequent in the old books, ‘that it exists merely in idea, and that it has neither soul nor body’.22 Julius Goebel Jr., Cases and Materials 428 (1946); cf. C.A. Cooke, Corporation, Trust and Company: An Essay in Legal History 76–79 (1951). Cooke bases much of his argument on Salmon v. The Hamborough Company (1671) 1 Chan Cas 206. 16 DuBois, supra note 9, at 99–104. 17 The Case of the York-Buildings Company (1740) 2 Atk 57, 26 ER 432 (Ch). 18 Stewart Kyd, 1 A Treatise on The Law of Corporations 13 (1793) (emphasis added). 19 William Blackstone, 1 Commentaries on the Laws of England in Four Books 468 (14th ed. 1803). 20 Kyd, supra note 18, at 16 (emphasis added). 21 The Case of Sutton’s Hospital (1612) 10 Co Rep 23a, 77 ER 960. 22 Kyd, supra note 18, at 71 (footnotes omitted and emphasis added). 15

The company and its constituents  11 Business corporations and eighteenth-century deed of settlement companies were different legal forms. Deed of settlement companies as a type of contractual Joint Stock Company were legally partnerships. Business corporations were incorporated and therefore a type of corporation. The conflation of forms may have come about because the documentation establishing the deed of settlement company was drafted to make the form as close as possible to the business corporation. Also the two forms were functionally and economically similar.23 Language may have exacerbated this conflation of legal forms. The terminology used for both the business corporation and the deed of settlement company implied that each was based on its shareholders. David Ciepley posits that the English East India Company copied the form of the Dutch East India Company’s structure while retaining the language of contractual Joint Stock Companies and merchant guilds, resulting in an ongoing theoretical misclassification of common law incorporated companies as being based on shareholders. Although shareholders were described at that time as ‘proprietors’, rather than the investors or shareholders they had become, Ciepley suggests the terminology remained in place in part because the change was gradual.24 That terminology, therefore, masked the actual critical characteristics of the business corporation. Crucially however that distinction remained clear to the courts during the eighteenth century. To the courts, the incorporated form, the business corporation, was a form of corporation on the one hand; and the unincorporated form, the deed of settlement company, was a partnership on the other. The Chancery Court presided over by Lord Eldon consistently treated deed of settlement companies legally as partnerships.25 The courts tolerated the desire of entrepreneurs to trade using deed of settlement companies as if they were single legal persons (the fiction) without departing from a fundamental position that these enterprises were partnerships at law, not corporations.26 Most significantly, deed of settlement companies were not separate legal entities so their shareholders were not protected from liability to third parties. As Televantos puts it: What is perhaps most remarkable about the law of the time is how it balanced these different political, economic, and ethical considerations. The courts gave effect to traders’ presumed expectation that partnerships and trusts had an existence separate from the partners and trustees, by shielding the partnership or trust assets from the private wealth and creditors of the partners or trustees. At the same time, the law made clear that partners and trustees took personal responsibility for debts they contracted in their own name – whether as partner, trustee, or personally.27

Paddy Ireland, Capitalism Without the Capitalist: The Joint Stock Company Share and the Emergence of the Modern Doctrine of Separate Corporate Personality, 17 J. Legal Hist. 41, 44–46 (1996). 24 David A. Ciepley, Corporate Directors as Purpose Fiduciaries: Reclaiming the Corporate Law We Need 41 Social Science Research Network, Jul. 29 2019, available at https://​ssrn​.com/​abstract​=​ 3426747. 25 Televantos, supra note 7, at 43 (‘courts of the Regency era, especially Lord Eldon’s Chancery, refused to treat deed of settlement companies as anything other than partnerships: the trust played only a minor role in their constitution, and did not oust most of the partnership law rules’). 26 Id. at 173. 27 Id. 23

12  Research handbook on corporate liability 2. After the general incorporation statutes That distinction between the incorporated form and the contractual form did not survive the general incorporation statutes. The modern company was initially considered to be an association of shareholders in the same way as a deed of settlement company was based on an association of shareholders, with modern companies initially often referred to in the plural as ‘they’. With the recognition of the impact of incorporation giving the company the status of a legal person, over time the company was understood to be a legal fiction based on those shareholders and an ‘it’. Initially therefore modern companies incorporated through the process set out in the general incorporation statutes were not viewed as separate legal entities from their shareholders. This is evidenced by the legislature considering that limited liability for shareholders required a statutory intervention. If the modern incorporated company was considered to be a separate legal entity from its shareholders like a business corporation with permanent capital, limited liability would have been considered one of the incidents of incorporation. The transition of the English company, following the general incorporation statutes, from being based on a collectivity, its shareholders, to being legally separate from its shareholders, can be traced through the nineteenth-century treatises of writer and jurist Nathanial Lindley, later Lindley LJ of the English Court of Appeal (and then Lord of Appeal in Ordinary). Lindley’s treatise on company law started life as an 1863 supplement to his treatise on partnership law,28 with Lindley seeing company law as a branch of partnership law subject to its principles.29 In the text he described companies as partnerships incorporated by registration and companies as a form of partnership.30 In the introduction to the text Lindley defined a company as an ‘association of many persons who contribute money or money’s worth to a common stock and employ it in some trade or business’.31 Like corporations, modern companies could transact as legal persons. Their status as legal persons was understood to be a legal fiction, with the underlying reality that they were based on shareholding collectivity. From 1855 the liability of shareholders of incorporated companies could be limited,32 and from 1856, limited liability was the default position.33 Statutory limited liability meant shareholders and their successors were liable only to the amount of capital they initially agreed to contribute when subscribing for shares. Unlike shareholders in deed of settlement companies, shareholders of incorporated companies could not be compelled to contribute more capital by either the company or the creditors of the company. Limited liability is significant in its effects on both shareholders and the company’s capital. By separating the company’s fortunes from the fortunes of its shareholders, limited liability to the company bounded the financial risk for shareholders. Also, shares became easily transferrable. Fully paid-up shares could be transferred free of the risk of future liability. If shares were partly paid up, transferees knew the extent of any future liability. The liability of a shareholder in a modern limited liability company was and is no greater or less than the amount of capital the shareholder promises to contribute. That amount of capital contribution is fixed. Once 28 Nathaniel Lindley, Supplement to a Treatise on the Law of Partnership Including its Application to Joint-Stock and Other Companies (5th ed. 1863). 29 Nathaniel Lindley, A Treatise on the Law of Companies Considered as a Branch of the Law of Partnership (5th ed. 1889). 30 Id. at 8. 31 Id. at 1. 32 See Limited Liability Act 1855, 18 & 19 Vict. c. 133 (Eng.). 33 See Joint Stock Companies Act 1856, 19 & 20 Vict. c. 47 (Eng.).

The company and its constituents  13 shares are fully paid up, the shareholder or any subsequent holder of the shares cannot be asked to contribute any more money to the company.34 Statutory limited liability meant that capital needed to be identified and separated from shareholders. The Companies Act 1862 was described as the accountants’ friend because it required the keeping of accounts at every point of a public company’s life.35 The law surrounding the company evolved to protect the permanent capital in the company from shareholders and their creditors. Indeed, the birth (or rebirth) of the modern company has been linked to the transformation of bookkeeping into modern accounting, and the emergence of the accounting profession.36 Accounts distinguished capital from costs and income. The requirement to keep proper and publicly available accounts that identified capital potentially available to creditors was also driven by the actions of the Railway Kings like George Hudson who ‘fiddled the books’, showing costs as capital investments rather than expenses.37 The requirement was to ensure that dividends were paid from profit and not capital – a rule set out judicially by Lord Jessel MR in Flitcroft’s case in 1882.38 As CA Cooke, writing in 1951, pointed out: The importance of the double entry system of keeping books lies not in its arithmetic, but in its metaphysics. To create a capital fund which can be shown as in debit or in credit towards its owners was to do the same thing in terms of finance that the lawyers did in terms of law. The lawyers created, for essentially practical purposes, the legal entity of the corporation, a legal person separate and distinct from its members, linked with them by rights and duties. The business men created the financial entity of the business, a fund separate and distinct from its subscribers, linked with them by debits and credits. The most common corporate form of the twentieth century, the [modern] company, is descended from these two inventions.39

In the second half of the nineteenth century, the consequences of incorporation and statutory limited liability saw a gradual recognition that the modern companies, like earlier business corporations, were separate legal entities from their shareholders. Thus, by 1873 Lindley acknowledged the implications of the incorporation of a modern company; that it was a separate legal entity from its shareholders: ‘[A] company which is incorporated, whether by charter, special act of Parliament, or registration, is in a legal point of view distinct from the persons composing it’.40

34 As the nineteenth century progressed, the practice shifted from issuing shares with high par values that were not fully paid up to issuing shares for low par values (one pound) fully paid up. Speculatively that may be one of the reasons why the business corporation form did not really flourish and grow until the 1880s. 35 Gleeson-White, supra note 9, at 144. The twentieth century’s biggest accounting firms were established in London during this period – William Deloitte (1845), Samuel Price and Edwin Waterhouse (1849), and William Cooper (1854). 36 Basil S. Yamey, The Historical Significance of Double-Entry Bookkeeping: Some Non-Sombartian Claims, 15 Acct., Bus. & Fin. Hist. 77, 77–78 (2005). 37 Gleeson-White, supra note 9, at 143. 38 In re Exchange Banking Company (Flitcroft’s case) (1882) LR 21 Ch D 519. 39 Cooke, supra note 15, at 185. 40 Nathaniel Lindley & Samuel Dickinson, 1 A Treatise on the Law of Partnership Including its Application to Companies 227 (3d ed. 1873).

14  Research handbook on corporate liability How the general incorporation statute was now to be interpreted was clear from the first words in the speech of Lord Halsbury LC in Salomon v Salomon & Co Ltd: My Lords, the important question in this case, I am not certain it is not the only question, is whether the respondent company was a company at all – whether in truth that artificial creation of the Legislature had been validly constituted in this instance; and in order to determine that question it is necessary to look at what the statute itself has determined in that respect. I have no right to add to the requirements of the statute, nor to take from the requirements thus enacted. The sole guide must be the statute itself.41

The use of the words ‘artificial creation of the legislature’ echoes the words in The Case of Sutton’s Hospital and the persona ficta concept. To Lord Halsbury it seemed ‘impossible to dispute that once the company is legally incorporated it must be treated like any other independent person with its rights and liabilities appropriate to itself.’42

III.

REVIVAL OF THE CONTRACTUAL MODEL

Salomon v Salomon & Co Ltd is a watershed case but the entity model did not prevail. The contractual model gained traction in the twentieth century when used by US corporate law scholars laying the groundwork for agency theory and for modern law and economics contractual conceptions of the company. F.W. Maitland refers to attempts ‘to dispel the Fiction or rather to open the Bracket and find therein nothing but contract-bound men’.43 (Maitland here is referring to the persona ficta not the legal fiction.) Maitland cited Victor Morawetz’s highly influential 1882 treatise The Law of Private Corporations.44 Morawetz argued that a number of individuals should be able to form a corporation of their own free will just as they can form partnerships and enter into contracts.45 A corporation existing independently of its shareholders was a fiction, with rights and duties being ‘in reality the rights and duties of the persons who compose it, and not of an imaginary being’.46 In common with Kyd a century earlier, Morawetz was clear in his understanding that the corporation and its members were really the same thing.47 The courts of the eighteenth century apprehended the distinction between a business corporation on one hand as an incorporated entity and a deed of settlement company on the other hand as a form of partnership. How sound was the authority Morawetz relied on? Describing Morawetz’s early struggles to establish himself as a legal practitioner in a history of the Cravath firm, his biographer Swaine says:48

Salomon v Salomon & Co Ltd [1897] 2 AC 22 (UKHL) (emphasis added). Id. at 30. 43 Gierke, supra note 12, at xxiv. 44 Victor Morawetz, A Treatise on the Law of Private Corporations other than Charitable (1882). 45 Id. at 24. 46 Morawetz, supra note 44, at 2. 47 Id. at 565. 48 Robert T. Swaine, 1 The Cravath Firm and its Predecessors 1819–1947 382 (2006). 41 42

The company and its constituents  15 For the lack of anything else to do he occupied himself in writing a book on the law relating to corporations, persuading his father to finance him in the year and a half it took him to complete it. Morawetz’ The Law of Private Corporations, published in 1882 when Morawetz was but 23 years old was immediately and generally recognised as the first important book in that field. As the field was new and authorities scarce, he was able to express dogmatically his own theories on controversial points and he deliberately omitted such authorities as were against him.

P.W. Duff’s statement that Bracket Theory (contractual theory) was ‘held unconsciously by those who knew no theories’ may be true.49 Rather than relying on legal sources, Morawetz and other US corporate treatise authors of the period such as Charles Fisk Beach and Henry O. Taylor50 drew primarily on classical economic notions that conceived of the economy as a system of transactions between individuals.51 These ideas were derived in part from contractual conceptions of the firm from British lawyers of the eighteenth century who asserted that ‘only natural persons occupied the legal world’.52 The contractual model of the modern corporation set out by Chancellor Allen lies behind prevailing law and economics theories that conceive of the company as a nexus of contracts. As David Millon puts it, ‘the private aggregation idea assumed the garb of neoclassical economics under the corporation as a “nexus-of-contracts” rubric. Advocates of this theory have used the freedom-of-contract metaphor to support their shareholder primacy, anti-regulatory policy objectives.’53 The revival of the contractual model was brought about by the neoclassical economic movement. Jensen and Meckling, drawing on the theories of agency, finance and property rights, set out agency theory in their seminal 1976 article.54 In agency theory, shareholders are viewed as the economic principal and management are viewed as the economic agents. The company is thus viewed from the perspective of contracting shareholders and seen as a black box represented by a production function.55 These scholars take an atomistic approach to the corporation. For example, Oliver Williamson argues that the relation between each constituency and the firm should be evaluated in contractual terms, and that corporate governance structures such as boards arise as a response to ‘the needs of an exchange relation for contractual integrity’.56 Until recently variants of contractual theory dominated corporate law in the common law world. Although the modern neoclassical version originated in the US, its taxonomy of management as agents of shareholders resonates with corporate law scholars and jurists outside the US as it mirrors the perceived legal position for deed of settlement companies in the late eighteenth and early nineteenth centuries when much corporate law doctrine developed. Notwithstanding the apparently clear rejection of a contractual basis for the modern company Duff, supra note 11, at 218. William W. Bratton, The New Economic Theory of the Firm: Critical Perspectives from History, 41 Stan. L. Rev. 1471, 1489 (1989). 51 Id. at 1484. 52 Id. See the discussion in Arthur J. Jacobson, The Private Use of Public Authority: Sovereignty and Associations in the Common Law, 29 Buff. L. Rev. 599 (1980). 53 David Millon, Theories of the Corporation, 1990 Duke L.J. 201, 203 (1990). 54 Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305 (1976). 55 Id. at 306. 56 Oliver Williamson, Boards of Directors, 93 Yale L.J. 1197, 1198 (1984). 49 50

16  Research handbook on corporate liability in the Salomon case, this model never died away. This may be because both the contractual model and the modern neoclassical theories of the firm share common origins in the classical economic tradition: Jensen and Meckling’s acknowledgement of Adam Smith is overt.57

IV.

CONSEQUENCES OF THE MODELS ON THE RELATIONSHIP OF THE COMPANY TO ITS CORPORATE CONSTITUTENTS

Governing bodies for corporations predate general meetings for investing shareholders. In corporations the guardianship role of the governing body was key: Canon law described the corporate person as a persona ficta. Its corporators stood in law as guardians of property which belonged in fact to no-one, and guardianship, rather than agency, became the mark of legally competent association.58

Regular general meetings for shareholders were an important innovation first seen in the English East India Company, right from its incorporation in 1600. The rights of the small investing shareholders in the Company as the collectivity against the elite merchants who controlled the governing body were debated in those meetings. The conflict between the collectivity and the managerial elite led to the modernisation of the Company, culminating in 1657 when the Company acquired permanent capital and the new age of corporate capitalism really began. The small shareholders were not empowered by increased control over the management of the Company. Instead, shareholder influence and rights through the general court (meeting) led to increased obligations on the governing body. Practices that favoured elite merchants, such as dividends paid in the form of commodities, and the elite merchants purchasing commodities at favourable rates, ended. The elite accepted that they did not have a permanent right to control the Company. They also accepted that the role of the governing body, supported by sworn oaths, was to act in the interests of all of the shareholders. The governing body was transformed into the modern managers that the Company’s shareholding collectivity had long demanded. This change involved a transition. The transition was away from personal accountability for property and consumable surplus to individual investors. The transition was towards economic accountability for a return on capital. For that purpose, the company began to recognise the need to distinguish capital from revenue. ‘[T]he greatest of accounting’s responsibilities is to hold management accountable for the rate of return on capital employed’.59 That approach also underpins the governance of a modern company when the entity model is adopted.

57 Jensen & Meckling, supra note 54, quoting Adam Smith at the beginning of their paper on the agency problem. 58 Roger Scruton & John Finnis, Corporate Persons, 63 Proc. Aristotelian Soc’y, Supplementary Volumes 239, 242 (1989). 59 R.A. Bryer, The History of Accounting and the Transition to Capitalism in England: Part 2 Evidence, 25 Acct., Org. & Soc’y 327, 368 (2000).

The company and its constituents  17

V.

THE IMPACT OF THE TWO MODELS ON THE LIABILITY OF CORPORATE CONSTITUENTS

Stephen Bottomley argues that the focus on economic analysis in the contractual model has led to a one-dimensional picture of corporate governance where ‘there can be no privileged or ultimate analytical framework for studying the complexity of corporate organisations’.60 He identifies four limitations on the application of the solely contractual paradigm to corporate governance. First, complex relationships between many people tend to be reduced to bilateral agreements between legal or economic actors.61 The organisation is ignored.62 Second, the economic analysis of corporate governance issues excludes other perspectives.63 Third, the contractual frameworks are orientated towards end results rather than their impact on the rights or interests of the persons involved.64 Finally, ‘corporations and the things they do are treated as essentially private phenomena’, meaning external regulation of corporate activity, or public-law like concepts, must be justified.65 In the entity model, at incorporation the company is an artificial legal person based on permanent capital contributed by shareholders. The company as an inanimate artificial person requires decision-making bodies to operate in the world. One decision-making body is the board comprised of individual directors who collectively make decisions. The other decision-making body is the shareholders collectively through the general meeting. Powers are allocated constitutionally to the two decision-making bodies. Each company is therefore itself a body politic with its own internal system of governance. Descriptions of general meetings as ‘little Parliaments’ (in the seventeenth century)66 may therefore be apt if the modern company is seen as a body politic. Considering the internal governance of the company from a constitutional perspective better reflects the origins of corporate governance in the Courts (meetings) of the seventeenth century discussed in section IV above. In cases like Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame,67 the courts enforced the constitutional division of powers in the company by not permitting shareholders to override management decisions allocated to the board. The English Court of Appeal said that once the power had been delegated to the directors, the shareholders could not take it back again (other than presumably prospectively and constitutionally through the articles of association). Is the source of the power of boards the shareholders collectively? Or do boards derive their authority from the incorporation statute? The former source might indicate that the modern company is based on its shareholders collectively in accordance with the contractual model; the latter that the entity model has ultimately prevailed. Unlike almost all US states and most other jurisdictions, directors are not granted the power to direct the company through the Stephen Bottomley, The Constitutional Corporation: Rethinking Corporate Governance 47 (2007). 61 Id. at 30. 62 Id. at 31. 63 Id. 64 Id. at 32. 65 Id. at 33. 66 A.B. Levy, Private Corporations and their Control 40 (1950). 67 Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame [1906] 2 Ch 34 (EWCA). 60

18  Research handbook on corporate liability statute in the United Kingdom. Instead that power is given through the articles of association. Much significance is attached to this difference by UK company law scholars. The leading text Gower and Davies’ Principles of Modern Company Law68 states that: It is … a point of some theoretical (even ideological) importance: the directors’ authority is derived from the shareholders through a process of delegation via the articles and not from a separate and free-standing grant of authority from the State. This helps to underline the shareholder-centred nature of British company law.

Consequently, perhaps, the orthodox view in the UK is that directors, either individually or collectively as part of the board, are in a relationship akin to agency with the shareholders as a whole who comprise the company as their principal. It is an application of the contractual model. The main reason for the difference is the legacy of the contractual model on the general incorporation statutes in the UK. As discussed in section II.C.2 above, an understanding that the modern company was an association of shareholders initially underpinned the general incorporation statutes. Directors were therefore the agents of the shareholders as a whole. The modern company however evolved differently through the nineteenth century so that by the end of the century it was considered to be an entity legally separate from its shareholders. The treatment by the courts of the indoor management rule highlights the conceptual difficulties created when directors are considered always to be agents. The common law indoor management rule means that third parties dealing with the company are not bound to ensure that all internal regulations of the company relating to the exercise and delegation of authority have been complied with. Two prevailing versions of the common law rule exist. Those versions draw on two different nineteenth-century cases and, it is suggested, the two different models of the modern company. In Royal British Bank v Turquand69 (‘Turquand’), a bond issued without a required internal resolution was deemed valid. It was established that third parties were not expected to take their inquiries beyond the public documents at the Companies Registry. They could assume internal company requirements had been complied with. The case could be viewed as setting out a rule about the apparent authority of agents. Indeed, many commentators view the indoor management rule as an aspect of the law relating to apparent authority – it was explained in that way by Diplock LJ in Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd.70 However, although the indoor management rule is sometimes called the rule in Turquand’s

68 Paul L. Davies, Gower and Davies’ Principles of Modern Company Law 366 (8th ed. 2008); See also Robert R. Pennington, Pennington’s Company Law 696 (8th ed. 2001) (‘[u]nlike American law and the laws of most European countries, English law does not regard certain functions and powers as managerial or executive and therefore as inherently exercisable by the board and inalienable by it’); and Brian R. Cheffins, Corporate Ownership and Control: British Business Transformed 30 (2008) (‘UK company law, in contrast, has never dictated who will have managerial authority in a company or the method by which managers are selected. This has instead been left to the internal governance rules of companies, most typically the articles of association, the contents of which the shareholders determine’). 69 Royal British Bank v Turquand (1856) 6 E & B 327, 119 ER 886. 70 Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480 (EWCA).

The company and its constituents  19 case, the rule was expanded and conceptualised differently by the House of Lords in Mahony v East Holyford Mining Co71 (‘Mahony’). In Mahony, Lord Hatherley considered that people who deal with the company externally ‘are not to be affected by any irregularities which may take place in the internal management of the company’.72 Despite the facts being essentially the same, the reasoning used in Mahony was quite different from the reasoning used in Turquand. Turquand was one of the raft of cases brought about by the failure of the Royal British Bank in 1856. The deed of settlement company had been registered under the Joint Stock Banking Act 1844. Under that Act, shareholders had unlimited liability and the deed of settlement was described as a deed of partnership. Directors would have been considered to be the agents of the shareholders. By contrast, the East Holyford Mining Co Ltd was incorporated under a general incorporation statute, the Companies Act 1862. The difference in conceptualisation by judges of the role of directors in a company incorporated under the 1862 Act is demonstrated in the speeches in Mahony. Unlike the judge in Turquand, most of the members of the House of Lords did not describe the directors as the agents of the shareholders. The issue in Mahony was not considered to be whether the shareholders had collectively given the putative directors apparent or ostensible authority. Instead, to the House of Lords the issue was whether a form authorising the signatories to the cheques of the company was invalid because the authorising signatory directors had not been duly appointed. Lord Hatherley considered that people dealing with a company are ‘entitled to presume that that of which only they can have knowledge, namely, the external acts, are rightly done, when those external acts purport to be performed in the mode in which they ought to be performed’.73 Lord Hatherley allowed the bank dealing with the company to rely on the cheque authorisations. The reason his Lordship allowed this reliance was not because the shareholders had given the de facto directors apparent authority to sign the cheque authorisations, but because he determined that those dealing with the company should not be affected by internal irregularities. Mahony was discussed by Diplock LJ in Freeman & Lockyer. He described the board as having actual authority but considered that allowing an individual to act in the management or conduct of the company’s business to be a form of representation creating an apparent authority. Diplock LJ went to some length to differentiate Mahony from other cases involving directors acting as corporate agents on the basis that in Mahony it was not the conduct of the board of directors that was relied on to create the apparent authority of the corporate agents. Instead, it was:74

Mahony v East Holyford Mining Co (1874–1875) 7 HL 869 (UKHL). Mahony is generally remembered as the case that affirmed the rule in Turquand’s case and Lord Hatherley coined the term ‘indoor management rule’ in it. See, e.g., Eilis Ferran, Company Law and Corporate Finance 468 (1999); see also J Birds et al., Boyle and Birds’ Company Law 180 (7th ed. 2009). 72 Mahony (1874–1875) 7 HL at 894. 73 Id. at 894. 74 Pennington, supra note 68, at 507; Furthermore, ‘[i]n Mahony’s case, if the persons in question were not persons who would normally be supposed to have such authority by someone who did not in fact know the constitution of the company, it may well be that the contractor would not succeed in proving condition (3), namely, that he relied upon the representations made by those persons, unless he proved that he did in fact know the constitution of the company’. 71

20  Research handbook on corporate liability ... the conduct of those who, under the constitution of the company, were entitled to appoint them which was relied upon as a representation that certain persons were directors and secretary. Since the appointers had ‘actual’ authority to appoint these officers, they had ‘actual’ authority to make representations as to who the officers were.

In Diplock LJ’s reading of Mahony, a form of apparent authority was created for the directors and therefore reliance by the third party became important. But in Mahony itself, although approaches differed, representations, either express or by conduct, made to any third party by the shareholders as the group entitled to appoint the directors, were not discussed. Instead the discussion centred on how the shareholders consented, assented or acquiesced to the de facto directors each occupying the position or office of director. Crucially, the liability-creating fact for the company in Mahony was not representations made by the shareholders as appointers, but rather occupation of office by the de facto directors. Notwithstanding Diplock LJ’s analysis, in Mahony the bank never inquired whether the directors had been appointed and did not rely on the appearance that they had been. In summary, therefore, two common law indoor management rules exist. The narrower agency-based form preferred by Diplock LJ in Freeman & Lockyer is the same as the principle of apparent authority in agency law. If a company holds out an individual as a director, then the company is estopped from denying the validity of the acts of that individual. That estoppel applies to decisions made by the director as part of the board and acts carried out by the individual director as an agent of the company. The narrower indoor management rule does not treat as special the decisions of directors as part of the board. It is underpinned, it is suggested, by the contractual model of the company. The broader indoor management rule outlined by Lord Hatherley in Mahony holds that all the internal decisions of directors as part of the board will bind the company whether or not representations of authority are made to third parties and whether or not third parties rely on that authority. This form of the indoor management rule extends only to acts of the board and acts of directors when acting as part of the board. The broader indoor management rule supports the entity approach as it fits a conceptualisation of the company where individual directors are not always corporate agents and are not corporate agents when they act collectively as part of the board carrying out their decision-making role. The broader indoor management rule does not require individuals to be held out as directors for their acts as part of the board to bind the company in legal relationships with third parties.75 Which approach is normatively preferable? The narrower apparent authority-based indoor management rule is problematic because it does not distinguish between collective board decisions and acts of individual directors. Particularly problematic are situations where a third party dealing with the company knows of an irregularity, but does not acquire that knowledge as a third party dealing with the company. This knowledge might arise because the third party also occupies a position in the company.76 The third party may even be responsible for the irregularity.77 If it is considered, for example, that a person who has not been duly appointed 75 For a discussion of the competing policy considerations underpinning the indoor management rule, see the discussion of Mason CJ in Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146 (Austl.). 76 Smith v Henniker-Major [2003] 1 WLR 1386 (UKHL); Howard v Patent Ivory Manufacturing Co (1888) 38 Ch D 156. 77 Morris v Kanssen [1946] AC 459 (UKHL).

The company and its constituents  21 as a director but who has been held out as a director has apparent authority, then it is difficult for the company to deny that apparent authority, even to third parties who know otherwise through knowledge acquired while acting in a different capacity in the company.78 The courts have consistently held that the presumption of regularity cannot be relied on by those who have notice of the irregularity or who have been put on inquiry.79 But even those who accept the apparent authority-based view of the indoor management rule acknowledge that such a holding would be difficult ‘if the Rule in Turquand’s case were an absolute or unqualified rule of law, applicable in all circumstances’.80 The broader indoor management rule works better. It does not give authority to individual directors; no qualification of its application is therefore needed. If a third party has any sort of knowledge of an irregularity acquired in any capacity, the indoor management rule cannot be relied upon to validate a transaction. The broader indoor management rule and the entity model may also align better with principles of attribution. In Meridian Global Funds Management Asia Ltd v Securities Commission, Lord Hoffmann set out the rules of attribution which help determine when actions can be attributed to the company for the purposes of determining the liability of the company. Lord Hoffmann observed that the company’s primary rules of attribution are generally found in the company’s constitution and deal with rules relating to the internal management of the company. Those rules ‘are obviously not enough to enable a company to go out into the world and do business’.81 It is the general rules of attribution, which include the rules of agency and vicarious liability and which are equally available to natural persons, that are essential if the individuals, including directors, are to engage in business with the outside world on behalf of the company. The key point is that the primary rules of attribution are concerned with decision making by the governing bodies of the company. These are often decisions that will affect the other internal decision-making body of the company, the shareholders. Examples are decisions of the board to authorise a dividend or liquidate the company. The primary rules of attribution will rarely involve acts. It is only when decisions of the board are acted on by the agents of the company that the general rules of attribution, including the principles of agency, come into play.

78 This is what happened in Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549 (EWCA). See also Cromwell Corp Ltd v Sofrana Immobilier (NZ) Ltd (1992) 6 NZCLC 67,997 (CA). 79 B Liggett (Liverpool) Ltd v Barclays Bank Ltd [1928] 1 KB 48; cf. Hely-Hutchinson [1968] 1 QB 549. In Broadlands Finance Ltd v Gisbourne Aero Club Inc [1975] 2 NZLR 496 (relating to an incorporated society with respect to which the doctrine of constructive notice did not apply), the Court of Appeal held that a person dealing with a corporation is put on inquiry if a document is executed in a manner which is not consonant with the normal method prescribed in the public documents. 80 Rolled Steel Products (Holdings) Ltd v British Steel Corp [1986] Ch 246 (EWCA). The irreconcilability of the cases where the indoor management rule has been applied has been commented on by a number of judges. See, e.g., Dawson J in Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146 at 192: ‘[t]he rule in Royal British Bank v Turquand has been applied in a number of cases, not all of which are entirely reconcilable’; and Wright J in B Liggett (Liverpool) Ltd v Barclays Bank Ltd [1928] 1 KB 48 at 56: ‘I am relieved from any examination of the exact definition of this very respectable but perhaps somewhat ambiguous rule of law…’. 81 Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500 at 506 (UKPC).

22  Research handbook on corporate liability It could be argued that the primary rules of attribution are examples of the board acting as agents of the company. That would be a similar argument to the arguments of Diplock LJ in Freeman & Lockyer82 and therefore an application of the contractual model. But if the primary rules of attribution were just examples of directors acting as agents of the company, Lord Hoffmann’s classification would have no meaning. The first two categories of the rules of attribution would be examples of general rules of attribution arising out of agency or as a result of vicarious liability. Also, it could be equally asserted that shareholders who take part in decision making in the general meeting are agents of the company; clearly a nonsense. It is suggested that acceptance of the principles set out in Meridian necessarily requires acceptance of two principles. The first is that directors are not always agents, and the second is that directors are not agents when they act collectively as part of the board. In summary, therefore, the argument is that the rules of attribution can be explained using a conception of the company that resembles the entity model. Acts and knowledge of the board and the shareholders acting collectively are attributed to the company using the primary rules of attribution that are not based on agency. The general rules of attribution are concerned with the acts and knowledge of agents and employees of the company (including directors when they act externally as corporate agents). The acts and knowledge are attributed to the company using agency principles such as the imputation of knowledge (in agency) and vicarious liability (for acts of agents and employees). The general rules of attribution relate to secondary forms of liability. The rules of attribution as applied necessarily mean that the directors collectively as the board and the shareholders collectively as the general meeting are the governing bodies of the company. When directors are acting collectively as part of the board, they are not the agents of the company. Their knowledge as part of the board is attributed to the company by the primary rules of attribution. Absent statutory provisions that override company law principles, or breach of directors’ duties, the board of directors collectively should therefore be immune from liability when they act in that role. But when accepting that the members of a board that acts collectively are, as a general principle, immune from liability, it is crucial to accept also that rather than always being agents, individuals who are directors are likely to have many different legal relationships with a company that in a temporal sense occur concurrently or sequentially. For example in Standard Chartered Bank v Pakistan National Shipping Corp (No 2),83 a director of a one-man company incurred liability for deceit when the House of Lords determined that when he committed the wrong he acted as an agent of the company. It was a reversal of the Court of Appeal where, counter intuitively, it was decided that the deceitful director was identified as the mind of the company and could not therefore be made personally liable.84

VI. CONCLUSION The argument set out in this chapter is that two models underpin our understanding of the modern company. The contractual and entity models of the modern company draw on the law Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480 (EWCA). Standard Chartered Bank v Pakistan National Shipping Corp (No 2) [2003] 1 AC 959 (UKHL). 84 Standard Chartered Bank v Pakistan National Shipping Corp (No 2) [2001] QB 167.

82

83

The company and its constituents  23 and principles surrounding earlier corporate forms: they were not built on new principles but on ancient foundations.85 Despite the recent dominance of the contractual model, it is argued that the entity model has stronger foundations and better mediates the relationships between corporate constituents.

85

Cooke, supra note 15, at 138–39.

2. Theoretical approaches to corporate liability Martin Petrin

I. INTRODUCTION The purpose of this chapter is twofold. First, to outline the perennial issue of corporate theories and their impact on the recognition and basic setup of corporate liability. Second, because the chapter is not solely dedicated to ‘corporate theories’ but rather to ‘theoretical approaches’ to corporate liability, the discussion will also extend to doctrinal justifications of corporate liability.1 Both areas are voluminous. The chapter’s coverage must therefore be selective. It does not attempt anything close to an exhaustive examination of all relevant theoretical approaches, which can originate not only from legal studies, but also from disciplines including economics, sociology, philosophy, and psychology, among others. The chapter proceeds as follows: Part II explores corporate or, more broadly, legal entity theories. Indeed, corporate liability is strongly connected to attempts to explain and conceptualize the nature of corporate and related entities. Corporate theories have played, and continue to play, an important role in the evolution of corporate liability. They have been instrumental in the march towards recognition of tort liability (which is now all-encompassing and undisputed) as well as criminal liability (which remains more limited in both scope and recognition). At the same time, these theories have directly influenced corporate liability attribution mechanisms, although these will only be covered more generally herein. The chapter begins by recounting early, but still highly relevant, foundational debates surrounding the nature of legal entities, focusing on attempts to conceptualize them as fictions, aggregates, and real entities. This is followed by a discussion of contemporary approaches, namely the nexus of contracts theory, stakeholderism, and the concept of asset partitioning. A particular focus will be on the significance of the various theories for the liability of corporate entities. Part III proceeds to look at justifications for holding corporations liable in civil and criminal contexts. While the traditional legal entity theories are mostly concerned with whether and how entities can be held responsible, the justifications addressed in this part will look at why we should (or should not) have corporate liability. Theoretical considerations on this latter point typically juxtapose corporate liability regimes with an exclusive system of corporate agents’ personal liability. A distinction will be drawn between traditional justifications and economic justifications, both of which are generally supportive of corporate liability, at least in the civil realm. Finally, a separate section is dedicated to a brief discussion of corporate criminal liability, where there is still an ongoing contentious debate concerning its justification.

1 This chapter is based in part on the more detailed treatment of these questions in Barnali Choudhury & Martin Petrin, Corporate Duties to the Public (2018) and Martin Petrin, From Nature to Function: Reconceptualizing the Theory of the Firm, 118 Penn. St. L. Rev. 1 (2013). I thank Alexandra Walker for her excellent research assistance.

24

Theoretical approaches to corporate liability  25

II.

CORPORATE THEORIES AND THEIR IMPACT ON LIABILITY

Historically, according to competing mainstream views, corporations and other legal persons were conceptualized as being either fictions, aggregates, or real entities. The fiction versus reality debate especially had significant consequences for corporate liability based on tort and criminal laws, some of which are still felt today. The fiction theory did not allow for liability, whereas the real entity theory (or ‘organic theory’) did. The debate was eventually mostly resolved in favour of the latter approach, permissive of corporate liability, although with limitations on legal entities’ criminal liability. More recently, the scholarship has developed, and a rivalry has ensued between, contractarian and stakeholder approaches. Additionally, the phenomenon of asset partitioning has been used to explain corporate entities. From the modern theories, contractarian and stakeholder approaches are far more concerned with governance than liability questions. Nevertheless, given their prominence, it is worth reflecting on their significance for corporate liability. This is an area that has thus far received only limited scholarly attention. A.

Early Debates: Fictions, Aggregates and Real Entities

Attempts to explain the corporate form date back to at least the Middle Ages, with more in-depth discussions emerging however in the nineteenth century.2 During this time, German scholars in particular developed a strong interest in exploring and debating the nature and legal status of groups or associations of individuals. They believed that understanding these issues was necessary for correctly assigning rights and duties to such groups, including to corporate entities. The ensuing discussion gathered intensity towards the turn of the twentieth century and revolved mainly around two theories and their variants: the Roman law inspired fiction theory, on the one hand, and the Germanic real entity theory on the other hand. The fiction theory was the first scientific theory of legal entities to arise. Early English corporate law incorporated fiction theory into the common law, and it is thought to have governed early American corporate theory.3 However, the theory is most strongly connected to German jurist Friedrich Carl von Savigny, whose work on the subject also greatly influenced common law scholars.4 Savigny contended that since legal persons could only have rights and duties as a consequence of an act of state,5 they were nothing but artificial beings or fictions.6 He, and

Literature on the history of corporate theories abounds, as do attempts to classify, assess, and improve them. Recent contributions include Eva Micheler, Company Law: A Real Entity Theory (2021); Visa A.J. Kurki, A Theory of Legal Personhood (2019); Susanna Kim Ripken, Corporate Personhood (2019); Amadike Nkem, Corporate Personality in Company Jurisprudence: Divergences in Theoretical Perspectives, 10 Nnamdi Azikiwe U. J. Int’l L. & Juris. 183 (2019); Susan Watson, The Corporate Legal Person, 19:1 J. Corp. L. Stud. 137 (2019). 3 Darrell A.H. Miller, Guns, Inc.: Citizens United, McDonald, and the Future of Corporate Constitutional Rights, 86 N.Y.U. L. Rev. 887, 916 (2011). 4 Of particular importance was Savigny’s treatise on Roman law. F.C. von Savigny, 2 System des Heutigen Römischen Rechts (1840). See A. Nékám, The Personality Conception of the Legal Entity 64–65 (1938); A.W. Machen, Corporate Personality, 24 Harv. L. Rev. 253, 255 (1911). 5 Savigny, supra note 4, at 275. 6 Id. at 236. 2

26  Research handbook on corporate liability other fiction theorists, insisted that due to its artificial personality, a legal entity could only have a very limited set of rights and duties, namely those pertaining to property.7 The nature of legal persons, representing but a small fraction of a human’s personality, did not allow for recognition of non-monetary rights and duties. Another group of German academics – under the leadership of historian and legal scholar Otto von Gierke – developed the late-nineteenth-century real entity theory or organic theory.8 According to this construct, legal entities were capable of having their own minds and will and could bear any rights and duties that they were capable of exercising.9 While real entity theory recognized that legal entities gained their personality through the law and an act of state, its proponents still contended that the legal person was not created by the law, but was rather based on a pre-existing reality that was solely recognized by the law.10 In contrast to fiction theory, the real entity view held that legal persons are distinct, autonomous entities that are both separate from and more than just the sum of their individual human parts. The legal entity was thought to be a composite organism with its own psychological or sociological existence, possessing attributes not found among its human components.11 Nevertheless, real entity theorists were confronted with the obvious problem that a legal entity, although thought to be ‘real’ and likened to a living organism, was not capable of acting by itself. The solution to this problem was to provide the entity with ‘organs’, that is a legal entity’s metaphorical ‘hands and mouth’.12 These organs, which were seen not as agents, but rather as an entity’s alter ego, were generally higher-ranking officials or governing bodies. Importantly, only actions by organs were fully and directly binding upon the entity.13 Around the turn of the twentieth century, the debate over the nature of legal entities was exported from German law to Anglo-American law, where it began to exert a strong influence on both practice and theory.14 Previously, during the first half of the nineteenth century, the fiction theory predominated in England and the United States.15 The theory was also known as the ‘concession theory’ or ‘grant theory’, owing to the fact that at the time corporations could only be incorporated based on a state legislature’s award of a special concession, grant, or



Id. at 238–39, 314. Otto Von Gierke, Die Genossenschaftstheorie und Die Deutsche Rechtsprechung (1887). On the real entity theory’s broader background, see Ron Harris, The Transplantation of the Legal Discourse on Corporate Personality Theories: From German Codification to British Political Pluralism and American Big Business, 63 Wash. & Lee L. Rev. 1421, 1427–30 (2006). 9 Gierke, supra note 8, at 473. 10 Id. at 611; Harris, supra note 8, at 1424. 11 Gierke, supra note 8, at 470, 472. 12 Id. at 603–10. 13 Id. 14 Harris, supra note 8, at 1423, 1435, 1461; Mark M. Hager, Bodies Politic: The Progressive History of Organizational ‘Real Entity’ Theory, 50 U. Pitt. L. Rev. 575, 580 (1989); Morton J. Horwitz, Santa Clara Revisited: The Development of Corporate Theory, 88 W. Va. L. Rev. 173, 179 (1985). 15 Michael J. Phillips, Reappraising the Real Entity Theory of the Corporation, 21 Fla. St. U. L. Rev. 1061, 1065 (1994); William W. Bratton, Jr., The ‘Nexus of Contracts’ Corporation: A Critical Appraisal, 74 Cornell L. Rev. 407, 434 (1989). 7 8

Theoretical approaches to corporate liability  27 charter.16 In the landmark case of Trustees of Dartmouth College v. Woodward,17 for instance, US Supreme Court Chief Justice Marshall characterized the corporation as an ‘artificial being, invisible, intangible, and existing only in contemplation of law’, which ‘possesses only those properties which the charter … confers upon it’.18 During this period, furthermore, the fiction theory competed with the aggregate theory – also known as participant or contractualist theory – which was particularly popular in nineteenth-century England.19 The same theory also emerged more clearly in the US during the latter half of the nineteenth century.20 The aggregate theory contended that corporations and other legal entities constituted aggregations of natural persons whose relationships were structured by way of mutual agreements.21 As such, a legal entity’s rights and duties were often seen, in an indirect or derivative manner, as simply being those of their shareholders or other individuals that made up the legal entity. In other words, using aggregate theory, rights and obligations held by individuals could be construed to reflect upon the legal entity itself.22 Towards the end of the nineteenth century, the increasing importance and prevalence of corporations led to growing dissatisfaction with the fiction theory’s implications, real-world effects, and hostility towards holding legal entities liable under civil and criminal laws.23 In addition, fiction and aggregate theory were difficult to reconcile with evolving features of corporate law. Among others, fiction theory did not align well with the shift from special chartering to general incorporation because it made the argument that corporations only existed by way of specific acts by the State less compelling. Aggregate theory, on the other hand, failed to provide a plausible explanation for the adoption of limited liability for corporations and of the decoupling of corporate and individual rights and duties.24 Because of these shortcomings, real entity theory gained traction in England and the United States, challenging both fiction and aggregate theory. Scholars – led by figures such as Frederick Maitland and Ernst Freund – and courts alike increasingly began to promote and rely on real entity principles.25 For instance, the House of Lords upheld a company’s

Harris, supra note 8, at 1424. Some scholars treat the fiction theory and the concession theory as different concepts. See Nicholas H.D. Foster, Company Law Theory in Comparative Perspective: England and France, 48 Am. J. Comp. L. 573, 581–83 (2000); John Dewey, The Historic Background of Corporate Legal Personality, 35 Yale L.J. 655, 665 (1926). 17 Trs. of Dartmouth Coll. v. Woodward, 17 U.S. 518 (1819). 18 Id. at 636. 19 Foster, supra note 16, at 585; Watson, supra note 2, at 147–50. 20 Phillips, supra note 15, at 1063–64; Jess M. Krannich, The Corporate ‘Person’: A New Analytical Approach to a Flawed Method of Constitutional Interpretation, 37 Loy. U. Chi. L.J. 61, 68 n.38 (2005). 21 See, e.g., Phillips, supra note 15, at 1065–67. 22 See, e.g., San Mateo v. Southern Pac. R.R., 13 F 722 (C.C.D. Cal. 1882). The aggregate approach recently staged a somewhat unexpected revival when the US Supreme Court appeared to rely on it to justify corporate speech rights. See Citizens United v. Federal Election Commission 130 S. Ct. 876 (2010). 23 See City of Salt Lake City v. Hollister, 118 U.S. 256, 260–61 (1886); Gilbert Geis & Joseph F.C. DiMento, Empirical Evidence and the Legal Doctrine of Corporate Criminal Liability, 29 Am. J. Crim. L. 341, 343 (2002); Horwitz, supra note 14, at 209–10; Mihailis E. Diamantis, The Body Corporate, 83 Law & Contemp. Probs. 133, 140–41 (2020). 24 See Reuven S. Avi-Yonah, The Cyclical Transformations of the Corporate Form: A Historical Perspective on Corporate Social Responsibility, 30 Del. J. Corp. L. 767, 789 (2005). 25 See Krannich, supra note 20, at 85; Horwitz, supra note 14, at 182. 16

28  Research handbook on corporate liability separate legal personality and limited liability for its members in the Salomon case,26 finding that a company’s existence was ‘real’ and rejecting the notion that it was nothing but a myth or a fiction.27 These developments, evidence of the real entity theory’s success, proved to be highly significant. As will be outlined in more detail below, real entity principles paved the way for legislators and courts to recognize, or partially recognize, corporate liability. B.

Modern Theories: Nexus of Contracts, Stakeholderism and Asset Partitioning

Despite the reality-fiction-aggregate debate and its persistent presence in both the common law and civil law, some scholars began to argue that theories of the firm should emphasize functional and economic aspects rather than only the nature of legal entities. The American legal realist movement around the 1920s and similar movements in Europe had largely discredited classical legal thought and formalism, paving the way for approaches such as law and economics.28 Academics were thus provided with the necessary breathing space to advance new theories of the firm, corporate law, and corporate governance in general. Around the 1970s, drawing upon economic theories developed by Ronald Coase and other pioneers,29 scholars in economics began to develop models of the firm that focused primarily on efficiency and the firm’s role as a device to minimize transaction costs within production processes.30 The most notable of these functional theories is the nexus of contracts theory.31 The theory was subsequently taken up by legal academics and judges, and became what in the United States is often regarded as the ‘dominant view of the corporation in legal scholarship’.32 According to the nexus of contracts model, the firm consists of various explicit and implicit contracts between a firm’s various constituencies33 – in other words, a complex ‘aggregate of various inputs acting together to produce goods or services’.34

Salomon v. A. Salomon & Co. [1897] AC 22 (UKHL). Id. at 30 (per Lord Halsbury LC). 28 See Kristoffel Grechenig & Martin Gelter, The Transatlantic Divergence in Legal Thought: American Law and Economics vs. German Doctrinalism, 31 Hastings Int’l & Comp. L. Rev. 295, 348–53 (2008). 29 The groundbreaking work in this regard is Ronald Coase, The Nature of the Firm, 4 Economica 386 (1937). Additionally, the development of contractual theory is connected to works of Armen Alchian, Harold Demsetz, Michael Jensen, William Meckling, and Eugene Fama. See Robert Anderson, A Property Theory of Corporate Law, 2020 Colum. Bus. L. Rev. 1, 12–16. (2020). 30 Simon Deakin, The Corporation as Commons: Rethinking Property Rights, Governance and Sustainability in the Business Enterprise, 37 Queen’s L.J. 339, 340–41 (2011). 31 For a discussion of the alternative view of the firm as a nexus for contracts, see David Gindis, Legal Personhood and the Firm: Avoiding Anthropomorphism and Equivocation, 12:3 J. Institutional Econ. 339, 499–513 (2016); Watson, supra note 2. See also Mariana Pargendler, Veil Peeking: The Corporation as a Nexus for Regulation, 169 U. Pa. L. Rev. 717 (2021); and Anderson, supra note 29 (emphasizing regulatory and property aspects, respectively, as factors comprising the nexus). 32 Anderson, supra note 29, at 3; see also Mario Koutsias, Shareholder Supremacy in a Nexus of Contracts: A Nexus of Problems, 38:4 Bus. L. Rev. 136, 136 (2017) (suggesting a similar dominance for the UK). Although sometimes used interchangeably, including in this chapter, note that the theory of the firm is not the same as the theory of the corporation. See Anderson, supra note 29, at 16. 33 See, e.g., Stephen M. Bainbridge, The New Corporate Governance in Theory and Practice 53 (2008) at 28; Frank H. Easterbrook & Daniel R. Fischel, The Economic Structure of Corporate Law 12 (1996). 34 Bainbridge, supra note 33, at 28. 26 27

Theoretical approaches to corporate liability  29 While the nexus of contracts approach is associated with the earlier aggregate or contractual conception of a legal entity, it also embraces a view of the firm that is, in part, analogous to the view of the firm as a fiction. As one commentator explains, ‘the nexus of contracts or contractarian model conceptualizes the firm not as an entity, but simply as a legal fiction representing the complex set of contractual relationships between many constituencies’.35 In contrast to entity theory, corporations are therefore seen as ‘not a thing’36 and separate legal personality is given less importance in describing firms.37 Conversely, in contrast to fiction theory, corporations are not characterized as creatures of the state, but rather as formed by contract.38 A central normative claim put forward by nexus of contracts proponents is therefore that corporate law should be largely non-mandatory in order to provide private parties with the opportunity to freely order their affairs as they see fit.39 Nexus of contracts theorists normally, although not always, subscribe to a shareholder primacy and shareholder wealth maximization view of the firm and its purpose. Corporate directors and officers are treated ‘as contractual agents of the shareholders, with fiduciary obligations to maximize shareholder wealth’.40 Shareholders thus retain a privileged position among the various contracting parties that make up the firm whereas the interests of non-shareholder constituencies are subordinated.41 In the case of conflicts between shareholder interest and non-shareholder interests, the former should therefore normally prevail under the contractarian model. While non-shareholder constituencies and their interests are ancillary to the typical contractarian model, they lie at the heart of stakeholder or pluralist theories of the firm. Stakeholder-oriented models, corporate social responsibility (CSR) thinking,42 and similar theories focus on the idea that companies have responsibilities not only to shareholders, but also to a variety of other constituents. These constituents – such as employees, communities, and governments – are regarded as additional stakeholders whose resources and various ‘investments’ in the corporation, financial or non-financial in nature, deserve protection and consideration to the same extent as shareholder interests. The corporate purpose is therefore widened and the strict focus on shareholder interests relaxed or abandoned. The responsibilities of corporations relate to both shareholders and non-shareholders, even if that necessitates corporate decisions or actions that run against shareholder value interests. Although there is no single overarching stakeholder or pluralist model of the firm, these approaches generally arrive at three conclusions: first, that there is a need for corporations to consider the interests of a broader group of non-shareholder stakeholders; second, that wealth

Stephen M. Bainbridge, Abolishing Veil Piercing, 26 J. Corp. L. 479, 485 (2001). Id. 37 Watson, supra note 2, at 138. 38 Id. 39 See Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 Nw. U. L. Rev. 547, 577–78 (2003); Phillips, supra note 15, at 1090–95. 40 Bainbridge, supra note 39, at 548. See also Easterbrook & Fischel, supra note 33, at 36–39, 92–93. 41 See, e.g., Bainbridge, supra note 39, at 548. 42 See generally, John M. Conley & Cynthia A. Williams, Engage, Embed, and Embellish: Theory Versus Practice in the Corporate Social Responsibility Movement, 31 J. Corp. L 1 (2005); David Millon, Two Models of Corporate Social Responsibility, 46 Wake Forest L. Rev. 523 (2011). 35 36

30  Research handbook on corporate liability maximization should not be an overriding concern that guides corporate decision-making;43 and third, that corporate decision-making, or corporate managers, should balance the interests of all stakeholders, including shareholders, against each other.44 With respect to corporate decision-making, crucially, this entails that even in the case of a conflict between shareholder and non-shareholder interests, the former should not necessarily always prevail. A third strand of corporate theory focuses on yet another aspect of corporate entities, namely its asset and liability partitioning capabilities. In Germany, the birthplace of the historical debate on the nature of the firm, the now prevailing view among scholars is that legal entities should be approached solely from an abstract and technical standpoint without regard to their personhood or nature.45 In defining legal entities, the scholarly view therefore focuses purely on their function. The most dominant functional elements are the ability of a legal entity to have assets partitioned between individuals and the entity as well as the limited liability effect caused by the entity’s ability to bear its own duties and liabilities.46 The separation of assets and limited liability lie also at the centre of a modern strand of US corporate law theory. Its proponents argue that the defining criterion of a legal entity is its ability to separate entity assets from assets belonging to individuals that constitute the entity.47 For instance, in characterizing the corporate form, Henry Hansmann and Reinier Kraakman refer to asset partitioning as the most important element.48 As they explain, asset partitioning comes in two forms. First, it means that a legal entity’s creditors normally have no means or only limited means of holding individuals that are members of or act for a legal entity liable for the entity’s debts.49 Second, creditors of members or officers and agents of the legal entity have no direct access to the firm’s assets. Instead, they must yield to creditors of the firm itself.50 While Hansmann and Kraakman acknowledge the utility of organizational law’s contractual functions, they argue that asset partitioning’s property law-based effect is far more important. This is true, they contend, because these effects would be difficult or impossible to achieve in the absence of organizational law and solely via contractual arrangements.51 In light of this importance, they also contend that asset partitioning provides a ‘simpler, clearer, and more

John Kaler, Differentiating Stakeholder Theories, 46 J. Bus. Ethics 71 (2003). Margaret M. Blair & Lynn A. Stout, A Team Production Theory of Corporate Law, 85 Virginia L. Rev. 247, 281 (1999); William Bradford, Beyond Good and Evil: The Commensurability of Corporate Profits and Human Rights, 26 Notre Dame J.L. Ethics & Pub. Pol’y 141, 149 (2012). 45 See, e.g., Günter Weick, Einleitung zu § 21 ff., in Julius von Staudingers Kommentar zum Bürgerlichen Gesetzbuch § 5 (Herbert Roth et al. eds., 2009). This view is inspired by the classic work of 1 Ludwig Enneccerus & Hans Carl Nipperdey, Allgemeiner Teil des Bürgerlichen Rechts § 103 (1959). 46 See Schmidt, Verbandszweck und Rechtsfähigkeit im Vereinsrecht 4 (1984); Franz Wieacker, Zur Theorie der Juristischen Person des Privatrechts, in Festschrift Rudolf Huber 339, 358–59 (Ernst Forsthoff et al. eds., 1973). 47 Fundamental in this regard is Henry Hansmann & Reinier Kraakman, The Essential Role of Organizational Law, 110 Yale L.J. 387 (2000). On the firm’s ‘capital lock-in’ effect, see also Margaret Blair, Locking in Capital: What Corporate Law Achieved for Business Organizers in the Nineteenth Century, 51 UCLA L. Rev. 387, 388–89 (2003) and Lynn A. Stout, On the Nature of Corporations, 2005 U. Ill. L. Rev. 253, 256 (2005). 48 Hansmann & Kraakman, supra note 47. 49 Id. at 393–98. 50 Id. 51 Id. at 436 (discussing the inadequacy of contractual solutions). 43 44

Theoretical approaches to corporate liability  31 functional’ definition of legal entities than the traditional approaches found in the literature.52 Indeed, in this same vein, there is now a growing body of literature on corporate theory that explores the property aspects of organizational law as an alternative or complement to purely contractual models of conceptualizing firms.53 C.

Implications for Liability

When the traditional real entity and fiction theories were developed, the issue of corporate liability towards third parties was an integral part of them. For those scholars who thought of legal entities purely as legal fictions, that meant these entities could never be liable for torts or criminal acts because a fictional being could not have the required state of mind to impose liability; that is, it could not act intentionally or negligently.54 Accordingly, given the absence of culpability or mens rea requirements, the only exceptions from the principle of non-liability were instances of strict liability. Apart from strict liability, however, only a legal person’s human representatives who committed a wrong could be held responsible.55 Aggregate theory, in its initial form, was similarly unsupportive of corporate liability. Nevertheless, more recent approaches that combine or ‘aggregate’ multiple individuals’ states of mind to construe corporate mens rea demonstrate how it can be used in this regard.56 The real entity or organic theory represented the opposite of the fiction theory. If viewed as a ‘real entity’ or ‘living creature’ with an existence and mind of its own, separate from the individuals behind it, a corporation could itself be held liable.57 However, because legal persons were only able to act through their organs, they could incur liability solely as a consequence of a tort or criminal offence committed by one or more of these organs acting within their official capacities.58 Relatedly, the entity’s responsibility was only meant to be an addition to, not replacement of, the relevant individuals’ personal liability, leading to joint and several liability between them and the entity. Conversely, misconduct by lower-level employees, who were not considered to be organs and thus corporate representatives, was insufficient to incur the legal entity’s own liability. The concept of vicarious liability, when leading to corporate liability for lower-level employees, therefore runs counter to strict real entity theory principles. Nevertheless, when it comes to tort law, vicarious liability is now recognized even in jurisdictions that otherwise adhere quite strictly to the organic approach.59 As described above, the real entity theory turned out to be more appealing and practical than its main competitor, fiction theory. For the most part, real entity theory prevailed. The real

Id. at 439. Anderson, supra note 29, at 64–66; John Armour & Michael J. Whincop, The Proprietary Foundations of Corporate Law, 27(3) Oxford. J. Legal Stud. 429 (2007). 54 Savigny, supra note 4, at 317. 55 Id. at 318–19. 56 See, e.g., Eli Lederman, Corporate Criminal Liability 2.0: Expansion Beyond Human Responsibility, 43:4 Man. L.J. 35, 39–42 (2020). See also Mihailis Diamantis, Corporate Criminal Minds, 91 Notre Dame L. Rev. 2049 (2016) (advancing a holistic social-cognitive approach for assessing corporate mens rea that goes beyond aggregation of individual states of mind). 57 Hager, supra note 14, at 588 (noting that ‘the real entity theory was pro-liability while the fiction theory was anti-liability’). 58 Gierke, supra note 8, at 743–60 and 768–71. 59 On this, see Choudhury & Petrin, supra note 1, at 146. 52 53

32  Research handbook on corporate liability entity theory’s influence can still be seen in numerous places. In Continental Europe, tort law remains almost wholly captured by the real entity theory. The idea that torts are attributed to legal entities via their organs is commonplace. In English and Canadian law, real entity theory, albeit now in milder and statutorily modified forms, most notably governs corporate criminal liability,60 although it also retains some influence over civil liability.61 Finally, in the US, real entity principles are reflected in some states’ laws on corporate criminal liability and punitive damages. In these states, corporations may only incur criminal liability,62 or be liable for punitive damages,63 when certain conditions are met. Typically, an offence needs to be linked to the behaviour of the directors, a managing agent, or similar individuals that are higher up in the corporate hierarchy. This approach contrasts with the vicarious liability or respondeat superior model under federal corporate criminal law, according to which criminal liability does not require any involvement by senior corporate officials.64 The fiction theory’s influence is comparatively more limited, although it can still be seen in corporate criminal liability. Numerous civil law countries do not recognize general corporate criminal liability, and instead rely on narrow exceptions based on certain statutory liabilities or regulatory offences.65 Although changes are under way, with increasing numbers of jurisdictions now introducing different forms of corporate criminal liability,66 the idea of the fictional character of the legal entity and its perceived inability to form mens rea endures. In contrast to the traditional theories, the significance of modern theories for corporate liability is less clear. Indeed, contemporary corporate theory focuses in great part on shedding light on two fundamental governance questions: (1) For whose benefit do businesses operate? and (2) Who should be in charge of corporate decision-making?67 Liability is often not seen as an essential part of this discussion. If liability is considered in the context of modern theories, then usually this is only to the extent that it relates back specifically to the governance questions surrounding corporate purpose and control of internal decision-making processes. Contractarians are typically not concerned with liability under non-corporate laws. Instead, they leave it up to tort, criminal, environmental, and other external laws to solve the theoret See the House of Lord’s ‘directing mind’ approach in Lennard’s Carrying Co. v. Asiatic Petroleum Co. [1915] AC 705 (UKHL) (appeal taken from Eng.), which was adopted by the Supreme Court of Canada in Canadian Dredge & Dock Co. v. R. [1985] 1 S.C.R. 662 (Can.). More recent statutes have modified, but not fully departed from, the organic approach. See the UK’s Corporate Manslaughter and Corporate Homicide Act 2007, c. 19 § 1 (U.K.) and sections 22.1–22.2 of the Canadian Criminal Code, R.S.C. 1985, c C–46. 61 Brenda Hannigan, Company Law 77 (3d ed. 2012). 62 Model Penal Code § 2.07(1)(c) (Am. L. Inst., Proposed Official Draft 1962). 63 See Christopher R. Green, Punishing Corporations: The Food-Chain Schizophrenia in Punitive Damages and Criminal Law, 87 Neb. L. Rev. 197, 200 (2008). 64 See Miriam H. Baer, Corporate Criminal Law Unbounded, in The Oxford Handbook of Prosecutors and Prosecution 475 (R. Wright, K. Levine & R. Gold eds., 2021), at 478–79. The milestone case for recognition of corporate criminal liability is New York Cent. & H.R.R. Co. v. U.S., 212 U.S. 481 (1909). 65 See, e.g., Gerhard O. W. Mueller, Mens Rea and the Corporation: A Study of the Model Penal Code Position on Corporate Criminal Liability, 19 U. Pitt. L. Rev. 21, 28–32 (1957); Patricia S. Abril & Ann Morales Olazábal, The Locus of Corporate Scienter, 2006 Colum. Bus. L. Rev. 81, 106 (2006). 66 See Susana Aires de Sousa & William S. Laufer, The State’s Responsibility for Corporate Criminal Justice, 47 J. Corp. L. 1109 (2022). 67 See René Reich-Graefe, Deconstructing Corporate Governance: Director Primacy Without Principle?, 16 Fordham J. Corp. & Fin. L. 465, 481 (2011). 60

Theoretical approaches to corporate liability  33 ical and practical liability issues that arise in these fields. In the nexus of contracts model, liability is normally only of interest in the context of it being one of the shareholders’ tools to discipline managers via derivative or, exceptionally, direct actions against directors and officers personally based on fiduciary duty breaches.68 Reflecting more closely on the nexus model and liability, however, commentators have pointed to some inconsistencies between the contractarian narrative and essential corporate features. The hallmark limited liability feature of corporations, for instance, is not contractual in nature.69 Furthermore, it is unclear why some of the firm’s constituents owe fiduciaries duties but others do not.70 Relatedly, it is also unclear why only shareholders should be beneficiaries of fiduciary duties, whereas other constituencies who may be affected by managerial failings – such as holders of convertible securities, creditors of an entity in the zone of insolvency, or members of the public – are not.71 Indeed, the contractarian approach is open to opposing interpretations. As one commentator observed, it even ‘can be turned toward a stakeholder or communitarian perspective’.72 An example is team production theory, which, although grounded in contractarian theory, suggests that boards should take into account all stakeholder interests.73 The nexus of contracts theory, if taken literally, can also be seen as negating entity liability. If the firm is simply a nexus of contracts between interconnected individual parties, the legal entity wholly disappears and all that is left are its single components. Given this atomistic nature of the firm, any claims would logically have to be directed against those individuals or constituencies that act for or as part of the nexus.74 To be sure, nexus of contracts theorists do not wish to absolve the firm of all liability and are pragmatic when it comes to allowing some ‘reification’ or an entity view for liability purposes.75 Still, the fact remains that contractarian approaches do not provide guidance on a number of important legal questions faced by corporations that fall outside of a narrower area of corporate law. Stakeholder or pluralist theories are different in that they may suggest an increased scope of directors’ and officers’ liability for fiduciary duty breaches, which would include non-shareholder parties. Although they may therefore speak more directly to the issue of corporate liability, their essential focus is still on corporate governance more generally, and not corporate liability specifically. Nevertheless, given their aim to strengthen the protection of third parties affected by corporate activities, pluralist theories can be interpreted as being supportive of parent company liability, in particular for human rights abuses, environmental hazards, and threats to public health and safety.76 More generally, the rise of corporate social

See Bainbridge, supra note 39, at 548. Grant M. Hayden & Matthew T. Bodie, Shareholder Voting and the Symbolic Politics of Corporation as Contracts, 53 Wake Forest L. Rev. 511, 513 (2018). 70 Anderson, supra note 29, at 35–36. 71 See id. at 86–99. 72 See id. at 99. 73 Blair & Stout, supra note 44. 74 See David Gindis, From Fictions and Aggregates to Real Entities in the Theory of the Firm, 5 J. Institutional Econ. 25, 28 (2009). 75 Stephen M. Bainbridge, Interpreting Nonshareholder Constituency Statutes, 19 Pepp. L. Rev. 971, 971 n.1 (1992); See also Frank H. Easterbrook & Daniel R. Fischel, The Economic Structure of Corporate Law 12 (1991). 76 Martin Petrin & Barnali Choudhury, Group Company Liability, 19:2 Eur. Bus. Org. L. Rev. 1 (2018). 68 69

34  Research handbook on corporate liability responsibility can be seen as one of the background factors that drive a trend toward the expansion of corporate (criminal) liability, motivated by broader policy considerations.77 Asset partitioning is more closely connected to issues of liability than other contemporary corporate theories, with limited liability being one of its main elements. Nevertheless, it does not offer a complete picture of corporate liability on a descriptive level. The asset partitioning effect of legal entities is weaker than one might expect. Despite the presence of a designated pool of assets for creditors, shareholders may still be personally liable when they are involved in harmful activities or the corporate veil is pierced.78 Moreover, individuals acting for the corporation normally remain personally liable for torts and crimes committed in the scope of their employment, or, in some jurisdictions, may be strictly liable based on statutory violations by their subordinates.79 In terms of normative aspects, asset partitioning as a core feature of corporate entities could form the basis for suggestions to limit corporate agents’ personal liability and broaden the scope of corporate liability. A case could be made, for example, for eliminating exceptions to limited liability and channelling third party liability exclusively to the entity instead of its agents. Thus far, however, asset partitioning theorists do not seem to have advanced arguments of this kind.80

III.

JUSTIFICATIONS FOR CORPORATE LIABILITY

Having examined attempts to conceptualize corporate entities and the resulting impacts on the question of whether legal entities can incur liability, this part of the chapter looks at why corporations should be liable. Indeed, it could be argued that only individuals who commit wrongful acts or crimes should be responsible, not corporations themselves. Although it is now settled that corporations can be civilly liable, and criminal liability of corporations is partially established, the question as to whether individual or corporate liability, or perhaps a mix thereof, should prevail has long engrossed legal scholars. While these discussions have often been conducted in the context of vicarious liability in tort law generally − whether the responsible principal is an individual or business organization – the arguments that scholars and courts have developed apply particularly well to corporations and to both their civil and criminal liability.81 Since differences between criminal and tort liability invoke several special considerations, this part’s final section will separately address questions that are specific to justifying the existence of corporate criminal liability.

Lederman, supra note 56, at 62–65, 79–83. See, e.g., Smith v. Isaacs, 777 S.W.2d 912, 913–14 (Ky. 1989). 79 See Martin Petrin, Circumscribing the ‘Prosecutor’s Ticket to Tag the Elite’ – a Critique of the Responsible Corporate Officer Doctrine, 84 Temp. L. Rev. 283 (2012). 80 On the contrary, important proponents of asset partitioning have criticized limited liability. See Henry Hansmann & Reinier Kraakman, Toward Unlimited Shareholder Liability for Corporate Torts, 100 Yale L.J. 1879 (1991). 81 Given this chapter’s scope, the following will refer to ‘corporations’ and ‘employees’ even where sources that the chapter relies on pertain to the broader context of ‘principals’ and ‘agents’. 77 78

Theoretical approaches to corporate liability  35 A.

Traditional Justifications

Perhaps the most basic explanation for holding corporations liable is the argument that they exercise control over employees and their work. This suggests that corporations should also use their influence to prevent employees from causing harm to third parties.82 Additionally, it has long been argued in both common and civil law jurisdictions that corporate liability for employees (or, more generally, for agents) is based on the necessity to align costs and benefits.83 Because corporations benefit from having employees and agents to carry out work on their behalf, corporations should be responsible for any ensuing costs, including those in the shape of liability, that flow from the division of labour. They should assume and absorb such costs, commentators argue, as part of the risks of doing business.84 The notion of cost-benefit alignment has been analysed both considering its economic efficiency as well as with respect to fairness or justice considerations.85 In this latter regard, distributive justice perspectives have been particularly important for corporate liability. Commentators have observed that it is appropriate and fair that corporations should be liable for harm caused by their employees. Indeed, fairness can be linked to enterprise liability and its principle of strict corporate responsibility that may attach to businesses regardless of their culpability.86 An important judicial milestone is the US Court of Appeals for the Second Circuit’s decision in Ira S. Bushey & Sons, Inc. v. United States.87 In this case, Judge Friendly opined that fairness, not efficiency, was the decisive factor justifying why a business should be liable when its activities cause harm to third parties.88 Further justifications in support of corporate liability are based on the need to protect injured third parties as well as the individuals who, while acting for the corporation, caused the injuries. It is arguably inappropriate to hold an employee responsible, or at least fully responsible, for the injuries he or she has caused to a third party. This is both because the damages caused may exceed the individual’s financial means – that is, he or she cannot compensate the victim − and because the employee has only been put in the position that allowed for the injury to occur in the first place because of his or her work for the corporation.89 Corporate liability for harmful acts by employees thus protects the employees by enabling the third party to sue the

See, e.g., National Convenience Stores, Inc. v. Fantauzzi, 584 P.2d 689, 691 (Nev. 1978); Talbot Smith, Scope of the Business: The Borrowed Servant Problem, 38 Mich. L. Rev. 1222, 1233 (1940); Roscoe T. Steffen, The Independent Contractor and the Good Life, 2 U. Chi. L. Rev. 501, 506–507 (1935). 83 See Christian von Bar, 1 Gemeineuropäisches Deliktsrecht § 1, ¶ 8 (1999); Douglas Brodie, Enterprise Liability: Justifying Vicarious Liability, 27 Oxford J. Legal Stud. 493, 496 (2007); Lister v Hesley Hall [2002] 1 AC 215 (UKHL); Petro-Tech, Inc. v. Western Company of North America, 824 F.2d 1349 (3d Cir. 1987). 84 Bar, supra note 83, at § 2 ¶ 180. 85 This is already reflected in Otto von Gierke, Die Soziale Aufgabe des Privatrechts (1889) (describing vicarious liability as a necessity of social justice). 86 On this, see Gregory C. Keating, The Idea of Fairness in the Law of Enterprise Liability, 95 Mich. L. Rev. 1266 (1997). 87 Ira S. Bushey & Sons, Inc. v. United States, 398 F.2d 167 (2d Cir. 1968). 88 Id. at 171. 89 See E. von Caemmerer, Reformprobleme der Haftung für Hilfspersonen, 14 Zeitschrift für Rechtsvergleichung [ZfRV] 241 (1973) (Ger.). 82

36  Research handbook on corporate liability corporation instead of the employee. At the same time, it protects the injured party from the risk of having to bring claims only against an employee. B.

Economic Justifications

In addition to the traditional justifications mentioned above, corporate liability has been examined through the lens of economic analysis of law. The starting point for this family of theories is whether a legal system that incorporates corporate liability for misconduct of employees is superior, in terms of overall economic efficiency, compared to a system that relies solely on the personal liability of individuals that commit harmful acts in their corporate capacities.90 As outlined below, law and economics scholars have generally concluded that corporate liability is, in many cases, the more efficient solution. While these insights have initially been developed with a focus on tort law, the relevant considerations have subsequently also been applied to liability for agents’ criminal conduct, leading to similar results.91 A first important element of economic analysis of corporate liability is loss prevention. To illustrate this principle, we have to assume that (a) the corporation can influence an employee’s level of care; (b) that a corporate employee’s assets are insufficient to cover damages that he or she can potentially cause to third parties; and (c) that the corporation’s assets are sufficient to compensate third party claims.92 Without corporate liability, the fact that an employee may not be able to fully compensate third parties can lead the employee to either use insufficient levels of care (especially if they have few or no assets and are thus de facto judgment proof)93 or, alternatively, too much care (to avoid a complete loss of their wealth). Both scenarios are not optimal from a strictly economic viewpoint.94 However, with a system of corporate liability, the corporate entity is incentivized to ensure that its employees use the correct level of care. As a result, corporate investments in safety measures to avoid liability should correspond to the expected loss to third parties, or, in other words, amount to an efficient level.95 Consequently, under the above-mentioned assumptions, corporate liability tends to lead to more efficient loss prevention than a system of exclusive individual liability. This is especially true where: there is a large difference between the potential damages and employees’ assets; the corporation can exercise effective supervision and control over employees; and in situations where it is costly to negotiate contractual allocations

Although vicarious liability entails the joint liability of employer and employee, economic analyses of vicarious liability are normally based on the assumption that only the employer/entity will be held liable. J.H. Arlen & W.H. Carney, Vicarious Liability for Fraud on Securities Markets: Theory and Evidence, 192 U. Ill. L. Rev. 691, 704 (1992). 91 Wallace P. Mullin & Christopher M. Snyder, Should Firms be Allowed to Indemnify their Employees for Sanctions?, 26 J.L. & Econ. 30, 40 (2010). 92 These assumptions are taken from Steven Shavell, Economic Analysis or Accident Law 170 (1987). 93 Id. 94 Bruce Chapman, Corporate Tort Liability and the Problem of Overcompliance, 69 S. Cal. L. Rev. 1679 (1996); Alan O. Sykes, The Boundaries of Vicarious Liability: An Economic Analysis of the Scope of Employment Rule and Related Legal Doctrines, 101 Harv. L. Rev. 563, 567 n.9 (1988). 95 See, e.g., Lewis A. Kornhauser, An Economic Analysis of the Choice Between Enterprise and Personal Liability for Accidents, 70 Cal. L. Rev. 1345, 1362 (1982); Alan O. Sykes, The Economics of Vicarious Liability, 93 Yale L. J. 1231, 1246 (1984). 90

Theoretical approaches to corporate liability  37 of liability between the corporation and employees.96 If this is not the case, then corporate liability will not be substantially more efficient than individual liability. Similarly, corporate liability is not essential from an efficiency standpoint where the injured parties themselves are able to take cheap measures to avoid damages.97 Economic analysis of law also translates the traditional idea of cost-benefit alignment into the concept of cost internalization. This provides that prices for goods and services should reflect the full cost of their production. Based on this information, the public can decide whether they regard goods or services as important and useful enough to accept the costs – including liability costs – that are reflected in their prices.98 Through the prism of cost internalization, corporate liability is essential as a tool to ensure that these costs are in fact incorporated in products and services, which in turn leads to them being offered at an efficient volume. For example, all things being equal, a dangerous product design is more expensive for the producer because of increased liability costs, which means it will be more expensive than a safer product, thus leading to less demand. In a system with exclusive individual liability, such internalization would not occur as liability would be directed to individuals.99 Finally, another factor in support of corporate liability is based on loss spreading and efficient risk allocation. According to a utilitarian argument, a multitude of small losses that are spread and borne by multiple individuals are preferable over a large loss that is borne by a single person. Consequently, this argument supports corporate instead of individual liability.100 Businesses can spread losses over time and to a broader group of people, including the shareholders through lower profits or dividends and to customers through higher product or service prices.101 In contrast, an individual employee would normally have to pay a damage award immediately and in full, without the option to spread it. Assuming that the corporation and the individuals are willing to obtain liability insurance, the premiums payable by a larger corporation would be lower than those of individual insured parties. The corporation, on all counts, therefore, appears to emerge as the cheapest cost avoider, making corporate liability the more efficient and thus economically superior system.102 C.

Specific Considerations: Criminal Liability

Doctrinal and legal obstacles to holding corporations liable, namely in the form of the fiction theory and its remnants – discussed above – have been gradually overcome. Nevertheless, there is still an ongoing debate concerning corporate criminal liability, which this section

See Kornhauser, supra note 95, at 1351–52; Shavell, supra note 92, at 170; Sykes, supra note 95, at 1241. 97 R.H. Kraakman, Vicarious and Corporate Civil Liability, in Tort Law And Economics 134, 137 (Michael Fauré ed., 2009). 98 Guido Calabresi, Some Thoughts on Risk Distribution and the Law of Torts, 70 Yale L.J. 499, 505 (1961). 99 Sykes, supra note 95, at 1244. 100 See P.S. Atiyah, Vicarious Liability in the Law of Torts 22 (1967); Harold J. Laski, The Basis of Vicarious Liability, 26 Yale. L.J. 105, 112 (1916); Y.B. Smith, Frolic and Detour, 23 Colum. L. Rev. 444, 456 (1923). 101 Fruit v. Schreiner, 502 P.2d 133, 141 (Alaska 1972); Calabresi, supra note 98, at 517–18. 102 See Guido Calabresi, The Costs of Accidents: A Legal and Economic Analysis 54 (1970); Sykes, supra note 95, at 1235–36. 96

38  Research handbook on corporate liability will briefly survey (see the more detailed discussion in the chapter on criminal liability). In its current shape, this debate is focused on the efficiency, utility, fairness, and philosophical questions of corporate criminal liability and criminal law theory. Two main literature streams have emerged in this respect. One is grounded in utilitarian and neoclassical perspectives rooted in economic theory, which emphasizes overall economic efficiency; the other includes retributive and philosophical accounts, which focus on morality, punishment, and the question of groups’ ability to assume responsibility and act in the capacity of moral agents. A common starting point for philosophical analyses of corporate criminal liability is the work of Peter French and Philip Pettit, who have separately advanced theories of corporate and group responsibility.103 A principal feature of these theories is that they view the responsibility of a corporation as that of an autonomous moral person or ‘group moral agent’. As one commentator has summarized them, the theories consist of three essential steps. First, corporations and other group agents are distinguished from mere aggregates of individuals. Second, an argument is made that group agents are capable of intentionality. Third, it is argued that it is fair to hold group agents morally responsible for the consequences of their acts and decisions.104 Although philosophical in nature, these theories’ conclusions on moral responsibility by extension also support the imposition of legal liability on corporations. Other commentators have argued against the idea of corporations as agents to which moral responsibility and legal liability can or should be assigned. According to these views, corporations are either not moral agents, or, alternatively, they are moral agents that lack the ability to understand the specific moral dimensions of criminal law and punishment.105 Some commentators have also voiced concern that corporate moral agency is used instrumentally, to justify ideological ends, by ethics and legal scholars as well as prosecutors and courts.106 Additionally, scholars have criticized corporate moral agency based on concerns that holding corporations criminally liable may shield blameworthy individuals from responsibility while punishing uninvolved parties; that it unduly emphasizes collectivist instead of individualist approaches; and that the concept incorrectly relies on an entity view of the corporate form, including the presumption that these constructs can possess knowledge and states of mind.107 In contrast to philosophical approaches, proponents of neoclassical law and economics theory address the problem of corporate criminal liability very differently. From their perspective, as discussed in the previous section, holding firms liable is potentially useful as a mechanism to achieve deterrence, cost internalization, and loss prevention.108 However, upon See, e.g., Christian List & Philip Pettit, Group Agency: The Possibility, Design, and Status of Corporate Agents (2011); Peter A. French, Collective and Corporate Responsibility (1984). 104 Ian B. Lee, Corporate Criminal Responsibility as Team Member Responsibility, 31 Oxford J. Legal Stud. 755, 759 (2011). 105 See Darcy Macpherson, ‘A Centenary of a Mistake?’ An Outsider’s Critical Analysis of, and Reply to, the Approach of Professor Hasnas, 18:1 Asper Rev. Int’l Bus. & Trade L. 104, 113 (2018) (summarizing and opposing John Hasnas’s views). 106 Matthew Caulfield & William S. Laufer, Corporate Moral Agency at the Convenience of Ethics and Law, 17 Geo. J.L. & Pub. Pol’y 953, 954–55, 971–72 (2019). 107 For a collection of works by scholars that oppose corporate moral agency, see Eric W. Orts & N. Craig Smith, The Moral Responsibility of Firms Part II. (2017), For a particularly notable recent ‘abolitionist’ contribution, see also John Hasnas, The Forlorn Hope: A Final Attempt to Storm the Fortress of Corporate Criminal Liability, 47 J. Corp. L. 1009 (2022). 108 See, e.g., Jennifer Arlen & Reinier Kraakman, Controlling Corporate Misconduct: An Analysis of Corporate Liability Regimes, 72 N.Y.U. L. Rev. 687, 692 (1997). 103

Theoretical approaches to corporate liability  39 closer analysis, some economic theorists have posited that civil or administrative law might be better than criminal law at achieving these effects.109 A problem, viewed through this specific lens, is that corporations cannot be imprisoned, which seems to leave monetary damages as the main sanction.110 Consequently, this raises the question of what is gained by having the option to subject firms to criminal prosecutions, in addition to civil claims. In essence, some critics ‘conceive of the corporate criminal system as a tort regime with procedural inefficiencies and inflexible sanctions’,111 leading them to conclude that it may be unnecessary, or even unhelpful and inefficient, to maintain it. In their influential account of the economics of corporate criminal liability, Daniel Fischel and Alan Sykes argued that civil law measures are better suited to punishing corporations as their penalties are linked more closely to the social harm caused by corporate misconduct. Although they concede that there is a need to ratchet up penalties to compensate for the likelihood that crime will not be detected, which could lead to under-deterrence, they argue that the civil system’s punitive damages are sufficient in this regard. Conversely, they find that the additional reputational harm inflicted by criminal law sanctions could result in excessive punishment and over-deterrence, thus leading to inefficient outcomes.112 Vikramaditya Khanna has put forward similar reasons in his analysis of the purpose of corporate criminal liability. He argues, among other things, that civil liability can already capture the benefits of corporate criminal liability, such as enforcement and information-gathering, and that it avoids unnecessary or costly features of criminal law, including procedural protections and stigma.113 On the latter point, Khanna suggests that it would be preferable to monetize stigma and replace it with an additional civil penalty that is equal to the corresponding monetary ‘value’ of stigma. Thus, instead of criminal liability, Khanna proposes an enhanced civil liability regime for corporations with cash fines, supplementary sanctions, and stronger enforcement tools.114 This system, he predicts, would achieve deterrence at a lower cost for society than utilizing criminal law in the corporate context.115 Apart from efficiency-based considerations, another argument against corporate criminal liability concerns its effects on individuals behind the corporation. Commentators have pointed out that penalties and fines imposed upon an entity will ultimately be paid by shareholders, consumers, or even the public at large, even though these parties were not involved

109 J.T. Byam, The Inefficiency of Corporate Criminal Liability, 73 J. Crim. L. & Criminology 582 (1982); Daniel R. Fischel & Alan O. Sykes, Corporate Crime, 25 J. Legal Stud. 319 (1996); Vikramaditya S. Khanna, Corporate Criminal Liability: What Purpose Does it Serve?, 109:7 Harv. L. Rev. 1477 (1996); John R. Lott, Corporate Criminal Liability, in Encyclopedia of Law and Economics, Vol V. The Economics of Crime and Litigation 494–95 (B. Bouckaert & G. De Geest eds., 2000). 110 Fischel & Sykes, supra note 109, at 320. 111 Diamantis, supra note 56, at 2059. 112 Fischel & Sykes, supra note 109, at 331–32. Note that this analysis was based on US law and its practice of allowing relatively (compared to other jurisdictions) high punitive damages awards. 113 Khanna, supra note 109. 114 Id. at 1533–34. 115 Id. Among others, this would also follow from the lower standard of proof that is applicable in tort law. Note in this context also the Australian civil penalty regime, which is based on monetary fines imposed and collected by civil courts. See, for example, Michael Gillooly & Nii Lante Wallace-Bruce, Civil Penalties in Australian Legislation, 13 U. Tas. L. Rev. 269 (1994).

40  Research handbook on corporate liability in any wrongdoing themselves.116 Similarly, in a worst case scenario, employees that are not connected with or aware of any misbehaviour may lose their jobs when a corporation is forced out of business, with Arthur Andersen’s demise offering a real-world example in this regard.117 Some scholars have criticized corporate criminal liability specifically because of these potential negative externalities affecting ‘undeserving’ groups and individuals.118 Scholars on the other side of the debate have countered the various attacks by corporate criminal law ‘abolitionists’. Important lines of reasoning in this regard rest on the criminal law’s multi-faceted purpose – including as an expression of societal disapproval and shaming – as well as its unique procedural tools and available sanctions.119 As one supporter of corporate criminal liability has put it, a problem with the abolitionist view is that its proponents ‘take as their starting point an anemic view of the purposes served by the criminal law and of the remedies potentially available against corporations’.120 Furthermore, adding another dimension to this discussion, Arlen suggests that retaining the option of criminal enforcement against corporations is vital given this tool’s greater robustness against threats of corporate capture.121 Some of the ‘anti-abolitionist’ scholars have also addressed and rejected the above-mentioned concerns regarding punishing innocent parties. The main counterargument is that the same objection could be raised against civil liability, where compensatory awards are also borne by the various individuals behind a legal entity.122 In essence, anti-abolitionist theorists wish to maintain the option of criminal sanctions as one of the tools that society has at its disposal when dealing with businesses and their activities.

IV. CONCLUSION The reference to ‘theoretical approaches’ to corporate liability can mean different things to different people. This chapter’s focus was, first, on corporate theories as the foundational bedrock on which corporate liability rests. The traditional dichotomy between the fictional or real nature of legal entities continues to influence the scope and structure of corporate liability for torts and criminal offences. The longevity of these theories may be partly due to intuitive appeal, especially of real entity theory. There is also the ‘first mover’ advantage that these century-old approaches have benefited from, resulting in entrenchment in legislation and jurists’ minds. Moving away from the discussion of the nature of legal entities, contemporary approaches redirected the scholarly focus towards issues including why firms and corporations

See, e.g., J. Hasnas, The Centenary of a Mistake: One Hundred Years of Corporate Criminal Liability, 46 Am. Crim. L. Rev. 1329, 1357 (2009). 117 David Rönnegard & Manuel Velasquez, On (Not) Attributing Moral Responsibility to Organizations, in Orts & Smith, supra note 107, at 133. 118 Id. at 134. This also reflects arguments by the defence in New York Cent. & H.R.R. Co. v. U.S., 212 U.S. 481 (1909). 119 See, e.g., Samuel W. Buell, A Restatement of Corporate Criminal Liability’s Theory and Research Agenda, 47 J. Corp. L. 938 (2022); Diamantis, supra note 56, at 2060–67; Ian B. Lee, supra note 104. 120 Diamantis, supra note 56, at 2059. 121 Jennifer Arlen, A Political Theory of Corporate Criminal Liability, 47 J. Corp. L. 861 (2022). 122 John C. Coffee, Crime and the Corporation: Making the Punishment Fit the Corporation, 47 J. Corp. L. 963, 966 (2022) (noting also that one innocent group, shareholders, are protected by limited liability). 116

Theoretical approaches to corporate liability  41 exist, what their core features are, and the relationships between management, shareholders, and other corporate constituents. Given their greater sophistication and more holistic approaches to theorizing corporations, these approaches have the potential to say more about corporate liability than older theories. Yet, thus far this potential remains mostly untapped as scholars tend to focus on governance issues that do not directly involve liability. Moving from the if and how of the liability of legal entities to the question of why we should hold them responsible, the chapter’s second broader focal area was on justifications for corporate liability. Corporate liability in civil law is widely accepted. Traditional justifications ranging from control and fairness to protecting individuals and matching costs with benefits align with more recent efficiency-based considerations. Although these approaches can and have been applied to corporate criminal liability as well, it is in this area that scholarly opinion on the existence of theoretical justifications remains starkly divided. Again, modern theories of the corporation have had little to say on this debate or have rarely been utilized by scholars in this context. Yet, corporate criminal law involves questions concerning the corporation and its constituencies that lie at the heart of corporate governance. We should therefore, in the future, expect the emergence of theoretical approaches that increasingly include this area as well, as part of a more holistic view of firms and their impact.

3. Corporate liability: a systems perspective Christian A. Witting1

I. INTRODUCTION The complexity of the company and its relationships calls for careful modelling. Modelling permits us to form mental representations of phenomena, which aids understanding and theorising.2 This chapter proffers a model of the company for use in considering problems of corporate liability. The aim is to present a model incorporating not just an ‘analysis’ of individual company components but also a ‘synthesis’3 of important internal and external relationships. This is achievable by employing systems theory, which is concerned with studying each phenomenon as a whole and which takes account of connections, causal influences, and complexity.4 The argument will be that the company is a managerial system composed of multiple structural and other components, which management coordinates in pursuit of system purposes. The basic purpose is to survive and, beyond this, to flourish as a profit-making entity. The company’s profit-making activities inevitably impact upon other persons and entities in the company’s environment, which comprises inter alia other market actors as well as lawmakers and courts. The company learns about changes in its environment (including changes in law) and about external threats (including judgments against it) through its feedback mechanisms. System modelling reveals important points about the company and its liabilities. First, it points to a deficiency in corporate governance arising from obsessive focus by lawmakers upon the board of directors. While directors’ duties should – because of the board’s formal powers and important monitoring role – be rigorously applied, observation of companies reveals that they are run by managers. As such, greater focus should be given to outlining an appropriate liability regime for managers. Second, the chapter demonstrates that a consequence of the latter finding is that common law jurisdictions need to promote mechanisms by which externally imposed conduct standards can be transposed reliably into internal company policies, procedures, routines, and cultures. The most obvious mechanism is the US Caremark duty as it applies to senior managers. The Caremark duty allows for societal/legal feedback about wrongdoing, which is conveyed to the company’s directors and senior managers through liability awards. Third, the chapter demonstrates the correctness of the focus of a company’s

1 Thanks to Kenneth Khoo, Ernest Lim, Martin Petrin, and Umakanth Varottil for comments made at various stages in the writing of this chapter. A special thanks also to Stephen Fordham for the benefit of his experience on multiple company boards. 2 Anders Ericsson & Robert Pool, Peak: Secrets from the New Science of Expertise Ch 9 (1st ed. 2016). 3 Russell L. Ackoff, Re-Creating the Corporation: A Design of Organizations for the 21st Century 11 (1st ed. 1999). 4 Id. at 12.

42

Corporate liability: a systems perspective  43 vicarious liability upon responsibility for the torts of employees as opposed to independent contractors.

II.

THE COMPANY AS SYSTEM

Much theorising about the company has been driven by the ‘economic analysis of law’ (EAL). EAL writings frequently neglect the significance of internal corporate structures, procedures, and routines, treating the company as a black box.5 The account of corporate liability to be offered in this chapter is different, being group-oriented and ‘structuralist’ in nature.6 Group-oriented theory takes account of the ways in which companies and individual participants in their operations are motivated by overlapping company-oriented purposes.7 Structuralism highlights constitutive legal rules, boundaries, hierarchical relationships, and defined procedures that align participants to corporate purposes. Formal corporate structures ‘shape’ decision-making and outcomes8 by providing the frameworks in which participants operate, criteria by which they make decisions, and paths of influence by which decisions take effect.9 Acknowledgement of these structural features allows us to appreciate the interconnections, loyalties, and systemic aspects of company operations. The systems-managerial approach accommodates these important dimensions of the company and yields fresh insights into corporate liability issues. Or so it is argued. A.

Systems Theory

We begin with an explanation of systems theory. Ludwig von Bertalanffy developed modern systems theory to address methodological shortcomings in scientific study.10 Scientists had studied living things in isolative and reductionist ways – adopting the ‘analytical method’ of breaking them down, stripping out less important features, and studying individual components. Von Bertalanffy sought to account for interconnection between components, external connections, and complexity.11 Although a biologist, he recognised that other disciplines suffered from reductionist tendencies12 and offered his General Systems Theory as a response. Its

For similar observations, see, e.g., Alfred D. Chandler Jr., The Visible Hand: The Managerial Revolution in American Business 490 (1977); Christopher D. Stone, The Place of Enterprise Liability in the Control of Corporate Conduct, 90 Yale L.J. 1, 8 (1980). 6 Mary Jo Hatch, Organization Theory: Modern, Symbolic, and Postmodern Views 91 (3d ed. 2013). See also Eva Micheler, Company Law: A Real Entity Theory 24, 28 (2021). 7 Edith Penrose, The Theory of the Growth of the Firm 25 (4th ed. 2009); Herbert A. Simon, Administrative Behavior: A Study of Decision-Making Processes in Administrative Organizations 4, 81 (4th ed. 1997). 8 Julia Black, New Institutionalism and Naturalism in Socio-Legal Analysis: Institutionalist Approaches to Regulatory Decision-Making, 19 Law & Pol’y 51, 80 (1997). 9 Michael G. Jacobides & Sidney G. Winter, Capabilities: Structure, Agency, and Evolution, 23 Org. Sci. 1365, 1373–74 (2012). 10 Ludwig von Bertalanffy, General System Theory: Foundations, Development, Applications 11–12, 31, and 44–45 (rev. ed. 1969); see also Talcott Parsons, The Social System (1st ed. 1951). 11 von Bertalanffy, supra note 10, at 11–12, 19, and 31. 12 Id. at 11–12, 36–37. 5

44  Research handbook on corporate liability principles have been applied in many fields, with most applications accepting that a system is a ‘set of distinct but interconnected elements or parts that operate as a unified whole’ to serve specified purposes.13 Interconnection arises through flows of information and/or physical matter14 and is evident in the ways that components function together in sustaining the system.15 It is recognised, as such, not to be possible fully to understand any individual component without recognising its relationships to other system components.16 Purpose, interconnection, and coordinated operations entail ‘wholeness’ among subsystems and their components17 and distinguish systems from their surrounding ‘environments’. System connections are not only internal; almost all systems interact with their environments.18 This is because living systems are open systems19 that draw energy and other matter from their environments.20 It is evident, moreover, that systems adapt to changes in their environments by ‘self-organising’. They have ‘feedback loops’ that provide them with information or other signals about their operations and about events going on in their environments.21 Feedback loops function through information/ signals which the system responds to (whether consciously or not) by growing, developing, and/or learning resilience.22 Their responsiveness ensures that systems tend to operate stably and in perpetuo.23 For lawmakers, this is important. Feedback loops can be useful in acting ‘to bring the state of the system in line with a goal or desired state’.24 B.

The Company

Systems theory has been applied to many living phenomena. This augurs well for its application to companies. Indeed, the value of the systems approach to companies and other organisations can be seen in early work by the corporate executive and organisation theorist Chester Barnard.25 Without having explicitly applied it, Barnard observed that: ● The organisation is a cooperative system that is itself part of a more-encompassing system, the state, which depends for its success largely upon the effective operation of organisations resident within its bounds;26 ● The organisation must be treated as a ‘whole’ because ‘each part is related to every other part included in it in a significant way’;27 13 Donella H. Meadows, Thinking in Systems: A Primer 14 (2008); Tamara Belinfanti & Lynn Stout, Contested Visions: The Value of Systems Theory for Corporate Law, 166 U. Penn L. Rev. 579, 599 (2018). 14 Meadows, supra note 13, at 14. 15 Alan Calnan, Torts as Systems 11 (2018) (unpublished manuscript). 16 von Bertalanffy, supra note 10, at 11–12, 27–28. 17 Id. at 11–12 and 15. 18 Ackoff, supra note 3, at 39–40. 19 Niklas Luhmann, Introduction to Systems Theory 28 (2012). 20 Meadows, supra note 13, at 59. 21 Id. at 25. 22 Id. at 76. 23 Belinfanti & Stout, supra note 13, 599–600. 24 John D. Sterman, Business Dynamics: Systems Thinking and Modeling for a Complex World 111 (2000). 25 Chester I. Barnard, The Functions of the Executive (1938). 26 Id. at 99. 27 Id. at 41–2, 77 and 240.

Corporate liability: a systems perspective  45 ● Participants are brought under the organisation’s control and into a deliberate relationship with it. Every employee has a place on the organisational chart, reports to someone, and is accountable for what she does;28 ● The organisation comprises a set of positions that relate to each other hierarchically, management responsibility being delegated to executives, who have ‘authority’ to make decisions that bind those validly subject to them;29 ● When an individual joins an organisation, the purposes for which she acts on the organisation’s time are the organisation’s own purposes. Indeed, ‘[i]t is the deliberate adoption of means to ends which is the essence of formal organization’;30 and ● The organisation’s survival depends upon its ability to maintain equilibrium, which means adapting to its external environment through adjustments to its purposes and their efficient pursuit.31 Occasionally systems theory has been of interest to academic lawyers. Indeed, it was brought into the twenty-first century by advocates such as LoPucki,32 who sets out a step-by-step methodology for studying law-related systems, and by Belinfanti and Stout, who use it to model the individual company.33 The latter authors describe public companies as being composed of multiple elements – financial, physical and human capital – that interact in the performance of functions such as the provision of employment opportunities and production of goods and investor returns.34 In this type of system, ‘directors and officers supply managerial expertise; employees supply labor; the physical plant produces goods for sale’ and so on.35 Further research underlines that systems methodology is useful because it: (i) recognises the significance of structures, procedures and cultures upon individual behaviour, not simply attributing negative actions and outcomes to individual disposition;36 (ii) helps to identify system purposes, which frequently are discernible not from statements of purpose but, more cogently, from actual operations;37 (iii) is premised upon the idea of interconnection between different functional parts of the company, recognising that change in one part can affect others;38 (iv) recognises that causal influences upon behaviour are multiple, being both direct and immediate as well as historical and distant;39 (v) recognises both the existence of and potential ‘confounding effect’ of feedback loops, which are ways of transmitting information within or to the system from the environment;40 (vi) recognises that the impact of change will be greatest when those introducing it act upon structures, mechanisms, and persons located within the boundaries of the company; and (vii) recognises that any changes sought 28 Henry Mintzberg, The Structuring of Organizations 37 (1979); Barnard, supra note 25, at 42 and 176. 29 Barnard, supra note 25, at 163 and 170. 30 Id. at 41–43 and 186. 31 Id. at 83. 32 Lynn M. LoPucki, The Systems Approach to Law, 82 Cornell L. Rev. 479 (1997). 33 Belinfanti & Stout, supra note 13. 34 Id. at 579, 583, and 600. 35 Id. at 600. 36 Meadows, supra note 13, at 75 and 89; Sterman, supra note 24, at viii, 28, 91, and 190. 37 Meadows, above note 13, at 14. 38 LoPucki, supra note 32, at 482–83 and 487. 39 Sterman, supra note 24, at 28. 40 Id. at 12.

46  Research handbook on corporate liability will be subject to delays, ‘slowing the ability to accumulate experience, test hypotheses, and improve’.41 Many of these points will be evident in the following discussion.

III.

COMPANY BOUNDARIES

This chapter aims to further develop systems theory in the corporate liability context by marrying it to organisation theory’s account of the company as a managerial hierarchy. We begin by considering the significance of the system dimension. An important first problem of corporate liability that systems theory assists with is in determining what ‘system’ we are referring to. Oftentimes, those with an interest in company law are ambivalent about what constitutes the company but systems theory does not tolerate ambivalence. It treats as critical the distinction between system and ‘environment’.42 Each system has a boundary beyond which is found its ‘environment’. The significance of this is that the: environment of a system consists of those things that can affect the properties and performance of that system, but over which it has no control. That part of its environment that a system can influence, but not control, is said to be transactional. Consumers and suppliers, for example, are part of the corporation’s transactional environment. That part of a system’s environment that can neither be influenced nor controlled is said to be contextual.43

The company comprises all those ‘components’, human and otherwise, that are subject to management commands. This coheres with the conception of the ‘firm’ frequently adopted in the organisation theory literature. Thus, Penrose wrote: It is the ‘area of co‐ordination’—the area of ‘authoritative communication’—which must define the boundaries of the firm for our purposes, and, consequently, it is a firm’s ability to maintain sufficient administrative co‐ordination to satisfy the definition of an industrial firm which sets the limit to its size as an industrial firm… ‘Authoritative communication’ can consist on the one extreme of the actual transmission of detailed instructions through a hierarchy of officials and, on the other, of the mere existence among a group of people of observed and accepted policies, goals, and administrative procedures established at some time in the past.44

Working out where the company ends and where the environment begins allows us to determine the extent of management’s competence in introducing compliance and other regimes, ‘competence’ extending in most cases only as far as the company’s boundaries, beyond which influence is exerted through market power. If injury-causing activity stems from independent contractors, suppliers, or financiers, the company will have no more than its market power with which to modulate that behaviour. In the liability context, this becomes important because we see that legal prohibitions and standards directed at the company are likely to be most effective when the company can modulate productive effort and other actions through managerial fiat and the ‘integration mechanisms’ discussed later.

Id. at 411. LoPucki, supra note 32, at 497; Cf. Meadows, supra note 13, at 97. 43 Ackoff, supra note 3, at 7 (emphasis added). 44 Penrose, supra note 7, at 17–18. See also W. Richard Scott & Gerald F. Davis, Organizations and Organizing: Rational, Natural, and Open System Perspectives 154 (2007). 41 42

Corporate liability: a systems perspective  47

IV.

THE BOARD OF DIRECTORS

Systems theory sheds light on other important corporate liability problems. It is helpful to lawmakers and regulators because it assists in forming mental representations about how companies function and cause harm and about how law can impact the company through its feedback loops.45 When considering ‘how companies function’, systems theory directs our attention to the identification of who manages company operations. Both directors and managers have roles in the setting of purposes and the coordination of persons and productive effort. Leaving aside the general meeting for the moment, the board of directors is at the apex of the decision-making hierarchy and is invested by law with large, formal powers to ‘manage’ the company.46 In practice, much of this power is delegated to the CEO, who makes her own sub-delegations. The main tasks undertaken by the board are the approval of corporate strategy47 and assurance thereafter that the company is (i) working within the parameters of agreed strategy and legal obligations and (ii) meeting its performance targets. Lawmakers acknowledge these ‘corporate governance’ roles and impose upon directors rigorous legal obligations. But the question arises whether the law’s obsessive focus upon the board and application of the directors’ duties is justified. Two well-understood limitations of the board relate to its constitution by independent directors and its part-time status. Whether independence has been statutorily mandated48 or adopted as best practice,49 the boards of medium- and large-size companies are dominated by independent directors.50 Although, in theory, board independence assists in safeguarding shareholder interests, these are not the only interests that need protection. Systems theory confirms that the independent directors’ role in protecting all relevant interests is far from unproblematic.51 A first difficulty is that independent directors’ service undertakings are restricted in nature: The directorial undertaking is a narrow, limited and periodically exercised one which focuses on the collective exercise of board power and responsibility for its exercise… [The director] undertakes only to attend duly convened board meetings and at such meetings to participate in the collective exercise of board power on the issues brought before the board duly convened.52

In this way, this use of systems thinking is related to ‘mechanism design’. See Dante Pavan, Tigers and Bears: Mechanism Design in Corporate Governance, 46 Del. J. Corp L. 325 (2022). 46 See, e.g., Companies (Model Articles) Regulations 2008 (UK), SI 2008/3229, reg 4, Sch 3, art. 3; Del. Code Ann. tit. 8, § 141(a) (2019). 47 Richard Leblanc & James Gillies, Inside the Boardroom: How Boards Really Work and the Coming Revolution in Corporate Governance 47 (2005). 48 See, e.g., Sarbanes–Oxley Act of 2002, Pub. L. 107–204, § 301, § 302, 116 Stat. 745, 775; NYSE Stock Listed Company Manual, Rules 303A.01 and 303A.04-5 (N.Y. Stock Exchange). 49 UK Corporate Governance Code prov 11 (Fin. Rep. Council 2018). 50 Randall S. Thomas & James D. Cox, A Revised Monitoring Model Confronts Today’s Movement Toward Managerialism, 99 Tex. L. Rev. 1275, 1280 (2021); Dorothy S. Lund & Elizabeth Pollman, The Corporate Governance Machine, 121 Colum. L. Rev. 2563, 2611 (2021). 51 See also Thomas & Cox, supra note 50, at 1281. 52 David Kershaw, Corporate Law’s Fiduciary Personas, 136 Law. Q. Rev. 454, 456, and 458 (2020). 45

48  Research handbook on corporate liability Second, and following on from the first point, independent directors of medium- and large-sized companies spend on average two or three days a month on each directorship.53 For most of the month they pursue other directorships and business concerns, rather than being immersed in the problems of any one company. Given that the board papers supplied to them prior to meetings are both voluminous and technical in nature,54 few would venture beyond them and make independent inquiries about the issues.55 Typically, they have little knowledge of the company’s operations because independent directors have not come up through company ranks.56 So, although independent directors contribute to board deliberations on the basis of real-world experience and business acumen, they cannot be proactive on tactical and technical matters.57 Third, during board meetings, directors’ time and attention is dominated by reporting on business performance and compliance with financial reporting requirements.58 This makes sense. Business performance is of central interest to shareholders as well as to credit rating agencies, creditors, and prospective investors. Accurate financial reporting is part of the modern disclosure regime59 that permits performance comparisons and feeds into the pricing of securities. This entails many obligations relating to the quality of reporting and disclosure.60 As such, in so far as the directors’ attention is drawn to questions of ‘risk’, their focus is upon financial risks to the company itself.61 Although the well-managed medium- to large-sized company board today incorporates periodic discussion of broader compliance and external liability risks, there have been startling examples of companies falling short.62 For these and other reasons, Cox and Thomas denigrate the ‘monitoring board’ model as ‘inherently weak’.63 Although it is tempting to rail against it and attribute all corporate liability problems to it, systems theory points to a certain futility in doing so. This is because systems theory involves the study of observed phenomena. It looks to actual states of affairs and actual

53 Stephen M. Bainbridge, The New Corporate Governance in Theory and Practice 199 (2008); Leblanc & Gillies, supra note 47, at 54, 55, 76, and 77; Martin Petrin, Corporate Management in the Age of AI, 2019 Colum. Bus. L. Rev. 965, 975 (2019). 54 Leblanc & Gillies, supra note 47, at 58. 55 Given that directors delegate powers to the CEO, it appears to be understood that they should not seek additional information about matters from more junior executives because this would undermine the delegation. 56 Leblanc & Gillies, supra note 47, at 49, 56, 58–59, 67–68, 71 and 75. 57 Id. at 60, 62, 67–71, and 80. 58 Lawrence A. Cunningham, The Appeal and Limits of Internal Controls to Fight Fraud, Terrorism, Other Ills, 2004 J. Corp. L. 267, 277 (2004). 59 See, e.g., Companies Act 2006, c. 46 §§ 386 & 414(1) (keeping and approval of accounting records), and §414A (preparation of strategic report); FCA Handbook DTR 4.1.5.R and LR 9.8.4.R and LR 9.8.6.R (content of reports and accounts) (Fin. Conduct Auth.); Sarbanes-Oxley Act of 2002, Pub. L. No. 107–204, § 303(a), 116 Stat. 745 (prohibition on director interference with audits); Reinier Kraakman et al., The Anatomy of Corporate Law: A Comparative and Functional Approach 49–50, 275–80 (2d ed. 2009). 60 Kraakman et al., supra note 59, at 50, 278–79, and 289. 61 See, e.g., UK Corporate Governance Code, supra note 49; Leblanc & Gillies, supra note 47, at 55–9. 62 See, e.g., In re Boeing Co Deriv. Litig., 2021 WL 4059934 (Del. Ch. 2021); Marchand v. Barnhill, 212 A.3d 805, 809 (Del. 2019). 63 Thomas & Cox, supra note 50, at 1284 & 1289; Cf. Bainbridge, supra note 53, at 1–2, 11, and 158.

Corporate liability: a systems perspective  49 practices when trying to understand them.64 In observing the operating company, rarely will we notice the presence of – let alone the importance of – boards and directors.65 ‘Only in a crisis does’ the board rise beyond its monitoring role and ‘become an organ of action – and then only to remove existing executives that have failed, or to replace executives who have resigned, retired or died…’.66 More noticeable is the outsized influence of the senior and middle managers. The reality is that (in legal, analytical terms) the management of the company is delegated to the CEO and other senior officers. It is the company’s senior, middle and other managers who direct operations and who have the technical expertise and practical experience necessary for implementing the policies, procedures, routines, and cultures that reduce wrongdoing and harm causation. And it is the physical, technical operation of the company, with its attendant impacts upon the surrounding commercial, social and ecological environment, that cause the liability problems that this chapter is concerned with. Given this, it is the CEO and senior officers who are likely to exercise decisive influence over the company. Any change to company practices that the law seeks to effect must be brought about (or ‘executed’) largely through the managers.

V.

THE MANAGEMENT HIERARCHY

In developing a systems-managerial model of the company, we notice that the company formulates its plans and acts through its management apparatus and that courts can and do influence the behaviour of system components (managers, employees, causal mechanisms, and so on) by ‘tapping into’ this apparatus, through which commands can be issued, rules promulgated, incentives set, and so forth. Laws and regulations are transposed through adoption by company managers into internal policies, procedures, routines, and cultures that employees must adhere to. In order to appreciate this fully, we need an understanding of companies as managerial hierarchies.67 The managerial hierarchy encompasses the following broad dimensions: ● Hierarchical management structure:68 Formally, the general meeting sits atop the company’s decision-making hierarchy and the board sits below it. While these corporate organs are ‘involved’ in major strategic and policy decisions,69 most major corporate initiatives

Meadows, supra note 13, at 14. Leblanc & Gillies, supra note 47, at 14. 66 Peter Drucker, The Practice of Management 178 (1954); see also Marc Moore & Martin Petrin, Corporate Governance: Law, Regulation and Theory 174–75 (2017); Corporations and Securities Advisory Committee, Corporate Duties Below Board Level: Report ¶ 1.2 (2006). 67 Pioneering work in this area includes Barnard, supra note 25; Simon, supra note 7; Chandler, supra note 5; Mintzberg, supra note 28; Peter A. French, Collective and Corporate Responsibility (1984). The discussion that follows is based upon organisation literature (the positive) and occasionally, especially in developing areas, on what best practice requires (the normative). In prior work, the present author examined the corporate group in systems-managerial terms: Christian Witting, The Corporate Group: System, Design and Responsibility 80 Camb. L. J. 581 (2021). 68 See, e.g., Jay R. Galbraith, Designing Organizations: Strategy, Structure and Process at the Business Unit and Enterprise Levels 22 (3d ed. 2014); Hatch, supra note 6, at 92–93, 242; Tracy Isaacs, Moral Responsibility in Collective Contexts 98 (2011); French, supra note 67, at 41, 48, and 51. 69 Galbraith, supra note 68, at 20; Mintzberg, supra note 28, at 156. 64 65

50  Research handbook on corporate liability come from senior management through the office of the CEO.70 These are implemented under the supervision of senior executives and middle managers. ● Allocation of responsibilities: The corporate organs and the CEO have formal responsibilities for organising company structures and for making key appointments. The general meeting appoints the directors, although this process is orchestrated by the board’s nomination sub-committee.71 The board makes appointments to its own sub-committees. The board/sub-committee confirms senior executive appointments,72 while lesser appointments are made through human resources. Appointments aside, the CEO and senior executives have responsibility for establishing the functions of each operating unit and for determining the relationships between them. The division of functions by grouping together persons with like skills and expertise, who undertake tasks at specified points in design, production and distribution processes,73 gives rise to specialisation.74 This manifests itself in departments (e.g., production, purchasing, and marketing) servicing the company as a whole.75 Significant management functions are delegated downwards76 so that they are closer to operations and responsive to the external environment. ● Power and authority relations: A corollary of the company’s management being ‘hierarchical’ is that higher committees and officers have power over lower officers and employees. This means that, if necessary, commands can be given that bind lower officers and employees to corporate purposes. In most cases, however, there is no need to issue commands.77 Most decisions within the company are communicated on the simple understanding that they just will be complied with. Indeed, Alfred P. Sloan (long-time President/CEO of General Motors) is famous for observing that he never gave an order.78 This is because of the existence of ‘authority relations’,79 which result from each officer and employee knowing their ‘ranking’ within the company’s management hierarchy and of their practical need to cooperate in pursuing company purposes. Company insiders understand that they can be sanctioned if they do not cooperate. The existence of authority relations (and of integrating mechanisms, considered later) negates the need for the use of commands and ensures that lower-ranking officers and employees ‘stick with the program’.80 This attests to the relative efficacy of the management hierarchy in pursuing company purposes.81

Leblanc & Gillies, supra note 47, at 63. Brenda Hannigan, Company Law ¶ 6-35 (5th ed. 2018). 72 Petrin, supra note 53, at 973–4. 73 Galbraith, supra note 68, at 34. 74 Alfred D. Chandler Jr., Scale and Scope: The Dynamics of Industrial Capitalism 230 (1st ed. 1990). 75 Hatch, supra note 6, at 91–92. 76 Penrose, supra note 7, at 46 and 49; Simon, supra note 7, at 7. 77 Mintzberg, supra note 28, at 3–4. 78 Manufacturing Intellect, Alfred P. Sloan Interview on Running a Successful Business, YouTube (1954), available at https://​www​.youtube​.com/​watch​?v​=​w52SYCtG94. 79 Scott & Davis, supra note 44, at 208; A.J. Grimes, Authority, Power, Influence and Social Control: A Theoretical Synthesis, 3 Acad. Mgmt. Rev. 724 (1978). 80 See, e.g., Drucker, supra note 66, at 138. 81 Id. at 131. 70 71

Corporate liability: a systems perspective  51 ● Coordination: Interactions between company units and with external partners must be coordinated by managers82 or by use of integrating mechanisms or automated processes.83 For decisions that need human implementation, these run down to middle managers,84 who coordinate the work of their units.85 Middle managers are crucial in implementing operational priorities and coordinating the work of those under their authority in order to implement changes86 – for example, in reducing the incidence of personal injuries and environmental damage.87 This might entail breaking down employee tasks, re-modelling mechanical processes, and changing operating standards. ● Integrating mechanisms: Other devices are available to the company in ensuring that company purposes are adhered to and that coordination is efficient – these being important, especially, in the exercise at lower, technical levels of residual discretion. In the organisation theory literature, these devices are referred to as ‘integrating mechanisms’.88 Integrating mechanisms ensure the efficacy of company units and operations by aligning executives and employees with the purposes of the company. They include company policy documents and manuals,89 training and indoctrination,90 committees and other coordinating devices, meetings and away-days, intra-corporate rotations through the divisions, and social events that extend into the private sphere. Through their use, each corporate participant is prompted to make decisions in ways that the company prefers without having to be instructed to do so.91 As such, integrating mechanisms constitute an indirect means of control which, because they displace the need for individual commands, ensure managerial efficiency. All of this holds true for medium- and large-sized companies involved in production and distribution processes that require exactitude in timing and other aspects of the coordination of operations.92 While likely to be less significant in ‘dynamic’ sectors of the economy in which innovation and adaptability are important,93 even companies operating in such sectors require a certain level of structure and managerial coordination regarding operational matters subject, for example, to health and safety and environmental laws, regulations, and standards. Indeed, by definition all organisations feature a minimum level of hierarchy, structure, and coordination.94 Galbraith, supra note 68, at 34 and 74. Id. at 39–40. 84 Derek S. Pugh, Does Context Determine Form?, in Organization Theory: Selected Classic Readings 34 (Derek S. Pugh ed., 5th ed. 2007). 85 Chandler, supra note 5, at 12; Mintzberg, above note 28, at 26. 86 Felix Reimann et al., Local Stakeholders and Local Legitimacy: MNEs’ Social Strategies in Emerging Economies, 18 J. Int’l Mgmt. 1, 11–12 (2012). 87 Mark A. Cohen et al., Deepwater Drilling: Law, Policy, and Economics of Firm Organization and Safety, 64 Vand. L. Rev. 1853, 1856 (2011). 88 Hatch, supra note 6, at 101; Mintzberg, supra note 28, at 3. 89 Mintzberg, supra note 28, at 5–7, 11, and 30–31. 90 Id. at 95. 91 Susanna Kim Ripken, Corporate Personhood 101 (2019); Simon, supra note 7, at 13; see also W. Richard Scott, Institutions and Organizations 152 (4th ed. 2014). 92 Hatch, supra note 6, at 151; Mintzberg, supra note 28, at 92. 93 Hatch, supra note 6, at 94 and 103; Tom Burns, Mechanistic and Organismic Structures, in Organization Theory: Selected Classic Readings 103 (Derek S. Pugh ed., 5th ed. 2007). 94 See Hatch, supra note 6, at 102–103. 82 83

52  Research handbook on corporate liability

VI.

FEEDBACK MECHANISMS

When the company fails to adhere to regulatory standards and/or criminal and tort laws, the imposition of a penalty or damages award is (in systems terms) communicated to the company through its feedback mechanisms, alerting persons such as the CCO, the compliance team, lawyers, and human resources personnel to the need to adhere to relevant norms in order to avoid future financial and reputational detriment. Frequently this leads to internal corporate changes.95 In more detail, the company responds to the imposition of a penalty or damages award in the following ways: ● Sense-making: The imposition of liability triggers a negative feedback mechanism and causes the company to engage in a process of sense-making.96 Sense-making might entail an investigation into what went wrong. Investigations might be conducted, in the case of intentional misconduct, by lawyers, compliance officers, and/or HR personnel, and, in the case of accidents, by compliance officers and/or health and safety representatives. ● Risk-management: In most cases, managers have an inherent interest in ensuring that their companies adhere to laws and avoid large – especially solvency-threatening – liabilities.97 As a result of ‘specific deterrence’,98 fines and/or civil awards against the company induce responses designed to avoid future liability. This might begin as a planning exercise at a senior managerial level99 or as a more technical exercise of ‘risk-management’ among in-house counsel/the compliance team.100 Judgments are construed by counsel and/or compliance officers101 and advice prepared about what they entail for the company’s compliance officers and middle managers.102 As such, norms and standards are adopted for future action. ● Implementation of change: Any necessary changes must be implemented. Senior managers should be able to effectively monitor middle-managers with delegated powers and operations managers responsible for risky processes and the conduct of individuals.103 There should be proper systems of internal disclosure and accountability by which information about risks makes its way from worksites to managers.104 Senior managers must design systems to counter inevitable human errors as well as person-specific behavioural tendencies.105 They should also ensure the existence of effective systems of internal discipline.106

Cf. Cunningham, supra note 58 (doubtful about efficacy of internal controls). Scott, supra note 91, at 237. 97 Nina A. Mendelson, A Control-Based Approach to Shareholder Liability for Corporate Torts, 102 Colum. L. Rev. 1203, 1247 (2002). 98 See, e.g., Lawrence M. Friedman, Impact: How Law Affects Behavior 97 (2016); Guido Calabresi, The Cost of Accidents 95 (1970). 99 Cohen et al., supra note 87, at 1856. 100 See, e.g., Christine Parker, The Open Corporation: Effective Self-regulation and Democracy 115–17 (1st ed. 2002). 101 Scott, supra note 91, at 237–38. 102 James A. Fanto, The Professionalization of Compliance: Its Progress, Impediments, and Outcomes, 35 Notre Dame J. L. Ethics & Pub Pol’y 183, 190, and 196–97 (2021). 103 Parker, supra note 100, at 116. 104 See discussion below. 105 See, e.g., Cohen et al., supra note 87, at 1856. 106 See discussion below. 95 96

Corporate liability: a systems perspective  53 ● Middle managers: Companies direct, restrain, and influence the actions of workers and others by issuing commands, through the operation of authority relations, and use of ‘integration mechanisms’, which orient action towards organisation goals, limit individual discretion, and embed standards of interaction. Typically, new norms or standards will be introduced by or under the supervision of middle managers. Changes might be implemented by altering the ways in which workshops are configured, adopting new or revised policies and operational manuals,107 or through training programmes,108 monitoring activities,109 improvement in organisational culture, and so on. Many of these processes will be devised by the company’s compliance team.110 ● Internal discipline: The imposition of liability against the company triggers the ‘internal enforcement’ process. When company executives and employees fail to perform as required, there are various means by which the company can discipline them. One is the use of the Caremark action available against directors and senior officers, to be considered later. Leaving this aside, other measures available internally include demotion, reassignment, reprimands, and retraining. In the case of serious or ongoing transgressions, relationships with employee/agents might be terminated.111 Often, these measures are resorted to without external prompting so as to ensure that the company complies with its legal operations and functions effectively. All of this underlines the ability of lawmakers (regulators, courts applying criminal and tort law) to impose standards of conduct, which provide guidance to those subject to them, and thereby deter (as far as law reasonably can) wrongdoing. The contention is that medium- and large-sized companies have an enhanced capacity to interpret and learn from court orders and the norms of conduct they promote. They are ‘deterrable’112 because of the forward-looking nature of their decision-making,113 their ability to formulate norms of behaviour, the structures through which decisions are implemented, and the managerial ability to compel employees to comply with decisions. The evidence from meta-studies is that regulatory/tort law does deter, if only modestly,114 and that the effect is greatest upon governmental agencies115 and larger companies.116 Deterrence is more likely to be realised with respect to companies that have been subject to legal actions themselves (specific deterrence) than with respect to those that simply Parker, supra note 100, at 116. Id. at 116. 109 Id. 110 Fanto, supra note 102, at 196–98 and 200. 111 Jennifer H. Arlen & W. MacLeod, Beyond Master-Servant: A Critique of Vicarious Liability, in Exploring Tort Law 120 (M. Stuart Madden ed. 2005). 112 Friedman, supra note 98, at 113. It is assumed herein that companies deploying their compliance systems to adhere to standards and to avoid liabilities are heavily influenced by deterrence imperatives. See Parker, supra note 100, at 69; Robyn Fairman & Charlotte Yapp, Enforced Self-Regulation, Prescription, and Conceptions of Compliance within Small Businesses: The Impact of Enforcement, 27 Law & Pol’y 491, 497 (2005). 113 Deborah A. DeMott, Organizational Incentives to Care about the Law, 60 Law & Contemp. Probs. 39, 54 (1997). 114 Friedman, supra note 98, at 137. 115 James F. Spriggs, The Supreme Court and Federal Administrative Agencies: A Resource-Based Analysis of Judicial Impact, 40 Am. J. Pol. Sci. 1122 (1996). 116 Christopher Hodges, Law and Corporate Behaviour: Integrating Theories of Regulation, Enforcement, Compliance and Ethics 39 (2015). Note that Hodges is a sceptic about deterrence. Id. at 107 108

54  Research handbook on corporate liability learn from the experience of others (general deterrence).117 Larger companies are more likely than not to be compliant with regulatory/tort norms because they are monitored internally through the managerial hierarchy118 and externally by parties, such as credit-rating agencies and corporate advisory firms.119 Usually, larger companies have the financial wherewithal to implement norms of good conduct,120 and, because of their community ‘presence’, they must be mindful of their reputations.121

VII.

LAW AND COMPANY LIABILITY

The systems-managerial understanding of companies has three immediate liability-related implications worth noting. First, the company is a responsible actor in its own right. It can be held to account separately from individual participants,122 in part because corporate decisions might not overlap fully with what any individuals desire and because some ‘decisions’ might be the result of the continued application of old policies or of omissions.123 Second, it is not enough to impose company-level liability when trying to stamp out wrongdoing. Companies can act only through their managerial hierarchies and through the individuals who occupy relevant roles.124 Third, in order to ensure the effective pursuit of the law’s goals, lawmakers and regulators need to ensure clarity in the legal messages given to companies, their management, and employees about legal responsibilities – which might mean, for example, emphasising the fundamental idea that individual participants’ first loyalty is towards the laws of the societies in which they live and, against the objections of many private law scholars, the legitimacy of deterrence objectives. Participants should be protected by whistle-blower and other programmes that promote fidelity to governing laws and standards at all levels in the company. This idea of fidelity to law leads us to a discussion of the Caremark duty. A.

Caremark Liability

US courts recognise in company directors a fiduciary ‘duty to be active monitors of corporate performance’.125 This is the ‘Caremark duty’, which is a mechanism for internalising regulatory, criminal law, tort law, and other standards through governance-cum-managerial process108–9 & 142. Yet he recognises potential deterrent effect through the managerial hierarchy (id. at 153–5 & 510) and even states that the problem might be over-deterrence (id. at 144). 117 Id. at 143 (discussing literature). 118 Fanto, supra note 102, at 183. 119 Robert A. Kagan et al., Fear, Duty, and Regulatory Compliance, in Explaining Compliance: Business Responses to Regulation 37 (C. Parker & V. Lehman Nielson eds., 2011). 120 Parker, supra note 100, at 96. 121 Friedman, supra note 98, at 164 & 173; Parker, supra note 100, at 77. 122 See, e.g., Micheler, supra note 6, at chs. 1–3; BG King et al., Finding the Organization in Organization Theory: A Meta-Theory of the Organization as Social Actor, 21 Org. Sci. 290, 293–4 (2010). 123 Isaacs, supra note 68, at 30. 124 Id. at chs. 4–6. 125 In re Caremark International Derivative Litigation 698 A.2d 959, 967 (Del. Ch. 1996). Space precludes discussion of the English position but see Brumder v. Motornet Service and Repairs Ltd [2013] 1 WLR 2783 47, 49 (Eng. C.A.).

Corporate liability: a systems perspective  55 es.126 It is significant because the obligations that it instils operate upon the very individuals who have the formal management and control of companies.127 So, whereas they might not otherwise be eager to expend company resources on internal compliance and control (given their frequently limited tenure and short-term outlook),128 Caremark has created ‘internal recognition among directors that they ha[ve] an obligation to build [sub-]systems that would monitor for risks’.129 The idea is that ‘oversight programs allow directors to intervene and prevent frauds or other wrongdoing that could expose the company to risk of loss as a result of such conduct’.130 Failures to reach minimal obligations to oversee the company leave company directors open to litigation aimed at compensating the company for losses incurred because of the need to pay criminal/regulatory fines, compensate tort claimants, and so on.131 As such, Caremark liability has a systemic dimension, which is absent from other forms of liability such as the liability of individual corporate participants to external parties in tort. In greater detail, Caremark sets out two kinds of obligation. First, there is an obligation to ensure that the company has in place sub-systems of management and control that in concept and design are reasonably adequate for assessing operational risks.132 As explained in the seminal case of In re Caremark International Derivative Litigation, directors must ensure:133 that information and reporting systems exist in the organisation that are reasonably designed to provide to senior management and to the board itself timely, accurate information sufficient to allow management and the board, each within its scope, to reach informed judgments concerning both the corporation’s compliance with law and its business performance…

Second, directors have an obligation to actively monitor the company and its compliance with the law to prevent wrongdoing that exposes the company to liability and subsequent losses.134 As Chancellor Allen stated in Caremark,135 ‘plaintiffs would have to show either (1) that the directors knew or (2) should have known that violations of law were occurring and, in either event, (3) that the directors took no steps in a good faith effort to prevent or remedy that situation, and (4) that such failure proximately resulted in the losses complained of’. Liability under this second prong typically arises when the directors fail to respond to ‘red flags’ in the company’s ‘mission critical’ regulated activities.136 Aneil Kovvali, Essential Businesses and Shareholder Value, 2021 U. Chi. L.F. 191, 213 (2021). Thus, it is likely to be more effective than other means by which good decision-making and values can be encouraged by external parties, such as institutional investors, hedge funds, and proxy advisors. As to the latter, see, e.g., Kobi Kastiel & Yaron Nili, The Corporate Governance Gap, 131 Yale L.J. 782, 795–97 and 802–12 (2022). 128 See John Armour et al., Taking Compliance Seriously, 37 Yale J. on Reg. 1 (2020). 129 Kovvali, supra note 126, at 208. 130 In re Citigroup Inc Shareholder Derivative Litigation 964 A.2d 131 (Del. Ch. 2009). The focus of what follows is, thus, upon primary infringement of laws by the company and the consequences for directors and managers. 131 In re Caremark International, 698 A.2d 970; see also In re Clovis Oncology, Inc Derivative Litigation, 2019 WL 4850188, *42 (Del Ch, 2019). 132 In re Caremark International, 698 A.2d at 970. 133 Id. at 969; see also Stone v. Ritter, 911 A.2d 362, 373 (Del. 2006); Marchand, 212 A.3d at 821. 134 In re Caremark International, 698 A.2d at 961; Marchand, 212 A.3d at 809; Teamsters Local 443 Health Services & Insurance Plan v. Chou, 2020 WL 5028065, *51 (Del. Ch. 2020). 135 In re Caremark International, 698 A.2d at 968–69 and 971. 136 Stone, 911 A.2d at 373; In re Citigroup, 964 A.2d at 131; Marchand, 212 A.3d at 809. 126 127

56  Research handbook on corporate liability Caremark liability is scienter-based. This means that a plaintiff bringing a derivative suit on the company’s behalf needs to demonstrate ‘bad faith’, which can be done, for example, by ‘properly alleging particularized facts that show that a director consciously disregarded an obligation to be reasonably informed about the business and its risks or consciously disregarded the duty to monitor and oversee the business’.137 Proof of such negates certificate of incorporation exculpation clauses that are typical in Delaware companies. Exculpation clauses do not exempt directors from personal liability in cases involving bad faith.138 Of course, courts are careful about making findings of bad faith. The scope of liability, moreover, is restricted under the first prong of Caremark because the conduct to which liability attaches is confined by a generous business judgment rule. As to this, Chancellor Chandler in In re Citigroup Inc Shareholder Derivative Litigation explained:139 The business judgment rule ‘is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.’140 The burden is on plaintiff[ ], the party challenging the directors’ decision, to rebut this presumption. Thus, absent an allegation of interestedness or disloyalty to the corporation, the business judgment rule prevents a judge or jury from second guessing director decisions if they were the product of a rational process and the directors availed themselves of all material and reasonably available information. The standard of director liability under the business judgment rule ‘is predicated upon concepts of gross negligence’.

Following Marchand v. Barnhill,141 the Caremark duty has become a more important mechanism for internalising proper standards of conduct and for deterring corporate wrongdoing. The Delaware Supreme Court held that directors must ensure that: a board sub-committee is created with responsibility for safety and regulatory compliance issues; there are sub-systems in place to ensure that management supplies the board with information about safety/regulatory compliance; and the full board considers key safety/regulatory compliance issues facing the company on a regular basis.142 And in the recent case of In re Boeing Company Derivative Litigation,143 Zurn VC observed that Caremark requires that ‘the board rigorously exercise its oversight functions with respect to mission critical aspects of the company’s business, such as the safety of its products that are widely distributed and used by consumers’.144 New emphasis is placed upon boards being proactive in their oversight of safety and other compliance risks.145

In re Citigroup, 964 A.2d at 125; see also Marchand, 212 A.3d at 820 (plaintiff must show bad faith). 138 Marc T. Moore, Redressing Risk Oversight Failure in UK and US Listed Companies: Lessons from the RBS and Citigroup Litigation, 18 Eur. Bus. Org. L. Rev. 733, 739–40 (2017). 139 In re Citigroup, 964 A.2d at 124. The use of the BJR has been criticised: Donald C. Langevoort, Compliance as Risk Management, in The Cambridge Handbook of Compliance 129–30 (B. Van Rooij & DD Sokol eds., 2021). 140 Citing Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). 141 Marchand, 212 A.3d 805. 142 Id. at 822. 143 In re Boeing Company Derivative Litigation, 2021 WL 4059934 (Del. Ch. 2021). 144 Id. at *74; In re Teamsters Local 443, at *51, Glasscock VC wrote of the need for ‘active[ ] exercise [of] oversight duties in order to properly discharge’ duties in good faith. 145 Roy Shapira, Max Oversight Duties: How Boeing Signifies a Shift in Corporate Law, 48 J. Corp. L. 119 (2022). 137

Corporate liability: a systems perspective  57 They can be made liable not only for what they knew, but for what they should have known; not only for what they have done, but for what they should have done.146 B. Caremark Liability of Senior Officers The Caremark cases reveal important insights into the operation of medium- and large-sized companies, which confirm the potential for incoherence in a liability regime that focuses single-mindedly on directors while senior officers call most of the shots and constitute the crucial link in the chain of responsibility for the transposition of regulatory, criminal, and tort laws into operational standards.147 The incoherence arises because modern boards comprise mostly independent directors with limited commitment to the companies they serve.148 The modern board does not in fact manage the business and affairs of the company,149 but (as stated earlier) performs a much more modest and selective monitoring role.150 It is little wonder, then, that Caremark has been said previously to induce little more than compliance box-ticking from (especially the independent) directors,151 although board sub-committees with defined roles152 hopefully counter this type of laxity. While courts exercising Delaware jurisdiction have asserted the applicability of Caremark to ‘senior officers’,153 the extent of their liability exposure is unclear because they are not subject to derivative claims with any frequency.154 Lawmakers should clarify that the standards that Caremark imposes apply, suitably modified, to all those senior managers in the company whose roles are functionally important.155 One reason for this is that senior managers with functionally important roles are best placed to transpose external legal obligations into internal company agendas for reform.156 They are best placed to ensure that management systems Id. Stone, 911 A.2d at 372. Delaware courts have recognised that ‘[m]ost of the decisions that a corporation, acting through its human agents, makes are, of course, not the subject of director attention’: Marchand, 212 A.3d at 823. 148 The average number of board positions occupied by directors of S&P 500 Companies is 7.8: Kastiel & Nili, supra note 127, at 838. Assuming a 50-hour working week, this provides independent directors with 22 hours a month in which to focus on the problems of any company. By contrast, each senior executive would have over 200 hundred hours per month. 149 This stems from the Delaware mantra that the board of directors manages the business and affairs of the corporation: Aronson, 473 A.2d at 811. 150 Thomas & Cox, supra note 50, at 1284 and 1289; Armour et al., supra note 128, at 32. 151 Armour et al., supra note 128, at 8; cf. Martin Petrin, Assessing Delaware’s Oversight Jurisprudence: A Policy and Theory Perspective, 5 Va. L. & Bus Rev. 433, 473 (2011); Martin Petrin, The Curious Case of Directors’ and Officers’ Liability for Supervision and Management: Exploring the Intersection of Corporate and Tort Law, 59 Am. U. L. Rev. 1661 (2010). 152 See, e.g., Gross v. Biogen Inc, C.A. No. 2020-0096-PAF (Del. Ch. 2021). For insight into the pressures that audit committees face, see Leo E. Strine et al., Caremark and ESG, Perfect Together: A Practical Approach to Implementing an Integrated, Efficient, and Effective Caremark and EESG Strategy, 106 Iowa L. Rev. 1885, 1915–17 (2021). 153 In re World Health Alternatives, Inc., 385 BR 576, 591 (Bkrtcy. D. Del. 2008); Stanziale v. Nachtomi (In re Tower Air, Inc) 416 F.3d 229, 234 (3d Cir. 2005). 154 Prima facie, officers owe the same fiduciary duties as directors: Gantler v. Stephens, 965 A.2d 695, 708–709 (Del. 2009). But see Deborah DeMott, The Character and Consequences of Executives’ Duties, 19 Austl. J. Corp. L. 251, 252 (2006). 155 The chances of liability are low. Petrin, supra note 53, at 1012–13. 156 See Corporations and Securities Advisory Committee, supra note 66, ¶ 3.2. 146 147

58  Research handbook on corporate liability respond to risks and attendant legal obligations.157 Having said this, some tricky issues attach to the question of non-director senior manager (NDSM) liability that the courts will need to work through as cases arise. NDSMs do not have the formal, legal powers of directors and cannot act inconsistently with board mandates. They might not have access to the same amount of information that the CEO has. In this way, it might be inappropriate to impose full-strength obligations upon them. Against this, as the systems-managerial approach has demonstrated, NDSMs ordinarily have much greater practical power than part-time directors. And, to the extent that their activities are technical (rather than policy-infused) they should have a lesser claim to protection under the business judgment rule.158 As such, they are amenable to suitably tailored Caremark obligations. C.

Vicarious Liability

The last lesson of the systems-managerial model of the company that we can discuss in the space available relates to the imposition of vicarious liability. Under the conception adopted here, vicarious liability and other strict liability doctrines indicate the unwanted outcomes that organisations are responsible for. Because responsibility is fixed in advance and there is no non-fault escape route, the company has reasons to ensure that its policies, procedures, routines, and cultures are geared towards preventing the unwanted outcome – which in the case of vicarious liability is employee torts. The systems-managerial model helps us see some important points about the company’s vicarious liability, especially as regards the proper extent of liability and the way it should work to achieve compliance/deterrence. First, the systems-managerial model provides a coherent explanation of why vicarious liability attaches to the acts of employees rather than independent contractors.159 This has to do with which persons fall within the company’s managerial hierarchy and decision-making competence. As Barnard noted, official communications are authoritative only within the organisation itself and ‘have no meaning’ to persons outside it.160 A company’s management hierarchy, prima facie, does not encompass the activities of external counterparties. Employees and interns fall within company boundaries, while auditors, suppliers, and independent contractors prima facie do not. In the latter case, Acme Co can make only those specific demands permitted by way of contractual agreement with Independent Co. Of course, Independent Co’s employees – who do the work – are not parties to the contract with Acme. Rather, they have their own positions within Independent’s managerial hierarchy and respond to commands and requests that come from its managers. (This scenario is different from Various Claimants v. Catholic Child Welfare Service,161 in which the UK Supreme Court acknowledged the ‘akin-to-employees’ category of worker. In CCWS, the brother teachers were required to adhere to commands and requests from both the employing schools and the defendant.)

See Stanziale, 416 F.3d 229. DeMott, supra note 154, at 252. 159 Restatement (Third) of Agency § 7.03(2)(b) (Am. L. Inst. 2006); Various Claimants v. Barclays Bank plc [2020] 2 WLR 960 (UKSC). 160 Barnard, supra note 25, at 173. 161 Various Claimants v. Catholic Child Welfare Service [2013] 2 AC 1 (UKSC). 157 158

Corporate liability: a systems perspective  59 Although doubt about where the liability borderline lies is not entirely a bad thing if it creates extra vigilance,162 clear cases in which workers respond primarily to the wishes of Independent Co ought not to be treated as Acme’s responsibility. So, while there is a case for treating individual contractors, whose functions are integral to the company engaging them (through contract) and who work primarily for that company as akin to company employees, these requirements were not fulfilled in Various Claimants v Barclays Bank plc,163 in which a wrongdoing doctor was engaged on a consultation basis only. He had other clients. The UK Supreme Court’s decision affirms that lines must be drawn where it is sensible to do so. The problem with extending vicarious liability too far beyond employees is that, although it helps satisfy the compensation goal, it undermines the deterrence goal. Deterrence can be achieved only through the imposition of liability upon the company the managerial hierarchy of which is competent to issue commands to the workers in question. Second, the systems-managerial model helps explain how vicarious liability should work to achieve deterrence outcomes. Unlike fault-based torts such as trespass torts (which define unwanted conduct) or negligence (which sets a general standard of reasonableness in action), vicarious liability is a strict liability doctrine; liability arises regardless of fault. In this way, vicarious liability looks forward rather than backwards. It ‘focuses energies on prevention, on systematic and proactive efforts’ to avoid harms ‘rather than discrete reactions to specific known instances of misconduct’.164 The threat of its imposition creates an ongoing pressure upon the company to find ways to prevent employee torts.165 Basically, vicarious liability facilitates the setting of standards of conduct by organisations themselves.166 Delegated standards-setting is enabled by the management hierarchy and internal control mechanisms.167 Medium- and large-sized companies, especially, have important capacities (already outlined) for planning and coordinating the work of large numbers of people, and these companies conduct their operations on a recurring basis. Fixing them with responsibility should either lower activity levels168 or increase effective precaution-taking.169

VIII. CONCLUSION This chapter develops a systems-managerial model of the company. It has argued that the company corresponds to the description of a ‘system’ because it inter alia features multiple components which are coordinated according to company purposes, interacts with its environment, and responds to changes in its environment signalled by its feedback mechanisms.

162 See Arlen & MacLeod, supra note 111, at 114–15 (noting the incentives vicarious liability creates to outsource to thinly capitalised independent contractors so that expansion of liability might be called for). 163 Barclays Bank plc, [2020] 2 WLR 960 ¶ 2. 164 DeMott, supra note 113, at 54. 165 See, e.g., Mohamud v. Wm Morrison Supermarkets plc [2016] AC 677 ¶ 62 (UKSC); DeMott, supra note 113, at 50 & 54. 166 DeMott, supra note 113, at 54. 167 Id. at 52; Arlen & MacLeod, supra note 111, at 120. 168 Kenneth S. Abraham, Strict Liability in Negligence, 61 DePaul L. Rev. 271 (2012). 169 Israel Gilead, On the Justifications of Strict Liability, in European Tort Law 2004 31 & 48 (H. Koziol & B.C. Steininger eds., 2004).

60  Research handbook on corporate liability The chapter argues, further, that the company can be understood as a managerial system and endeavours to demonstrate this through extensive reference to organisation theory literature. The main point is that each company features a decision-making hierarchy through which action in coordinated. The model allows us to see important things. First, the breach of Caremark-type duties, which entail the liability of directors and senior officers to the company, is a type of feedback signalling to the company and its management that internal reform is required. In this way, courts are able to commandeer the managerial hierarchy in order to ensure the adoption of better corporate policies, procedures, routines, and cultures. Second, vicarious liability is most coherent when imposed for torts of employees rather than independent contractors. This follows from the fact that a company’s managerial hierarchy is of limited reach. Companies can better control the conduct of employees than they can that of independent contractors.

PART II CORPORATE LIABILITY

4. Corporate law and statutory liability Deirdre Ahern

I. INTRODUCTION Although debate on the attribution of liability to companies often focuses on common law offences and non-statutory causes of action, in reality, companies and their officers face considerable potential for legal liability for acts and omissions arising out of statutory causes of action: they are subject to an ever-increasing body of rules that have been placed on a statutory footing. Both criminal and civil liability are of interest here. Corporate statutory liability has a long pedigree; since section 2 of the Interpretation Act 1889 (UK), ‘person’ has been understood to include a body corporate as well as a natural person.1 Although less frequently explored in a systematic way by scholars, a central plank of the accountability of companies concerns (i) how effectively they are held to account by individual criminal and civil statutory liability schemes; and (ii) the bigger picture of whether there is overall theoretical and operational cohesiveness and coherence in relation to statutory liability, including in relation to the growth of regulatory offences. In examining aspects of this terrain,2 the chapter focuses primarily on the UK legal system, while drawing on some comparative material and scholarship. Corporate statutory liability logically arises under legislation within the realm of company law, insolvency law and financial services law. Liability also potentially arises from the full spectrum of legislation that impacts on how each individual company carries on its affairs. Such legislation ranges from competition law to trade description law to occupational health and safety law. Given both the sheer breadth of the subject-matter of such legislation, and divergences of legislative approaches, the approach taken in this chapter is to focus analysis mainly on bigger picture questions in relation to diagnosing what policy choices and impacts are in evidence. Attention is also devoted to significant developments that have occurred in certain areas, what ought to change and what the future may hold. The chapter opens by broadly introducing aspects of regulatory philosophy and Parliamentary intent in relation to the statutory liability of companies which raise normative questions concerning regulatory goals. It then moves to consider models of attribution of statutory corporate liability. There has been a focus on tightening the liability net by creating bespoke targeted provisions establishing both civil and criminal liability. Often these are calculated to encourage a culture of compliance throughout companies. Legislative inventiveness evident in the crop of ‘failure to prevent’ offences is then probed. It is contended that reverse burdens of proof are justifiable for regulatory offences. Next, aspects of officer liability are considered. Interpretation Act 1889, 52 & 53 Vict c. 63 (Eng.). See now Interpretation Act 1978, c. 30 (Eng.). The terrain is vast, and of necessity this chapter is focused on highlighting thematic aspects, rather than offering a comprehensive consideration of the subject-matter. The most thorough treatments typically come from law reform bodies contemplating the potential need for reform. See, e.g., Law Commission of England and Wales, Consultation Paper on Criminal Liability in Regulatory Contexts (CP No 195 2010). 1 2

62

Corporate law and statutory liability  63 The chapter then moves to reflect upon observed and evolving legislative and judicial developments of note. These include the increasing interest in making companies and/or their officers liable for environmental, social and governance (‘ESG’) matters, not only in relation to the company, but also in relation to its worldwide operations and supply chain. Some thoughts on future directions are also offered, with an emphasis on the importance of coherent policymaking in this area for the future, and deeper systematic reflection on when civil liability may be preferable to criminalisation.

II.

REGULATORY GOALS AND REGULATORY COHERENCE

A.

Devising Regulatory Models

Consistent with the concession theory of corporations, there is a familiar tension between the facilitative objectives of company law, other public interest objectives of deterrence, and punishment and retributory objectives. However, a further important statutory objective is that of raising standards of conduct in corporate life. Civil and criminal legislation is being used as a regulatory tool and to change corporate behaviour and to judge it.3 Yet, to successfully achieve that while allowing for the realities of corporate organisation is complex. Furthermore, regulatory coherence matters, both doctrinally and in terms of application including matters of relative fairness and real-world consequences. Strict liability is often associated with what may be termed ‘regulatory breaches’, for example, in relation to health and safety.4 The open and shut nature of strict liability is designed to encourage companies to embed appropriate compliance regimes. UK companies legislation scores high on deterrence in attaching criminal labelling to liability even for lower order regulatory corporate non-compliance. One such example is the offence of failing to send the Registrar a copy of the company’s amended Articles within 15 days of their alteration, which attaches criminal liability both to the company and officers in default.5 Nevertheless, strict liability can be tempered by proportionality provisions. For example, although a criminal offence is committed by a UK company failing to lodge its amended articles with the Registrar on time,6 section 27 of the Companies Act 2006 (UK) provides an opportunity for the Registrar to issue a 28-day compliance notice. If compliance occurs within 28 days no criminal proceedings may be brought.7 If it does not comply, the company is liable to a civil penalty of £200. It is, however, still open to the authorities to initiate criminal proceedings.8 This is an example of a regulatory carrot and stick strategy being employed. Having said as much, the justifiability

3 Jeremy Horder, Bureaucratic ‘Criminal’ Law: Too Much of a Bad Thing?, in Criminalization: The Political Morality of the Criminal Law 101, 103 (R.A. Duff et al. eds., 2014); Samuel Walpole & Matt Corrigan, Fighting the System: New Approaches to Addressing Systematic Corporate Misconduct, 43 Sydney L. Rev. 489 (2021). 4 This applies to ‘no fault’ offences under the Health and Safety at Work etc. Act 1974, c. 37 (UK). 5 Companies Act 2006, c. 46, § 26(3) (UK). The same treatment occurs in relation to failing to notify the Registrar of where the Register of Members is kept. Id. at § 114(5). 6 Id. at § 26(3). 7 Id. at § 27(3). 8 Id. at § 27(4).

64  Research handbook on corporate liability of criminalising minor regulatory infractions and the differential regulatory treatment of the company and its officers are causes of concern.9 In other domains, legislative techniques are growing in sophistication. The Bribery Act 2010 (UK)10 (discussed below) was a breakthrough piece of public policy legislation designed to promote free and fair competition and is remarkable for its extra-territorial international scope and ambition. The Act applies, not just to companies incorporated in the UK irrespective of where they carry on business, but also to those not incorporated in the UK, but carrying on business in the UK.11 There is pressure on companies to implement meaningful compliance processes in order to avoid liability and reputational damage. However, looking at approaches to statutory liability of companies, one can observe a noticeable drift away from the traditional ‘command and control’ style model, a trend that is not surprising given that it is blunt and inflexible as a regulatory tool. Indeed, the command and control model with its focus on the deterrent of monetary sanctions is often woefully inadequate in the face of large and complex organisations,12 including corporate groups and multinationals. What we see now is an observable trend that is gathering momentum in the use of corporate statutory liability as a regulatory lever to effect best practice by indirectly impacting upon organisational culture13 and due diligence practices. This coheres with the growth of decentred regulation, associated with responsive regulation, new governance regulatory approaches and reflexive law.14 Public policy objectives can be achieved by regulatory framing that guides behavioural norms and outcomes rather than directly mandating them. As Doorey points out, decentred regulation involves regulatory power being wielded astutely ‘so as to provoke and steer self-reflection and self-regulation in ways that further state objectives’.15 Thus the public transparency associated with disclosure-based regulation encourages corporate actors to pull up their socks.16 Although decentred regulation includes soft law, it also includes statutory legal principles and associated liabilities. This type of regulation subtly floodlights the preferred public policy course of action. Thus ‘failure to prevent’ offences with associated due diligence defences17 force attention on risk and, by extension, internal corporate reflection and action on suitable risk management procedures.

In some instances the criminal liability consequences attach solely to the officer in default and not to the company. Companies Act 2006, § 228(5) (copy of director’s service contract or memorandum of terms to be kept for inspection); § 248(3) (failure to keep minutes of directors’ meetings); § 387 (failure to keep accounting records). 10 Bribery Act 2010, c. 23, § 7 (Eng.). 11 See id. at § 12(5). For another example of an Act with extra-territorial effect see Criminal Justice (Corruption Offences) Act 2018, No. 9, Acts of Parliament, 2018 (Ireland). On the meaning of ‘carrying on business’ see Akzo Nobel N.V. v. Competition Commission [2014] EWCA Civ 482. 12 Cynthia Estlund, Regoverning the Workplace: From Self-Regulation to Co-Regulation 76 (2010). 13 On culture, see Fiona Haines, Corporate Regulation: Beyond ‘Punish or Persuade’ 25 (1997). 14 Julia Black, Decentering Regulation: Understanding the Role of Regulation and Self-Regulation in a ‘Post-Regulatory World’, 54 Current Legal Probs. 103 (2001). 15 David J. Doorey, A Model of Responsive Workplace Law, 50 Osgoode Hall L.J. 47, 50 (2012). 16 Deirdre Ahern, Turning Up the Heat: CSR Reporting, Sustainability and the Parameters of Regulated Autonomy in the European Union, 13 Eur. Co. & Fin. L. Rev. 599 (2016). 17 These include the offences of failure to prevent bribery and failure to prevent facilitation of tax evasion discussed below. 9

Corporate law and statutory liability  65 As noted by Glanville Williams, when Parliament chooses to set down a statutory duty ‘it settles the value-judgment implicit[ly] …, supplanting the judge in deciding what risks inhere in the conduct and what means may be expected to be used to minimise the risk’.18 Statutory provisions sometimes have the objective of providing an alternative or successor to common law offences and torts such as the tort of negligence. Where Parliament steps in, its objective is often to plug a gap in the law to make it easier to make companies and their officers accountable. As such, legislative intervention can seek to rework the trajectory of corporate liability including the likelihood of the case being prosecuted, the proofs involved, and the deterrent and accountability outcomes for corporations and their officers. The Bribery Act 201019 replaced the antiquated common law offences of bribery and embracery and other restricted statutory provisions in the Prevention of Corruption Acts 1899 to 1916 (UK).20 Bespoke statutory offences specifically created to address corporate criminal liability and the ineffectiveness of pre-existing common law offences include the offences of corporate manslaughter,21 failure to prevent bribery,22 and facilitation of tax evasion.23 A challenge lies in designing penalties of an appropriate nature and scale for companies. The Corporate Manslaughter and Corporate Homicide Act 2007 (UK)24 provides scope to award an unlimited fine.25 Additionally, the court may devise remedial orders requiring companies to make good deficiencies in their policies and practices26 and the Act provides for ‘naming and shaming’.27 Of course, in assessing this landscape, realities concerning enforcement policy, including likelihood of prosecution and conviction, matter. Following the arrival of the Bribery Act 2010, official policy was initially to take a civil action under Part 5 of the Proceeds of Crime Act 2012 (UK)28 to extract the value of the business obtained though the unlawful conduct.29 A change of focus came with the arrival of Deferred Prosecution Agreements (‘DPAs’) in 2014 where the company ‘has demonstrated a genuine cooperation and a willingness to reform and where a DPA would be in the interests of justice’.30 The Post-Legislative Scrutiny of the Bribery Act endorsed the use of DPAs to encourage organisational change, stating ‘[t]he ability to influence the future conduct of an organisation, rather than just penalise past failures, makes a DPA an appropriate tool for addressing corporate economic crime, where the organisation fully and transparently cooperates with the authorities’.31

18 Glanville Williams, The Effect of Penal Legislation in the Law of Tort, 23 Mod. L. Rev. 233, 236 (1960). 19 Bribery Act 2010, c. 23 (UK). 20 Id. at § 17. In Scotland the equivalent common law offences of bribery and accepting a bribe were abolished. 21 Corporate Manslaughter and Corporate Homicide Act 2007, c. 19, § 1 (UK). 22 Bribery Act 2010, c. 23, § 7 (UK). 23 Criminal Finances Act 2017, c. 22, §§ 45 & 46 (UK). 24 Corporate Manslaughter and Corporate Homicide Act 2007, c. 19 (UK). 25 Id. at § 1(6). For the sanctioning of penalties of up to 10% of turnover, see Competition Act 1998, c. 41, § 36(8) (UK). 26 Corporate Manslaughter and Corporate Homicide Act 2007, § 9. 27 Id. at § 10. 28 Proceeds of Crime Act 2002, c. 29 (UK). 29 Ministry of Justice, Bribery Act 2010: Post-Legislative Scrutiny Memorandum, 2018, Cm. 9631, ¶ 21 (UK). 30 Id. 31 Id. at ¶ 116.

66  Research handbook on corporate liability In Australia, flexibility has arrived with civil penalty provisions replacing criminalisation and fines in many cases. This would be worth considering in other jurisdictions as part of a well thought out regulatory strategy. An exceptional instance in UK company law of imposition of a civil penalty on a company occurs in section 453 of the Companies Act 2006 (UK) in relation to failure to file company accounts and reports in accordance with section 441.32 In the United States, under the Comprehensive Environmental Response, Compensation, and Liability Act (US), known as ‘CERCLA’,33 the Environmental Protection Agency (‘EPA’) can require companies responsible for releases of contaminants or pollution or with dormant hazardous waste sites to assist in the clean-up operation. Contributing to environmental clean-up costs under CERCLA has not been regarded as involving a criminal penalty or providing punitive deterrence.34 B.

Framing Liability and Statutory Drafting Options

Issues of legislative framing loom large in the realm of corporate statutory liability. There are a host of drafting choices open to Parliament with a view to imposing liability. These were well-enumerated in the context of statutory offences by Davis LJ (sitting as a judge of the High Court) in Serious Fraud Office v Barclays plc,35 where he perceptively observed: It is always open to Parliament to draft statutory offences with the position of corporations in mind. For example, some statutes may impose strict liability: as, for instance in health and safety legislation or various regulatory offences. Another statutory technique is to provide for the existence of a criminal offence in specified circumstances but to make available a statutory defence, often with the burden of proof on the company (as in Tesco v Nattrass).36 A variant of that statutory technique is to impose general criminal responsibility on a corporation for the specified criminal offence but with a defence available to a corporation that it had adequate preventative procedures in place: as in s 7 of the Bribery Act 2010.37

Strict liability and absolute liability offences frequently feature in models of statutory lability for companies. Both are species of offences that do not require proof of a mental element of criminal fault. An absolute offence, as seen in the offence of failure to file company accounts38 is open and shut in nature, making no provision for a defence. Such offences can also be categorised as ‘duty-based offences’39 that directly attribute liability to the company.40 By contrast, a strict liability offence often provides for a due diligence type defence. This model is often used where liability attaches to company officers. For example, for the offence of default in See further The Companies (Late Filing Penalties) and Limited Liability Partnerships (Filing Periods and Late Filing Penalties) Regulations 2008, SI 497/2008 (UK). 33 Comprehensive Environmental Response, Compensation, and Liability Act, 42 U.S.C. § 9606 et seq. 34 Yarik Kryvoi & Shaun Matos, Non-Retroactivity as a General Principle of Law, 17 Utrecht L. Rev. 46 (2021). 35 Serious Fraud Office v. Barclays plc [2018] EWHC 3055 (QB). 36 Tesco Supermarkets Ltd v. Nattrass [1972] AC 153 (UKHL). 37 Id. at ¶ 103. 38 Companies Act 2006, c. 46, § 453 (UK). 39 Samuel Walpole & Matt Corrigan, Fighting the System: New Approaches to Addressing Systematic Corporate Misconduct, 43 Sydney L. Rev. 489, 500­–501 (2021). 40 See, e.g., R v. Gateway Food Markets Ltd (1997) 2 Cr App R 40 (CA Crim). 32

Corporate law and statutory liability  67 filing financial records and reports for a financial year, it is a defence for persons charged to prove that they ‘took all reasonable steps for securing that those requirements would be complied with before the end of that period’.41 Some statutory provisions provide for a right of action by a third party such as a liquidator while others are silent on rights of action. This has led to judicial clarification concerning the potential for civil liability to third parties for breach of statutory obligations which is of relevance to companies and their officers. In the early nineteenth century in Doe d. Murray v Bridges42 Lord Tenterden CJ outlined the general position that ‘where an Act creates an obligation, and enforces the performance in a specified manner... that performance cannot be enforced in any other manner’.43 In the absence of a statutory cause of action, a party would be restricted to any available remedies under the general law. Since then courts have been loath to imply the existence of civil remedies for breach of statutory duties where no express Parliamentary intent is evident.44 As such, it is well established in the UK that statutory obligations of a regulatory character under companies legislation do not typically permit private shareholder suits.45 While statutory intervention concerning fraudulent preferences may render an offending payment voidable, the existence of a statutory cause of action for recovery is a matter of statutory construction.46 That said, where statutory liability arises, in appropriate cases, the directors of the company may be sued separately for breach of their fiduciary and non-fiduciary duties as directors.47 The artificial nature of companies, being unable to act without human input, means that although the company may be classed as the wrongdoer, as in the case of unlawful financial assistance, ‘it is generally the victim of the wrong, not the real culprit’.48 Thus where statutory liability leads to an arrangement being classed as voidable rather than void, the company may be able to elect to enforce an otherwise illegal contract.49

III.

MODELS OF ATTRIBUTION AND STATUTORY LIABILITY

Given their status as non-natural persons, models of attribution are often used to attribute civil and criminal liability to corporate bodies. Attribution models in relation to statutory liability have evolved over time, with contributions from both the courts and Parliament. An important early-twentieth-century ruling came in Mousell Bros Ltd v London and North-Western Companies Act 2006, § 451(2). Doe dem Murray, Lord Bishop of Rochester v. Bridges (1831) 1 B. & Ad. 847. 43 Id. at 859. 44 Cutler v. Wandsworth Stadium Ltd [1941] AC 398 (UKHL); Lonrho v. Shell Petroleum Co Ltd (No. 2) [1982] AC 173, 185 (UKHL); Morison Sports Ltd v. Scottish Power plc [2010] UKSC 37. Limited exceptions do exist. See further, arguing for greater clarity: Eleanor J. Russell, Breach of Statutory Duty – Time to Jettison the ‘Guesswork Puzzle’?, 3 Jurid. Rev. 227 (2011). 45 See further John Armour et al., Private Enforcement of Corporate Law: A Comparative Empirical Analysis of the UK and the US, 6 J. Emp. Legal Stud. 697, 695 (2009). 46 Re J Leslie Engineers Co Ltd (In Liq) [1976] 1 WLR 292, 298 (Ch D); Skandinaviska Enskilda Banken AB (Publ) v. Conway [2019] UKPC 36. 47 See, e.g., Chapter 11 in this volume. 48 Belmont Finance Corpn Ltd v. Williams Furniture Ltd [1979] Ch 250, 261–262 (per Buckley LJ); Nature Resorts Ltd v First Citizens Bank Ltd [2022] UKPC 10, ¶ 69 (per Lady Arden JSC). 49 Nature Resorts Ltd v. First Citizens Bank Ltd [2022] UKPC 10, ¶ 34 (per Lord Briggs JSC and Lord Burrows JSC). 41 42

68  Research handbook on corporate liability Railway.50 In Mousell Atkin J recognised that, where Parliamentary intent could be ascertained from the purpose of the statute and the language used, vicarious liability for the acts of a servant or agent could be used to establish corporate liability for a statutory offence. This included liability for a statutory offence with a mental element where the mental state of the agent could be attributed to the company. The knowledge of the servant exercising delegated responsibility is attributed to the master where he is the legally responsible person under the relevant statute and has delegated his duties. This means that even where a manager has no knowledge of the breach of the law by his servant, he may be made liable for an absolute liability offence including where in delegating responsibility he has expressly instructed his servant not to carry out the infringing conduct.51 Thus in interpreting statutory offences under licensing legislation, the courts have been willing to allow criminal responsibility to be attributed to a master for the acts of a servant exercising delegated responsibility.52 Subsequently, the courts moved to favour attribution based on the identification doctrine founded on identifying the company’s human ‘directing mind and will’.53 The identification doctrine is entirely removed from a vicarious liability model, as the human actor is seen as the very mind of the company.54 An alternative view propounded by Colvin sees it as a ‘modified form’ of vicarious liability whereby ‘[i]nstead of all employees and agents having the capacity to make the corporation liable, only … persons with directorial or managerial responsibilities [have] this capacity’.55 The leading case of Tesco Supermarkets Ltd v Nattrass56 concerned a statutory prosecution for misleading advertising which ran aground because the House of Lords considered that a branch manager was too low in the hierarchy to constitute the company’s ‘directing mind and will’. The crux in terms of practical application is that in larger companies with diffuse structures or those that do not rely on a ‘top down’ management model and allow junior employees to assume responsibility, it can be harder to pin down responsibility while using assumptions that board and senior management drive all policy and operational decisions. Thus the identification doctrine ‘rewards companies whose boards do not pay close attention’.57 Assigning corporate culpability proves difficult.58 A subsequent judicial development – the Meridian59 effect – opened the door to alternative modes of attribution being recognised for affixing statutory liability (criminal or civil). The principles applicable to statutory offences were enlarged upon by Lord Hoffmann (whose judgments throughout his career were distinguished by judicial problem-solving and creativity Mousell Bros Ltd v. London and North-Western Railway [1917] 2 KB 836, 845–846. Allen v. Whitehead [1930] 1 KB 211. 52 Coppen v. Moore (No. 2) [1898] 2 QB 306; Allen v. Whitehead [1930] 1 KB 211; R v. Winson [1969] 1 QB 371 (EWCA). 53 This approach derived from Viscount Haldane LC in Re Lennard’s Carrying Co v. Asiatic Petroleum Co Ltd [1915] AC 705 (UKHL) and Lord Denning in HL Bolton (Engineering) Co Ltd v. TJ Graham & Co Ltd [1957] 1 QB 159 (EWCA). 54 This was cogently expressed in Tesco Supermarkets Ltd v. Nattrass [1972] AC 153, 170 (UKHL). 55 Eric Colvin, Corporate Personality and Corporate Crime, 6 Crim. L.F. 1, 13–14 (1995). 56 The leading case being Tesco Supermarkets [1972] AC 153 (concerning Trade Descriptions Act 1968, c. 29, § 24 (UK). 57 Law Commission of England and Wales, Corporate Criminal Liability: An Options Paper, ¶ 3.83 (2022). 58 R v. Andrews-Weatherfoil Ltd [1972] 1 W.L.R. 118 (EWCA). 59 Meridian Global Funds Management Asia Ltd v. Securities Commission [1995] 2 AC 500, 507 (PC). 50 51

Corporate law and statutory liability  69 often leading to judicial activism) giving the advice of the Privy Council in Meridian Global Funds Management Asia Ltd v Securities Commission.60 Here Lord Hoffmann recognised that an alternative to the identification doctrine could exceptionally arise – a special rule of attribution. Determining the appropriate model of attribution would require construction of the purpose of the legislation including its intended application to companies. Thus we have a pocket of corporate statutory liability provisions where the primacy of the ‘directing mind and will’ approach of the identification model is supplanted by a special rule of attribution based on legislative intent. An example is the bespoke civil liability investor compensation regime for misleading corporate disclosures and dishonest omissions by issuers.61 This is expressed to apply where a person ‘discharging managerial responsibilities’ within the issuer had knowledge of or was reckless in relation to a misstatement made or knew the omission dishonestly concealed what amounted to a material fact.62 The Meridian approach was purposively judicially applied to fill gaps in express legislative intent in Bank of India v Morris,63 where the Court of Appeal found a special rule of attribution of civil liability to a company for being ‘knowingly a party’ to fraudulent trading under section 213 of the Insolvency Act 1986 (UK).64 Mummery LJ stated: the wording of, and policy behind, s.213 indicate that it would be inappropriate, in the case of a company, to limit attribution for its purposes to the board, or those specifically authorised by a resolution of the board. To limit it in such a way would be to ignore reality, and risk emasculating the effect of the provision.65

The classical identification doctrine was statutorily supplanted in one important context by the Corporate Manslaughter and Corporate Homicide Act 2007 (UK).66 Its corporate manslaughter offence replaced the offence of manslaughter by gross negligence as it applied to companies and other organisations. Corporate liability for the section 1 offence is predicated on serious health and safety management failings which are the cause of a death in circumstances which amount to gross negligence through breach of a duty of care owed to the victim. The provision focuses on the acts and omissions of an organisation’s ‘senior management’ rather than its ‘directing mind and will’. For large companies and organisations, the Crown is required to identify the tier of management that it considers forming the lowest culpable level of the senior management team and to target the claim from there up.67 That said, given that the focus remains on senior management, the statutory approach taken to corporate manslaughter still resonates strongly with the identification theory and its directing mind approach. Other legislative drafting options exist to bypass the attribution conundrum. The deficiencies of the identification doctrine in attributing anthropomorphic liability in large, diffuse companies can be overridden by drafting a provision which creates direct corporate liability. Furthermore, a consequence of removing any statutory focus on a mental element is that

62 63 64 65 66 67 60 61

Id. Financial Services and Markets Act 2000, c. 8, § 90A and Sch. 10A (UK). Id. at Sch.10A, § 3(2), (3). Bank of India v. Morris [2005] EWCA Civ 693. Insolvency Act 1986, c. 45 (UK). Bank of India [2005] EWCA, ¶ 129. Corporate Manslaughter and Corporate Homicide Act 2007, c. 19, § 18 (UK). R v. Cornish [2015] EWHC 2967 (QB).

70  Research handbook on corporate liability a company’s inability to think for itself and the lack of knowledge of breach in a company’s higher echelons present no obstacle to affixing statutory liability.68 Statutory liability (both civil and criminal) built around absolute or strict liability does not require intent to ascertain culpability. Clear drafting will aid the statutory interpretation that is required to determine whether an offence is one of strict liability that does not require a mental element.69 An organic or organisational view of the corporation views corporate wrongdoing as a failure of the organisation itself, a systemic problem. This turns the spotlight on the quality of organisational systems that were in place, rather than focusing exclusively on the behaviour of individuals. Australia’s Criminal Code has provided for organisational attribution of criminal liability to corporations based on ‘corporate culture’ since 1995.70 A corporate body may be held liable for a federal criminal offence if its organisation, including its corporate culture ‘directed, encouraged, tolerated or led’ to non-compliance,71 or alternatively if it failed to maintain a culture that requires compliance.72 ‘Corporate culture’ is defined as ‘an attitude, policy, rule, course of conduct or practice existing within the body corporate generally or in the part of the body corporate in which the relevant activities take place’. Although lauded for its progressive approach,73 in assessing its effectiveness, the dearth of prosecutions is relevant to consider. Perhaps the concept of ‘corporate culture’ is too amorphous.74 The effectiveness of the provision may also have been inhibited by legislative policy choices. First, pre-existing legislative offences were allowed to remain on the statute book. Second, subject-specific legislation often rules out its application.75 Nonetheless the provision was prescient.76 Its thinking ties in with the now common corporate governance policy focus on culture and ‘tone from the top’.77 A.

The Failure to Prevent Liability Model

‘Failure to prevent’ corporate offences use strict liability, combining it with the availability of a due diligence style defence to liability. In doing so, the model addresses the over-inclusiveness of the vicarious liability model. The first failure to prevent offence was the failure to R v. British Steel plc [1995] 1 W.L.R. 1356 (EWCA). As the Law Commission notes, ‘[t]he courts have been generally happy to infer strict liability in relation to environmental pollution and food, product and workplace safety’: Law Commission of England and Wales, Corporate Criminal Liability: A Discussion Paper ¶ 2.16 (2021). 70 Criminal Code Act 1995 (Cth) s 12.3(2), (c) and (d) (Austl.). Since December 2001, this applies to all Australian Commonwealth offences. See further Jennifer Hill, Corporate Criminal Liability in Australia: An Evolving Corporate Governance Technique, J. Bus. L. 1 (2003). 71 Criminal Code Act 1995, s 12.3(2)(c). 72 Id. at s 12.3(2)(d). 73 James Gobert & Maurice Punch, Rethinking Corporate Crime 74 (2003); Law Commission of England and Wales, supra note 2, Appendix C: Celia Wells, Corporate Criminal Liability: Exploring Some Models 199. 74 Criminal Code Act 1995, s 12.3(6). 75 See, e.g., Occupational Health and Safety (Commonwealth Employment) Act 1991 (Cth) s 15 (Austl). 76 On the formative nature of the provision see Rick Sarre, Penalising ‘Corporate Culture’: The Key to Safer Corporate Activity?, in European Developments in Corporate Criminal Liability 84, 93 (James Gobert & Ana-Maria Pascal eds., 2011). 77 See, e.g., Financial Reporting Council (UK), Creating Positive Culture: Opportunities and Challenges (2021). 68 69

Corporate law and statutory liability  71 prevent bribery offence under section 7 of the Bribery Act 2010 (UK).78 This was subsequently emulated in the creation of offences of failure to prevent the facilitation of tax evasion in sections 45 and 46 of the Criminal Finances Act 2017 (UK).79 Despite support for introducing a new failure to prevent economic crime offence within the Financial Services Act 2021 (UK)80 (which contains provisions dealing with insider dealing and financial services offences), this did not come to pass because of a reluctance to pre-empt the then ongoing work of the Law Commission on corporate liability.81 The establishment of ‘failure to prevent’ offences evinces a regulatory desire to address corporate failings that cannot easily be pinned down given the shortcomings of the identification doctrine.82 The problem was well described by HMRC as follows: Bodies that refrained from implementing good corporate governance and strong reporting procedures were harder to prosecute, and in some cases lacked a strong incentive to invest in preventative procedures. It was those bodies that preserved their ignorance of criminality within their organisation that the earlier criminal law could most advantage.83

Failure to prevent offences go to the heart of corporate culture in providing a form of indirect liability for companies that is not predicated on establishing an underlying duty of care.84 Instead, these offences tackle an omission by a company to put in place reasonable precautions to prevent a wrong occurring. The existence of reasonable precautionary measures will provide a defence for a company against liability even if the wrong does take place. Thus, the failure to prevent offence in relation to bribery under section 7 of the Bribery Act 2010 will not be committed where bribery occurred but reasonable precautions against it were in place in the company. This recognises good faith efforts and the role of corporate policies and culture.85 The benefit of this approach is that it promotes good corporate policies and practices as well as due diligence in companies. In this regard, the ‘failure to prevent’ model appears like a natural legislative evolution from due diligence defence models.86 Some differences in legislative 78 Bribery Act 2010, c. 23, § 7 (UK). Australia is considering a failure to prevent bribery offence: the Crimes Legislation Amendment (Combatting Corporate Crime) Bill 2019 (Cth) (Austl.). 79 Criminal Finances Act 2017, c. 22, §§ 45 and 46 (UK). 80 Financial Services Act 2021, c. 22 (UK). 81 Herbert Smith Freehills, Parliamentary vote to introduce failure to prevent economic crime offence in the Financial Services Bill abandoned, pending Law Commission review, FSR and Corporate Crime Notes (19 January 2021), https://​hsfnotes​.com/​fsrandcorpcrime/​2021/​01/​19/​parliamentary​-vote​ -to​-introduce​-failure​-to​-prevent​-economic​-crime​-offence​-in​-the​-financial​-services​-bill​-abandoned​ -pending​-law​-commission​-review. On the potential extension of the failure to prevent offences to other forms of economic crime, see Law Commission of England and Wales, supra note 57. 82 HM Revenue & Customs, Tackling Tax Evasion: Government Guidance for the Corporate Offences of Failure to Prevent the Criminal Facilitation of Tax Evasion (2017) (UK). 83 Id. at 3. 84 See generally Nicholas Lord & Rose Broad, Corporate Failures to Prevent Serious and Organised Crimes: Foregrounding the ‘Organisational’ Component, 4 Eur. Rev. Org. Crime 27 (2018); Liz Campbell, Corporate Liability and the Criminalisation of Failure, 12 Law & Fin. Mkt. Rev. 57 (2018). 85 In Serious Fraud Office v. Standard Bank plc [2016] Lloyd’s Rep FC 102, ¶ 11 (Southwark Crown Court), the defendant bank’s policy was considered to be unclear and training insufficient, and the court was not satisfied that it had adequate procedures in place to prevent persons associated with it from committing bribery. 86 For example, Financial Services and Markets Act 2000, c. 8, § 23(1), (1A) (UK) criminalises the provision of financial services by non-authorised persons or by authorised persons operating in breach

72  Research handbook on corporate liability formulation exist. As Campbell notes, ‘[w]hereas the bribery defence refers to adequacy, the defence for tax evasion centres on reasonableness, and it remains unclear how we differentiate between these’.87 A sticking point has been the failure to translate the ‘failure to prevent’ offences into enforcement.88 The ‘failure to prevent’ model has led to considerable compliance costs but little in the way of prosecutions. It was assumed that the failure to prevent offence would become the usual conduit for corporate bribery prosecutions.89 To date UK prosecutions following investigation for bribery have been scarce, often due to insufficient evidence to warrant proceeding.90 It is also still early days in relation to enforcing the failure to prevent facilitation of tax evasion offences.91 Where companies refer instances of bribery to the Serious Fraud Office and cooperate with an investigation and make full disclosure, this is taken into account in deciding whether to institute criminal proceedings under the Bribery Act.92 The arrival of court-approved Deferred Prosecution Agreements (DPAs)93 presaged the Serious Fraud Office using these for ‘failure to prevent’ bribery, and often there are no prosecutions of ‘associated persons’. DPAs can be used to reflect cooperation and contrition by the relevant companies and associated financial settlements.94 Considerable corporate reputational damage can also accrue from the publicity surrounding a DPA. The time may now be ripe for tweaks to the ‘failure to prevent’ model. Indeed, the Law Commission (England and Wales) has set out a sensible list of general principles that could be adopted for these offences as well as suggesting new substantive areas for ‘failure to prevent’-style offences.95

of the terms of their authorisation. A defence is provided in § 23(3) where a company can show that it took all reasonable precautions and exercised appropriate due diligence to prevent the offence being committed. 87 Campbell, supra note 84, at 61. 88 Although investigations have been carried out, in 2021, four years after the Bribery Act came into force, there had not been an enforcement action on the failure to prevent the facilitation of tax evasion in the UK or foreign tax evasion. 89 Ministry of Justice, Bribery Act 2010: Post-Legislative Scrutiny Memorandum, 2018, Cm. 9631, ¶ 14 (UK). 90 As of 2021, just two companies had been convicted under s 7: the first was on a guilty plea: Serious Fraud Office v. Sweett Group plc 19 February 2016 (unreported) (Southwark Crown Court), the second on a jury conviction R v. Skansen Interiors Ltd 21 February 2018 (unreported) (Southwark Crown Court). 91 As of May 2022, HMRC had not made any charging decisions under §§ 45 and 46 of the Criminal Finances Act 2017 (UK). Seven investigations were live. 92 Secretary of State for Justice, The Bribery Act 2010: Guidance about Procedures Which Relevant Commercial Organisations Can Put into Place to Prevent Persons Associated with Them From Bribing (Section 9 of The Bribery Act 2010), 2011, ¶ 12 (UK). 93 Under the Crime and Courts Act 2013, c. 8 (UK), a DPA operates for a fixed term of 2–5 years to suspend the indictment of the organisation charged where the court declares that the DPA is in the interest of justice and that its terms are fair, reasonable and proportionate. A breach of the terms of the agreement provides grounds for the proceedings to be reactivated. 94 See supra text accompanying note 93. 95 Law Commission of England and Wales, supra note 57, Ch. 8.

Corporate law and statutory liability  73 B.

Reverse Burdens of Proof

It may be thought that reverse burdens of proof should be avoided and that failure to prevent style offences could be challenged on the basis of the need for caution around use of reverse burdens of proof.96 Indeed, the traditional approach in criminal prosecutions is that the onus lies on the prosecution to prove the case against the defendant.97 However, the principle that the accused does not bear a burden of proof is not absolute and the English courts have been willing to draw a distinction between regulatory offences with criminal consequences, on the one hand, and traditional-style criminal offences on the other.98 Reverse burdens of proof are often used in order to secure regulatory objectives. In Australia, the joint venture exception from prohibited cartels was legislatively amended to reverse the burden of proof such that the defendant must establish that the cartel was formed for the purposes of a joint venture and was reasonably necessary.99 For regulatory offences, a reversal of the burden of proof may qualify as justified, necessary and proportionate and therefore attract no ‘read down’ consequences under section 3 of the Human Rights Act 1998 (UK).100 Furthermore, there is judicial acceptance for reverse burdens of evidential proof in relation to due diligence defences. In the Canadian Supreme Court case of R v Wholesale Travel Group, Cory J. observed: If the false advertiser, the corporate polluter and manufacturer of noxious goods are to be effectively controlled, it is necessary to require them to show on a balance of probabilities that they took reasonable precautions to avoid the harm which actually resulted. In the regulatory context there is nothing unfair about imposing that onus; indeed it is essential for the protection of our vulnerable society.101

IV.

OFFICER LIABILITY

Over time, the understanding of an ‘officer’ under companies legislation broadened such that by the mid-twentieth century, ‘officer’ in relation to a body corporate included ‘a director, manager or secretary’.102 It now may be expanded to include others based on the intent of the provision in question.103 Targeting liability provisions at company officers acts as a deterrent and encourages corporate compliance. Personal liability provisions (including for fraudulent and wrongful trading) seek to withdraw the privilege of separate legal personality and limited liability from those deemed to have abused it. A pertinent criticism of the Corporate

See Salabiaku v. France, App. No. 10519/83, 13 Eur. H.R. Rep. 379, ¶ 28 (1988). Attorney General’s Reference No. 4 of 2002; Sheldrake v. DPP [2005] 1 AC 264, ¶ 9 (UKHL). 98 Sliney v. Havering London Borough Council [2002] EWCA Crim 2558; R v. Chargot Ltd (t/a Contract Services) [2008] UKHL 73 (health and safety offences). See also the Australian case of Kuczborski v. Queensland (2014) 254 CLR 51, [2014] HCA 46, ¶ 240 et seq. 99 Competition and Consumer Amendment (Competition Policy Review) Act 2017 (Cth) sch 2, pt 1, ss 12 and 13, No. 114 (Austl.). 100 Davies v. Health and Safety Executive [2002] EWCA Crim 2949. 101 R v. Wholesale Travel Group, (1991) 3 S.C.R. 154 (Can.). This was adopted by the English Court of Appeal in Davies v. Health and Safety Executive [2002] EWCA Crim 2949, ¶ 16. 102 Companies Act 1948, c. 38, § 455 (UK). 103 This is the effect of the Companies Act 2006, c. 46, § 1121(2) (UK). 96 97

74  Research handbook on corporate liability Manslaughter and Corporate Homicide Act 2007 is that it did not permit secondary liability to be imposed on corporate officers.104 The effect of officer in default liability (a core part of modern companies legislation) is to create secondary liability for any officer in default who ‘authorises or permits, participates in, or fails to take all reasonable steps to prevent, the contravention’.105 On occasion, statutory liability of an officer is founded upon ‘consent or connivance’ and ‘neglect’ (as seen in section 37(1) of the Health and Safety at Work etc. Act 1974 (UK)).106 In Attorney General’s Reference (No.1) of 1995,107 Lord Taylor indicated that to prove ‘consent’, a defendant must be shown to know the material facts which establish the offence by the body corporate and to have agreed to conduct the business of the company accordingly. It has subsequently been judicially suggested that this state of mind may be established by inference.108 In R v Chargot Ltd (t/a Contract Services) Lord Hoffmann said of sections 2(1) and 3(1) of the Health and Safety at Work etc. Act 1974:109 Where it is shown that the body corporate failed to achieve or prevent the result that those sections contemplate, it will be a relatively short step for the inference to be drawn that there was connivance or neglect on his part if the circumstances under which the risk arose were under the direction or control of the officer. The more remote his area of responsibility is from those circumstances, the harder it will be to draw that inference.110

In R v Hitchins111 the Court of Appeal applied Chargot and clarified it, holding that it is not necessary to prove actual knowledge of specific instances of infractions of the law, otherwise directors could shut their eyes and avoid liability. Rix LJ emphasised that the purpose of secondary liability provisions in regulatory statutes was to ensure that that company officers are held to proper standards of supervision and that the size of the company and the distance of directors and managers from the coal face of individual acts should not, where there is consent, connivance or neglect, afford directors or managers without the necessary knowledge a defence.112

106 107 108 109 110 111 112 104 105

Corporate Manslaughter and Corporate Homicide Act 2007, c. 19, § 18 (UK). Companies Act 2006, § 1121. The Health and Safety at Work etc. Act 1974, c. 37 (UK). Attorney General’s Reference (No.1) of 1995 [1996] 1 WLR 970, 980 (EWCA). R v. Chargot Ltd (t/a Contract Services) [2008] UKHL 73, ¶ 34 (per Lord Hoffmann). The Health and Safety at Work etc. Act 1974. Chargot [2008] UKHL 73, ¶ 34 (per Lord Hoffmann). R v. Hitchins [2011] EWCA Crim 1056. Id. at ¶ 25.

Corporate law and statutory liability  75

V.

DEVELOPING AREAS OF CORPORATE STATUTORY LIABILITY

A. Bribery The Bribery Act 2010 introduced statutory offences relating to bribing another person,113 offences relating to being bribed114 and offences relating to the bribery of public officials.115 For these offences, if the offence was committed ‘with the consent or connivance of’ a senior officer of a company or a person purporting to act as such, this person suffers secondary criminal liability in tandem with the company for an offence.116 For companies, they have a liability risk under section 7 if they have failed to take appropriate steps to prevent bribery. Furthermore, there is the independent possibility of corporate liability arising in relation to the offences under sections 1 and 6 of the Bribery Act due to the application of the common law identification principle deriving from Tesco Supermarkets Ltd v Nattrass117 whereby the acts and omissions of a person who is the directing mind or will of the company and who commits the offence can be attributed to the company.118 A number of points are worth noting. The ‘failure to prevent’ offence under section 7 arises even where a prosecution has not taken place against the person associated with the company provided that the underlying bribery offence under section 1 or section 6 has taken place and can be proven.119 However, a company has a complete due diligence defence against liability for the statutory offence where it can prove on the balance of probabilities that it ‘had in place adequate procedures designed to prevent persons associated with [the company] from undertaking such conduct’. The statutory guidance on the Bribery Act is centred on the principle of proportionality that assists companies in their task of putting robust anti-bribery procedures in place.120 Companies are expected to adopt a proportionate risk-based approach to managing the possibility of bribery occurring. This will be particularly challenging in complex global supply chains where the risk of bribery is far higher.121 Companies are likely to fulfil the objective of managing this risk where they provide for an appropriate due diligence process to manage the risk and specify the use of anti-bribery terms and conditions in contracts along the supply chain. The failure to prevent offence in section 7 is an example of using a large stick – the prospect of being prosecuted, and strong penalties – accompanied by a carrot – the potential to deflect liability where a company has put reasonable anti-bribery procedures in place. The Guidance makes it clear that the assessment that will be undertaken by the courts will be fact-sensitive,

Bribery Act 2010, c. 23, § 1 (UK). Id. at § 2. 115 Id. at § 6. 116 Id. at § 14(2). 117 Tesco Supermarkets [1972] AC 153. 118 This is acknowledged in the non-binding Statutory Guidance. Secretary of State for Justice, supra note 92, at ¶ 14. 119 Secretary of State for Justice, supra note 92, at ¶ 13. 120 Id. 121 Provision for internal whistleblowing will generally be appropriate. 113 114

76  Research handbook on corporate liability having regard to the particular circumstances of the company in question, including its size and whether it is a domestic or multi-national enterprise in operation.122 B.

Modern Slavery

Modern slavery is a scourge that offends societal values. Building on the precedent of the Bribery Act 2010, the Modern Slavery Act 2015 (UK)123 is another legislative development with extra-territorial effect bringing the possibility of corporate criminal liability for offences of slavery, servitude and forced or compulsory labour and for human trafficking. To assist with transparency in supply chains, section 54 requires companies within scope to prepare a slavery and human trafficking statement for each financial tier.124 The Secretary of State could potentially bring civil proceedings for failure to comply with the statutory duty. However, it is widely acknowledged that this represents an insufficient enforcement mechanism with consequent lack of corporate accountability. It lacks teeth. Most notably, there is no express financial penalty associated with breach. There is some momentum to amend the Modern Slavery Act to provide a basis for corporate liability including potential civil penalties for non-compliance following a government consultation on transparency in supply chains in 2020.125 Regrettably, the UK Government response did not, however, consider the possibility of devising a new ‘failure to prevent’ modern slavery offence. C.

Environmental, Social and Governance Matters

Globally, there is considerable socio-political momentum building around ESG matters. In the European Union advances are being made on environmental and human rights protection in global supply chains. The European Commission’s Proposal for an EU Directive on Corporate Sustainability126 shows considerable ambition to impact upon the corporate law systems of Member States in order to expand the reach of corporate responsibility and directors’ duties and liabilities for large companies within scope. The Proposal goes far beyond a ‘failure to prevent’ approach. Under the Proposal, when directors act in the interest of the company, they must take into account the human rights, climate and environmental consequences of their decisions and the likely consequences of any decision.127 Companies are obliged to conduct environmental and human rights due diligence for the company, its subsidiaries and the supply chain.128 The board is responsible not only for setting up and overseeing the implementation of environmental and human rights due diligence processes, but more importantly for integrating due diligence including risk identification and mitigation into the corporate strategy. Significantly, this double-edged approach is not just concerned with organisational Secretary Of State For Justice, supra note 92. Modern Slavery Act, 2015, c. 46 (UK). 124 This contrasts with the position under s 7 of the Bribery Act 2010 where bribery risk management by commercial organisations is encouraged but not mandated. 125 Home Office, Transparency in Supply Chains Consultation (2019) (UK); Home Office, Transparency in Supply Chains Consultation: Government Response (2020) (UK). 126 Proposal for a Directive on Corporate Sustainability Due Diligence, COM (2022) 71 (Final, Feb. 23. 2022). 127 Id. at Art 25. 128 Id. at Art 26. 122 123

Corporate law and statutory liability  77 culture, but also with strategy at board level. These provisions will give rise to liability for non-compliance.129 More significant again is the potential for victims of harm to maintain civil actions against companies for due diligence failures. It seems implicit that board and senior management’s failings would be attributed to the company. The legislative journey of this truly path-breaking Proposal will be fascinating to observe. The EU Proposal also presents solutions to issues touched upon in jurisdictional tug-of-war cases such as those concerning the potential liability of parent companies for the environmental and human rights abuses of their subsidiaries.130 These cases can also raise the ability for claimants to successfully bring a claim for breach of statutory duty against parent companies. The decision of the UK Supreme Court in Vedanta Resources plc v Lungowe131 concerned a large-scale action against a parent company for breach of a common law duty of care in negligence in respect of alleged harm of its subsidiary KCM being advanced in parallel with a claim for breach of a statutory duty of care under mining and environmental legislation being advanced in respect of alleged harm.132 Although focusing on jurisdiction, the justices suggested that, under either claim (which would be under Zambian law), the question of the actual extent of the controlling influence of the parent over the subsidiary’s operations would be crucial.133 Finally, against the backdrop of the Russian invasion of Ukraine, the Economic Crime (Transparency and Enforcement) Act 2022 (UK) created an updating duty on registered overseas entities in relation to registering beneficial ownership in the Register of Overseas Entities.134 This was designed to target money laundering and hidden beneficial ownership of offshore companies which own property and sources of funds. Failure to comply results in an offence being committed by the entity and every officer in default.135 However, its critics have queried its likely effectiveness given the possibility of evading it through entering into nominee agreements with professional services firms.136

129 Member States will have responsibility for ensuring that companies comply with their due diligence obligations. Member States could potentially impose fines on non-compliant companies, or issue mandatory orders requiring such companies to comply with the due diligence obligations. 130 See generally Cees van Dam, Breakthrough in Parent Company Liability: Three Shell Defeats, the End of an Era and New Paradigms, 18 Eur. Co. & Fin. L. Rev. 714 (2021); Christian Witting, The Corporate Group: System, Design and Responsibility, 80 Camb. L.J. 581 (2021). 131 Vedanta Resources plc v. Lungowe [2019] UKSC 20. See also Chandler v. Cape plc [2012] EWCA Civ 525. 132 Notable is the Environmental Management Act 2011, s 4(e) and (f), No. 12 (Zambia) which allows a court to compel restitution by ‘the person responsible for any environmental degradation’ to restore the environment to its status quo ante and to provide compensation to any victim for the harm caused. 133 Lord Briggs confessed obiter to ‘having some difficulty with the concept of a fault-based liability which does not depend upon the existence of a prior legal duty to take care’. Vedanta Resources [2019] UKSC 20, ¶ 65. 134 Economic Crime (Transparency and Enforcement) Act 2022, c. 10, § 7 (UK). 135 Id. at § 8. 136 Kate Beioley, Laura Hughes & George Hammond, What Are the Main Points of the UK’s Economic Crime Bill?, Fin. Times (Mar. 1, 2022).

78  Research handbook on corporate liability

VI.

FUTURE DIRECTIONS

‘Law has always been and no doubt will always continue to be, “in a process of becoming”’.137 As regards statutory liability, coherence is an issue due to disparate and piecemeal accretion of the statute book.138 Issues of attribution for companies continue to loom large in statutory and non-statutory contexts. Absolute liability offences can have a strong deterrent effect but may lead judges to baulk at applying them in hard cases. On the other hand, there are instances of companies being made statutorily liable for conduct that they have internally prohibited.139 As observed by Glanville Williams, ‘[t]he obvious injustice which arises in some cases … occasionally leads the courts to seek to construe the statute in such a way that it is held not to have been broken. This may mean that the issue of fault, expelled through the front door, is readmitted at the rear.’140 Indeed, the Law Commission of England and Wales has previously consulted on whether a due diligence defence should be available in appropriate cases for statutory offences that are entirely or partly silent on whether intention or mens rea is required.141 Legislative inventiveness concerning corporate statutory liabilities is welcome but on deeper scrutiny may not be without flaws. A criticism of the Corporate Manslaughter and Corporate Homicide Act 2007 is that the statutory attribution model under section 1(3) relies on substantial breach occurring by ‘the way in which its activities are managed or organised by its senior management’. As has been pointed out, this ‘perpetuates or continues the paradox that flows from the identification doctrine, that smaller corporate bodies remain easier to prosecute than large ones’.142 As regards failure to prevent offences, a shortcoming is that the focus on the inadequacies of corporate policies and practices rather than on acts and omissions allows the morally significant issue of direct liability of corporations for economic crime to be side-stepped or placed at one remove.143 On the other hand, judicial activism cannot be a substitute for overarching legislative reform. Wells was right to characterise Meridian as ‘a step of uncertain dimensions’,144 given the uncertainty as to when courts will see fit to invoke the special rule, and its necessarily piecemeal application on a case-by-case basis. Indeed, we have not seen the demise of the ‘directing mind and will’ test in the intervening years.145 There is a sense of a cat and mouse game being played by law reform bodies, legislatures, and courts. The Law Commission was alive to the problem that Tesco146 did not account for the Roscoe Pound, Law in Books and Law in Action, 44 Am. L. Rev. 12, 22 (1910). This is part of a wider problem: John R. Spencer, The Drafting of Criminal Legislation: Need it Be so Impenetrable?, 67 Camb. L.J. 585, 597 (2008). 139 Director General of Fair Trading v. Pioneer Concrete (UK) Ltd [1995] AC 456 (UKHL) (absolute liability under the Restrictive Trade Practices Act 1976 (UK)). 140 Williams, supra note 18, at 239. 141 Law Commission of England and Wales, supra note 2, ¶¶ 1.71–1.80. No final report was published. 142 Law Reform Commission, Report on Regulatory Powers and Corporate Offences, Vol. 2, ¶ 8212, LRC 119-2018 (2018) (Ir.). 143 Mark Dsouza, The Corporate Agent in Criminal Law – An Argument for Comprehensive Identification, 79 Camb. L.J. 91 (2020). 144 Celia Wells, The Law Commission Report on Involuntary Manslaughter: The Corporate Manslaughter Proposals: Pragmatism, Paradox and Peninsularity, Crim. L.R. 545, 548 (1996). 145 Eilis Ferran, Corporate Attribution and the Directing Mind and Will, 127 Law. Q. Rev. 239 (2011). 146 Tesco Supermarkets Ltd v. Nattrass [1972] AC 153 (UKHL). 137 138

Corporate law and statutory liability  79 reality that decision-making is often not top down and that, for example, middle management or below may have a degree of autonomy. It regarded Tesco as leaving legislators ‘with a stark choice – create an offence which cannot be enforced in the case of large corporations or create an offence of strict liability and accept that corporations may be convicted despite blame lying with people over whom they have limited control’.147 That seems like a fair summary of the status quo. The Law Commission had previously hoped that the courts would not proceed on a presumption that the identification doctrine of attribution applied and would only resort to it if to do so would best fulfil the statutory objectives.148 However, the courts have continued to regard the identification doctrine as the primary rule of attribution, only to be displaced to avoid defeating parliamentary intention.149 Accordingly, the Law Commission’s ambition for the identification doctrine to no longer occupy centre stage has not been judicially achieved. The Law Commission’s excavation of corporate criminal liability may prompt government proposals for more far-reaching statutory intervention impacting how statutory liability functions in corporate law.150 The options presented could lead to a broader base for corporate criminal liability through refining liability attribution principles to make attribution of liability easier and fairer. If changes to the identification doctrine in a criminal context result, it would be important to also ensure doctrinal coherence in relation to corporate civil liability. For now, a cohesive approach to framing statutory liability is absent. As Ferran rightly notes, ‘[m]any civil and criminal wrongs have a common law base or are in statutes that do not include express provision relating to the conditions for corporate liability to arise, so rules of more general application are also needed in order to ensure that companies are not above the law’.151 Discerning the modus operandi behind the status quo on corporate statutory liability is not always easy. A consequence of the proliferation of regulatory offences using absolute and strict liability along with special statutory rules of attribution has been to stretch the fundamentals of corporate criminal liability.152 Normatively, the object of regulatory coherence calls for a fundamental, systematic examination of when it is appropriate to wield a criminal label and outcome and when it is not. To implement this would require a root and branch legislative review to identify instances of inappropriate labelling of regulatory breaches as criminal. In this vein the Australian Law Reform Commission has sensibly called for a more considered approach and has indicated that ‘it is fault that should distinguish criminal conduct from prohibited conduct that is subject only to civil regulation’.153 It has called for civil regulation to

Law Commission of England and Wales, supra note 69, at ¶ 2.71. Law Commission of England and Wales, supra note 2, at ¶¶ 5.103–5.105. 149 See Serious Fraud Office v. Barclays plc [2018] EWHC 3055 (QB). 150 In 2021 the Law Commission published a Discussion Paper seeking views on whether criminal liability for corporations needed to be framed on a broader model than the identification doctrine. Law Commission of England and Wales, supra note 69. This was followed in 2022 by an options paper. Law Commission of England and Wales, supra note 57. 151 Ferran, supra note 145, at 241. 152 Id. at 246; Samuel Walpole, Criminal Responsibility as a Distinctive Form of Corporate Regulation, 35 Austl. J. Corp. L. 235 (2020). 153 Australian Law Reform Commission, Corporate Criminal Responsibility Final Report ¶ 1.29 (ALRC Report 136, 2020). An exception is made for regulatory offences based on strict or absolute liability. 147 148

80  Research handbook on corporate liability be treated as the default approach for regulating corporate behaviour, with criminal law being reserved for serious corporate wrongdoing.154 Furthermore, when considering the future of statutory liability, the regulatory choices for corporate liability ought no longer to be polarised between civil and criminal liability. Over the last 30 years Australia has increasingly set down intermediate civil penalty provisions in regulatory law predicated on deterrence and compliance motivations, the contravention of which leads to civil proceedings and attracts a pecuniary penalty.155 Another Australian development worth studying is the introduction of administrative penalties which enables a regulator to impose a variety of penalties without having to institute judicial proceedings. These can include the issuing of infringement notices, monetary penalties and enforceable compliance undertakings.156 This type of flexibility to choose the most appropriate means from a toolbox to achieve regulatory ends in individual cases is smart. Such regulatory agility may in turn influence other jurisdictions’ future approaches.157

VII. CONCLUSION Statutory liability plays an integral part in the liability framework for corporate actors. Legislation is accretive and attempts to review and rationalise it as a mass are rare. Rather, reform is piecemeal. Consequently, the statute book as it applies to companies continues to suffer from a raft of different approaches, which, taken together, do not reveal a ‘guiding hand’ in the form of a rational pattern or logical approach. This extends to matters such as whether statutory liability contemplates criminal or civil liability or both and the extent of primary and secondary liability and associated penalties and liabilities. Furthermore, within the statutory landscape there are multiple methods for attributing criminal liability to companies.158 This makes drawing meaningful conclusions on regulatory goals surrounding statutory liability challenging. The ball remains firmly in the court of law reform bodies and Parliaments to take a long hard look at how best to proceed (i) to enable corporate statutory liability to work effectively and (ii) to ensure overall regulatory coherence. As Roscoe Pound memorably observed, ‘the growing point of law is in legislation’.159 Legislative bodies have exhibited ingenuity in recent decades in their approaches to framing specialist statutory liability for corporations and their officers. Statutory offences for corporations have plugged gaps in the accountability of corporations, including perceived deficiencies

Id. at Chapter 5. They exist in the Corporations Act 2001 (Cth) No. 50 (Austl.) in relation to contraventions of directors’ duties and apply in a wide range of corporate law and regulatory contexts in Australia. On the motivations behind their introduction see generally Australian Government, ASIC Enforcement Review Taskforce Report (2017). 156 In Australia the Treasury Laws Amendment (Strengthening Corporate and Financial Sector Penalties) Act 2019 (Cth) designated some existing regulatory provisions in the Corporations Act as civil penalty provisions. 157 See the discussion on administrative monetary penalties and other civil options in Law Commission of England and Wales, supra note 57, at Ch 11. 158 For a comment on this in an Australian context see Australian Law Reform Commission, supra note 153. 159 Pound, supra note 137, at 23. 154 155

Corporate law and statutory liability  81 of common law models for attributing liability. Furthermore, increasingly statutory duties and liabilities are being used to instrumentalise and reinforce public values irrespective of where companies carry on their business and have their supply chains. The ‘failure to prevent’ model shows that Parliament is capable of wielding its power flexibly – corporate liability for failure to prevent does not rule out the independent attribution of direct liability to human agents or companies in an appropriate case. The rise in the organic approach to the corporation, framed by concepts of organisational culture founding organisational liability, portends less focus in the attribution exercise on individual humans and their job descriptions and more on corporate policies, training and compliance programmes – key hallmarks of organisational behaviour. However, in practice, clear drafting is key to successful application of corporate culture offences. As regards ‘failure to prevent’ offences, it remains to be seen what legislative transplants will take root elsewhere in the common law world and whether a more flexibly based ‘failure to prevent economic crime’ offence will ultimately emerge in the UK. Furthermore, the lack of corporate prosecutions and convictions for bribery and other forms of economic crime suggests that the lack of a dedicated, well-resourced enforcement agency for economic crime sorely needs to be addressed. More than ever, policymakers, parliamentary counsel, parliaments and courts need to reflect carefully when making choices in relation to framing statutory liability for companies and the associated consequence of non-compliance.

5. Issuer liability: ownership structure and the circularity debate Martin Gelter

I. INTRODUCTION Issuer liability refers to a publicly traded firm being financially responsible for misstatements in disclosures under securities law. While it may seem intuitively appealing to hold issuers liable, the advantages are far less clear from a policy perspective. As in many other areas of collective litigation in the United States, there is an intense debate about the merits of securities class actions. Besides the more general discussion about whether and to what extent plaintiff attorneys produce benefits for their clients,1 issuer liability has been subject to a debate about the ‘circularity’ critique. Because issuer liability is ultimately borne by shareholders, compensation of losses by wrongdoers cannot be a plausible policy goal. Deterrence also suffers from considerable difficulty. Stockholders should have incentives to avoid their entity’s liability by monitoring and selecting conscientious and honest managers. However, because relatively dispersed shareholders suffer from collective action problems, incentives rarely translate into action. However, the arguments developed against the backdrop of the US corporate governance system do not apply in other jurisdictions where there are typically large blocks of shares. Therefore, this chapter argues that issuer liability potentially has greater social value in corporate governance systems with concentrated ownership.2 This chapter proceeds as follows. Section II provides a brief international survey on issuer and individual liability for false disclosures under securities law. Section III explores the rationale for issuer liability, focusing on compensation and deterrence. It explores the circularity critique and factors that undermine deterrence. Section IV investigates the impact of ownership structure and suggests that issuer liability creates better incentives in concentrated ownership systems. Section V examines the comparative political economy of issuer liability and discusses entrenched interest groups motivated to block reform. Section VI summarizes and concludes.

1 Arguably, plaintiff lawyers prefer ‘to proceed by class action rather than derivative action’ because they ‘get paid a share of the recovery’. Richard A. Booth, What’s A Nice Company Like Goldman Sachs Doing in the Supreme Court? How Securities Fraud Class Actions Rip Off Ordinary Investors – and What to Do About It, 66 Vill. L. Rev. Online 71, 79 (2022). 2 For this argument, see also Martin Gelter, Risk-shifting through Issuer Liability and Corporate Monitoring, 14 Eur. Bus. Org. L. Rev. 497 (2013); Martin Gelter, Global Securities Litigation and Enforcement, in Global Securities Litigation and Enforcement 3, 46–51 (Pierre-Henri Conac & Martin Gelter eds., 2018).

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Issuer liability  83

II.

A BRIEF INTERNATIONAL SURVEY

Issuer liability contrasts with and complements the liability of individuals who personally initiate false disclosures, such as managers. Vicarious liability of the corporation for the actions of its officers is rooted either in general legal principles (such as respondeat superior in common law countries) or a statute explicitly establishing issuer liability. While the legal basis of liability is typically different for primary and secondary market cases, the main difference arises between countries that hold directors, officers, and other individuals directly liable and those that do not. In most countries, directors and officers are subject to prospectus liability in the primary market.3 Germany and the Netherlands are exceptions in only holding liable those ‘initiating’ the prospectus or those determining the content of the prospectus, which does not necessarily include board members.4 Italy mentions persons responsible for certain parts of the prospectus.5 German and Israeli law mention controlling shareholders, while some countries hold promoters of the company liable.6 Countries that do not establish prospectus liability of directors

3 E.g., Stéphane Rousseau, Canada: The Protection of Minority Investors and the Compensation of their Losses, in Global Securities Litigation, supra note 2, at 143, 161 [hereinafter Canada]; Pierre-Henri Conac, France: The Compensation of Investors’ Losses for Misrepresentation on Financial Markets, in Global Securities Litigation, supra note 2, at 331, 354 [hereinafter France]; Emmanuel P. Mastromanolis, Greece: Public Enforcement and Civil Litigation in the Greek Paradigm of Minority Investor Protection, in Global Securities Litigation, supra note 2, at 412, 430 [hereinafter Greece]; Umakanth Varottil, India: The Efficacy of India’s Legal System as a Tool for Investor Protection, in Global Securities Litigation, supra note 2, at 813, 834 [hereinafter India]; Kyung-Hoon Chun, South Korea: Protection of Minority Investors in Capital Markets, in Global Securities Litigation, supra note 2, at 988, 1013 [hereinafter South Korea]; Paulo de Tarso Domingues, Portugal: The Legal Framework of the Portuguese Capital Market, in Global Securities Litigation, supra note 2, at 537, 549 [hereinafter Portugal]; Yuliya Guseva, Russia: Russian Capital Markets and Shareholder Litigation: Quo Vadis?, in Global Securities Litigation, supra note 2, at 657, 677 [hereinafter Russia]; Mónica Fuentes Naharro, Spain: Minority Investors’ Protection in Spain: Civil Liability Remedies under Securities Law, in Global Securities Litigation, supra note 2, at 595, 615–16 [hereinafter Spain]; Mirko Vasiljević, Jelena Lepetić & Jasna Vaslijević, Serbia: The Protection of Minority Investors and the Compensation of their Losses, in Global Securities Litigation, supra note 2, at 692, 712–13; Wang-ruu Tseng, Taiwan: Investor Protection in Taiwan’s Capital Market, in Global Securities Litigation, supra note 2, at 1025, 1037 [hereinafter Taiwan]. 4 Dirk A. Verse, Germany: Liability for Incorrect Capital Market Information, in Global Securities Litigation, supra note 2, at 363, 376 [hereinafter Germany]; Loes Lennarts & Joti Roest, Netherlands: Protection of Investors and the Compensation of their Losses, in Global Securities Litigation, supra note 2, at 469, 484–85 [hereinafter Netherlands] (noting that it is not clear whether directors can be held liable under securities law). 5 Dmitri Boreiko & Stefano Lombardo, Prospectus Liability and the Role of Gatekeepers as Informational Intermediaries: An Empirical Analysis of the Impact of the Statutory Provisions on Italian IPOs, 20 Eur. Bus. Org. L. Rev. 255, 260­­–61 (2019). 6 Robin Hui Huang, China: Private Securities Litigation: Law and Practice, in Global Securities Litigation, supra note 2, at 879, 887 [hereinafter China] (promoters and controlling shareholders); Germany, supra note 4, at 376 (controlling shareholders); India, supra note 3, at 835 (using the term ‘promoters’, which typically includes the controlling shareholder); Uriel Procaccia, Israel: The Protection of Minority Investors and the Compensation of their Losses, in Global Securities Litigation, supra note 2, at 755, 769 (including controlling shareholders) [hereinafter Israel]; Aiman Nariman Mohd-Suleiman, Malaysia: Protection of Minority Investors in the Capital Market – Public

84  Research handbook on corporate liability and officers include Finland and Austria (although individuals may be responsible in specific circumstances on some other legal basis).7 Similarly, for subsequent disclosures, most countries permit concurrent liability of the issuer with its directors and officers. The laws of some jurisdictions hold any person involved with or responsible for the misrepresentation liable.8 Other countries explicitly refer to directors or managers.9 By contrast, in Austria, Finland, Germany, and Switzerland, individuals are liable only under general civil law – which sometimes limits circumstances for the compensation of pure economic loss.10 An exception is South Africa, which apparently relies on individual liability only.11 From a practical perspective, the issuer is often the most attractive defendant. The individual responsibility of a specific person may be difficult to establish for the plaintiff, whereas collective responsibility can easily be assigned to the legal entity. Individuals’ wealth from which recovery can be sought is typically more limited.12 In the United States, only the issuer contributes to settlements in most cases.13 Evidence shows that managers rarely contribute to

Enforcement and Shareholders’ Litigation, in Global Securities Litigation, supra note 2, at 944, 977 (promoters); Portugal, supra note 3, at 549 (promoters). 7 Martin Gelter & Michael Pucher, Austria: Securities Litigation and Enforcement, in Global Securities Litigation, supra note 2, at 261, 293 [hereinafter Austria]; Ville Ponkä, Finland: Protecting Minority Investors and Compensating their Losses, in Global Securities Litigation, supra note 2, at 303, 316–17 [hereinafter Finland]. 8 Franklin A. Gevurtz, United States: The Protection of Minority Investors and Compensation of Their Losses, in Global Securities Litigation, supra note 2, at 109, 133 [hereinafter United States]; Olivia Dixon & Jennifer Hill, Australia: The Protection of Investors and the Compensation of their Losses, in Global Securities Litigation, supra note 2, at 1063, 1086 [hereinafter Australia]; China, supra note 6, at 887; Greece, supra note 3, at 431. 9 Viviane Muller Prado, Brazil: The Protection of Minority Investors and Compensation for their Losses, in Global Securities Litigation, supra note 2, at 179, 199–200; Canada, supra note 3, at 166; France, supra note 3, at 331, 346–47; Guido Ferrarini & Paolo Giudici, Italy: The Protection of Minority Investors and the Compensation of their Losses, in Global Securities Litigation, supra note 2, at 446, 455; South Korea, supra note 3, at 1014; Netherlands, supra note 4, at 492; Russia, supra note 3, at 677; Spain, supra note 3, at 624; Ferna Ipekel Kayali, Turkey: The Protection of Minority Investors and the Compensation of their Losses in Turkish Capital Markets, in Global Securities Litigation, supra note 2, at 729, 744–48. 10 Austria, supra note 7, at 283, 288; Finland, supra note 7, at 317; Germany, supra note 4, at 386; for Switzerland, Rashid Bahar et al., Disclosure Duties: How does Swiss Law Protect Minority Shareholders?, in Lukas Heckendorn Urscheler, Rapports Suisses Présentés au XIXe Congrès International de Droit Comparé / Swiss Reports Presented at the XIXth International Congress of Comparative Law 211, 239–40 (2014); Taiwan, supra note 3, at 1043 (reporting a debate on whether individuals in charge of disclosures are liable in addition to the issuer); Johannes Flume, Private Enforcement of the Market Abuse Regulation in European Law, in Sebastian Mock & Marco Ventoruzzo, Market Abuse Regulation A.6. A24–25 (2nd ed. 2022) (discussing Austria and Germany). 11 Here, the seller of securities is liable rather than the issuer. Piet Delport, South Africa: Investor Protection, in Global Securities Litigation, supra note 2, at 779, 794. 12 See generally Reinier Kraakman, Corporate Liability Strategies and the Costs of Legal Control, 93 Yale L. J. 857, 885 (1984) (considering employee liability as a backstop to company liability limits). 13 Janet Cooper Alexander, Rethinking Damages in Securities Class Actions, 48 Stan. L. Rev. 1487, 1499 (1996); John C. Coffee, Jr., Reforming the Securities Class Action: An Essay on Deterrence and its Implementation, 106 Colum. L. Rev. 1534, 1551 (2006); Jill E. Fisch, Confronting the Circularity Problem in Private Securities Litigation, 2009 Wis. L. Rev. 333, 337; Bernard Black et al., Outside

Issuer liability  85 a settlement fund14 and do so mainly in insolvency or as part of an agreement to avoid criminal prosecution.15 Directors’ and officers’ (D&O) insurance usually covers both individuals and issuers.16 Moreover, individuals are primarily protected by indemnification agreements with their employers.17 Thus, to identify the rationale and effects of liability, we need to look at issuer liability.

III.

THE RATIONALE FOR ISSUER LIABILITY

A.

Compensation and Deterrence

Liability has two main economic functions: compensation and deterrence.18 The victim’s compensation is perhaps the more intuitive and dominates doctrinal debates.19 We may not want to saddle a victim with the risk of injury. In economic terms, the risk is assigned to a better risk-bearer.20 If accident victims are risk-averse, they will suffer a smaller ex ante loss in utility than payers that are risk-neutral and required to compensate them. Compensation will thus be welfare-enhancing because the benefits of the victim’s reduced burden outweigh the cost of saddling the payer with it. However, if accident victims can easily purchase insurance, the risk is spread out across the pool of insured individuals.21 Consequently, who ultimately bears the financial risk of an activity should depend on the availability and cost of insurance.22 The more important function of liability is to create incentives to avoid further harm-doing. If A is responsible for the damage inflicted on B, A should be motivated to take precautions. A’s incentives will be influenced by whether she purchased insurance. However, insurers typically create incentives for the insured through the pricing mechanism by adjusting premia to risk or engaging in monitoring.23

Director Liability, 58 Stan. L. Rev. 1055, 1068–74 (2006); Urska Velikonja, Distortion Other Than Price Distortion, 93 Wash. U. L. Rev. 425, 429 (2015). 14 Alexander, supra note 13, at 1498–99; Coffee, supra note 13, at 1551; Fisch, supra note 13, at 337; Black et al., supra note 13, at 1068–74. On the significance of insurer’s payments, see Tom Baker & Sean J. Griffith, How the Merits Matter: Directors’ and Officers’ Insurance and Securities Settlements, 157 U. Pa. L. Rev. 755, 760–61 (2009). 15 Coffee, supra note 13, at 1551; see also Alexander, supra note 13, at 1498. 16 Coffee, supra note 13, at 1570; Tom Baker & Sean J. Griffith, Ensuring Corporate Misconduct: How Liability Undermines Shareholder Litigation 46 (2010). 17 Baker & Griffith, supra note 14, at 797. 18 Investor confidence is also sometimes cited as a goal. E.g., Note, Congress, the Supreme Court, and the Rise of Securities-Fraud Class Actions, 132 Harv. L. Rev. 1067, 1083 (2019). 19 E.g., Lord Bingham of Cornhill, The Uses of Tort, 1 J. Eur. Tort L. 3, 4 (2010) (‘Securing compensation is, however, the primary function of tort’); Ulrich Magnus, Why is US Tort Law so Different?, 1 J. Eur. Tort L. 102, 106 (2010); Jean-Sébastian Borghetti, The Culture of Tort Law in France, 3 J. Eur. Tort L. 158, 164, 177 n.64 (2012); Helmut Koziol, Basic Questions of Tort Law from a Germanic Perspective ¶ 3/1 (2013). 20 E.g., Steven Shavell, Foundations of Economic Analysis of Law 257–58 (2004). 21 E.g., id. at 268. 22 Id. at 268–69; see also Borghetti, supra note 19, at 164 (pointing out the role of the social insurance system for victim compensation). 23 Jennifer H. Arlen & William J. Carney, Vicarious Liability for Fraud on the Securities Market: Theory and Evidence, 1992 U. Ill. L. Rev. 691, 712 (1992).

86  Research handbook on corporate liability The mandatory disclosure regime created by securities law is intended to instill confidence in investors, improve the basis for decisions, and tackle the agency problem between investors on the one hand and management and controlling shareholders on the other hand.24 Issuer liability is concerned with harm resulting from violations of these disclosure requirements, particularly false and misleading disclosures. As in other corporate liability cases, the incentive may be indirect because shareholders bear the cost of liability through reduced stock values. Consequently, it is thought to create indirect incentives: shareholders will ex ante be interested in having directors and officers in charge who will not cause the corporation to be liable to third parties ex post.25 Therefore, the effectiveness of shareholders’ incentives will depend on how easily they can appoint, monitor, remove, and replace directors. B.

The Compensation Rationale and the Circularity Problem

1. Pocket-shifting In the context of issuer liability, the compensation rationale suffers from several additional problems relating to a phenomenon known as ‘circularity’.26 It is trivial to point out that a payout based on issuer liability reduces firm value by the same amount, with a corresponding effect on market capitalization. As plaintiff investors often own stock in the defendant corporation, money is distributed from one of the investors’ ‘pockets’ to the other, reduced by the cut taken by attorneys.27 False disclosures will typically inflate the stock price. In ‘primary market’ cases, where the corporation issued stock, the stock bought by new investors is diluted, from which the existing stockholders benefit.28 These cases are less troublesome because the rescission of stock sales averts the redistributive effects of fraud. Consider the stylized example in Table 5.1, where nine original shareholders gain $20 each because of the price at which the defrauded plaintiff pays $180 for newly issued shares. Rescission in the form of returning stock against the purchase price eliminates the redistributive effect. Table 5.1

Redistributive effects of issuer liability in primary markets

  Plaintiff(s) Each of the nine old shareholders

Loss/gain due to

Loss of share value

misinformation

due to judgment

Judgment received

Net harm

-$180

$0

$180

$0

$20

-$20

$0

$0

24 E.g., Iris H-Y. Chiu, Reviving Shareholder Stewardship: Critically Examining the Impact of Corporate Transparency Reforms in the UK, 38 Del. J. Corp. L. 983, 987–90 (2014). 25 Richard A. Posner, Law and the Theory of Finance: Some Intersections, 54 Geo. Wash. L. Rev. 159, 169–70 (1986). 26 Amanda M. Rose, Better Bounty Hunting: How the SEC’s New Whistleblower Program Changes the Securities Fraud Class Action Debate, 108 Nw. U. L. Rev. 1235, 1243 (2014). 27 E.g., id. at 1244; Thomas E. Dubbs, A Scotch Verdict on ‘Circularity’ and other Issues, 2009 Wis. L. Rev. 455, 456; Manning Gilbert Warren III, The U.S. Securities Class Action: An Unlikely Export to the European Union, 37 Brook. J. Int’l L. 1075, 1077–78 (2012). 28 E.g., Frank H. Easterbrook & Daniel R. Fischel, Optimal Damages in Securities Cases, 52 U. Chi. L. Rev. 611, 638–39 (1985); see also Coffee, supra note 13, at 1556; Richard A. Booth, The End of Securities Fraud as We Know It, 4 Berkeley Bus. L.J. 1, 25 (2007).

Issuer liability  87 By contrast, in ‘secondary market’ cases, where inflated prices affect trades in the market, the beneficiaries are former shareholders who happened to sell before the misinformation was corrected.29 If the issuer is held liable for misstatements, the cost of a judgment is borne by all current shareholders through the loss in share value. These may include the plaintiffs themselves as well as buy-and-hold investors, but notably not those lucky enough to sell stock at a high price.30 Consider a corporation with ten shareholders, one of whom suffered a loss of $200 because she bought stock when the price was inflated. Table 5.2 shows how each shareholder loses $20 from the payment corresponding to their share in the firm.31 Table 5.2

Redistributive effects of issuer liability in secondary markets

  Plaintiff (10%) Each of the other shareholders (10%)

Loss/gain due to

Loss of share value due to

Judgment

Net

misinformation

judgment

received

harm

-$200

-$20

$200

-$20

$0

-$20

$0

-$20

Issuer liability thus spreads the risk of fraud from the buyers across all shareholders.32 One could consider this diffusion of risk desirable because it implicitly creates a form of insurance.33 However, there are reasons to object to exposing innocent stockholders to risk because they abstained from selling.. Those sellers who gained from an inflated price get off without contributing to the cost of a payout.34 Buy-and-hold investors may also bear additional losses, such as a reduction in firm value resulting from reputational losses following the discovery of fraud.35 2. Diversification The term ‘circularity’ is also used to describe the effects of diversification. In theory, investors with broad portfolios will sometimes be members of the plaintiff class that gains from a securities class action and sometimes they will be stockholders who lose from issuer liability.36 Diversification reduces the exposure to the risk of fraud at any individual company, which

29 Donald C. Langevoort, Capping Damages for Open-Market Securities Fraud, 38 Ariz. L. Rev. 646 (1996); Coffee, supra note 13, at 1556; James J. Park, Shareholder Compensation as Dividend, 108 Mich. L. Rev. 323, 331 (2009); Merritt B. Fox, Why Civil Liability for Disclosure Violations When Issuers Do Not Trade?, 2009 Wis. L. Rev. 297, 302; William W. Bratton & Michael L. Wachter, The Political Economy of Fraud on the Market, 160 U. Pa. L. Rev. 69, 94 (2011); Joseph A. Grundfest, Damages and Reliance Under Section 10(b) of the Exchange Act, 69 Bus. Law. 307, 313 (2014). 30 But see James Cameron Spindler, We Have a Consensus on Fraud on the Market – and It’s Wrong, 7 Harv. Bus. L. Rev. 67, 70, 95–96 (2017) (modelling how plaintiffs are arguably compensated by non-plaintiff shareholders under the assumption that stock prices accurately reflect the possibility of liability as soon as the fraud is revealed). 31 For a similar example, see Park, supra note 29, at 336. 32 See Fox, supra note 29, at 303 n.6. 33 Id. at 304–305; Langevoort, supra note 29, at 649. 34 Coffee, supra note 13, at 1557–58. 35 Park, supra note 29, at 330; see also Richard A. Booth, The Future of Securities Litigation, 4 J. Bus. & Tech. L. 129, 140 (2009); Booth, supra note 1, at 79–80; Amanda M. Rose & Richard Squire, Intraportfolio Litigation, 105 Nw. U. L. Rev. 1679, 1703 (2011); Velikonja, supra note 13, at 429. 36 Park, supra note 29, at 328–29.

88  Research handbook on corporate liability replicates the effect of the ‘insurance’ provided by issuer liability.37 Across a portfolio, a diversified investor will suffer a loss due to the cut for litigation costs.38 Arguably, even a stock picker might disfavor issuer liability because it is not predictable for her ex ante if she will be on the winning or losing side of a lawsuit.39 One could counter-argue that liability is important to keep certain types of traders in the market. Other investors may be particularly vulnerable because they neither diversify nor pick stocks based on in-depth information. This includes employees with restricted stock40 and certain retail investors.41 Information trading will bring stock prices closer to firms’ intrinsic value, thus making the market more informationally efficient.42 3. Trading frequency Whether gains and losses from issuer liability balance out will depend not only on diversification but also on the frequency of trades. To be part of the plaintiff class, one must have bought or sold during the period when the price was distorted by misinformation. This is often not true for retail investors, who typically pay less attention to market movements and hold on to shares for extended periods.43 ‘Buy-and-hold’ investors will more often be on the losing side than institutional investors, who often adjust their portfolios.44 The latter are more likely to benefit than less diversified investors even if compensation provides smaller benefits to them in light of their already well-spread risk.45 This redistributive effect may play out differently in the modern world of passive investing: When retail investors participate in the market primarily through passive index funds, they benefit from diversification. However, as index funds do not adjust their portfolio in reaction to market movements, they are more likely harmed by issuer liability than managed funds.46

Booth, supra note 35, at 139–40; Booth, supra note 28, at 17; Grundfest, supra note 29, at 313–14. Amanda Marie Rose, The Shifting Raison D’Être of the Rule 10b-5 Private Right of Action, in Research Handbook on Representative Shareholder Litigation 39, 48 (Sean Griffith, Jessica Erickson, David H. Webber & Verity Winship eds., 2018); Rose, supra note 26, at 1244; Richard A. Booth, Sense and Nonsense about Securities Litigation, 21 U. Pa. J. Bus. L. 1, 6 (2018). 39 Richard A. Booth, OOPs! The Inherent Ambiguity of Out-of-Pocket Damages in Securities Fraud Class Actions, 46 J. Corp. L. 319, 334 (2021). 40 Booth, supra note 38, at 15; James. D. Cox & Randall S. Thomas, Mapping the American Shareholder Litigation Experience: A Survey of Empirical Studies of the Enforcement of the U.S. Securities Law, 6 Eur. Co. & Fin. L. Rev. 164, 176 (2009). 41 See, e.g., Alicia Davis Evans, The Investor Compensation Fund, 33 J. Corp. L. 223, 234–36 (2007); Velikonja, supra note 13, at 430. 42 Park, supra note 29, at 342–44; David H. Webber, Shareholder Litigation Without Class Actions, 57 Ariz. L. Rev. 201, 258–59 (2015); see also Fisch, supra note 13, at 347. 43 Evans, supra note 41, at 232–34. 44 Langevoort, supra note 29, at 649–50; Coffee, supra note 13, at 1559–60; Bratton & Wachter, supra note 29, at 97. 45 E.g., Booth, supra note 35, at 147; Alexander, supra note 13, at 1502. 46 Booth, supra note 39, at 334. 37 38

Issuer liability  89 C.

Issuer Liability and the Deterrence Rationale

1. The social cost of securities fraud The second traditional rationale for liability is deterrence. According to the classic law and economics view, harm should be matched by a corresponding level of sanctions to induce an efficient level of care.47 This typically means that not all harmful conduct should be deterred, but only actions where the expected social cost exceeds social benefits. These include benefits to the acting person, including cost savings from taking fewer precautions.48 Moreover, for the system to be viable, a ‘liability regime must save more in social cost than it creates in enforcement cost’.49 This standard rationale does not apply directly to securities litigation, where social cost is harder to identify compared to accident law. Following the logic of private law, aggrieved investors will sue for compensation of losses corresponding to the difference between the purchase price of the stock and the value ‘without’ false information.50 However, as outlined above, this purchaser’s loss is balanced by a mirroring gain captured by the seller. The transaction is thus merely redistributive, with a net zero social cost.51 The actual social costs are thus not related to the injury to the plaintiff. First, they include resources spent to conceal fraud52 as well as increased monitoring costs borne by investors.53 Second, mispricing because of pervasive fraud results in a misallocation of capital between different issuers.54 Consequently, capital will not flow to its highest value use.55 Since this risk is systemic and cannot be eliminated through diversification, firms will face a higher cost of capital unless they can signal an absence of fraud risk.56 Third, misinformation may increase managerial agency cost by making it harder to use the stock price as a disciplinary mechanism.57 Fraudulent financial results affect the compensation and performance evaluation of managers and will distort the managerial labor market.58 If

E.g., Shavell, supra note 20, at 178. E.g., Steven Shavell, Criminal Law and the Optimal Use of Nonmonetary Sanctions as a Deterrent, 85 Colum. L. Rev. 1232, 1234–35 (1985); Robert Cooter & Thomas Ulen, Law and Economics 300–302 (3d ed. 2000). See Amanda M. Rose, The Multienforcer Approach to Securities Fraud Deterrence: A Critical Analysis, 158 U. Pa. L. Rev. 2173, 2188–89 (2010). 49 Rose, supra note 38, at 42. 50 See generally Gelter, Global Securities Litigation, supra note 2, at 76–79 (surveying damages in securities fraud cases across countries). 51 E.g., Richard A. Posner, Law and the Theory of Finance: Some Intersections, 54 Geo. Wash. L. Rev. 159, 169–70 (1986); Paul G. Mahoney, Precaution Cost and the Law of Fraud in Impersonal Markets, 78 Va. L. Rev. 623, 629–30 (1992); Fox, supra note 29, at 302; Marcel Kahan, Securities Laws and the Social Costs of ‘Inaccurate’ Stock Prices, 41 Duke L.J. 977, 1006–1007 (1992). 52 Posner, supra note 51, at 170; Easterbrook & Fischel, supra note 28, at 623; Mahoney, supra note 51, at 631. 53 Posner, supra note 51; Easterbrook & Fischel, supra note 28; Mahoney, supra note 51, at 629–30. 54 Easterbrook & Fischel, supra note 28, at 623–24; Kahan, supra note 51, at 1006–1007, 1013; Mahoney, supra note 51, at 633–34. 55 Kahan, supra note 51, at 1008–1009. 56 Rose, supra note 48, at 2179. 57 Mahoney, supra note 51, at 634; Rose, supra note 48, at 2179; Rose, supra note 26, at 1246. 58 See James D. Cox, Making Securities Fraud Actions Virtuous, 39 Ariz. L. Rev. 497, 510 (1997); Coffee, supra note 13, at 1562; Arlen & Carney, supra note 23, at 702–703, 720–34 (lending empirical support to this thesis). 47 48

90  Research handbook on corporate liability a firm’s stock is misleadingly overvalued, managers are overcompensated59 and less likely to be fired.60 Finally, if the firm’s financial position appears better, overconfident managers may offer lower prices to consumers and recruit more staff.61 Other ‘stakeholders’ will make decisions on how to interact with the firm based on false information. Creditors may misprice debt, and employees may forego opportunities to find better employment.62 2. Unclear incentives for deterrence Considering this complex set of costs, it is not surprising that the US literature debates whether securities class actions over- or under-deter. While the empirical literature suggests that securities litigation creates at least some deterrence,63 this may be partly due to the inherent unpleasantness of litigation.64 According to one theory, plaintiffs’ claims exceed social welfare losses.65 In this view, firms have incentives to err on the side of publicizing information rather than keeping it confidential and to overspend on compliance with securities law.66 Some scholars add that uncertainties in the law add to these problems.67 Adherents to the contrary view point out that the beneficiaries of false disclosures are typically managers68 concerned about personal financial and reputational losses resulting from bad financial results.69 Because managers have access to professional staff and consultants, they will be aware of which statements are accurate and which ones are problematic without incurring a significant cost.70 Firms are unlikely to be over-deterred in expending too many resources on avoiding or concealing misstatements. D&O insurance strongly impacts the incentive effects of liability. Insurance that covers all liability extinguishes incentives to avoid misrepresentations.71 However, insurers should have

Rose, supra note 48, at 2182. Arlen & Carney, supra note 23, at 720. 61 Urska Velikonja, The Cost of Securities Fraud, 54 Wm. & Mary L. Rev. 1887, 1915–29 (2013). 62 Id. at 1916–23. 63 Dain C. Donelson et al., The Role of Directors’ and Officers’ Insurance in Securities Fraud Class Action Settlements, 58 J.L. & Econ. 747 (2015); Simi Kedia et al., Evidence on Contagion in Earnings Management, 90 Acct. Rev. 2337, 2363–65 (2015) (suggesting that firms are deterred from fraudulent disclosures by litigation and enforcement actions against peer firms); James P. Naughton et al., Private Litigation Costs and Voluntary Disclosure: Evidence from the Morrison Ruling, 94 Acct. Rev. 303 (2019) (finding that the Morrison decision resulted in a reduction of voluntary disclosures); Justin Hopkins, Do Securities Class Actions Deter Misreporting?, 35 Contemp. Acct. Rsch. 2030 (2018). 64 Velikonja, supra note 13, at 430. 65 Easterbrook & Fischel, supra note 28, at 625; Alexander, supra note 13, at 1497–98; Langevoort, supra note 29, at 646–47; Rose, supra note 26, at 1246; Booth, supra note 38, at 8. 66 Rose, supra note 48, at 2190, 2192, 2194; Langevoort, supra note 29, at 652; Note, supra note 18, at 1082. 67 Rose, supra note 48, at 2190–94; Rose & Squire, supra note 35, at 1686. 68 E.g., Coffee, supra note 13, at 1562 (suggesting that managers are interested in securing their positions and maximizing compensation); Fox, supra note 29, at 280. 69 Arlen & Carney, supra note 23, at 715, 725; Cox, supra note 58, at 510; Langevoort, supra note 29, at 654. 70 Urska Velikonja, Leverage, Sanctions, and Deterrence of Accounting Fraud, 44 UC Davis L. Rev. 1281, 1340 (2011). 71 Baker & Griffith, supra note 16, at 60–61. 59 60

Issuer liability  91 incentives to reduce moral hazard, for example by monitoring, screening, requiring deductibles, and adjusting the insurance premium to the risk. Thus, insurance is sometimes considered a mechanism that solves collective action problems among shareholders relating to monitoring directors.72 Insurers are typically involved in settlement negotiations. Baker and Griffith found that issuer liability cases typically settled close to (or slightly above) the insured sum.73 Contrary to theoretical predictions, D&O insurers rarely monitor and usually do not use premia to create incentives. Baker and Griffith’s explanation is agency cost: Insurance is chosen by managers or directors rather than shareholders, which results in the choice of insurance plans serving the interest of the intermediate beneficiaries. These plans reduce liability risk but do not typically result in monitoring or better incentives to avoid liability.74 Corporations rarely seek reimbursement from individuals, which, if anything, would result in the depletion of insurance coverage.75

IV.

THE IMPACT OF OWNERSHIP STRUCTURES ON INCENTIVES

A.

Issuer Liability, Corporate Governance and Individual Liability

In practice, issuer liability shifts the financial impact of misrepresentations from personally responsible individuals to the issuer. Even if investors can sue individuals, the issuer tends to have deeper pockets. Insurance, in theory, moves the risk to the insurer, which may push the risk back to the issuer through monitoring and adjusting insurance premia. Issuer liability thus puts shareholders in a position akin to someone strictly (but proportionately) liable because of the effect of settlements and insurance premia on the value of their stock. Theoretically, shareholders collectively should have incentives to reduce the probability of misconduct. The critical question is how well they are positioned to prevent wrongdoing to avoid issuer liability and keep insurance premia down. Boards and significant shareholders could monitor officers potentially responsible for misstatements or select officers that will avoid them.76 Moreover, shareholders and boards could push to implement incentive structures to prevent wrongdoing. Ideally, officers or managers would suffer financial and career penalties,77 and firms might consistently attempt to seek reimbursement for financial losses resulting from issuer liability. One technique is clawbacks

See Arlen & Carney, supra note 23, at 712. Baker & Griffith, supra note 14, at 760–61; see also Fox, supra note 29, at 305; Cox, supra note 58, at 512 (finding that the settlement amount is covered by insurance in 96% of cases); Bratton & Wachter, supra note 29, at 100; but see Donelson et al., supra note 63 (finding that insurance matters in settlement amounts only in weaker cases, but not typically in those involving accounting fraud). 74 Baker & Griffith, supra note 16, at 72–74. 75 Dubbs, supra note 27, at 462. 76 Posner, supra note 51, at 169–70. 77 See Alexander I. Platt, Index Fund Enforcement, 53 UC Davis L. Rev. 1454, 1475–76 (2020) (summarizing evidence on career penalties suffered by managers following securities class actions, including ‘removal, reduced pay, diminished opportunities at other firms, negative ISS recommendations, and fewer supportive votes from shareholders’). 72 73

92  Research handbook on corporate liability of executive compensation in the case of restatements of earnings, which have been legally mandated in the US in specific situations78 but which, arguably, are not effectively implemented.79 Ideally, one might expect shareholders to push for internal clawback policies to create the right incentives. However, we do not see these in practice. Arlen and Carney describe three circumstances under which corporate liability is superior to individual liability. First, the corporation must be well-positioned to prevent misconduct. Second, it must be able to impose sanctions more effectively than a court. Third, a suit by the corporation must be more likely than an investor suit.80 These conditions do not apply to issuer liability because corporations are unlikely to sanction managers engaging in misconduct.81 Corporations do not have an advantage over outside plaintiffs in identifying responsible individuals.82 Boards hesitate to sue managers.83 Suing or sacking a manager is typically a measure of last resort that hints at the board’s prior failure in selecting the individual in question. Disciplining a manager may entail a reputational cost for the company or the board.84 B.

How Ownership Structure Shapes Monitoring Incentives and Capabilities

The incentive effects of liability depend primarily on how well the board is incentivized to reduce liability risk. This will depend on the firm’s corporate governance structure and environment, which may or may not push board members to implement goals in the interest of the corporation and its shareholders. As in many areas of corporate governance, ownership structure plays a significant role. It is easy to conceptualize the avoidance of issuer liability as an agency problem between shareholders and managers: Managers will often benefit from embellishing corporate performance, whereas shareholders will collectively benefit from avoiding the financial harm from issuer liability.85 While issuer liability, in principle, would create incentives to take steps for monitoring and screening that will avoid securities fraud, such incentives will be eviscerated by diversification.86 With only a small investment in any firm, efforts to reduce agency costs may not be cost-justified both for a diversified retail investor or a fund. Individual shareholders are unlikely to have incentives to ensure the selection of directors and officers who will avoid misconduct and securities fraud.87 In other words, the classic collective action problem is to blame for the lack of effectiveness of issuer liability. 78 Sarbanes–Oxley Act of 2002, Pub. L. 107–204, § 304, 116 Stat. 745, 778; Dodd–Frank Act of 2010, Pub. L. 111–203, § 954, 124 Stat. 1376, 1904. The latter provision has not become effective because the SEC has not yet passed implementing rules. 79 E.g., Jesse Fried & Nitzan Shilon, Excess-Pay Clawback, 36 J. Corp. L. 721, 729–35 (2011) (discussing the limited effectiveness of the Sarbanes–Oxley clawback). 80 Arlen & Carney, supra note 23, at 707. 81 Id. at 708; see also Velikonja, supra note 61, at 1308. 82 Arlen & Carney, supra note 23, at 710. 83 Id. at 711–12; see also Fox, supra note 29, at 281; Coffee, supra note 13, at 1564, and Bratton & Wachter, supra note 29, at 72–73 (all noting the superior deterrence effects of individual liability). 84 See, e.g., Rose, supra note 26, at 1256–57; Russell M. Gold, Compensation’s Role in Deterrence, 91 Notre Dame L. Rev. 1997, 1997 (2016). 85 Cox, supra note 58, at 511; Fox, supra note 29, at 303 n.6. 86 Rose, supra note 26, at 1255. 87 See Urska Velikonja, The Political Economy of Board Independence, 92 N.C. L. Rev. 855, 895–97 (2014); Webber, supra note 42, at 258; and Hal S. Scott & Leslie N. Silverman, Stockholder Adoption

Issuer liability  93 The extent to which incentives are present for shareholders plays out at two levels, namely at the investor level and the firm level. In a recent paper, Dharmapala and Khanna identify controller wealth concentration as a key factor determining how strongly a shareholder will be motivated to induce a firm to internalize externalities.88 The same intuition applies to the incentives created by issuer liability: shareholders most of whose wealth is tied up in a particular firm will want to avoid the hit on their finances by an extensive settlement diminishing the value of their stock holdings. Measures to avoid issuer liability in the first place would thus seem to be the self-interest of such stockholders. Second, dispersed ownership at the firm level results in a reduction of the ability of shareholders to take effective measures, regardless of whether they have personal incentives. At least in passing, US scholars have noted that the lack of a deterrent effect of securities litigation is likely the result of collective action problems caused by ownership structure.89 This is because collective action problems prevent shareholder monitoring in the classic Berle-Means corporation.90 Therefore, the board will consider shareholders’ collective financial interests to a lesser extent than is desirable.91 Large shareholders do not suffer from collective action problems. Some may even be consulted before essential transactions in order to gain their blessing. Sometimes they are represented on the board, which provides them with direct decision-making powers and access to information.92 Concentrated ownership structures generally should result in a stronger incentive effect of issuer liability. With controlling shareholders sometimes involved in financial fraud and close to the core of corporate scandals,93 issuer liability creates incentives against possible wrongdoers. We cannot expect this relationship to change with the rise of institutional investors, specifically those managing index funds. Most observers agree that they have little to gain from firm-specific activism, and they have no incentive to reduce fraud because diversification protects them from firm-specific risk.94

of Mandatory Individual Arbitration for Stockholder Disputes, 36 Harv. J.L. & Pub. Pol’y 1187, 1205 (2013) (all noting that investors may potentially benefit from socially undesirable conduct). 88 See Dhammika Dharmapala & Vikramaditya S. Khanna, Controlling Externalities: Ownership Structure and Cross-Firm Externalities (Eur. Corp. Gov. Inst., Law Working Paper No. 603/2021, 2021), https://​ssrn​.com/​abstract​=​3904316. 89 Rose & Squire, supra note 35, at 1689 (pointing out that justification of securities class actions with deterrence is greater if there are large, non-diversified shareholders). 90 Gelter, Risk-shifting, supra note 2, at 511–15. 91 Arlen & Carney, supra note 23, at 693; see generally Andrei Shleifer & Robert W. Vishny, A Survey of Corporate Governance, 52. J. Finance 737, 740–44 (1997). 92 E.g., Johannes Semler, The Practice of the German Aufsichtsrat, in Comparative Corporate Governance: The State of the Art and Emerging Research 267, 269 (Klaus J. Hopt, Hideki Kanda, Mark J Roe, Eddy Wymeersch & Stefan Prigge eds., 1998); Claus Luttermann & Jean J. du Plessis, Banking on Trust: The German Financial Sector, Global Capital Markets and Corporate Finance and Governance, in German Corporate Governance in International and European Context 329, 335–36 (Jean J. du Plessis et al. eds., 2d ed. 2012); Martin Gelter & Geneviève Helleringer, Lift Not the Painted Veil! To Whom are Directors’ Duties Owed?, 2015 Ill. L. Rev. 1069, 1079–81 (2015). 93 See John C. Coffee, Jr., A Theory of Corporate Scandals: Why the USA and Europe Differ, 21 Ox. Rev. Econ. Pol’y 198, 206–207 (2005). 94 Platt, supra note 77, at 1482, 1483 (summarizing the literature on both points); Lucian A. Bebchuk & Scott Hirst, Index Funds and the Future of Corporate Governance, 119 Colum. L. Rev. 2029, 2096 (2019).

94  Research handbook on corporate liability The smaller the agency cost in the shareholder–board relationship, the more effective issuer liability is. With more significant shareholders and more shareholder wealth tied up in a particular firm, issuer liability has more potent incentive effects. D&O insurance should be similarly affected: Arguably, the agency problem between shareholders and boards deprives the former of the ability to push for D&O insurance plans that are more tailored toward reducing incidents of liability. Without the collective action problems, shareholders should be able to influence boards to take out insurance that minimizes insurance premia. It is tempting to object that similar agency problems between shareholders and managers exist between controlling and outside shareholders. Controlling shareholders may hesitate to push for procedures and practices at firms that reduce the likely incidence of issuer liability, such as transparent disclosure mechanisms that inhibit private benefits of control.95 They will not be interested in having an effective insurance mechanism in place. However, the position of a significant shareholder differs from that of management in that the former absorbs the cost of a large settlement and insurance premia. Consequently, the cost of issuer liability will be (indirectly) borne by a controlling shareholder positioned to avoid misconduct.96 C.

The Effects of Issuer Liability on Creditors

In several jurisdictions, there have been debates about how issuer liability should be treated relative to the claims of other creditors of the issuer. In the US, § 510(b) of the Bankruptcy Code subordinates issuer liability to other claims that would otherwise be equal in rank. A contrary direction was heralded by § 308(a) of the Sarbanes-Oxley Act of 2002,97 which permits the SEC to set up ‘fair funds’ sourced from penalties for securities law violations to compensate investors. Contrary to the Bankruptcy Code’s policy, federal courts have decided against the subordination of such funds.98 In Europe, the issue is sometimes discussed in the context of the legal capital system: Payment to shareholders resulting from issuer liability might be considered a return of capital contributions.99 Yet, according to the Court of Justice of the European Union, issuer liability to shareholders is not contrary to secondary EU law,100 also considering that EU capital markets law gives the Member States the incentive to establish issuer liability. Member States may therefore put investor claims based on false disclosures on a pari passu level with claims of other unsecured creditors.101

95 Allen Ferrell, The Case for Mandatory Disclosure in Securities Regulation Around the World, 2 Brook. J. Corp. & Fin. L. 81, 87–92 (2007). 96 On possible objections based on stock pyramids and sales of control, see Gelter, Risk-shifting, supra note 2, at 516–18. 97 Sarbanes–Oxley Act of 2002, Pub. L. 107–204, § 308(a), 116 Stat. 745, 784. 98 In re Adelphia Commc’ns Corp., 327 B.R. 143, 168–170 (Bankr. S.D.N.Y. 2005); Ad Hoc Adelphia Trade Claims Comm. v. Adelphia Commc’ns Corp., 337 B.R. 475, 478 (S.D.N.Y. 2006); SEC v. WorldCom, 273 F. Supp 2d 431, 434 (S.D.N.Y 2003); Official Comm. Unsecured of Creditors of WorldCom Inc. v. SEC, 467 F.3d 73, 85 (2d Cir. 2006). See Wendy S. Walker, Alan S. Maza, David Eskew & Michael E. Wiles, At the Crossroads: The Intersection of the Federal Securities Laws and the Bankruptcy Code, 63 Bus. Law. 125, 141–45 (2007). 99 E.g., Austria, supra note 7, at 283–84; Germany, supra note 4, at 375–76, 386. 100 Case C-174/12, Hirmann v. Immofinanz, ECLI:EU:C:2013:856 (Dec. 19, 2013). 101 Gelter, Global Securities Litigation and Enforcement, supra note 2, at 3, 64.

Issuer liability  95 Concerns about creditor protection should not guide the policy decisions on issuer liability. As the debate about legal capital has shown, creditors cannot rely on a particular equity cushion.102 Moreover, many creditors can protect themselves against the risk of default by using covenants, adjusting the interest rate to the perceived threat, and refusing to extend credit in the first place.103 The decision about subordination thus has a marginal impact on the extent to which shareholders or creditors bear the risk of fraud. The guiding question should therefore be what incentives are created for creditors. Here, the same arguments apply to shareholders: If creditors bear some of the fraud risk, they will be more strongly incentivized to monitor.104 While US firms are thought to have a rather diffuse debt structure, it is often believed to be more concentrated in Europe, even in the UK.105 Bank monitoring may be beneficial where the bank enjoys a close relationship with a firm and interacts closely with management.106 Occasionally, large creditors are even represented on the board. Even if credit concentration is receding in Continental Europe, creditor monitoring may contribute to a reduction of issuer liability risk. Consequently, shifting some of that risk to creditors can create value by setting the right incentives.107

V.

THE POLITICAL ECONOMY OF ISSUER LIABILITY

If issuer liability creates monitoring incentives for large investors, why is it not more frequently used in concentrated ownership jurisdictions? Comparative research shows that it is most commonly imposed in the US, where a litigation model rooted in private enforcement based on high-powered incentives of plaintiff attorneys has taken root.108 The reasons are well-known, particularly contingency fees making up approximately 20–30 percent of the award or the settlement,109 and the so-called ‘American Rule’ in civil procedure where each party pays its expenses.110 Pre-trial discovery makes litigation viable even where the initial evidentiary basis 102 E.g., Luca Enriques & Jonathan R. Macey, Creditors Versus Capital Formation: The Case against the European Legal Capital Rules, 86 Cornell L. Rev. 1165, 1186 (2001). 103 E.g., id. at 1188–95; John Armour, Legal Capital: An Outdated Concept?, 7 Eur. Bus. Org. L. Rev. 5, 16–17 (2006). 104 Kenneth B. Davis, Jr., The Status of Defrauded Securityholders in Corporate Bankruptcy, 1983 Duke L.J. 1, 66; see also Nicholas L. Georgakopoulos, Strange Subordinations: Correcting Bankruptcy’s § 510(b), 16 Bankr. Devs. J. 91, 95 (1999). 105 E.g., John Armour et al., Corporate Ownership Structure and the Evolution of Bankruptcy Law: Lessons from the United Kingdom, 55 Vand. L. Rev. 1699, 1763–77 (2002). 106 See generally Shleifer & Vishny, supra note 91, at 757–58. 107 Gelter, Risk-shifting, supra note 2, at 525–28. 108 E.g., Thomas M.J. Möllers, Efficiency as a Standard in Capital Market Law – The Application of Empirical and Economic Arguments for the Justification of Civil Law, Criminal Law and Administrative Law Sanctions, 2009 Eur. Bus. L. R. 243, 261; Fox, supra note 29, at 318–19; Luca Enriques et al., Corporate Law and Securities Markets, in The Anatomy of Corporate Law 243, 260 (Reinier Kraakman et al. eds., 3d ed. 2017); Gelter, Global Securities Litigation and Enforcement, supra note 2, at 80–81. 109 E.g., Park, supra note 29, at 348; on the lodestar method, see also Gelter, Global Securities Litigation and Enforcement, supra note 2, at 88. 110 E.g., Möllers, supra note 108, at 267; Martin Gelter, Why Do Shareholder Derivative Suits Remain Rare in Continental Europe?, 37 Brook. J. Int’l L. 843, 863–64 (2012); Warren, supra note 27, at 1082. At least under Delaware law, it appears to be possible for firms to introduce ‘fee-shifting’ bylaws

96  Research handbook on corporate liability is relatively weak.111 But most importantly, the nature of securities class actions in the US as an opt-out system, where all members of the class are by default included, means that plaintiff attorneys have more leverage when negotiating a settlement with defendant issuers.112 In much of the world, securities lawsuits remain comparatively rare. Jurisdictions where the model has to some extent expanded include Canada, Australia, and Israel.113 Most other countries are characterized by an absence of such litigation, including those in Continental Europe, due to a lack of its key elements.114 However, there has been considerable change in recent years, even in the civil law world. Most prominently, the Netherlands has introduced a collective enforcement mechanism that replicates some of the effects of securities class actions.115 Both Taiwan and China use a private enforcement model based on a non-profit entity.116 Germany, among other countries, has adopted a model litigation mechanism.117 In the US, securities litigation seems to hang in an awkward political equilibrium between shareholders, institutional investors, management, and plaintiff lawyers. With stock ownership having become common since the 1970s, even if in the form of investments intermediated through institutions rather than direct retail ownership,118 it is hard for politicians to neglect shareholder interests.119 Eliminating issuer liability would therefore be difficult. It would seem unfair to pursue a policy where a seemingly responsible and deep-pocketed corporation is freed from liability.120

with respect to securities litigation. See Del. Code Ann. tit. 8, §§ 109(b), 115 (prohibiting fee-shifting bylaws for internal corporate claims and defining this term); Salzberg v. Sciabacucchi, 227 A.3d 102 (Del. 2020) (permitting a choice of forum for federal securities law claims based on the definition in § 115); e.g., Mohsen Manesh, The Corporate Contract and the Internal Affairs Doctrine, 71 Am. U. L. Rev. 501, 560–61 (2021) (noting that firms might introduce fee-shifting bylaws that concern securities class actions). 111 See, e.g., Guido Ferrarini & Paolo Giudici, Financial Scandals and the Role of Private Enforcement 50–51 (Eur. Corp. Gov. Inst., Law Working Paper No. 40/2005, 2005), http://​ssrn​.com/​abstract​=​730403; Möllers, supra note 110, at 267; Nathan M. Crystal & Francesca Giannoni-Crystal, Understanding Akzo Nobel: A Comparison of the Status of In-House Counsel, the Scope of the Attorney-Client Privilege, and Discovery in the U.S. and Europe, 11 Global Jurist 1, 23–24 (2011); Warren, supra note 27, at 1082; Érica Gorga & Michael Halberstam, Litigation Discovery and Corporate Governance: The Missing Story about the ‘Genius of American Corporate Law’, 63 Emory L.J. 1383 (2014). 112 E.g., Warren, supra note 27, at 1082; Gelter, Global Securities Litigation and Enforcement, supra note 2, at 81–82. 113 Canada, supra note 3, at 175–78; Australia, supra note 8, at 1091–97; Israel, supra note 6, at 770–74. 114 For a comparison, see Warren, supra note 27, at 1085–87. 115 Netherlands, supra note 4, at 499–513; Brigitte Haar, Regulation Through Litigation – Collective Redress in Need of a New Balance Between Individual Rights and Regulatory Objectives in Europe, 19 Theoretical Inq. Law 203, 215–20 (2018). 116 Lauren Yu-Hsin Lin & Yu Xiang, The Rise of Non-Profit Organizations in Global Securities Class Actions: A New Hybrid Model in China, 60 Colum. J. Transnat’l L. 493, 516–19, 540–44 (2022). 117 Germany, supra note 4, at 402–7; Haar, supra note 115, at 225–30. 118 Bratton & Wachter, supra note 29, at 138–39. 119 Martin Gelter, The Pension System and the Rise of Shareholder Primacy, 43 Seton Hall L. Rev. 909, 948–62 (2013). 120 Bratton & Wachter, supra note 29, at 140 (‘So long as catering to shareholder interests appears advantageous to Congress, it is difficult to imagine a political coalition forming to eliminate FOTM’); see also Donald C. Langevoort, Structuring Securities Regulation in the European Union: Lessons from the US Experience, in Investor Protection in the EU: Corporate Law Making, The MiFID

Issuer liability  97 Still, one might not expect issuer liability to persist because retail investors are not a coordinated interest group. Institutional investors also do not seem to be a strong force for issuer liability; neither mutual funds nor index funds or hedge funds often serve as lead plaintiffs or otherwise promote securities litigation. Arguably, this is because they would bear considerable cost and are concerned about free-riding by other investors;121 moreover, actively promoting a suit might cost them business brought to them by issuers.122 Public pension funds serve as lead plaintiffs more often because they do not have to compete for clients and sometimes pursue a public political mission.123 This means that plaintiff attorneys remain the primary interest group benefiting from keeping issuer liability alive by making strategic political contributions.124 Obviously, issuers and their management oppose securities class actions at times. However, if these are ineffective in setting strong managerial incentives, one cannot expect political resistance to persist. The critical beneficiary group is attorneys (and possibly insurers), whose rent-seeking opportunities should suffice for the system to stay in place. If ownership structure makes a difference for incentives created by issuer liability, one would also expect a different political economy under concentrated ownership. As we have seen, the social value of securities class actions in the US is partly undermined by its dispersed ownership structure. Countries with more concentrated equity and debt structures could benefit from sharpened issuer liability because it creates incentive effects for large investors. The comparative corporate governance literature has amply documented how jurisdictions outside the common law world tend to have more concentrated ownership structures.125 Despite a constantly evolving landscape, block ownership (e.g., by families or governments) persists in many Continental European and East Asian countries.126 Intuitively, one could speculate that those for whom the incentives are created – large shareholders and large creditors – also tend to be among the dominant interest groups in corporate governance in these jurisdictions. Opposition by groups who might lose from issuer liability aligns with the literature on path dependence in comparative corporate governance. Powerful interest groups such as these will prevent change that could better protect outside investors.127

and Beyond 485, 503 (Guido Ferrarini & Eddy Wymeersch eds., 2006) (‘no interest group wants to be caught on the wrong side of investor anger’). 121 Webber, supra note 42, at 218–19; see also Bebchuk & Hirst, supra note 94, at 2112–13 (finding that index funds from the ‘Big 3’ have never served as lead plaintiffs). 122 Webber, supra note 42, at 219–20. 123 Id. at 221. 124 Bratton & Wachter, supra note 29, at 142, 144 (noting that plaintiffs’ law firms make strategic political contributions). 125 E.g., Marco Becht & Alisa Roëll, Blockholdings in Europe: An International Comparison, 43 Eur. Econ. Rev. 1049 (1999); Raphael La Porta, Florencio Lopez-de-Silanes & Andrei Shleifer, Corporate Ownership Around the World, 54 J. Finance 471 (1999); Mara Faccio & Larry H.P. Lang, The Ultimate Ownership of Western European Corporations, 65 J. Fin. Econ. 365 (2002) 379–80; Peter A. Gourevitch & James Shinn, Political Power and Corporate Control 18 (2005). 126 For recent data, see Adriana de La Cruz, Alejandra Medina & Yung Tang, Owners of the World’s Listed Companies, OECD Cap. Mkt. Series (OECD), Oct. 17, 2019, at 27, http://​www​.oecd​ .org/​corporate/​Owners​-of​-the​-Worlds​-Listed​-Companies​.htm; Gur Aminadav & Elias Papaioannou, Corporate Control around the World, 75 J. Finance 1191, 1205 (2020). 127 Mark J. Roe, Chaos and Evolution in Law and Economics, 109 Harv. L. Rev. 641, 651–52 (1996); Lucian A. Bebchuk & Mark J. Roe, A Theory of Path Dependence in Corporate Ownership and Governance, 52 Stan. L. Rev. 127 (1999).

98  Research handbook on corporate liability In many jurisdictions, plaintiff lawyers never developed into a powerful interest group because an effective enforcement system might have been costly and a deterrent for those controlling large companies. In the long run, there may even be a dynamic effect on ownership structure upsetting corporate control: if issuer liability is a common concern, large shareholders (especially those with a large proportion of their assets tied up in the firm128) or creditors might be incentivized to diversify their holdings more strongly to avoid exposure to issuer liability. Over time, issuer liability may thus contribute to a more diversified ownership structure (and then potentially lose its bite). Debates about private enforcement of securities law enforcement often blend into other controversies about corporate liability: the EU Commission’s 2011 Public Consultation on Collective Redress129 (which emphasized consumer protection in general rather than securities law specifically) revealed significant opposition from business groups against mechanisms such as contingency fees and an opt-out class action mechanism.130 Neither the Commission’s 2013 recommendation131 nor the 2020 Directive on Collective Redress establishes a class action mechanism. The Directive requires Member States to give standing in representative actions to consumer protection associations operating on a not-for-profit basis.132 The existence of stronger anti-litigation interests may explain why mechanisms that were adopted in most countries remained relatively harmless compared to US class action. The literature on regulatory dualism might provide a way out of this dilemma. Authors writing in this area have proposed a strategy whereby some firms will be able to opt into a more investor-friendly law if they hope to tap the international market, for example by selecting a listing regime with heightened standards. Others may remain subject to the less exacting requirements. Arguably, giving companies a choice will erode political resistance against pro-investor reforms.133 To some extent, this will be possible in issuer liability if a firm seeks to cross-list. However, as issuer liability often only covers investors in a particular country, it may redistribute wealth to these plaintiffs from shareholders in jurisdictions without an effective issuer liability system.134

Dharmapala & Khanna, supra note 88. EU Commission, Public Consultation: Towards a More Coherent European Approach to Collective Redress, SEC (2011) 173 (Final, 4 February 2011). 130 See Warren, supra note 27, at 1112 (discussing responses to the public consultation); for a historical overview of the EU Commission’s work in this area, see Astrid Stadler, Are Class Actions Finally (Re)conquering Europe?, 30 Juridica Int’l 14, 14–15 (2021). 131 Commission Recommendation of 11 June 2013 on common principles for injunctive and compensatory collective redress mechanisms in the Member States concerning violations of rights granted under Union Law (2013/396/EU), 2013 O.J. (L 201) 60. 132 Directive (EU) 2020/1828 of 25 November 2020 on representative actions for the protection of the collective interests of consumers and repealing Directive 2009/22/EC, art. 4, 2020 O.J. (L 409). 133 Ronald J. Gilson et al., Regulatory Dualism as a Development Strategy: Corporate Reform in Brazil, the United States, and the European Union, 63 Stan. L. Rev. 475 (2011). 134 Érica Gorga, The Impact of the Financial Crisis on Nonfinancial Firms: The Case of Brazilian Corporations and the ‘Double Circularity’ Problem in Transnational Securities Litigation, 16 Theoretical Inq. L. 131 (2015). 128 129

Issuer liability  99

VI. CONCLUSION Most countries with a developed securities law provide for issuer liability, typically in addition to individual liability for misstatements to the markets. This chapter has argued that issuer liability creates better incentives to avoid securities fraud in concentrated ownership systems than in dispersed ownership systems. In reality, we tend to see effective enforcement of issuer liability primarily in countries with dispersed ownership, such as the United States. As a matter of policy, a greater emphasis on individual liability for misstatements would be desirable, as some scholars have suggested.135 Conversely, more effective issuer liability would seem desirable in countries with concentrated ownership. It is tempting to speculate whether the preferences of key interest groups in corporate governance have contributed to maintaining the current position. The critical interest group benefiting from issuer liability is that of plaintiff attorneys; the key interest group benefiting from its ineffectiveness in Continental Europe is that of blockholders. Given the respective influence of these groups, we can expect differences in practices to persist.

Coffee, supra note 13, at 1582–84; Langevoort, supra note 29, at 639–40.

135

6. Corporate criminal liability Samuel W. Buell

I. INTRODUCTION The most common question associated with corporate criminal liability in the academic literature is why the doctrine should exist.1 From the standpoint of criminal law theory, some question the conceptual soundness of applying the concepts of blame and punishment to inanimate legal persons.2 However, one can turn this framing around, observing that criminal liability’s standard burdens of justification arise from the painful and liberty-depriving characteristics of punishment, which corporations cannot experience.3 From the standpoint of corporate law theory, some question the potential wastefulness (‘over-deterrence’) in criminal liability’s potential to spill over into harming employees, investors, counterparties, and others who neither participated in wrongdoing nor can directly control whether others within the corporation do – especially in instances of substantial reputational sanction or industrial delicensing or debarment.4 However, this framing also can be inverted, by pointing out that the argument’s concession to criminal liability’s unique potency highlights the very reason legal systems might view criminal liability as a necessary supplement to civil liability in encouraging managers of firms to control agent misconduct. Such misconduct, after all, can be highly profitable to both firms and individual agents.5 While such consequentialist and deontological debates have proceeded without pause over decades and produced a voluminous literature, the United States and, more recently, many other legal systems have eagerly embraced criminal liability for corporations. Alongside increased scale, complexity, and globalization of the activities of multinational firms has come greater and justified worry about the costs of corporate crime. Salient corporate scandals seem to pile up like the faulty automobiles, crashed airplanes, spilled oil, laundered assets, and depleted pension funds left in their wake. A common response of governments has been to use criminal liability, and especially the threat of its imposition, as a lever in strategies meant to compel the massive private industrial sector to get its house in order.6 The law of corporate

1 V.S. Khanna, Corporate Criminal Liability: What Purpose Does It Serve?, 109 Harv. L. Rev. 1477 (1996). 2 Albert W. Alschuler, Two Ways to Think About the Punishment of Corporations, 46 Am. Crim. L. Rev. 1359 (2009). 3 Samuel W. Buell, Corporate Crime: An Introduction to the Law and its Enforcement Vol. II 550 (2021) [hereinafter Buell 2021]. 4 Alan Sykes & Daniel Fischel, Corporate Crime, 25 J. Legal Stud. 319; V.S. Khanna, supra note 1. 5 Jennifer Arlen, Corporate Criminal Liability: Theory and Evidence, in Research Handbook on the Economics of Criminal Law 144 (K. Hylton and A. Harel eds., 2012). 6 Jennifer Arlen & Samuel Buell, The Law of Corporate Investigations and the Global Expansion of Corporate Criminal Enforcement, 93 S. Cal. L. Rev. 697 (2020).

100

Corporate criminal liability  101 criminal liability can no longer be meaningfully understood without comprehending the institutional and political particulars of its enforcement.7 This chapter introduces the subject of criminal liability for corporations at a basic level and in four steps, with its application in American law and enforcement. First, the framework for theoretical debate is set forth. Second, the doctrinal specifics of corporate criminal liability are explained, with attention being paid to available options. Third, the chapter describes enforcement mechanisms and how they strive to exploit the potential of criminal law as a means of corporate regulation. Fourth, the enforcement landscape is situated within the realm of politics, explaining why criminal liability has grown as an attractive supplement to other legal interventions in corporate affairs.

II.

CRIMINAL LIABILITY FOR CORPORATIONS

A. Theory Theoretical discussion of criminal liability for corporations generally starts from the standpoint of criminal law, specifically what has become known as punishment theory. Because corporate liability, the subject of a full volume here, is not in itself controversial,8 the question becomes why law should impose liability on corporations through criminal process. This question logically points, at least initially, to the tools of criminal law theory. Criminal sanctions are generally justified on two familiar lines of argument: deontological (roughly Kantian) theories that see punishment, given necessary conditions, as morally mandated, usually on grounds of retributive desert;9 and consequentialist (roughly Benthamite) theories that see punishment, when justified according to cost-benefit analysis, as necessary to the project of reducing crime, usually through the mechanism of deterrence.10 Again, one could question whether the special justificatory burdens for criminal sanctions, over other forms of legal control, apply in the case of corporations since they cannot be imprisoned and do not have the same liberty interests as human persons, if corporations even have cognizable interests in discussions of moral condemnation. Nonetheless, given the many other legal and non-legal mechanisms available for the control of, and response to, behaviors within business organizations, it is probably fair to place some burden on the argument for corporate criminal liability. The most common objection to justifying criminal punishment of corporations on grounds of moral imperative is probably that corporations are inanimate (indeed, somewhat ethereal) objects in the world, not people or even living creatures, and thus cannot be themselves moral Samuel W. Buell, Capital Offenses (2016). Lewis Kornhauser, An Economic Analysis of the Choice Between Enterprise and Personal Liability for Accidents, 70 Cal. L. Rev. 1345 (1982); Reinier Kraakman, Corporate Liability Strategies and the Costs of Legal Controls, 93 Yale L.J. 857 (1984); Alan Sykes, The Economics of Vicarious Liability, 93 Yale L. J. 1231 (1984). 9 Michael S. Moore, Justifying Retributivism, 27 Isr. L. Rev. 15 (1993); Mitchell Berman, Two Kinds of Retributivism, in Philosophical Foundations of Criminal Law (R.A. Duff and Stewart Green eds., 2011). 10 Gary Becker, Crime and Punishment: An Economic Approach, 76 J. Pol. Econ. 169 (1968); Cesar Beccaria, On Crimes and Punishments (1764). 7 8

102  Research handbook on corporate liability agents bearing responsibility and deserving retribution for wrongs committed by humans working within them. In the often-cited phrase of the Baron Lord Thurlow, a corporation has ‘no soul to damn, no body to kick’.11 One critical author has compared the practice of prosecuting corporations to the ancient practice of ‘deodand’, whereby a jury might find a horse or a cart involved in a fatal accident punishable (forfeitable to the Crown) for having ‘moved [unto death]’.12 Some modern legal systems continue to reject corporate criminal liability on the ground that it cannot be squared with an absolute requirement that criminal liability be based on moral agency and responsibility.13 It is an error, however, to analogize corporations to physical objects or even animals. Corporations, especially large ones, are institutions, not objects. Their legal existence may be limited to paper filings and statutes. But their presence in the world is far larger and more complex. They comprise the collective actions of groups of humans engaged in directed and often highly impactful industrial projects. As Bishop said in a foundational criminal law treatise, ‘If … the invisible, intangible essence or air which we term a corporation can level mountains, fill up valleys, lay down iron tracks, and run railroad cars on them, it can intend to do it, and can act therein as well viciously as virtuously.’14 Social practice certainly reflects Bishop’s view. The modern world would be unintelligible without the common language of responsibility ascription that applies to corporations, especially when harm, disaster, or failure strikes. When we say that a company spilled oil, harmed consumers, deceived markets, corrupted a government, or the like, we mean more than that some number of people did those things. We mean that their group enterprise went wrong, as a result of how they arranged themselves and pursued their common project. The idea of group or collective responsibility has been well plumbed by philosophers and is robust to rigorous analysis.15 The problem with a deontological case for corporate criminal liability is not that corporations cannot be blameworthy. Furthermore, they can be punished. The state has ample means at its disposal to harm corporations through legal sanctions, up to and including destroying a corporation. The inability to imprison a corporation does not end the discussion of corporate punishment. The trouble with corporate retribution is not that it cannot be deserved. It is that it cannot be carried out.16 Because a corporation, apart from its constituents, has no affective capacity to experience punishment as a grave setback to its interests (again, it can be a setback, but it cannot be a felt or experienced one), seeking to punish a corporation on retributive grounds is fruitless. Retribution may be deserved but it cannot be carried out. And a retributive program for criminal punishment depends centrally on the idea that, when deserved, actual retribution is a moral imperative that must be satisfied, regardless of whether such punishment

John Coffee, ‘No Soul to Damn, No Body to Kick’: An Unscandalized Inquiry into the Problem of Corporate Punishment, 79 Mich. L. Rev. 386 (1981). 12 Alschuler, supra note 2. 13 Sara Sun Beale & Adam Safwat, What Developments in Western Europe Tell Us About American Critiques of Corporate Criminal Liability, 8 Buffalo Crim. L. Rev. 89 (2004). 14 Joel Prentiss Bishop, New Commentaries on the Criminal Law § 417 (7th ed. 1882). 15 Peter Cane, Responsibility in Law and Morality (2002); Christopher Kutz, Complicity (2000); Christian List and Philip Pettit, Group Agency: The Possibility, Design, and Status of Corporate Agents (2011); Larry May, The Morality of Groups (1987). 16 Samuel W. Buell, Retiring Corporate Retribution, 83 Law and Contemporary Problems 25 (2020). 11

Corporate criminal liability  103 accomplishes anything beyond fulfillment of the moral imperative.17 It may be true in a given case that some number of individuals within a corporation deserve punishment and can be punished retributively. But criminal law theory would require independent, individualized justification for punishment of any such person. Corporate punishment could not satisfy the demand for retribution against individuals unless criminal law were to radically relax the rules of individual liability so that much less in the way of action and mental state were required for complicity-based liability than are at present required under doctrines such as conspiracy and accomplice liability.18 It thus should not be surprising that, even as some authors continue to explore the problem of corporate retribution, the literature on corporate criminal liability is overwhelmingly, and increasingly, in the consequentialist tradition. Here, corporate criminal liability finds much theoretical support. The basic instrumental case in favor of corporate criminal liability sees the firm as an additional actor, beyond the state and the individual, that can be exploited in the project of reducing criminal violations.19 If sanctions are directed at firms for the crimes of their agents, then firms, in their nicely rational cost-managing way, will be encouraged to invest in efforts to prevent crime on the job and to punish it when it occurs in order to deter others within the firm. Firms have exceptional ‘policing’ capacities in their ability to monitor their employees and see within themselves. They also have ‘sanctions’ (and rewards) they can impose on their employees in the form of assignments, promotion, compensation, and hiring or termination. All this corporate activity combines now roughly into an entire field of practice and study, called compliance.20 The powers of the firm, properly directed, complement the powers of the state. Consider a corporate employee deciding whether to engage in activity that is a possible or known legal violation. There may be strong incentives and rewards available for pursuing such activities if they do not result in sanctions. With the state and the firm allied in the project of sanctioning wrongdoing, such an employee must consider: (1) the extent of official legal sanctions likely to be imposed if such an activity is detected; (2) the negative consequences to the employee’s career within the firm, and elsewhere in the market, if the activity is uncovered; and (3) critical to any analysis of deterrence, the enhanced probability of being caught that comes from the state’s surveillance capabilities coupled with the firm deploying its own surveillance capabilities, in hopes of avoiding or reducing the imposition of criminal sanctions on the firm itself should the employee’s crime be revealed. The triangular relationship of the individual, the state, and the firm in the effort to deter corporate crime is represented in Figure 6.1. Now consider complications to this model, and how a consequentialist case for corporate criminal liability would respond. The most basic complication is one that the US Sentencing Commission and the US Department of Justice recognized quickly when they began designing guidelines for the sentencing decisions and prosecutorial discretion involved in criminal

Moore, supra note 9. Samuel Buell, The Responsibility Gap in Corporate Crime, 12 Crim. L. & Phil. 471 (2018) [hereinafter Buell 2018b]. 19 Jennifer Arlen & Reinier Kraakman, Controlling Corporate Misconduct: An Analysis of Corporate Liability Regimes, 72 N.Y.U. L. Rev. 687 (1997). 20 Miriam Baer, Governing Corporate Compliance, 50 Bos. Coll. L. Rev. 949 (2009); Veronica Root Martinez, Complex Compliance Investigations, 120 Colum. L. Rev. 249 (2020); Geoffrey Miller, The Law of Governance, Risk Management, and Compliance (2014). 17 18

104  Research handbook on corporate liability

Figure 6.1

Triangular relationship of the individual, the state, and the firm

enforcement against corporations.21 If firms are not rewarded for internal policing and sanctioning efforts (compliance) through reduced penalties, then they often will choose to forego such efforts and hope that legal violations will not be caught. What is the benefit in discovering and disclosing employee crimes if doing so only guarantees full prosecution of the firm? If it is to yield deterrence benefits, corporate criminal liability should be structured to include both sticks and carrots.22 A further complication is agency costs. Managers may not fear the imposition of criminal liability on the corporation if the costs of such liability do not flow through to managers sufficiently to outweigh the benefits managers may enjoy from tolerating legal risk-taking by underlings, foregoing the distracting focus on compliance, or even engaging in criminal

21 U.S. Dep’t of Just., Just. Manual § 9-28.000 (2015); U.S. Sent’g Guidelines Manual (U.S. Sent’g Comm’n), ch. 8. See Sally Quillian Yates, Memorandum for Assistant Attorneys General and United States Attorneys, Individual Accountability for Corporate Wrongdoing (Sept. 9, 2015), available at https://​www​.justice​.gov/​archives/​dag/​file/​769036/​download. A substantial problem with the Yates Memo itself, and the discussion in the field that ensued from it, was omission of the problem of the substantive scope of white-collar criminal liability, which explains more about non-prosecution of individuals in corporations than the policies and motivations that affect prosecutors’ decisions. Samuel Buell, Is the White Collar Offender Privileged?, 63 Duke L.J. 823 (2014) [hereinafter Buell 2014]; Samuel Buell, Criminally Bad Management, in Research Handbook on Corporate Crime and Financial Misdealing 59 (J. Arlen ed., 2018) [hereinafter Buell 2018a]; Buell 2018b, supra note 18. 22 Jennifer Arlen, The Potentially Perverse Effects of Corporate Criminal Liability, 23 J. Legal Stud. 833 (1994) [hereinafter Arlen 1994].

Corporate criminal liability  105 violations themselves.23 Corporate criminal liability itself, of course, cannot directly address the problem of agency costs in corporate governance. However, managers have substantial reasons to seek to avoid prosecution of the firm. Highest management has a legal duty under corporate law to do so.24 Criminal scandals are failures that can tarnish the reputations of corporate managers, potentially lead to termination, and affect their self-esteem and prospects. While it is frequently observed that fear of individual criminal liability is a more powerful reason for managers to steer firms away from criminal wrongdoing, core principles of legality and criminal punishment, at least at present, do not allow for the imposition of criminal liability for failures of supervision except in some very narrow circumstances involving misdemeanor liability.25 Even when senior managers personally engage in acts that are clearly defined as crimes, prosecutors may struggle to obtain indictments and convictions given the steep burden of proof for criminal liability and the tendency of the activities of supervisors to be less enmeshed in corporate documents and the testimony of employees. A final complication to the consequentialist case for corporate criminal liability is that civil regulatory mechanisms, in most legal systems, allow for the imposition of financial and other penalties on corporations. A corporation can be fined, suspended or debarred from sectors or lines of business, and even placed under court supervision and monitoring with mandated reforms, without having to resort to criminal prosecution. Some therefore argue that criminal liability for corporations is unnecessary or, worse, wasteful in at least some cases because of the capacity of criminal indictment and conviction to severely damage a corporation’s ability to do business, causing losses to investors, employees, and counterparties who did not engage in wrongdoing and are not logical targets for deterrent incentives.26 The response to this argument embraces, rather than disfavors, the reputational effects of corporate criminal prosecutions.27 Civil enforcement and liability cannot convey the seriousness and fault involved in a corporation’s production of crime. Criminal prosecution – because it arises from, after all, the commission of defined crime, because it must satisfy the highest burden of proof, and because it has higher salience to observers than civil proceedings – carries a unique messaging effect that no other legal mechanism can produce. Corporate managers will especially seek to avoid the threatened or actual imposition of criminal sanctions on their firms, and thus the presence of prosecutorial institutions in corporate affairs supplies a powerful incentive to devote resources to compliance. A criminal prosecution of a firm that carries strong reputational effects may result in individual reputational damage to managers, and even employees, and may cause persons within a firm and in similar firms to reflect on the group failure represented by a criminal scandal and devote energies to avoiding such disasters in

23 Jennifer Arlen & William Carney, Vicarious Liability for Fraud on Securities Markets: Theory and Evidence, 1992 U. Ill. L. Rev. 691 (1992); John Coffee, Crime and the Corporation: Making the Punishment Fit the Corporation, 47 J. Corp. L. 963 (2022). 24 Jennifer Arlen, The Story of Allis-Chalmers, Caremark, and Stone: Directors’ Evolving Duty to Monitor, in Corporate Law Stories (J. Mark Ramseyer ed., 2009); See also In re Caremark Int’l Inc. Derivative Litig., 689 A.2d 959 (Del. Ct. Chanc. 1996); In re The Boeing Co. Deriv. Litig., 2021 WL 4059934 (Del. Ct. Chanc. Sept. 7, 2021). 25 Buell 2018a, supra note 21; Buell 2018b, supra note 18. 26 V.S. Khanna, supra note 1; V.S. Khanna, What Rises from the Ashes, 47 J. Corp. L. 1029 (2022). 27 Samuel Buell, The Blaming Function of Entity Criminal Liability, 81 Ind. L.J. 473 (2006) [hereinafter Buell 2006]; Samuel Buell, A Restatement of Corporate Criminal Liability’s Theory and Research Agenda, 47 J. Corp. L. 937 (2022).

106  Research handbook on corporate liability the future. Importantly, in many legal systems, including that of the United States, regulatory regimes treat criminal convictions, beyond civil regulatory violations, as more likely to trigger debarment or exclusion of firms from industries or lines of business.28 In some industries and under some regulatory schemes, such provisions have the potential to operate in conjunction with criminal conviction as essentially a corporate death penalty. B. Doctrine Legal doctrine, of course, does not often arise from pure theory. Historical paths, politics, and the particulars of institutions of legislation and adjudication have a great deal of influence over the shape of doctrine. This has certainly been the case with the law of corporate criminal liability. It would also be genuinely difficult, as it turns out, to tailor the doctrine of criminal liability of corporations to the theory arguments sketched above, essentially because the large corporation and corporate crime are extremely complex phenomena.29 The simplest rule for corporate criminal liability is the one that applies in the United States under federal law, and which governs most corporate prosecutions: respondeat superior. Under this doctrine, a corporation will be criminally liable for any criminal violation committed by any agent of the corporation while acting within the scope of employment and at least in part with the intention to benefit the company (thus excluding, for example, employee theft from the employer as a basis for employer liability).30 This very old doctrine of agency law was allowed to travel from tort law into the criminal law by an early-twentieth-century decision of the United States Supreme Court dealing with enforcement of the first antitrust laws.31 The respondeat superior rule has two primary advantages. The first is its simplicity. All issues of actions and mental state involved in determining whether a crime has been committed are dealt with in the traditional manner of criminal law, through the conduct of an individual. Corporate liability is then analyzed separately, through the application of agency principles, only after a crime has been proven.32 Regulated actors, prosecutors, judges, and juries can all see clearly when criminal liability will and should apply, if crimes are defined clearly (which is not always the case, of course). The second advantage to the rule is its potency. Because it does not consider the conduct of the corporation itself in relation to the crime, firms cannot insincerely escape imposition of criminal liability by, for example, simply telling their employees not to break the law, adopting merely cosmetic compliance programs, or purposely turning a blind eye to crimes committed by lower-level employees.33

Cindy Alexander & Jennifer Arlen, Does Conviction Matter? The Reputational and Collateral Consequences of Corporate Crime, in Research Handbook on Corporate Crime and Financial Misdealing 87 (J. Arlen ed., 2017). 29 Buell 2006, supra note 27. 30 United States v. Dye Constr. Co., 510 F.2d 78 (10th Cir. 1975). 31 N.Y. Central & Hudson River R.R. Co. v. United States, 212 U.S. 481 (1909). 32 An exception to this approach is the much-discussed United States v. Bank of New England, NA, 821 F.2d 844 (1st Cir. 1987), in which a court defined corporate mens rea as consisting of the collective knowledge of the firm’s employees, as well as the firm’s level of indifference towards legal requirements as reflected in its compliance efforts. This approach, however, has not been widely influential and the court’s interpretation of the statutory language defining the crime charged in Bank of New England is not entirely persuasive. 33 United States v. Hilton Hotels Corp., 467 F.2d 1000 (9th Cir. 1972). 28

Corporate criminal liability  107 The greatest problem with the respondeat superior rule is that it is badly over-inclusive. If the primary purpose of corporate criminal liability is to encourage firms to invest in efforts to prevent crime by their employees, then holding them liable for any crime by any employee in any branch and at any level of the firm may cause firms to forego such investment on the view that sanctions will be imposed in any event.34 Moreover, if the special potency of criminal liability for corporations comes from the communication of institutional fault, and the resulting reputational effects on the firm, then imposing criminal liability for employee crimes that do not represent instances of genuine institutional wrongdoing clouds and weakens the expressive potential of such legal processes.35 The first of these problems has caused some to advocate for rules of corporate criminal liability that would insulate firms from sanctions if they can be shown to have engaged in sufficient compliance efforts prior to a given instance of employee crime.36 The second problem has led some to maintain that a corporation should be held criminally liable only if a crime has been committed by one or more members of higher-level management, or only if it has been committed by a large number of employees across the organization.37 Unfortunately, these more limited approaches are so badly under-inclusive that they would make corporate criminal liability ineffective. If firms can avoid liability whenever managers cannot be proven to have engaged in criminal acts themselves, the law ends up providing corporate management with a perverse incentive not only to forego affirmative compliance efforts but also to actively insulate itself from knowledge of the conduct of employees, or even to affirmatively incentivize employees to take excessive legal risks through corporate systems and then to ignore the consequences. In addition, large and damaging cases of corporate criminality sometimes involve acts by lower-level employees that are correctly attributed to corporate systems and to decisions and conduct of corporate managers that are causal of crime, even though not themselves criminal. Disallowing corporate liability in such cases fails to communicate the truth of institutional responsibility. A rule that required that lower-level employee crime be pervasive or widespread for the firm to be held liable falters for similar reasons. Under such a rule, management might be encouraged to push legal risk-taking onto a small number of individuals or a single node in the firm that could still do enormous damage as a result of intentionally designed corporate systems. Some recent cases of serious corporate crime, particularly in the financial sector, have involved one or a handful of persons who engaged in activities such as large-scale trading fraud or massive bribery as a result of being able to control assets and through having decision authority that higher management intentionally delegated to them. Depending on causal explanations that usually emerge fully only following investigation, a corporation can sometimes be seriously at fault for even a single mid-level employee’s crime. It thus has proven difficult to design doctrines of corporate criminal liability that resolve the tension between under- and over-inclusion in relation to the target phenomenon of insti Arlen 1994, supra note 22. Mihailis Diamantis, Clockwork Corporations: A Character Theory of Corporate Punishment, 103 Iowa L. Rev. 507 (2018); Dan Kahan, Social Influence, Social Meaning, and Deterrence, 83 Va. L. Rev. 349 (1997); William Laufer & Alan Strudler, Corporate Intentionality, Desert, and Variants of Vicarious Liability, 37 Am. Crim. L. Rev. 1285 (2000). 36 Andrew Weissmann & David Newman, Rethinking Corporate Criminal Liability, 82 Ind. L.J. 411 (2007). 37 V.S. Khanna, Should the Behavior of Top Management Matter?, 91 Geo. L.J. 1215 (2003). 34 35

108  Research handbook on corporate liability tutional fault. There is a literature in which various scholars have proposed concepts and tests that would pose the question of institutional responsibility directly, such as by examining whether employee crime resulted from the ‘ethos’ of the corporation, whether the wrongdoing stemmed from the corporation’s character, or whether the corporate organization can be said to have been ‘constructively’ at fault.38 These efforts have not yet successfully brought their arguments at the level of theory fully to ground in doctrinal realities. Any workable rule of corporate criminal liability must give legal actors – prosecutors, judges, and juries – the ability to argue about and determine the intersection of rule and fact. American criminal adjudication, at the charging and liability stages, fundamentally proceeds through the proof of elements of criminal offenses. It is hard to see how legal actors can be expected to proceed fairly and rigorously with their duties when working with vague concepts such as the ethos, character, or even adequacy of compliance efforts. Again, this difficulty arises from the great complexity of the large industrial organization and the intangible nature of corporate culture, which is real and causal but cannot be described, at least with present tools, in the terms of either the basic models of corporate governance or the traditional act and mental state elements of criminal offenses. This survey of the doctrinal problem explains why American law and practice, as well as those of some other legal systems, have developed procedures for examining questions of organizational responsibility outside the liability phase of criminal adjudication. Under American law, respondeat superior remains the de jure rule of liability but its severe effects are often slackened at the charging or sentencing phases of the criminal process. In the structure of the American criminal process, decisions are controlled at these stages by actors (the prosecutor at the charging stage and the judge at the sentencing stage) who are afforded discretion to engage in broader inquiries that account for a diverse totality of relevant circumstances. C. Enforcement The introduction of official discretion brings any discussion of corporate criminal liability to the enforcement process and its institutional particulars. Without having been subject to any legal mandates, federal prosecutors in the United States have developed elaborate guidelines and practices under which corporations can earn leniency under the overly broad respondeat superior rule according to a variety of factors that relate to (1) the deterrent purposes of corporate criminal liability and (2) the question whether fault for the crime is correctly attributed to the corporation.39 On the first score, enforcers strongly emphasize the extent to which a corporation has invested efforts in lowering the probability of employee crime ex ante and in making the prosecution of employees more likely ex post (thus lowering the probability that others will choose to violate in the future). Effective compliance systems, self-reporting to the government violations not yet known to officials, and full cooperation in providing prosecutors with access to testimonial and documentary proof are continually stressed as the most effective paths to leniency when it comes to sanctions at the corporate level. In recent years, the Justice Department has emphasized the importance of corporations, in order to receive 38 Pamela Bucy, Corporate Ethos: A Standard for Imposing Corporate Criminal Liability, 75 Minn. L. Rev. 1095 (1990); Diamantis, supra note 35; William Laufer, Corporate Bodies and Guilty Minds, 43 Emory L.J. 647 (1994). 39 U.S. Dep’t of Just., Just. Manual §§ 9-28.000, 9-47.120 (2015).

Corporate criminal liability  109 credit for effective cooperation, identifying all culpable employees and supplying all available evidence of all discovered wrongdoing. On the second score – corporate fault – prosecutors emphasize the extent to which an instance of employee crime involved, or was tolerated by, more senior managers, the prevalence of the criminal activity within a firm or business unit, the nature and extent of the victimization and harm caused by the offense, the corporation’s efforts to remediate any harm caused in the wake of its discovery, the firm’s history, if any, of legal violations and enforcement actions, and any efforts to conceal the wrongdoing or obstruct official investigation. These factors are designed to guide the sort of ‘all things considered’, fact-dependent inquiry into institutional responsibility that, as explained in the prior section, can be very difficult to specify with liability doctrines. Leniency, when justified, is provided through several aspects of settlements of corporate prosecutions.40 Prosecutors may reduce monetary sanctions below what could have been legally imposed in the form of fines. They may forego requiring firms to be subject to onerous and intrusive outside monitoring mechanisms designed to ensure that they follow through on any post-crime commitment to reforms, such as improved compliance programs. Most importantly for firms, prosecutors may choose forms of settlement that are less damaging to firms because they are less likely to result in a firm being prevented from doing future business in various regulated areas. Prosecutors may work with civil regulatory counterparts to agree to forego punitive debarment and delicensing measures. More commonly, prosecutors will permit firms to settle outside the traditional criminal settlement context in order to slacken the potential collateral consequences of a criminal conviction. In the United States, criminal settlements for individuals usually take the form of guilty pleas with plea agreements (a form of contract) in which prosecutors agree to forego some charges or recommend lesser punishments. In the corporate context, because of the collateral consequences that can apply when a going business concern has been convicted of a serious crime, and because of the seriousness with which a formal conviction can be seen by constituents, counterparties, and other observers, a guilty plea is seen as a punitive resolution. Prosecutors thus frequently offer corporations settlements in the form of deferred- and non-prosecution agreements (DPAs and NPAs) as less punitive settlements.41 The form of agreement under a DPA or an NPA is largely the same. It consists of a contract between the government and the company in which sanctions are imposed and obligations are undertaken, with at least theoretically severe consequences for the company, at the discretion of the prosecutor, should the company fall short on its commitments. With a DPA, a charge is also filed before a judge and agreed to be kept pending, with no further proceedings, until the company is determined to have completed its commitments, at which time the charge is dismissed. An NPA is more like a pre-suit settlement in a civil matter, in that no charge is filed and no court’s jurisdiction is invoked. It is perhaps believed that a DPA, with its pending charge on file, represents a more threatening sword over the neck of a company, although under an NPA the government has the right to file charges immediately if it determines that a company has breached the agreement.

40 41

Brandon Garrett, Too Big to Jail (2014). Alexander & Arlen, supra note 28.

110  Research handbook on corporate liability Almost all such corporate criminal settlements are available for public inspection.42 As the Justice Department has become more detailed in what it includes in those settlements – especially in ‘statements of facts’, under which corporations are required to agree to the truth of detailed narratives of the criminal wrongdoing and its causes – it is now possible to see at least hints of a ‘common law’ of corporate prosecution under which the facts and sanctions of one case can be compared to another to derive some sense of how prosecutors are likely to proceed. The picture that emerges is of prosecutorial institutions that have fully committed themselves to the project of viewing corporations – at every step and stage of the process – as vehicles to deter, punish, and remediate individual criminal conduct in the business context. This system is highly dependent on the American constitutional structure, which affords enormous discretion to the prosecutor in shaping charging and settlement decisions, featuring the theory of separation of powers: that the executive branch must exclusively perform the function of deciding when and how to enforce the law. Indeed, in the occasional case in which a federal judge has attempted to intervene in a DPA settlement, on the basis that the court has jurisdiction over a charge pending before it, appellate courts have said that the judge’s role is highly limited in that context and does not extend in any way to a review of the resolution’s merits.43 This enforcement system has abundant critics. A strain of argument based in populist impulses, or in skepticism of prosecutors’ motivations, has painted the contemporary American enforcement practice as affording undue leniency to corporations that violate the law.44 By allowing corporations to settle frequently without convictions (under DPAs and NPAs), routinely reducing monetary penalties to reward cooperation to a degree that makes criminal fines a priceable ‘cost of doing business’, often arranging for regulatory forbearance on suspension and debarment, and almost never taking a large corporation all the way through indictment and trial, the government under-deters corporate crime and expresses public toleration of corporate criminality. It is sometimes contended that this pattern has emerged through distasteful ‘revolving door’ capture dynamics, whereby American prosecutors handling corporate crime tend to negotiate forgivingly and amenably with their corporate counterparts, who now practice in a highly lucrative professional compliance and defense industry, into which most American prosecutors will move following a period of public service.45 Some add the criticism that programmatic leniency in the corporate prosecution area – a system based in a philosophy of carrots before sticks – is especially distasteful and expressively problematic

Samuel Buell, Why Do Prosecutors Say Anything? The Case of Corporate Crime, 96 N.C. L. Rev. 823 (2018); Garrett, supra note 40. 43 See United States v. Fokker Svcs. B.V., 818 F.3d 733 (D.C. Cir. 2016); United States v. HSBC Bank USA, N.A., 863 F.3d 125 (2d Cir. 2017). 44 Mihailis Diamantis & W. Robert Thomas, But We Haven’t Got Corporate Criminal Law!, 47 J. Corp. L. 991 (2022); Brandon Garrett, The Corporate Criminal as Scapegoat, 101 Va. L. Rev. 1789 (2015); Julie O’Sullivan, Is the Corporate Criminal Enforcement Ecosystem Defensible?, 47 J. Corp. L. 1047 (2022); David Uhlmann, Deferred Prosecution and Non-Prosecution Agreements and the Erosion of Corporate Criminal Liability, 72 Md. L. Rev. 1295 (2013). 45 Jesse Eisinger, The Chickenshit Club: Why the Justice Department Fails to Prosecute Responsible Executives (2017). 42

Corporate criminal liability  111 in the American criminal justice system, which treats street offenders notoriously harshly and with ingrained racially discriminatory effects.46 Business interests, not surprisingly, tend to see the enforcement landscape from an entirely different perspective. To them, the Justice Department’s program is not one of negotiated settlements but one of dictated corporate behavior.47 Because respondeat superior doctrine affords companies virtually no viable argument to defeat liability any time an employee commits a crime, because even the best compliance programs cannot prevent all crime, and because criminal convictions threaten to disable firms from continuing to do business in the short or even long term, management must do what the government says, whether doing so is best for the firm’s stakeholders or not. Full cooperation, they would say, is not an option but an obligation, when measured from the standpoint of business risks. Especially because some business crimes, including regulatory offenses, are defined vaguely and very broadly, this means that corporations must cooperate, settle, and admit wrongdoing even when they may believe they have meritorious defenses, or at least mitigating arguments, and that prosecutors are mistaken or overreaching. This line of argument is not without force, particularly when it comes to considering how prosecutors might best be supervised and regulated. But it strains credulity to think that large corporations, with the superb legal representation they typically enjoy, do not have ample opportunity to argue their points with prosecutors on questions such as the gravity of the wrongdoing or the fair level and kind of punishment. A more nuanced line of criticism, based in corporate governance literature, questions whether prosecutors are institutionally competent to carry out the mission they have set for themselves.48 If the objective of corporate criminal liability is to exploit the firm as a vehicle to prevent crime by corporate employees and raise the probability that it will be sanctioned when it occurs, the argument goes, then one would want officials operating any enforcement program to have expertise in corporate management. Especially when it comes to remediation of harm and the use of outside monitors to reform corporate systems after wrongdoing has been discovered, younger public lawyers trained in litigation, often with backgrounds in street crime investigation and prosecution, are not likely to be the best at identifying what works or what may do more harm than good. The Justice Department has been modestly responsive to this line of criticism in designing some internal mechanisms for oversight and consistency in prosecutorial practices in the corporate sector. Much more could certainly be done to make federal prosecutorial practices more rigorous and evidence-based, although the Justice Department remains ever protective of its enormous powers.49 Also, legislative dynamics have

Rachel Barkow, Using the Corporate Prosecution and Sentencing Model for Individuals: The Case for a Unified Federal Approach, 83 Law & Contemp. Probs. 159 (2020); O’Sullivan, supra note 44. 47 Alschuler, supra note 2; Richard A. Epstein, Opinion, The Deferred Prosecution Racket, Wall St. J. (Nov. 28, 2006), https://​www​.wsj​.com/​articles/​SB116468395737834160. 48 Jennifer Arlen & Marcel Kahan, Corporate Governance Regulation Through Non-Prosecution, 84 U. Chi. L. Rev. 323 (2017); Prosecutors in the Boardroom: Using Criminal Law to Regulate Corporate Conduct (Anthony Barkow & Rachel Barkow eds., 2011); Lawrence Cunningham, Deferred Prosecutions and Corporate Governance: An Integrated Approach to Investigations and Reform, 66 Fla. L. Rev. 1 (2014). 49 Brandon Garrett & Gregory Mitchell, Testing Compliance, 83 Law & Contemp. Probs. 47 (2020). 46

112  Research handbook on corporate liability usually resulted in Congress being persuaded to refrain from acting whenever there has been a push to statutorily regulate prosecutors’ handling of corporate enforcement.50 Even as the enforcement system has been criticized by many in the United States, it has drawn considerable interest from other nations’ governments that are increasingly interested in responding to the problem of corporate crime.51 The idea that full prosecution should be traded for lenient settlements as a way of encouraging self-reporting and cooperation – with its underlying concept that corporations should be viewed simply as vehicles for the production or prevention of business crime – has had intuitive appeal across Europe and, lately, into the Pacific Rim. The United Kingdom, for example, has adopted a statutory regime for corporate prosecutions that permits prosecutors to settle cases by means of DPAs, subject to court review and approval on a broad public interest standard.52 The factors a court must consider under this scheme are highly similar to those the Justice Department uses in its directives to prosecutors regarding the exercise of their discretion, including whether the corporation has fully assisted in making the successful prosecution of individuals more likely. Such systems for corporate ‘non-trial resolutions’, as they are called in Europe, will depend for their effectiveness on sufficiently broad underlying rules of corporate criminal liability, as well as on rules of investigation and procedure that permit corporations to fully gather and share information and evidence with the government, as has become routine in the United States.53 Undoubtedly, other nations have been drawn to these enforcement practices by watching the size and frequency of big financial penalties that American prosecutors have exacted from large firms, including foreign firms, through the settlement process. Such recoveries will not automatically be available to countries that do not have the very broad liability rule and very light regulation of corporate investigation of employee activity that apply under American law. In the United States, sometimes corporations do plead guilty or are convicted after trial and thus end up before judges for sentencing according to ordinary criminal procedure. American sentencing rules for corporations also fully embrace the idea of using corporate criminal liability to encourage corporations to internally police and sanction crime, as well as remediate harm and reform themselves to make future wrongdoing less likely.54 Indeed, these rules, which followed major federal sentencing reforms in the 1980s, greatly influenced the discretionary practices that prosecutors developed over the course of the 1990s and 2000s, which have come to predominate over sentencing law because of the prevalence of settlements over litigation or even plea agreements. When a corporation is judicially sentenced, a court will discount the amount of the fine according largely to the quality of the firm’s compliance program, whether it reported the wrongdoing before outside discovery, whether it fully cooperated in the official investigation, the extent to which it remediated harms to victims or the general public, and its efforts at reorganization and reform. The corporate sentencing guidelines, like prosecu Daniel Richman, Corporate Headhunting, 8 Harv. L. & Pol’y Rev. 265 (2014); William Stuntz, The Pathological Politics of Criminal Law, 100 Mich. L. Rev. 506 (2001). 51 Jennifer Arlen & Samuel Buell, The Law of Corporate Investigations and the Global Expansion of Corporate Criminal Enforcement, 93 S. Cal. L. Rev. 697 (2020). 52 Crime and Courts Act 2013, c. 22 § 45 (UK), https://​www​.legislation​.gov​.uk/​ukpga/​2013/​22/​ contents/​enacted; See Serious Fraud Office v. Rolls Royce Energy Systems Inc. [2017] Lloyd's Rep. FC 249 (Southwark Crown Court). 53 Arlen & Buell, supra note 51. 54 U.S. Sent’g Guidelines Manual (U.S. Sent’g Comm’n), ch. 8. 50

Corporate criminal liability  113 tion guidelines, also consider factors relevant to institutional fault and corporate culture, such as the involvement of mid-level or senior managers in the wrongdoing (or their toleration of it), the number of employees involved, the corporation’s prior history of legal violations, and whether the firm took any steps to obstruct any official inquiry. In sum, enforcement procedures have, over time, sought to accommodate the choice of an overbroad rule of corporate criminal liability, rather than an under-inclusive one, with the necessity of rewarding corporations with leniency in order to encourage their partnership with the state in the project of reducing corporate crime. Most common business crimes are not observable outside the enforcement process, and present empirical tools cannot effectively measure their prevalence. It thus cannot yet be meaningfully assessed whether an entirely different model, such as one in which prosecutors routinely prosecuted corporations to the fullest extent of on-the-books penalties and did not shy away from putting firms out of business, would result in more effective deterrence of corporate crime at justifiable cost. In the absence of better evidence, there remains – nearly a century after the concept of ‘white-collar crime’ was invented – an unfortunate amount of say-so in the literature about whether corporate crime is allowed to run rampant at present and whether a radically different approach to criminalization and enforcement would yield a much safer world.55 D.

Political Economy

Any complete account of the law’s approach to corporate crime must, of course, situate doctrine and enforcement practices within political economies. The starting point for doing so is to appreciate that ‘corporate crime’ is a social phenomenon before it is a legal one. The subject of this chapter exists as a field of law only because seriously harmful and blameworthy acts emanating from large industrial organizations have been a growing problem in modern life for well over a century. From this ground-up perspective, the word crime is inapt. It assumes the matter that politics must resolve prior to law: which behaviors by corporations and their agents should be treated as crimes? While the criminalization of business activities has grown over time, especially with regulatory violations as opposed to core criminal conduct such as fraud or bribery, the project of managing corporate externalities – in simpler terms, of putting safety guardrails on capitalist ambition and greed – starts well outside the criminal law. First one looks to corporate governance law (including the law of contracts), then to the law of private liability (including torts), then to regulatory interventions such as health and safety or investor protection regimes, and only after that is criminalization seen as a necessary response. This ‘pyramid’ concept of legal controls structures every developed nation’s approach to the problem of undesirable conduct within corporations.56 The point at which any legal system resorts to criminalization is highly contingent on political attitudes towards the role of corporations in society, and on the influence of various constituencies in the legislative process. In the United States, corporate interests have been,

Sally Simpson, Making Sense of White-Collar Crime: Theory and Research, 8 Ohio State J. Crim. L. 481 (2011); April Wall-Parker, Measuring White-Collar Crime, in The Handbook of White-Collar Crime (M. Rorie ed., 2019). 56 Ian Ayres & John Braithwaite, Responsive Regulation: Transcending the Deregulation Debate (1992). 55

114  Research handbook on corporate liability perhaps surprisingly, not influential in curtailing the scope of substantive definitions of criminality in the business context.57 The federal criminal code is rather infamously vast in its coverage and duplicative in the ways that it defines economic conduct as criminal, especially in highly regulated industries.58 Prosecutors rarely lack an available legal theory when seeking to subject serious corporate misconduct to criminal charges. However, it remains true that, when it comes to strongly punished offenses, American law adheres to the Anglo-American tradition of requiring highly culpable mental states of at least knowledge and often of intent for conviction. Proof of such mens rea can be difficult for prosecutors in the corporate context given the complexity of much business conduct, the embeddedness of wrongful conduct within legitimate and lawful activities, and the frequent remove of managers from deep involvement in operational details.59 Perhaps business interests would have better prospects of legislatively curtailing criminal liability if prosecutors were more aggressive and successful in invoking all the criminal statutes and regulations that are available to them. On the other hand, judging from the way the popular media handles the issue, the American public seems highly condemnatory of corporate wrongdoing, on a bipartisan basis, and it is hard to see how legislators could be swayed in large numbers to openly favor an express program of decriminalization in the business sector. Procedurally, corporations have been more effective in shaping the political economy of corporate crime. As noted, the Justice Department’s practice of affording companies extensive opportunities to argue their cases to prosecutors in advance of indictment, often in successful pursuit of resolutions short of criminal conviction, strikes many as a special privilege reserved for wealthy actors and denied to mostly under-resourced street offenders.60 Two responses should be borne in mind. First, business crime often presents a substantively different problem for prosecutors from many street crimes, once categories of criminalization have been determined.61 When entire products or markets have not been banned, but rather excessive aggression or risk-taking have been prohibited, prosecutors must take care to accurately distinguish the undesirable conduct from that which is considered of economic value, often at a scale that implicates national interests. Second, the Justice Department, whatever its faults, is less vulnerable to industry capture than most or all regulatory agencies because of its unique institutional structures and norms.62 Corporations may have more influence over the decisions of federal prosecutors than do common street offenders but they have far more influence over the legislation and enforcement decisions that determine what relevant regulatory agencies do within their industries. Managers of large corporations would almost always choose the lesser poison of a regulatory enforcement action over a criminal investigation and prosecution, even via settlement, under the Justice Department. Some of this preference connects back to, and perhaps provides 57 V.S. Khanna, Corporate Crime Legislation: A Political Economy Analysis, 82 Wash. U. L.Q. 95 (2004). 58 Sara Sun Beale, Too Many and Yet Too Few: New Principles to Define the Proper Limits of Federal Criminal Jurisdiction, 46 Hastings L.J. 979 (1994). 59 Buell 2014, supra note 21; Buell 2018a, supra note 21; Samuel Buell, Fraud, in Palgrave Handbook of Applied Ethics and Criminal Law 265 (L. Alexander and K. Ferzan eds., 2020). 60 O’Sullivan, supra note 44. 61 Buell, supra note 7. 62 Jennifer Arlen, Countering Capture: A Political Theory of Corporate Criminal Liability, 47 J. Corp. L. 861 (2022).

Corporate criminal liability  115 evidence of, the unique expressive potential of criminal prosecution among corporate legal controls. A final point about political economy has to do with evident public dissatisfaction with the government’s settlement-based approach to corporate prosecutions, the relative infrequency of large numbers of individual prosecutions following major corporate scandals, and, not least, the persistence of large-scale corporate wrongdoing even after decades of rapidly growing prosecutorial efforts at deterrence.63 The public understandably does not have deep interest in the particulars of how the legal doctrine defines white-collar criminality. People are apt to observe large, salient, damaging events and want to see a harsh legal response. In this way, corporate ‘crime’ is publicly understood more as something like corporate ‘wrongs’. If the public is to receive more of the legal response that it appears to desire when things go badly wrong within corporations, the political process will need to force a fairly fundamental shift in foundational principles of criminal law, to allow even greater criminalization that would severely punish negligent or reckless business conduct or failure to act by managers in the face of legally imposed duties.64 A genuine worry about this sort of move – a worry that indeed applies even under present legal rules – would be the tendency of a focus on criminalization of ‘bad actors’ to displace political attention from more comprehensive projects of ex ante regulatory control, some of which have slackened in recent years. Something like the fundamental attribution error can apply to the politics of corporate crime. There is a tendency to see corporate scandals as the product of individual moral wrongdoing when, even if such wrongdoing is amply involved, the problem can be fully understood only as one of organizations and systems that require deeper thinking and understanding if societies are to develop more effective tools for preventing such fiascos.

III. CONCLUSION Criminal liability is, of course, neither the first nor the wisest path by which legal systems might seek to regulate corporate activity. Its role in corporate regulation, however, is substantial and growing. The most persuasive case for it rests on its deterrent capabilities as a supplement to, or booster for, other forms of liability. Even with extensive academic attention to the problem, joining a good theory of crime within firms to a clear and workable doctrine for corporate criminal liability has been difficult. This problem of fit has produced enforcement practices, now spreading globally, that combine the strong stick of corporate criminal liability with carrots designed to encourage corporations to partner with the state in preventing and sanctioning crime by corporate agents. In this way, corporate criminal liability has begun to entrench itself as a regulatory device more than a traditional practice of criminal punishment. The field of corporate crime is probably now more about corporations than it is about crime. Whether that trend continues, or settles at the current equilibrium, is ultimately contingent on the politics that react to corporate misconduct – which does not distinguish the future of this form of liability from the fate of other means of corporate control. Matt Taibbi, The Divide: American Injustice in the Age of the Wealth Gap (2014) Buell, supra note 7; Peter Henning, A New Crime for Corporate Misconduct?, 84 Miss. L.J. 43 (2014). 63 64

7. Corporate tortious liability Robert J. Rhee1

I.

LIABILITY RULES AND RISK-SPREADING

Liability for torts can fall on any person who participates in the corporate enterprise. The laws of agency and of corporations provide rules dealing with the tort liability of employees, agents, managers, and shareholders. The rules form the foundation of the liability scheme in the enterprise for all major corporate constituents whose acts may inflict injuries on protected interests. The liability scheme for constituents of business entities follows a basic legal contour. Tortfeasors in a corporate enterprise are liable for their own wrongful acts. Employees, agents, and managers of the corporation can be held personally liable for their torts.2 Liability is more consequential in the corporate context than in non-corporate firms. Managers in unincorporated entities can be legal persons, including limited liability entities. But corporate directors and officers must be natural persons.3 Without law or contractual arrangements, the liability buck could stop at individuals and their net worth. Personal liability and concentrated risk may have distorting effects on the quality of human capital and incentives within a firm. Understanding this basic problem in agency relationships, business organization laws permit indemnification and insurance.4 Insurance can cover the liabilities of the corporation and its employees, including directors and officers. Indemnification and insurance spread tort risk to the entire enterprise and to contracting parties. They mitigate the risk of personal liability, thus curbing potential incentive problems in agency relationships. Insurance can also be seen as a substitute for capital. Since fortuitous risk is a state of nature and tort risk is a condition of business, insurance permits a firm to hold less capital than would otherwise be advisable to finance potential spikes in liability costs. Corporations can be held directly or vicariously liable for the harms caused by an agent’s conduct. Some types of wrongful conduct are directly attributable to the corporation.5 Legislatures or regulators may impose heightened duties resulting in attribution of culpabil-

1 I thank my colleagues Andrew Hammond, Lars Noah, William Page, Daniel Sokol, and Russell Stevenson for their helpful comments. 2 Restatement (Third) of Agency § 7.01 (Am. L. Inst. 2006). See Martin Petrin, The Curious Case of Directors’ and Officers’ Liability for Supervision and Management: Exploring the Intersection of Corporate and Tort Law, 59 Am. U. L. Rev. 1661 (2010). 3 Delaware General Corporation Law (DGCL), Del. Code Ann. tit. 8, § 141(b) (2001); Mod. Bus. Corp. Act § 1.40 (2020); id. § 8.02(e); id. § 8.40(b). Managers in non-corporate firms can be legal persons such as limited liability entities. See Revised Unif. Ltd. Liab. Co. Act § 102(9), (15) (Unif. L. Comm’n 2006) (amended 2013); Unif. P’ship Act § 102(10), (14) (Unif. L. Comm’n 1997). 4 Del. Code tit. 8, § 145(a), (g); Mod. Bus. Corp. Act §§ 8.51, 8.52, 8.56, 8.57. See Ltd. Liab. Co. Act § 408; Unif. P’ship Act § 401(e). 5 E.g., Restatement (Third) § 7.03(1).

116

Corporate tortious liability  117 ity that may not ordinarily be found under the laws of agency and torts.6 Corporations are also subject to vicarious liability for losses resulting when employees act within the scope of employment under the doctrine of respondeat superior.7 Respondeat superior reflects the principle that employers should bear the costs of employees’ work-related torts.8 Firms are incentivized to take precautions against employee torts, and victims of corporate activities have a source of deep pockets.9 In most situations, the liability buck stops at the corporation. The firm’s investors (capital creditors and shareholders) are on the hook for the amounts of their investment, and no more. The corporate rule of limited liability ensures that shareholders are not vicariously liable for the firm’s liabilities including losses for torts.10 The rule is grounded in intersecting instrumental, conceptual, and policy reasons.11 An important exception is the doctrine of veil piercing.12 Courts are less likely to pierce the veil in tort cases than in contract cases.13 They are more likely to pierce when the shareholder is an individual and when there are fewer shareholders.14 Public shareholders will never be subject to veil piercing because corporations operate in a setting of regulatory, institutional, and market oversight that makes it structurally impossible to satisfy the elements of veil piercing. The veil could be pierced against a public corporation, qua shareholder, if the elements of veil piercing are met, principally an inequitable abuse of the corporate form. Also, a corporation can voluntarily waive the protection of limited liability as a part of a settlement or some other felt need.15

E.g., Cortez v. Nacco Material Handling Group, Inc., 337 P.3d 111, 121–23 (Ore. 2014) (en banc) (‘Our negligence cases have held that, in the absence of knowledge or participation, corporate officers and directors are not liable for their employees’ negligence. That is so even though corporate officers, having delegated responsibility to others to carry out tasks, retain the right to control how those tasks are carried out. Our ELL cases [construing Employer Liability Law, Ore. Rev. Stat. tit. 51, § 654.305 (2019)], however, have held that persons who retain the right to control how others carry out risk-producing activities are liable under the ELL’). 7 Restatement (Third) §§ 2.04, 7.03. 8 Id. § 2.04 cmt. b. Respondeat superior may play a crucial role in the business models of some ‘gig’ economy companies, such as Uber Technologies. E.g., Hoffman v. Silverio-Delrosar, 2021 WL 2434064 at *2–*3 (D.N.J. 2021) (citing cases holding that Uber is not subject to vicarious liability for intentional wrongful conduct by Uber drivers). 9 E.g., Ira S. Bushey & Sons, Inc. v. U.S., 398 F.2d 167, 171–72 (2d Cir. 1968) (‘The employer should be held to expect risks, to the public also, which arise out of and in the course of his employment of labor’ (internal quotation marks omitted)). 10 Del. Code Ann. tit. 8, § 102(b)(6); Mod. Bus. Corp. Act § 6.22(b). 11 Robert J. Rhee, Bonding Limited Liability, 51 Wm. & Mary L. Rev. 1417, 1423–29 (2010). 12 Piercing is the most litigated issue in corporation law. Robert B. Thompson, Piercing the Corporate Veil: An Empirical Study, 76 Cornell L. Rev. 1036, 1036 (1991). In addition to veil piercing, the rule of enterprise liability permits liability imposed on corporate groups. E.g., Mortimer v. McCool, 255 A.3d 261, 278–88 (Pa. 2021). 13 Thompson, supra note 12, at 1038, 1058. A critical element in veil piercing is some form of inequity or fraud, which is found more in ex ante contractual dealings rather than ex post chance encounters of many torts outside of the product liability context. Accidents resulting in ex post undercapitalization are unfortunate but precisely the kind of situation that limited liability was meant to address. E.g., Walkovszky v. Carlton, 223 N.E.2d 6 (N.Y. 1966). 14 Thompson, supra note 12, at 1038. 15 See Nina A. Mendelson, A Control-Based Approach to Shareholder Liability for Corporate Torts, 102 Colum. L. Rev. 1203, 1243 (2002) (stating that due to public pressure Exxon Corp. waived its 6

118  Research handbook on corporate liability Corporate transactions should not result in much substantial escape from tort liability, in theory at least. In mergers, tort liability passes to the surviving corporation.16 The status of legal liability is unaffected, but post-merger changes in the capital structure and business plan could potentially alter the probability of bankruptcy, and, thus, the expected value of payment to victims. Where one company sells assets to another, the rule of successor liability precludes the passing of debts and liabilities, absent an agreement to do so.17 In a bona fide arm’s length transaction, the sale would affect a change in the form of assets but not much in value, including the firm value as a going concern, and thus the seller would and should still be responsible for its liabilities. There are important exceptions. Tort liability passes to the buyer if the acquisition works a fraudulent conveyance or results in the buyer continuing the seller’s business.18 In practice, there would be leakage of some liability if a seller fails to negotiate a fair market value or otherwise diminishes its firm value in the sale, and the rule of limited liability is triggered. The exceptions attempt to capture much of the anticipated workings of inequity or fraud-like devices. Collectively, the above rules of agency, tort, and corporation laws ensure that the actual cost of the corporation’s activities are ultimately directed to the corporate treasury. From the corporation’s perspective, tort liability is one form of a business cost. The venture, including decisions on insurance, achieves risk spreading among constituents of the enterprise. Since tort liability is paid from corporate assets, capital creditors and shareholders ultimately bear the risk, subject to the rules of limited liability and bankruptcy when there is ex post undercapitalization.

II.

RISK AND RISK MANAGEMENT

Although the intellectual origins of tort law date back to the era of William Blackstone, it only became a discrete branch of law in America in the late nineteenth century.19 This timing limited liability protection against being responsible for the oil spill in Alaska’s Prince William Sound by its subsidiary Exxon Shipping Corp.). 16 Del. Code Ann. tit. 8 § 259(a); Mod. Bus. Corp. Act § 11.07(a)(4). However, the Texas merger statute enables an opposite result. If a corporation incurred severe liability, the statute enables it to split into several entities and in so doing assign certain assets and liabilities to one of these newly created entities. Tex. Bus. Org. Code, tit 1 § 1.002(55)(A) (defining a merger to include ‘the division of a domestic entity into two or more new domestic entities’). See generally Cliff Ernst, Divisive Mergers: How to Divide an Entity into Two or More Entities under a Merger Authorized by the Texas Business Organization Code, 36 Corp. Couns. Rev. 233 (2017). Thereafter, in an internal restructuring called the ‘Texas Two Step’ the split-off entity would file for Chapter 11 bankruptcy reorganization. New Bill Would End the ‘Texas Two-Step’ and Eliminate Non-Debtor Releases in Chapter 11, Dechert LLP (Nov. 11, 2021). E.g., Steven Church, J&J’s Texas Two-Step Leads to Baby Powder Bankruptcy Being Sent to New Jersey, Bloomberg Wire (Nov. 10, 2021). 17 E.g., Niccum v. Hydra Tool Corp., 438 N.W.2d 96, 98 (Minn. 1989). 18 Id.; Restatement (Third) of Torts: Products Liability, Ch. 3 Liability of Successors and Apparent Manufacturers, § 12 (Am. L. Inst. 1998). E.g., Turner v. Bituminous Casualty Co., 244 N.W.2d 873, 883 (Mich. 1976) (‘[I]t does not make sense or promote justice to require a merger and a de facto merger to respond to products liability suits, and then to leave a transfer of assets for cash free from suit, when the needs and objectives of both the injured party and the corporation are the same in all three instances’). 19 G. Edward White, Tort Law in America 3 (expanded ed. 2003).

Corporate tortious liability  119 is not an accident of history. The development of law generally responds to social needs and pressures. Tort law has always involved colorful cases of individuals committing civil wrongs against others,20 but it took on greater social significance with the rise of industrial capitalism and corporations.21 Tort liability is a cost. There are, of course, the primary and incidental costs of accidents in the form of legal liability, litigation costs, and the opportunity cost of labor. Operational improvement in mitigating the sum of these costs is a business function. Corporations often engage in a cost-benefit analysis within a regulatory framework of public safety. Tort law sometimes explicitly embraces such cost-benefit analysis.22 Cost-benefit analyses are at times applied mechanically, as if they were rote click-n-drag calculations of obtuse actuaries. Corporations can be criticized for coldly equating dollar values with lives, limbs, or livelihoods without the softening of ethics or even an appreciation that dollars are imperfect substitutes for human misery.23 Public disclosure of such attitudes may not only beget a public relations imbroglio, but may also durably impair a firm’s goodwill. When decisions are made with ethical and social considerations, corporations can adeptly negotiate crises arising from torts or crimes.24 Cost-benefit analysis is unavoidable in running a business; it is the calculus of profit. But applied formalistically, that is to say thoughtlessly, a cost-benefit analysis can undermine its end and the net positive social contribution of any corporate enterprise. A.

High Frequency Low Severity and Low Frequency High Severity Antipodes of Risk, Uncertainty, and Knowledge

If tort liability is a business cost, it can be considered in the context of risk and risk management. From a financial perspective, the corporation is an asset that produces expected returns with a concomitant risk associated with those returns, and the risk determines the investor’s expectation of return on capital.25 The greater the risk, the greater is the firm’s cost of capital and the lesser is the firm’s value. As a recurring cost, tort liability affects profitability and the expected return on capital. We should understand how different risks affect the corporation. Figure 7.1 conceptualizes this risk schema. The combination of two variables – frequency of occurrence and severity of loss – defines the nature of the tort risk. This framing suggests that the risk can be categorized into four types. Two require little comment: low frequency low severity liabilities pose no problem for obvious reasons; high frequency high severity liabilities are a surefire way to corporate demise. E.g., Vosburg v. Putney, 50 N.W. 403 (Wis. 1891). ‘The Industrial Revolution added an appalling increase in dimension. The new machines had a marvelous, unprecedented capacity for smashing the human body.’ Lawrence M. Friedman, A History of American Law 350 (3d ed. 2005). 22 E.g., U.S. v. Carroll Towing Co., 159 F.2d 169 (2d Cir. 1947). Economic analysis of tort law revolves around a cost-benefit analysis. E.g., Steven Shavell, Economic Analysis of Accident Law (1987); Richard A. Posner, A Theory of Negligence, 1 J. Legal. Stud. 29 (1972). 23 E.g., The Ford Pinto Case: A Study in Applied Ethics, Business, and Technology (Douglas Birsch & John H. Fielder eds., 1994). 24 E.g., David Collins, A Lesson in Social Responsibility: Corporate Response to the 1980s’ Tylenol Tragedies, 27 Vt. L. Rev. 825 (2003); Judith Rehak, Tylenol Made a Hero of Johnson & Johnson: The Recall that Started Them All, N.Y. Times, Mar. 23, 2002. 25 Richard A. Brealey et al., Principles of Corporate Finance 2 (13th ed. 2020); Tim Koller et al., Valuation: Measuring and Managing the Valuation of Companies 68 (4th ed. 2005). 20 21

120  Research handbook on corporate liability

Figure 7.1

Conceptualization of tort liability risks

Two types of risks are problematic: (1) high frequency low severity occurrences; and (2) low frequency high severity occurrences.26 Of course, liability can fall in between these bookends, but these antipodes help to reveal the relationship between liability risk and corporate finance. When liability is high frequency low severity, it is conducive for risk pooling, the ideal kind of risk for insurers.27 The same principle applies to a corporation. The cash cost of anticipated outlays can be predicted with some certainty, and thus financed and factored into the business model. The firm’s profit and cash flow are not subject to much variance, and thus the cost of capital is less affected by losses. An example of a high frequency low severity risk is routine transport accidents and other kinds of expected mishaps due to faulty actions or products. High frequency low severity liability events are dealt with through a cost-benefit triangulation of precautions, insurance, and product pricing. As a generalization, then, old risks tend to fall in this category. Because these risks are known and not novel, their management has been routinized through experience. A small but important clarification should be noted. The concept of high frequency occurrences assumes that risks are uncorrelated. The idea is that accidents and mishaps occur in the ordinary course here and there without correlation or strong causal commonality. The notion of high frequency is not used literally to mean just counting claims. As conceived here, highly correlated losses, albeit resulting in high frequency of many small claims (e.g., asbestos, cig26 As used here, ‘high severity’ does not have a precise quantitative definition. It is analogized to the concept of materiality. Generally, then, high severity is liability so severe relative to the corporation’s financial position that it causes some form of financial distress. See Robert J. Rhee, A Financial Economic Theory of Punitive Damages, 111 Mich. L. Rev. 33, 39 n.36 (2012) (‘Financial distress is defined as substantial disruptions in a firm’s ordinary operations resulting from a severe financial loss. It has significant economic consequences’). 27 See Jeffrey R. Brown et al., An Empirical Analysis of the Economic Impact of Federal Terrorism Reinsurance, Wharton Fin. Insts. Ctr. 6 (2004) (‘Insurance works best for smaller, more frequent events, where it is possible to gather sufficient statistical data to support actuarial pricing estimates and provide for risk diversification’).

Corporate tortious liability  121 arettes, and opioids), are really low frequency high severity occurrences arising from a single act, event, product, or function. They are a class of severe events. Tort law came of age when courts were no longer dealing with the occasional civil wrongs of individuals (e.g., battery, conversion, defamation, etc.), but with the high frequency accidents of early industrial development. Something had to be done to address the aggregate of social cost from business activity. The solution was the development of tort law and workers’ compensation insurance in the era of the railroads and the factory system.28 Since tort law and insurance adequately deal with most known high frequency low severity events, at least for physical losses, such risks are routine as a matter of business operations; they are an unavoidable cost of the production process. This statement is not intended to diminish the social impact of ‘routine’ harms on victims of human misery or the fact that these risks occasionally produce severe outcomes on corporations as well, especially when aggregated.29 The anodyne idea is that a risk-free society is not the real world and corporations will cause harms. For old risks, tort liability tends to be reduced to a cost-benefit analysis, risk management, and financing for proper compensation. However, if novel risks of misfortune or mishap arise, corporations are exposed to more aggregate or severe liability. They can expect the application of existing rules to new situations or the development of new rules. Such responses would address new social needs and pressures, and they would be the legal manifestations of novel risks.30 The uncertainty in how the response would unfold begets legal risk. Low frequency high severity events are more problematic for both insurers and corporations. Insurers may have problems when confronted with an event of unexpected severity.31 The same applies to corporations. Infrequency and high severity of known risks pose undesirable choices. (1) A corporation could opt to not hold the necessary capital in the unlikely event in any given year of risk manifestation. This is the most profitable short-term choice. Given the same return, less capital means greater return on that capital. But this strategy runs the risk of financial distress or insolvency as probabilities tend to catch up in the long run. It is a matter of luck. (2) A corporation could purchase insurance, assuming that the risk is insurable.32 This choice has a recurring cost that is commensurate with the long-run expected actuarial loss plus the loading charge of insurance. Insurers or reinsurers could price in a higher risk premium for any capital charges they may incur for insuring severe losses. If the risk is complex, it may require alternative risk transfer and capital market solutions. This strategy incurs a continuing insurance cost, which may not be cheap. (3) A corporation could choose to hold excess equity capital. This choice may buffer the financial shock of a high severity event, but the corporation has a recurring capital cost that would be a drag on profit and asset values. Assuming that the cost of equity capital, the most expensive form of capital, is greater than the cost of insurance, this choice is the least profitable option for the corporation. Thus, the cost of risk cannot be Robert J. Rhee, Tort Arbitrage, 60 Fla. L. Rev. 125, 170–81 (2008). E.g., Jan Hoffman, Purdue Pharma Is Dissolved and Sacklers Pay $4.5 Billion to Settle Opioid Claims, N.Y. Times, Sept. 1, 2021. 30 E.g., infra notes 85–87 and accompanying text. 31 Robert J. Rhee, Catastrophic Risk and Governance after Hurricane Katrina: A Postscript to Terrorism Risk in a Post-9/11 Economy, 38 Ariz. State L.J. 581, 595 (2006). 32 The elements of insurable risk are: (1) a sufficiently large number of homogeneous exposures to make losses reasonably predictable; (2) definiteness and measurability of losses; (3) losses being fortuitous or accidental; (4) losses not being catastrophic. Emmett J. Vaughan & Therese Vaughan, Fundamentals of Risk and Insurance 41 (9th ed. 2003). 28 29

122  Research handbook on corporate liability eliminated, but only allocated among the corporation and counterparties and shifted in time among present and future corporate constituents. The problem of risk management has another facet. The potential for tort liability can be considered through the economic distinction between risk and uncertainty. ‘Many years ago, Frank Knight distinguished the concepts of risk and uncertainty: risk connoting a future state of known distribution, and uncertainty connoting a future state of unknown distribution or imperfect information.’33 Most business risks are in the form of uncertainty. Firms are not yet autonomously managed by algorithms of risk and return. Given experience, some tort liability can be in the form of Knightian risk. Routinely occurring accidents are subject to ordinary risk management. The failure to prepare adequately for such expected costs would constitute business malpractice. In some situations, however, tort liability, like business risk, appears in the form of Knightian uncertainty. There are known and unknown uncertainties.34 Known uncertainty can be new; unknown uncertainty is by definition novel. The most unfortunate outcomes for corporations usually occur when the contingencies are unknown as to frequency or magnitude at the time of the conduct, and thus come as a nasty surprise: for example, a seemingly harmless product is introduced into the market with latent defects and subsequently the uncertainty morphs into high frequency or high severity (or both) claims. These situations frequently result in unexpected financial distress, bankruptcy, or dissolution. B.

Examples of the Law’s Response to High Severity

The law is not ignorant of the effect of risk manifestation on business and industry. American courts have displayed a sensitivity to business enterprise and devised rules that curtail liability. In an early era, doctrines reflected judicial favor of enterprise and economic development over victims and workers.35 In the modern era, courts are still cognizant of the problem that severity of liability can create for corporations. The Supreme Court has notably created judicial rules, obvious in their pro-business tilt, having the effect of reducing the severity of loss or the frequency of such loss. This effort is an attempt to balance competing considerations, one being the effect of low frequency high severity losses on corporations. Two examples illustrate the point: the rules of class action and punitive damages. Regarding the former, the Supreme Court has sharply limited the scope of class actions. Class actions can make remedies pragmatically available, whereas without them atomized injuries among many victims may go without legal redress even when the legal right to com-

33 Robert J. Rhee, Toward Procedural Optionality: Private Ordering of Public Adjudication, 84 N.Y.U. L. Rev. 514, 548 (2009) (citing Frank H. Knight, Risk, Uncertainty and Profit 233–34 (Dover Publications 2006) (1921)). 34 See Michael Shermer, Rumsfeld’s Wisdom: Where the Known Meets the Unknown Is Where Science Begins, Sci. Am., Sept. 1, 2005 (quoting Donald Rumsfeld: ‘There are known knowns. There are things we know we know. We also know there are known unknowns. That is to say, we know there are some things we do not know. But there are also unknown unknowns, the ones we don’t know we don’t know’). 35 See Morton J. Horwitz, The Transformation of American Law 1780–1860 97–101 (1977) (explaining that the development of tort law resulted in a ‘subsidization’ in favor of industry); Friedman, supra note 21, at 356 (‘Enterprise was favored over workers, slightly less so over passengers and members of the public’).

Corporate tortious liability  123 pensation is immutable.36 In a series of recent cases, the Court has restricted the use of class actions. When a national cellphone dealer imposed a consumer contract with an arbitration agreement that purported to waive class-wide arbitration, the provisions were held to be enforceable under the federal arbitration statute.37 When a national retailer was alleged to have discriminated against female employees by underpaying them, a class certification was held to be improper because the claims purportedly lacked commonality in light of the lack of proof of a company policy of discrimination.38 When a cable television company was alleged to have engaged in anticompetitive practices, a class certification was denied because damages purportedly could not be measured class-wide.39 When an employer and employee entered into a contract providing for individualized arbitration of employment disputes, the contract was held to be enforceable under the federal arbitration statute and precluded a class certification under federal labor laws.40 When an employee brought a class action against the employer for negligence related to improper securing of personal data against hackers, a class-wide arbitration was held to be improper because the contract did not affirmatively provide for class-wide arbitration.41 These decisions span a range of issues: contractual waiver of class actions, class action when the contract was ambiguous as to class action, class actions in the contexts of federal labor and antitrust laws, class actions in the context of disputed commonality of claims, and class-wide damages. Each of the above cases was decided by a monolithic 5-4 margin, featuring the same four dissenting justices who comprise the liberal faction of the Supreme Court. If the cases were decided in a sterile vacuum in which nuanced doctrinal distinctions based on facts, procedure, and substantive legal context are the only factors of decision at play and political and economic predispositions play no role in decision making, one would expect that the compositions of the majority and the dissent would have been somewhat different over a multi-case series, as a matter of chance alone, due to unique combinations of the sterile factors leading to at least some variation in individual judgments therein. But the dispositive point is the conservative faction’s pro-corporation leaning and its unequivocal hostility to class actions that can concentrate liability risks on corporations. These cases do not deal with mass tort actions, but convey a lesson for thinking about corporate tort liability. While they can be interpreted in any number of ways, by denying class certification they undoubtedly have the common effect of shifting from the low frequency high severity claim of a single-shot action to the high frequency low severity cluster of atomized E.g., Basic Inc. v. Levinson, 485 U.S. 224, 243, 250 (1988) (adopting the ‘fraud-on-the-market’ theory of reliance and reasoning ‘[r]equiring proof of individualized reliance from each member of the proposed plaintiff class effectively would have prevented respondents from proceeding with a class action, since individual issues then would have overwhelmed the common ones’). 37 AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011) (5-4 decision with Ginsburg, Breyer, Sotomayor, Kagan JJ. dissenting). See American Express Co. v. Italian Colors Restaurant, 133 S. Ct. 2304, 2312 (2013) (5-4 decision with Ginsburg, Breyer, Sotomayor, Kagan JJ. dissenting). 38 Wal-Mart Stores, Inc. v. Dukes, 564 U.S. 338 (2011) (5-4 decision with Ginsburg, Breyer, Sotomayor, Kagan JJ. dissenting). 39 Comcast Corp. v. Behrend, 133 S. Ct. 1426 (2013) (5-4 decision with Ginsburg, Breyer, Sotomayor, Kagan JJ. dissenting). 40 Epic Systems Corp. v. Lewis, 138 S. Ct. 1612 (2018) (5-4 decision with Ginsburg, Breyer, Sotomayor, Kagan JJ. dissenting). 41 Lamps Plus, Inc. v. Varela, 139 S. Ct. 1407 (2019) (5-4 decision with Ginsburg, Breyer, Sotomayor, Kagan JJ. dissenting). 36

124  Research handbook on corporate liability actions. This shift affects litigation valuations and surely reduces liability exposure and ultimate settlement values.42 When a corporation confronts high frequency low severity claims, the losses are more readily manageable. Diversification effects apply, and a corporation can approach these claims from a more risk neutral perspective. On the other hand, when a corporation confronts low frequency high severity claims, which describe many class actions, the potential variance in outcomes may reduce the effect of diversification, influence the incentives in decision making, and affect the variability of a firm’s profitability and cash flow. In the realm of punitive damages, the Supreme Court transformed the law of punitive damages in a pair of cases under the doctrine of substantive due process. These cases share a common theme with the class action cases. In BMW of North America, Inc. v. Gore, the Court invalidated a state court award of punitive damages.43 A national car dealership sold a car as new when in fact it had been repaired. The jury awarded compensatory damages of $4,000 and punitive damages of $4 million, reduced to $2 million on appeal. The Court set forth a legal standard composed of three guideposts: the degree of reprehensibility; the disparity between the harm and the punitive damages; and the difference between punitive damages and civil penalties imposed in other cases. The Court determined that the conduct was not so reprehensible, considering that the harm was ‘purely economic in nature’. It ruled that ‘a breathtaking 500 to 1’ ratio is a violation of the due process clause.44 In State Farm Mutual Automobile Insurance Co. v. Campbell, the Court further strengthened the constraints on punitive damages.45 The jury awarded $1 million in compensatory damages and $145 million in punitive damages for insurance bad faith based on the wrongful denial of a claim. The Court applied Gore’s three guideposts and invalidated the punitive damage award. The Court then laid down a quantitative marker: ‘Our jurisprudence and the principles it has now established demonstrate … that, in practice, few awards exceeding a single-digit ratio between punitive and compensatory damages, to a significant degree, will satisfy due process.’46 The punitive damages rulings do not stand as the Supreme Court’s finest hour of analytic rigor.47 It is not clear at all why a 500x ratio is so ‘breathtaking’ other than that, perhaps, the number seems large in the abstract. As applied, a number is often relative. A 500x price-to-earnings valuation of a corporation would be indeed breathtaking, but if a large corporation escaped liability for abusing consumers hundreds of times in the past, the award would seem about right in terms of deterring bad conduct and internalizing its cost.48 ‘Breathtaking’ is a rhetorical device masking what the Court could not explicitly express – a judicial preference 42 See generally Robert J. Rhee, The Effect of Risk on Legal Valuation, 78 U. Colo. L. Rev. 193 (2007). 43 BMW of N. Am., Inc. v. Gore, 517 U.S. 559 (1996). 44 Id. at 583. 45 State Farm Mut. Auto. Ins. Co. v. Campbell, 538 U.S. 408 (2003). 46 Id. at 425. 47 Subsequently, the Supreme Court has conceded as much: ‘A survey of the literature reveals that discretion to award punitive damages has not mass-produced runaway awards, and … by most accounts the median ratio of punitive to compensatory awards has remained less than 1:1’. Exxon Shipping Co. v. Baker, 554 U.S. 471, 497–98 (2008). The tort system has exercised ‘overall restraint’. Id. at 497–99. 48 See Rhee, supra note 26, at 39–40 (arguing that ‘the cap on punitive damages should not be some arbitrary cap based on a numeric ratio, but it should instead be a function of the defendant’s wealth such that punitive damages are limited to the point at which the defendant would experience financial distress’).

Corporate tortious liability  125 against imposing severe exemplary damage liability. Truth be told, a constitutional ceiling of 9x ratio is an arbitrary number that has no basis in theory other than the veneer of rationality pegged to the decimal system of mathematics. The cases represent a fiat hard stop on the severity of loss. As unartful as the Court’s analysis may be, an underlying policy may be that corporations have more trouble dealing with low frequency high severity losses, particularly if such liability imposes financial distress on large economic entities defined by the investment and participation of many constituents. C.

Effects of High Severity Liability

Although the rules on class actions and punitive damages are unrelated in legal doctrine, they have a common effect on the risk profile of corporations – dilution of the risk of concentrated loss. Courts understand the distinction between high frequency low severity and low frequency high severity risks. One way to view a class action is that it converts high frequency low severity claims into a low frequency high severity claim. A punitive damage award acts as a claim multiplier.49 Given a choice, corporations prefer high frequency low severity claims for reasons tied to the expected value of the ultimate economic losses, which are different from the ex ante expected cash value of legal liabilities. First, high frequency low severity losses make for easier financial and risk management and do not increase the firm’s cost of capital due to increased riskiness of cash flow and an increase in bankruptcy risk. To put it another way, even though high frequency low severity and low frequency high severity losses may have the same expected value, their effect on corporate finance and firm value would be different due to differences in risk. With the same expected value, corporations prefer liability in the form of high frequency low severity losses. Suppose there are two choices: (1) 100 coin flips with the possibility of losing $2 or $0 in each flip; (2) one coin flip with the possibility of losing $200 or $0. Both choices have an expected value of $100. Assume that $200 is in the territory of ‘severe’. A corporation would prefer choice (1). We are told that firms should pursue risk-neutral strategies, suggesting that a corporation should be indifferent here. While true generally, the selected choice is not grounded in an anthropomorphized risk preference of a legal entity or even of its agents therein. The choice recognizes that the two scenarios present different capital costs. Faced with expected losses, investors may need to account for the cost of bankruptcy.50 Tort risk can be seen as financial leverage, since, if it manifests, it is a liability on the balance sheet, and the cost of bankruptcy always affects firm value.51 Markets could discount the value of firms if they, albeit infrequently, are expected to be struck by lightning at some point. These effects of low frequency high severity claims increase the firm’s cost of capital and the economic cost of an increased

See A. Mitchell Polinsky & Steven Shavell, Punitive Damages: An Economic Analysis, 111 Harv. L. Rev. 869, 874 (1998) (proposing that when a defendant has a chance of escaping liability for wrongful conduct, the total damages should be the harm caused multiplied by the reciprocal of the probability of being found liable). 50 See Rhee, supra note 26, at 62 (‘catastrophic losses pose special challenges, including the problem of insuring or self-insuring, the financial implications of bankruptcy and capital raising, and the settlement pressure associated with a litigation involving a potentially catastrophic loss’). 51 See Robert J. Rhee, Essential Concepts of Business for Lawyers 261 (3d ed. 2020) (‘firm value diminishes as the cost of bankruptcy eats into the benefit of leverage’). 49

126  Research handbook on corporate liability probability of bankruptcy, thus reducing asset value. These effects would also likely increase settlement values as corporate managers seek to avoid them. Second, the financial consideration of capital cost affects litigation decisions. Litigation outcomes are affected by differences in risk preference and repeat plays in litigation dynamics between individual tort victims and corporate tortfeasors.52 Settlement is the rule, trial the exception. In the ordinary tort case involving a high frequency low severity loss claim, plaintiffs are generally risk averse and exposed to the high variance of a potential all-or-nothing personal outcome at trial, whereas corporations consider decisions from a risk-neutral perspective and can count on the diversification effect to smooth out the variance of individual claims in a portfolio of claims. The upshot of these effects is that there will be systematic differences in risk preferences. Claims will be systematically undervalued since legal actions proceed in the shadow of bargaining.53 But this calculus changes when claims involve low frequency high severity losses such as the remote possibility of extreme punitive damages or aggregation of claims in class actions. The advantageous effects of different risk preferences and repeat plays are diminished. The leveling of the playing field in bargaining would work to the disadvantage of corporations when they manage the risks and the costs of tort liability. This effect is the common thread that binds the Supreme Court’s jurisprudence in class actions and punitive damages, types of case that almost exclusively deal with corporate defendants. The effects of the Court’s pro-business rulings are apparent. Whether they advance the right policy or the just balance is contestable. In summary, the discussion of both financial risk and litigation value are two sides of the same coin. When there is a preference against an option, a party will pay a premium to avoid it. In the case of corporations, the preference is less a matter of an individual agent’s utility, and more an issue of the cost on capital. Assume the same expected cash value of legal liability U(c), where cs is liability from a single high severity liability and ci is liability from cases in an aggregate of high frequency low severity losses, such that: U  c   U  cs   U (

n

c ). Despite i

i 1

the same probabilistic cash value U(c), the values of economic loss may not be the same. If severe liability is at play, financial values must account for capital charges and investors’ expectations of returns such that: V  cs   V (

n

c ). Economic value, and not expected value, i

i 1

ultimately drives litigation value. Settlement dynamics then should result in the addition of a premium p that accounts for any additional economic cost in a severe loss such that: V  cs   V (

n

c )  p. Thus, low frequency high severity losses are the most problematic type i

i 1

of tort claims for corporations.

See generally Marc Galanter, Why the ‘Haves’ Come Out Ahead: Speculations on the Limits of Legal Change, 9 Law & Soc’y Rev. 95 (1974). 53 See generally Rhee, supra note 28. 52

Corporate tortious liability  127

III.

NEW ERA AND NEW RISKS

Starting in the second half of the nineteenth century, corporations harnessed the power of complex machinery and delivered an unprecedented array of new products to consumers.54 Tort law mirrors American economic development. It developed during the rapid growth spurt of industrial capitalism and large public corporations.55 The concepts of fault-based negligence and social insurance, such as workers’ compensation, came to the fore.56 Later, when consumerism became a large part of the post-war American economy,57 courts developed the rules of product liability.58 Today’s tort rules form the core liability scheme when corporations inflict a wide range of physical injuries on victims, injuries from dangerous products to industrial accidents to environmental disasters. These kinds of accidents are inherent in certain businesses and cannot be eliminated. The risks to the corporation can be managed or transferred. Starting in the second half of the twentieth century, new risks emerged from global trends and new technologies. Corporations are again central players. They create new risks or are the causal agents of losses. These new risks can be sources of low frequency high severity losses. Where there are new risks and harms, we can expect the continued development of law that addresses social needs and pressures. The following discussion provides some examples of new risks in a new era. A.

Information Revolution and Interconnectivity

The past fifty years have witnessed the information revolution powered by the widespread availability of the microprocessor to consumers.59 Personal computers became widely available in the 1980s, and the internet and the cellphone were popularized in the 1990s. Some of the largest and most important American companies today were formed around this era, for example: Apple, Microsoft, Google, Amazon, and Facebook. The information revolution and the digitalization of society created new risks, and these risks have the potential to expand liability or create new torts. Some new risks are immediate in the imagination. Mass losses can result from the use of software, algorithms, and artificial intelligence (AI), for example in terms of transportation and logistics, energy supply and delivery, and healthcare. The most basic legal issues seem to be: Who is responsible when bad or vulnerable software, algorithms or AI cause harm? How do the rules of negligence, product liability, duty, proximate cause, and pure economic loss apply in these new settings? It is quite possible that the liability risk from AI is overblown,

54 See Dodge v. Ford Motor Co., 170 N.W. 668, 670–71 (Mich. 1919) (describing the growth of the Ford Motor Co. due to high demand for its cars). 55 See Adolf A. Berle, Jr. & Gardiner C. Means, The Modern Corporation and Private Property (1933) (describing the large size and diffuse ownership of corporations giving rise to the phenomenon of the separation of ownership and control). 56 See Friedman, supra note 21, at 350–51, 516–23. 57 See generally Lizabeth Cohen, A Consumer’s Republic: The Politics of Mass Consumption in Postwar America (2003). 58 E.g., Greenman v. Yuba Power Prods., Inc., 377 P.2d 897 (Cal. 1963); Henningsen v. Bloomfield Motors, Inc., 161 A.2d 69 (N.J. 1960). 59 See Robert J. Gordon, The Rise and Fall of American Growth: The U.S. Standard of Living Since the Civil War 441–60 (2017).

128  Research handbook on corporate liability but only if risk is diffuse and not concentrated, this being dependent on the potential severity of a single event. AI deployed in a utility grid could inflict many physical injuries, and in the financial markets it could wreak enormous chaos and economic losses. It is difficult to know at this point whether algorithms and AI are like most consumer products or components thereof, or whether they can amplify risk in some systemic way. As AI becomes more integrated into society, we can expect that lawmakers will need to confront these questions and balance the needs of compensation, deterrence, and the protection of important industries. If necessity is the mother of invention, harm and societal interest are the parents of tort. One potential, but not inevitable or even preferred, avenue of redress would be private tort law. One profound effect of information technology and trends in social organization is the change in the spatial relationship between risk and harm. There is a spatial aspect to tort, not formally in doctrine but implied in the concept of foreseeability and the limits of plausible imagination. In the days of railroads and industrial machines, physical space generally marked the limit of liability as accidents broke body and property. Doctrines like duty and proximate cause limited liability’s reach over physical distances when the risk was seen as not plausibly imaginable.60 The space of danger expanded when corporations were able to reach consumers with defective products and when harmful chemicals entered into the environment. The dissemination of products and toxins created the phenomenon of mass torts, which increased the frequency of high severity losses on corporations. Information technology and the internet have the effect of contracting and even eliminating the space around us. For example, the internet is a common office space; a thief can steal assets from the far side of the world; a corporation’s negligence in managing a system can cause accidents a thousand miles away. In certain contexts, space is no longer a natural liability-limiting condition, and the ‘fore’ in foreseeability reflects an ever-expanding ripple across the globe.61 Thus, expanding foreseeability may increase the potential severity of liability. When space contracts, it tends to expose more interests to risks and to create new forms of risk. Risks are not localized, but can become more systemic. As spatial limits dissolve into the internet ether, information technology can expand interests at risk and the group of potential tortfeasors. Invasion of privacy is one potential area of expansion of liability due to the marginalization of spatial constraint. Another potential source of liability is data breach, a problem arising from the transformation of paper to bytes.62 The contraction of space may expose corporations to potentially higher severity losses. One form of a new risk is the increased interconnectedness of risk and interests. Interconnectivity is not limited to information technology; it is a broader phenomenon of the modern world. People are interconnected by greater and cheaper access to physical travel and reduced restrictions on borders. Financial markets are interconnected due to freer flows of capital. National economies are interconnected from the standpoint of supply chains and E.g., Palsgraf v. Long Island R.R. Co., 162 N.E. 99, 104 (N.Y. 1928) (Andrews, J., dissenting) (‘A chauffeur negligently collides with another car which is filled with dynamite, although he could not know it. An explosion follows. … A nursemaid, ten blocks away, startled by the noise, involuntarily drops a baby from her arms to the walk. … We will all agree that the baby might not [recover]’). 61 See generally Rebecca Crootof, The Internet of Torts: Expanding Civil Liability Standards to Address Corporate Remote Interference, 69 Duke L.J. 583 (2019). 62 See generally Robert L. Rabin, Perspectives on Privacy, Data Security and Tort Law, 66 DePaul L. Rev. 313 (2017); Catherine M. Sharkey, Can Data Breach Claims Survive the Economic Loss Rule?, 66 DePaul L. Rev. 339 (2017). 60

Corporate tortious liability  129 markets. Increased interconnectedness among financial institutions increased risks manifesting in the financial crisis of 2008–2009. Few aspects of society today are limited spatially to borders and markets. Much of the potential for tort liability is precluded by the doctrine of pure economic loss to the extent that harms are purely economic and there is no existing relationship that may give rise to duty.63 However, interconnectedness can result in compensable injuries to recognized interests. If so, an issue is the possibility that interconnectedness may magnify outcomes and produce high severity losses. Consider the interconnection of risk and harm in the context of our recent experience with the Covid-19 pandemic and the potential high severity of losses for culpable action by a corporation in the chain of healthcare delivery. Another example is the potential liability of internet companies for ordinary torts such as defamation, invasion of privacy, and incitement to or deemed participation in violence. Information technology and social media companies have the power to amplify harmful conduct. They could face mass, crippling liability absent a legal shield. They currently find protection in Section 230 of the Communication Decency Act.64 Enacted in the 1990s when the internet became widely available, the statute advances a policy to promote the continued development of the internet, to preserve a vibrant and competitive online free market, and to maximize user control over information.65 These policies were based on the congressional findings that, among other things, the internet provides ‘a forum for a true diversity of political discourse, unique opportunities for cultural development, and myriad avenues for intellectual activity … Americans are relying on interactive media for a variety of political, educational, cultural, and entertainment services’.66 Based on these findings and policies, Congress provided internet companies with broad immunity from torts.67 If these findings and policies no longer hold as much, Congress could change the liability rules. As internet and social media companies have become dominant players in communications and information, they are increasingly exposed to political risks. These changing risks reflect current trends and a changing environment. As social and political conditions change, such legal shields could be diminished, eliminated, or regulated. This is a political and economic question as much as it is a legal one. B.

Globalization and the Alien Tort Statute

Globalization of commerce is not new. Global corporate commerce traces back at least as far as the East India companies of Britain and Holland.68 The post-1970s era of the neoliberal turn is characterized by, among other things, the globalization of production and supply chains and

63 E.g., Robins Dry Dock & Repair Co. v. Flint, 275 U.S. 303 (1927). See generally Robert J. Rhee, A Production Theory of Pure Economic Loss, 104 Nw. U. L. Rev. 49 (2010). 64 47 U.S.C. § 230. At the time of writing, the US Supreme Court heard arguments on a case involving the scope of Section 230 but ultimately declined to rule on the issue. Gonzalez v. Google LLC, 598 U.S. _ (2023) (per curiam). 65 47 U.S.C. at § 230(b). 66 Id. at § 230(a). 67 ‘No provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.’ Id. at § 230(c)(1). The statute also preempted state law to the extent it is inconsistent with the statute. Id. at § 230(e)(3). 68 See generally Ron Harris, Going the Distance: Eurasian Trade and the Rise of the Business Corporation, 1400–1700 (2020).

130  Research handbook on corporate liability the pursuit of the cheapest sources of labor, raw goods, and production. Among large trends is the choice of the United States to shift from an economy of industrial manufacturing to one based on consumption, information technology, and finance. For corporate tort liability, the globalization of the economy raises the question of the relationship between corporate capitalism and exploitation. The Alien Tort Statute (ATS), enacted as a part of the Judiciary Act of 1789, provides: ‘The district courts shall have original jurisdiction of any civil action by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States.’69 This statute lay dormant until 1980, when the Second Circuit ruled that the ATS is applicable to claims based on torture by foreign government officials because customary international law prohibits these kinds of human rights violations.70 Once the ATS awoke from its slumber, courts had to contend with a modern question: To what extent does the statute cover corporate conduct? The circuits have split on this question. The Second Circuit held that corporations do not come within the ambit of the ATS.71 But the Seventh, Ninth, Eleventh, and D.C. Circuits have held that corporations can be held liable.72 Cases reveal a broad range of possible liability against corporations: victims of terrorism who sued a foreign bank that allegedly financed terrorism;73 plaintiffs alleging that a mining corporation operating in Indonesia committed environmental abuses, human rights violations and genocide;74 class action against British and Dutch oil corporations for aiding and abetting the Nigerian government in abusing human rights;75 children alleging that a rubber manufacturer operating in Liberia violated customary international law arising from the use of child labor;76 children alleging that Ivory Coast farmers committed child slavery in the production of cocoa on behalf of a corporation that supported the cocoa farming industry;77 plaintiffs alleging that their protest against a mining corporation was violently put down by the military in Papua New Guinea;78 and plaintiffs alleging that an oil corporation committed violence and human rights violations in Indonesia.79 If the ATS applies to corporations, a claim could include thousands of victims.80 Thus far, the Supreme Court has not squarely resolved this circuit split. In Jesner v. Arab Bank, PLC, the Court held that foreign corporations do not come within the ambit of the ATS

28 U.S.C. § 1350. Filártiga v. Peña-Irala, 630 F.2d 876, 890 (2d Cir. 1980). 71 Arab Bank, PLC Alien Tort Litig., 808 F.3d 144, 152, 158 (2d Cir. 2015); Kiobel v. Royal Dutch Shell Petroleum Co., 621 F.3d 111, 148 (2d Cir. 2010). 72 Beanal v. Freeport-McMoran, Inc., 197 F.3d 161, 163 (5th Cir. 1999); Flomo v. Firestone Nat. Rubber Co., 643 F.3d 1013, 1021 (7th Cir. 2011); Doe I v. Nestlé USA, Inc., 766 F.3d 1013, 1021–22 (9th Cir. 2014); Sarei v. Rio Tinto, PLC, 671 F.3d 736, 747–48 (9th Cir. 2011) (en banc), vacated on other grounds by 569 U.S. 945 (2013); Aldana v. Del Monte Fresh Produce, N.A., Inc. 416 F.3d 1242, 1245 (11th Cir. 2005); Doe VIII v. Exxon Mobile Corp., 654 F.3d 11, 40–55 (D.C. Cir. 2011). 73 Arab Bank, 808 F.3d at 147. 74 Beanal, 197 F.3d at 163. 75 Kiobel, 621 F.3d at 123. 76 Flomo, 643 F.3d at 1015. 77 Doe I, 766 F.3d at 1017. 78 Sarei v. Rio Tinto, PLC, 671 F.3d 736, 742 (9th Cir. 2011). 79 Doe VIII v. Exxon Mobile Corp., 654 F.3d 11, 15 (D.C. Cir. 2011). 80 Jesner v. Arab Bank, PLC, 138 S. Ct. 1386, 1394 (2018) (indicating that plaintiffs in five ATS cases against Arab Bank number over 6,000). 69 70

Corporate tortious liability  131 when they injure aliens by violating the law of nations or a treaty of the United States.81 It specifically limited its holding to foreign corporations,82 and did not extend the analysis generally to all corporations. For domestic corporations operating internationally, it is unclear whether they can be sued under the ATS.83 Moreover, in Kiobel v. Royal Dutch Shell Petroleum Co. and Nestlé USA, Inc. v. Doe, the Court held that the ATS does not give extraterritorial reach to any cause of action and that plaintiffs must establish that the tortious conduct occurred in the United States.84 It is unlikely that an ATS claim will be brought as a small claim, either in the damages alleged or the number of plaintiffs. These cases are complex and costly to investigate, and one presumes that, unless there is a public interest motive, attorneys will require economic incentives. The ATS could be a potential source of low frequency high severity losses given that a suit could arise from conduct that attracts the ATS and potential plaintiffs could number in the thousands. The risk of tort liability under the ATS is a product of the globalization of markets, production, and supply chains. With this said, the current Supreme Court does not seem inclined to expose domestic corporations to severe liability under the ATS, though it had opportunities to exclude all corporations from ATS liability and did not take them. C.

Global Warming

Global warming is another development that could affect corporate tort liability. Global warming is far more consequential as a matter of business than legal liability. As a matter of intermediate and long-term trends, no company or industry will escape the effects of global warming. Global warming can result in liability arising from the new application of existing rules,85 or the development of new rules for new circumstances.86 With respect to the specific link between corporations and tort liability, global warming will disproportionately affect certain industries while others will probably be less affected. Id. at 1407. Id. 83 Three justices of the majority hinted in section II.B.3. of the opinion that the analysis could extend to all corporations: ‘corporate liability under the ATS is [not] essential to serve the goals of the statute.’ Id. at 1405–406. Two justices in the majority did not join this part of the opinion. Id. at 1408 (Alito, J., concurring in part, but not joining section II.B.3.); id. at 1412 (Gorsuch, J., concurring in part, but not joining section II.B.3). 84 Nestlé USA, Inc. v. Doe, 141 S. Ct. 1931, 1936 (2021) (citing Kiobel v. Royal Dutch Shell Petroleum Co., 569 U.S. 108, 115–18, 124 (2013)), reversing Doe I v. Nestlé USA, Inc., 766 F.3d 1013, 1021–22 (9th Cir. 2014). 85 For example, if carbon pollution can ever be deemed to be a ‘violation of the law of nations or a treaty of the United States’, such tort could lead to liability under the ATS. On climate change liability, courts in other nations may take the lead. See Stanley Reed & Claire Moses, A Dutch Court Rules that Shell Must Step Up its Climate Change Efforts, N.Y. Times, Oct. 28, 2021 (‘The District Court in The Hague ruled that Shell was “obliged” to reduce the carbon dioxide emissions of its activities by 45 percent at the end of 2030 compared with 2019’). 86 Global warming can result in criminal liability under existing criminal laws. See infra note 87. It can also potentially lead to the enactment of new theories of crime, such as ecocide. See generally Anastacia Greene, The Campaign to Make Ecocide an International Crime: Quixotic Quest or Moral Imperative?, 30 Fordham Envtl. L. Rev. 1 (2019); Gwynn MacCarrick & Jackson Maogoto, The Significance of the International Monsanto Tribunal’s Findings with Respect to the Nascent Crime of Ecocide, 48 Tex. Env’t. L.J. 217 (2018). 81 82

132  Research handbook on corporate liability The most recent example of the link between global warming and tort liability is the bankruptcy of Pacific Gas & Electric. PG&E accumulated an estimated $30 billion in liabilities for fires in California, prompting the bankruptcy filing, and it also faced criminal charges for involuntary manslaughter.87 It is of no significance that a direct causal link between global warming and any specific event would be impossible to prove; causation in law does not link fortuitous condition to negligence, but instead negligence to injury. Global warming is the conditional medium, the petri dish, in which negligence and liability grow. Corporations will be subject to greater risk of tort liability, though the magnitude of loss is a known Knightian uncertainty. Certain industries will probably experience heightened liability as global warming creates the conditions for faulty conduct to trigger or exacerbate an accident. It is also important to not just think about tort liability as liability from a legal judgment against a corporate tortfeasor, but about all forms of economic liability, including the financial obligations of all corporate constituents arising as a matter of the legal structure of the corporate form, contracts, or other imperatives, for example insurers and capital creditors. The most immediate groups that may face increased economic liability from torts would be industry sectors in utilities, energy, real estate, engineering, insurance, banking and financial services, as well as the public sector if government is the ultimate risk manager or bearer.88

IV.

NAVIGATING RISKS

Tort liability is a product of liability rules and the conditions in which the corporation operates. Some risks are controllable, and some not. Control becomes more problematic as the outcome is less a Knightian risk and more an uncertainty. Known uncertainty makes a cost-benefit analysis precarious as crucial inputs are unknown. Unknown uncertainty makes pragmatic foreseeability impossible. Taking precautions against unforeseeable events may not be possible as a matter of epistemology or of pragmatic concern – the latter because in most situations the probability of the event would be quite small for the purpose of a cost-benefit analysis. Liability can produce high severity loss, the kind that causes disruption of operations, increased cost of capital, financial distress, bankruptcy, or dissolution. Nothing may be done after the fact about a single event that produces extreme losses under ordinary tort doctrine, even if new conditions increase the risk of severe liability, for example the link between global warming and increased risk of losses. Insurers and banks can manage such risk ex ante through contracting and pricing, but indemnitors and creditors, like the corporation, are financially obligated after the fact. New conditions may be a basis for a subsequent change in the liability rule through the legal or political processes, but compensation must be provided upon culpability and loss. Mass torts are sometimes resolved through complex structured settlements in which a compensation fund is established.89 If compensation

See Ivan Penn, PG&E, Troubled California Utility, Emerges from Bankruptcy, N.Y. Times, July 1, 2020; Ivan Penn, PG&E Faces Criminal Charges Over Fatal 2020 Wildfire in California, N.Y. Times, Sept. 24, 2021. 88 See generally David A. Moss, When All Else Fails: Government as the Ultimate Risk Manager (2002). 89 E.g., Deepwater Horizon Court-Supervised Settlement Program (last retrieved Mar. 30, 2022), https://​www​.deepwat​erhorizons​ettlements​.com/​[https://​web​.archive​.org/​web/​20220330061752/​ 87

Corporate tortious liability  133 is beyond the ability to pay and results in insolvency, bankruptcy reorganization is available, if not dissolution. While old risks become ordinary matters of actuarial science and risk management for the most part, corporations confront new risks as they manifest in time and condition. These risks pose potential sources of low frequency high severity losses, and corporations must navigate them. Questions to consider are: What is the new framework of liability, either new rules of liability or existing rules applied to new circumstance? What is the range of liability? How can the risks be managed? In a business-oriented country, lawmakers sometimes resist imposing high aggregate or high severity losses. In an earlier era, courts developed rules like the concept of negligence, contributory negligence, and the fellow servant doctrine to limit liability on business. Lawmakers look askance at disproportionality between conduct and liability. Prime examples of this concern are the tort doctrines of foreseeability and pure economic loss. The right to full compensation may be immutable upon injury to a cognizable interest, but aggregate outcomes may not achieve this ideal in practice due to the workings of other rules.90 The same anti-severity impetus is behind the Supreme Court’s fiat cap on punitive damages and Congress’s provision of the Section 230 legal shield for internet and technology companies. The paring of the scope of class actions reduces the frequency of high severity losses and its negative effect on settlement valuations, even if the aggregate liability amount would be the same and aggregate transaction costs of litigating multiple cases could be higher, in theory at least.91 With respect to whether the ATS applies to domestic corporations, an open policy consideration is the frequency with which they would be subject to crippling liability. Thinking strategically, corporations probably consider a link between tort liability and the role of politics. When social losses become severe, the issues of liability and compensation come within the political realm. Examples abound: September 11 terrorist attacks, Exxon Valdez, BP Deepwater Horizon, PG&E’s wildfires, etc. It is easier to generalize the role of politics than to predict the way in which the political process affects individual cases.92 Public pressure may affect the corporate tortfeasor, regulators, and the political branches.93 Corporate tortfeasors may seek to resolve the claims through a political prism. Regulators may consider other issues than just compensation for victims. An important consideration for lawmakers and

https://​www​.deepwat​erhorizons​ettlements​.com/​]; September 11th Victim Compensation Fund, available at https://​www​.vcf​.gov. 90 See Rhee, supra note 28, at 125 (arguing that the concept of negligence devalues the litigation asset and reduces liability in a litigation world dominated by settlement). 91 In practice, the denial of a class would likely lead to less expected aggregate liability for two reasons. First, when there is a diversified portfolio of cases, a corporation may not assign a premium to settlement valuation. See generally Rhee, supra note 28; Rhee, supra note 42. Second, the expected aggregate of liability in individual cases does not equal the expected liability in a single class action because the number of suits may decrease when the actions are atomized. In practice, cases would fall through the cracks for various reasons, including issues related to access to justice and the economics of legal actions. 92 E.g., September 11th Victim Compensation Fund of 2001, § 405(c)(3(C)(i) (requiring ‘the claimant waives the right to file a civil action … for damages sustained as a result of the terrorist-related aircraft crashes of September 11, 2001’), codified in 49 U.S.C. § 40101. 93 E.g., Mendelson, supra note 15, at 1243; Cecilia Kang, Lawmakers See Path to Rein in Tech, But It Isn’t Smooth, N.Y. Times, Oct. 9, 2021 (suggesting that Big Tech may be like Big Tobacco and that a possibility is ‘reworking a law that shields tech companies from lawsuits’).

134  Research handbook on corporate liability regulators is the implications of a firm’s demise. The dissolution of Arthur Andersen in the face of criminal prosecution in connection with the Enron fraud may have raised the question of how a firm’s demise could affect stakeholders including the accounting profession and corporate clients. The collapse of Lehman Brothers during the financial crisis of 2008–2009 showed that the dissolution of a systemically important firm could impart society-wide negative externalities. In hindsight, it is plausible perhaps that, despite the gross misdeeds occurring in these firms for which there should be accountability, policymakers may have approached these situations differently or enacted policies to do so.94 The collapse of systemically important companies from the weight of a severe tort liability may have broad social and economic implications. Companies that could inflict mass disasters on society also tend to be large or important, which means that their demise could have negative externalities. An option is bankruptcy reorganization, but bankruptcy is not without substantial cost, including the under-compensation of tort victims who typically recover pennies on the dollar for pre-petition injuries.95 When tort liability or consideration of it draws in the public sphere, two corollary political questions are raised: the degree to which government action can contribute to a firm’s or an industry’s duress or demise, and the degree to which it can shield a firm or an industry from duress or demise. The proper answers to both questions presume a principled approach, though the rankings of priorities and interests may be varied and contested. It is not inconceivable that, thinking strategically, corporations would pursue rent-seeking in the political arena. The political questions may become a part of a corporate strategy to address potentially high severity loss events, both ex ante in the exertion of political influence on potential new rules of liability and devices of liability curtailment and ex post in the management and mitigation of liability upon severe loss.

V. CONCLUSION Tort law developed as a response to the rise of industrial capitalism and the modern corporation. It is most consequential when corporations are involved because they have the greatest capacity to inflict civil wrongs on society and are also a source of deep pockets. The corporate form and laws spread risk within the corporation. Civil wrongs create liabilities against corporate assets. Like many kinds of business risk, tort risks are heterogeneous. Some are more manageable than others. New becomes old, and unknown becomes new. Industrial accidents and product liability are no longer new risks even when accidents are unexpected and sometimes severe in the aggregate or the few. They are generally known and calculable. Any new era may create novel risks as social, economic, political, and technological conditions change. Tort law will continue to develop with new risks in new eras. A particular concern is the amplification of risk resulting in low frequency high severity losses. The risk is

See Arthur Andersen LLP v. U.S., 544 U.S. 696 (2005) (unanimously overturning the criminal conviction of the firm for its role in the Enron fraud); Ben S. Bernanke, The Federal Reserve and the Financial Crisis 95 (2013) (‘So we had no legal way to save Lehman Brothers. I think if we could have avoided letting it fail, we would have done so’); Henry M. Paulson, Jr., On the Brink: Inside the Race to Stop the Collapse of the Global Financial System 225 (2010). 95 Vincent S.J. Buccola & Joshua C. Macey, Claim Durability and Bankruptcy’s Tort Problem, 38 Yale J. Regul. 766, 773–74 (2021). 94

Corporate tortious liability  135 exacerbated when it is uncertain or unknown. Such losses, if severe, are always problematic for corporations. Corporate managers must navigate such risks. Lawmakers are well-cognizant of these challenges, and this recognition is seen at times in legislative and judicial laws. Such compromises can arise from political judgments as much as legal judgments, suggesting that political risk also attaches when rules are changed.

8. Agency liability Tan Cheng-Han

I. INTRODUCTION The law of agency is an important aspect of corporate liability. While agency law is also applicable to human persons, its relevance is arguably far greater to corporations. Unlike a human person who can and will generally act for herself, a corporation can only act through human agents.1 Indeed, the notion of a corporation cannot exist practically unless it is recognised in some form or other that the acts of others may have legal consequences for a company including incurring liability (and rights) for such acts. This need for companies to act through others therefore makes the law of agency essential to corporate vehicles. An agent in this context is a person who has been expressly or impliedly authorised by a corporate principal to act on the principal’s behalf in a manner that is capable of altering the principal’s legal relations,2 usually by entering into contracts on behalf of the principal.3 This legal concept of agency should be contrasted with the looser use of the term ‘agent’ which occurs in many cases, some of which are discussed in other sections of this chapter. For example, an employee may be loosely referred to as an agent. However, whether such an employee is a true agent in the legal sense will depend on whether she has the authority from the principal to alter the principal’s legal position. 1 E.g., Singularis Holdings Ltd v. Daiwa Capital Markets Europe Ltd [2020] AC 1189 ¶ 28 (UKSC) (appeal taken from Eng.). 2 Restatement (Third) of Agency § 1.01 (Am. L. Inst. 2006); Peter Watts & F.M.B. Reynolds, Bowstead and Reynolds on Agency ¶ 1-001 (22d ed. 2021). Some commentators have suggested that platforms using automated processes powered by artificial intelligence should be regarded as agents. See, e.g., S. Chopra & Laurence White, Artificial Agents and the Contracting Problem: A Solution via an Agency Analysis, U. Ill. J.L. Tech. & Pol’y 363 (2009); Lauren Henry Scholz, Algorithmic Contracts 20 Stan. Tech. L. Rev. 128 (2017). While it is possible for a party that owns or deploys an automated process to be an agent for the contracting parties where the aforementioned party is a separate entity from the contracting parties (see Ruscoe v. Cryptopia [2020] NZHC 728, [2020] 2 NZLR 809 and it is suggested this should have been the case as well in Quoine Pte Ltd v. B2C2 Ltd [2020] 2 SLR 20 (SGCA(I)) (Sing.)), it is unlikely that a computer program in itself will be regarded in law as an agent. The law of agency is premised on agents being sentient human individuals or entities having legal personality that can act through sentient individuals. Restatement (Third), § 1.04(5) and comment e and § 3.05; Bowstead & Reynolds, supra, ¶ 2-013. A contracting party that uses an automated process to enter into agreements will generally be treated as contracting directly. See, e.g., Chwee Kin Keong and Others v. Digilandmall.com Pte Ltd [2005] 1 SLR 502 (SGCA) (Sing.). 3 It is also possible for agents to be authorised by principals to commit tortious acts, although for obvious reasons this is not a common use of agents. Agency law may also cause a principal’s legal position to be affected outside the context of contracts, e.g. where the knowledge of an agent is attributed to a principal for criminal liability, or where a third party may reasonably assume that an agent was duly authorised to act as she did, thereby depriving the principal of a cause of action that might otherwise have arisen. An example of the latter is Ciban Mgmt. Corp. v. Citco (BVI) Ltd [2021] AC 122 (UKPC) (appeal taken from BVI).

136

Agency liability  137 Such authority is not necessarily linked to seniority within the corporate structure. Thus a non-executive director of a company will generally not have any agency authority even though directors are at the apex of the corporate hierarchy. The existence of authority capable of altering a company’s legal position may also be wielded by outsiders such as independent contractors who are tasked by the corporate principal to act on its behalf. Where a company incurs liability through the act of an agent, such liability is primary as the agent’s act on behalf of the company is regarded as the company’s act. This is to be contrasted with vicarious liability by a company for a non-authorised tortious act of an employee or a person in a role analogous to employment.4 Where a company is held vicariously liable for the act of an employee, the wrong committed by the employee is not regarded as the company’s wrong. Rather, the company is made vicariously liable for such wrong as a matter of policy to optimise the victim’s prospects of receiving compensation.5 Although true agency focuses on persons who have been authorised by the principal to act on its behalf, the law of agency includes within its ambit a number of situations outside this paradigm. These situations are diverse and range from instances where authority was exceeded to those where the ‘agent’ had no authority whatsoever. The latter includes cases where it can be said that an agency was constructed for policy reasons. The law of agency therefore goes beyond the concept of authority to include the idea of power on the part of an agent to affect the principal’s legal position.6 This illustrates the broad and flexible nature of agency that brings a potentially wide group of intermediaries within its fold.

II.

NON-AUTHORISED AGENTS

Although the paradigmatic instance of agency is a person who has been authorised by a principal, corporate or otherwise, to act on behalf of the principal and has done so, a principal may be bound even if an agent acted without authority. The two most common instances of this are, first, where the agent is said to have apparent authority and, second, where the principal has ratified the agent’s unauthorised act. In both situations, the basis for liability is founded on the principal’s actions as the law is slow to impose obligations on a person without consent. In the case of ratification, the principal voluntarily adopts the agent’s non-authorised act and the law treats this as conferring retrospective authorisation on the agent.7 Ratification is brought about by the unilateral act of the principal to which the third party has no say. Thus the retrospective conferment of authority means that an initially non-authorised transaction is validated even if the third party purported to withdraw from the contract prior to ratification.8 The premise behind the doctrine is that the third party was willing to enter into such an agreement in the first place and the principal should be given the opportunity to cure any defect in authority. It has the practical value of foreclosing unnecessary disputes over whether the agent

See Various Claimants v. Barclays Bank plc [2020] A.C. 973 (UKSC) (appeal taken from Eng.) (and the cases referred to in the judgment). 5 Ong Han Ling v. Am. Int’l Assurance [2018] 5 SLR 549 ¶¶ 209–10 (SGHC) (Sing.). On this, see Chapter 15 on vicarious liability in this volume. 6 Bowstead & Reynolds, supra note 2, at ¶ 1-013. 7 See generally Tan Cheng-Han, the law of agency Ch. 6 (2d ed. 2017). 8 Bolton Partners v. Lambert (1889) 41 Ch. 295 (Eng.). 4

138  Research handbook on corporate liability had the requisite authority from the outset where the third party regrets the bargain entered into. Yet, as ratification arises by the unilateral act of the principal, it is necessary that this is not taken to extremes such that unfairness is caused to the third party. Accordingly, various limitations on the ability to ratify have been developed by the courts, the most important being that ratification must take place within a reasonable time.9 While the doctrine of ratification aids the principal who wishes to take the benefit of a hitherto unauthorised act of agency, apparent authority is relied on by third parties who want to hold the principal to an unauthorised transaction entered into by the agent. They may do so where the principal has said or done something that amounts to a representation to the third party that the agent was authorised to perform the act in question. In the case of corporations, such representations are usually made by the board of directors or those in senior management positions.10 Often, this will be by placing the agent in a position that would normally have the requisite authority. For instance, a managing director of a company often has wide-ranging powers to manage the corporation’s day-to-day affairs, including entering into contracts on behalf of such company. A third party dealing with a managing director will therefore ordinarily be entitled to assume that such managing director has the authority usual for such an office, even if the board has placed restrictions on such authority.11 Accordingly, where a third party without knowledge or notice of any lack of authority reasonably enters into a contract seemingly within such usual authority, the third party may enforce the contract. Using the doctrine of estoppel, the courts say that the principal is estopped from denying the existence of such authority as it was by the principal’s own act, i.e. the representation, that the third party changed its position.12 By focusing on the principal’s representations, the law strikes a balance between the interests of a third party in having her legitimate interests recognised, and that of the principal in generally not being bound by the acts of another unless duly authorised. In addition to representations as to an agent’s authority that give rise to apparent authority by way of estoppel, it is said that a principal can also be estopped from denying an agency relationship where the principal has induced a third party to detrimentally change such a party’s position because of a belief in the existence of an agency relationship. Such belief must have been induced by the principal intentionally or carelessly, or, having notice of such belief and that it might induce others to change their positions, the principal did not take reasonable steps to notify them of the facts. The difference between this estoppel and apparent authority is that the representation does not take the form of a representation of authority.13 It is doubtful that there is a separate category of ‘estoppel in agency’ that is distinct from estoppel in apparent authority. The Singapore Court of Appeal expressed scepticism over any



Tan Cheng-Han, The Principle in Bird v Brown Revisited, 117 L.Q. Rev. 626 (2001). In Ciban Mgmt. Corp. v. Citco (BVI) Ltd [2021] AC 122 (PC) (appeal taken from BVI), the Privy Council held that the effect of the principle in In re Duomatic Ltd (1969) 2 Ch. 365 (Eng.) is that the unanimous representation of all the shareholders or sole shareholder in a company (including beneficial owners if they are different from the registered shareholders) can lead to apparent authority being conferred. 11 Freeman & Lockyer v. Buckhurst Park Prop. (Mangal) Ltd (1964) 2 QB 480 (Eng.). 12 Id. In the United States, on the other hand, apparent authority is seen as an aspect of the objective interpretation of contracts. See Restatement (Third) of Agency § 2.03, comment c (Am. L. Inst. 2006). 13 Restatement (Third), § 2.05; Bowstead & Reynolds, supra note 2, at ¶ 2-103. 9

10

Agency liability  139 such distinction14 and it is submitted that the court was right to do so. There is already a clearly justified and established category of apparent authority whose parameters are relatively clear, and while the true extent of the doctrine will always be a matter of judgment, it is a broad one and potentially quite far reaching already. It is difficult to contemplate situations where there has been no sufficient representation of authority to give rise to apparent authority, but some other representation exists so as to preclude the principal from denying the existence of an agency relationship. The examples used in Restatement, Third to support this supplementary class of estoppel are explicable for other reasons including apparent authority itself. The creation of this estoppel is therefore confusing and, to the extent that it does go beyond apparent authority, might undermine the careful balance that apparent authority strikes between the interests of principals and those of third parties.15 Two examples will suffice to illustrate this. First, Restatement, Third provides the illustration of P having two co-agents, A and B.16 P has notice that B, acting without actual or apparent authority, has represented to T that A has authority to enter into a transaction that is contrary to P’s instructions. T does not know that P has forbidden A from engaging in the transaction and cannot establish conduct by P which has reasonably caused T to believe that A has the requisite authority. T can, however, establish that P had notice of B’s representations and that it would have been easy for P to inform T of the limits on A’s authority. P did not do so. On such facts, it is said that P is estopped from denying B’s authority to make the representation if T has acted to T’s detriment on the faith of B’s representation and such action on the part of T is justifiable. This illustration does not establish a separate category of estoppel from apparent authority because Restatement, Third recognises that silence may amount to a manifestation or representation of authority when the circumstances are such that a reasonable person would expressly dissent from the inference that others will draw from silence.17 Accordingly, in the case of McWhorter v. Sheller18 it was held that the failure on the part of the principal to inform the third party that his agents were acting outside authority was a sufficient manifestation of authority to give rise to apparent authority. Another example of a case relied on by Restatement, Third for the category of estoppel in agency is Patrick v. Miss New Mexico-USA Universe Pageant19 where the plaintiff had been informed that she was eligible to compete even though she did not reside in the state. After she won the state beauty pageant, she was told that her non-residence made her ineligible for the title. As the principal was aware of what the plaintiff had been told, it was held that the principal’s acquiescence or silence amounted to ratification of the agent’s act. Furthermore, the court found that the agent did have actual or apparent authority to inform the plaintiff as he did. While the court did add that the principal had an affirmative duty to correct any misinformation that the principal was aware would be relied on by the plaintiff, and the failure to do so would further support an estoppel, any such estoppel was unnecessary given the existence of ratification, and actual and apparent authority.

16 17 18 19 14 15

The Bunga Melati 5 [2016] 2 SLR 1114 (SGCA) (Sing.). See Tan Cheng-Han, Estoppel in the Law of Agency, 135 L.Q. Rev. 315, 321–22 (2020). Restatement (Third) § 2.05, comment d. Restatement (Third) § 1.03, comment b. McWhorter v. Sheller 993 S.W.2d 781 (Tex. App. 1999). Patrick v. Miss New Mexico-USA Universe Pageant 490 F. Supp. 833 (W.D. Tex. 1980).

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III.

APPARENT AUTHORITY AND THE INDOOR MANAGEMENT RULE

The doctrine of apparent authority is closely related to the indoor management rule in corporate law. The indoor management rule is a presumption that a third party dealing with a company may assume that matters of internal formality have been complied with in the absence of any notice to the contrary.20 Where for example a company’s constitution provides that the power of management is vested in the board of directors and a bank requests a copy of a board resolution authorising the company’s loan application, upon such resolution being provided by the company secretary the bank is entitled to assume inter alia that the company secretary and the board have been properly appointed, and that the board meeting in question was properly convened and had the requisite quorum. This presumption of regularity is a sensible one because a third party dealing with a company cannot generally be expected to know of any internal irregularities and if transactions could be adversely affected by this there would be great uncertainty in many commercial transactions. The indoor management rule is relevant in the context of agency liability because its operation is largely dependent on the operation of normal agency principles. As the board’s power to delegate is usually a wide one, it would be theoretically possible for the indoor management rule to be invoked in every case where a third party has dealt with an individual claiming to act on behalf of a company.21 The rule is therefore constrained by the law of agency which requires the purported intermediary to at least have apparent authority to act. Where this is the case, the indoor management rule supplements agency principles by rendering non-compliance with internal formalities irrelevant in the absence of notice to such effect.22 Occasionally, the common law position is supplemented by statute now, for example under section 40(1) of the UK Companies Act 2006.23 This provision states that in favour of a person dealing with a company in good faith, the power of the directors to bind the company, or authorise others to do so, is deemed to be free of any limitation under the company’s constitution. This means that an act of an agent on behalf of a company may be valid even if the board was constitutionally constrained from approving the transaction, provided there was approval or apparent authority.

IV.

DIRECTORS AS AGENTS

Although anyone can be conferred authority by a company to act on its behalf so as to alter its legal relations, in general the persons most likely to have material authority to do so are its executive directors and senior managers. The extent of the authority will depend on the facts and circumstances but some general points can be made.

Royal British Bank v. Turquand (1856) 6 E&B 327 (Eng.). Houghton & Co v. Nothard, Lowe & Wills Ltd (1927) 1 KB 246, 266 (Eng.). 22 B. Liggett (Liverpool) Ltd v. Barclays Bank (1928) 1 KB 48 (Eng.); Northside Dev. Pty Ltd v. Registrar-General (1990) 170 CLR 146 (Austl.); East Asia Co Ltd v. PT Satria Tirtatama Energindo (Bermuda) (2020) 2 All ER 294 (UKPC) (appeal taken from Bermuda). 23 There is a similar provision in section 25B(1) of the Singapore Companies Act, 1967 (Cap. 50, 2006 Revised Edition). 20 21

Agency liability  141 First, as mentioned briefly at the beginning of this chapter, many directors and senior managers might have no agency authority at all in which case they are not properly to be regarded as agents in the legal sense of the word. It is not uncommon for companies to have non-executive directors whose major role is to provide some level of oversight and strategic thinking without being involved in the day-to-day business of the company. Indeed, even the Chairman of the Board, who is often a non-executive director, will generally be without any agency authority.24 Similarly, senior managers such as a finance manager in charge of the finance and accounting department might also not have such authority.25 Second, where directors or senior managers have agency authority, such authority will often be conferred expressly and might also arise by implication. This raises the question of where such conferment of authority may come from given the corporation is an artificial entity. The answer to this is usually to be found in legislation relating to corporations and in corporate constitutions.26 Taking section 40(1) of the UK Companies Act 2006 again as an example, the provision confers power on the board of directors acting collectively ‘to bind the company or authorise others to do so’, provided a third party dealing with the company has done so in good faith. In addition, the UK ‘Model articles for private companies limited by shares’ provides in regulation 3 that the directors are, subject to the articles, ‘responsible for the management of the company’s business’ and in regulation 5(1) that they may delegate any of the powers which are conferred on them to such person or committee as they think fit.27 Third, it would be unlikely in many corporate transactions involving agents that the board had conferred authority directly on the agent. This is a level of board involvement that would only be practical for very small companies. Often agents will derive authority from another agent such as where a managing director authorises another to procure a transaction for the company’s benefit.28 Such authority is nevertheless likely to be traceable back to the board where legislation provides or corporate constitutions have been drafted to the effect that the board is the ultimate decision maker and the body from which authority originates. Fourth, while it has been suggested that directors acting collectively as the board can be regarded as an agent of the company,29 it is submitted that the better view is that the board is not an agent but an organ of the company.30 Accordingly, where the directors of a company act

24 Hely-Hutchinson v. Brayhead Ltd [1967] 3 WLR 1408, 1417, 1419; Northside Dev., 170 CLR 146. 25 Skandinaviska Enskilda Banken AB (Publ), Singapore Branch v. Asia Pacific Breweries (Singapore) Pte Ltd [2011] 3 SLR 540 (SGCA) (Sing.). 26 This is also relevant to the question whether knowledge of a person should be attributed to a company. While some reference is made to attribution in this chapter, the topic is covered in detail in Chapter 9 in this volume. 27 Similar regulations exist in the Singapore Companies (Model Constitutions) Regulations 2015, at regs. 77 and 89. 28 For example, see Newcastle International Airport Ltd v. Eversheds LLP [2014] 1 WLR 3073 (EWCA) involving a holding out of the managing director’s authority by the chairperson of the company’s remuneration committee. 29 Peter Watts, Directors as Agents – Some Aspects of Disputed Territory, in Agency Law In Commercial Practice 97 (Danny Busch, Laura Macgregor & Peter Watts eds., 2016). 30 Gabriel Peter & Partners v. Wee Chong Jin [1997] 3 SLR(R) 649, ¶ 25 (Sing.); see also Paul L. Davies & Sarah Worthington, Gower’s Principles of Modern Company Law ¶ 7.4 (10th ed. 2016); Ross Grantham, The Limited Liability of Company Directors, 3 Lloyd’s. Mar. & Com. L.Q. 362, 384–86 (2007); Susan Watson, Conceptual Confusion: Organs, Agents and Identity in English Courts,

142  Research handbook on corporate liability as the board, the board’s act is equivalent to an act of the company rather than an act for and on behalf of such company. Fortunately, whatever is the correct view of this, the distinction is likely of theoretical interest only. Regardless of whether the board as a whole is an agent, the board’s powers must flow from corporate law or the corporate constitution. This includes the board’s ability to confer authority on others to act on behalf of the company. In addition, the directors continue in their individual capacities to owe fiduciary obligations to the company as such duties are not limited to agents per se and directors (even without agency powers) have long been recognised as a distinct class on whom fiduciary duties are placed.31 Corporate legislation in general recognises two distinct bodies, namely the board of directors and the shareholders acting collectively in the context of a general meeting. Indeed, English and Singapore law proceed on the basis that both bodies are the principal decision makers for the company.32 Such a legislative scheme and typical corporate constitutions point to these bodies as an aspect of the corporation rather than standing apart from it.33 Certainly the shareholders in general meeting have generally not been equated to agents even though they may make decisions binding on a company.34 The traditional view is that when shareholders act collectively, their acts are the acts of the company.35 The Australian High Court has also stated that the right of a shareholder to vote is an incident of property. Accordingly, the power by the shareholders in general meeting to alter the corporate constitution is not a fiduciary power.36 This points strongly to the shareholders in general meeting not being agents or some other fiduciary to the company. Such an outcome does not mean that every act of the majority will necessarily be binding on a company by virtue of the general meeting being an organ of the company.37 This presumptive position is subject to corporate law rules that constrain shareholders in their individual capacities if they act oppressively or fraudulently towards minority shareholders.38 It is suggested that the board operates similarly. Like the shareholders in general meeting, the board’s decisions are the company’s very own rather than the acts of an agent acting on 23 Sing. Acad. L.J. 762 (2011); Christian Witting, The Small Company: Directors’ Status and Liability in Negligence, 24 King’s L.J. 343 (2013). 31 Accordingly, if a director votes in a board meeting in favour of a transaction in which the director has an interest, such director is potentially in breach of the fiduciary obligation against conflicts of interest if there was no prior disclosure of such interest. 32 Marex Financial Ltd v. Sevilleja [2021] AC 39 (UKSC); Miao Weiguo v. Tendcare Medical Group Holding Pte Ltd [2021] SGCA 116 (Sing.). 33 For example, the UK Companies Act 2006, c. 46 § 281(3) equates a ‘resolution of a company’ with a resolution ‘of the members … of a company’, and reg. 3 of the UK ‘Model articles for private companies limited by shares’ refers to directors (when they act collectively as a board) exercising ‘all the powers of the company’. 34 For a contrary view, see Ernest Lim, A Case For Shareholders’ Fiduciary Duties in Common Law Asia 137–60 (2019). 35 For example, see Multinational Gas and Petrochemical Co v. Multinational Gas and Petrochemical Services Ltd [1983] 1 Ch. 258, 269 (Eng.). 36 Peter’s American Delicacy Co Ltd v Heath (1939) 61 CLR 457 (Austl.); Gambotto v. W.C.P. Limited (1995) 182 CLR 432 (Austl.). The author is sympathetic, however, to the idea that in certain circumstances controlling shareholders should have fiduciary obligations imposed on them towards minority shareholders. This is beyond the scope of this chapter. 37 See also Lim, supra note 34, at 142–43. 38 The classic examples are the common law derivative action in Foss v Harbottle (1843) 67 ER 189 and the ‘unfair prejudice’ action found in section 994 of the Companies Act 2006, c 46 (UK).

Agency liability  143 behalf of another distinct person. The board of directors can only exercise powers that the company itself has and as a body it has no distinct personality (unlike agents) separate from that of the company. That the acts of the board (and shareholders in general meeting) are the acts of the company was the reason why in MCA Records Inc v. Charly Records Ltd39 the English Court of Appeal stated that a person who is a director or controlling shareholder of a company should generally not be liable as a joint tortfeasor if such a person was exercising control through the constitutional organs of the company rather than in some other capacity. Presumably, if the wrongful acts were done in some other capacity, those would be the acts of the individual in question rather than acts solely attributed to the company. Although courts did often use the language of agency to describe boards in the nineteenth century, this did not seem to survive the early twentieth century re-characterisation of the articles as a constitution that divided the powers of the company between the shareholders collectively and the board.40 In Moulin Global Eyecare Trading Ltd v. Commissioner of Inland Revenue,41 Lord Walker, speaking about corporate boards, stated that as issues of attribution grew more complex, the courts began to see beyond agency as the only explanation for corporate liability or rights, citing the following statement of Lord Reid in Tesco Supermarkets Ltd v. Nattrass:42 ‘It must be a question of law whether, once the facts have been ascertained, a person in doing particular things is to be regarded as the company or merely as the company’s servant or agent’.43 Some support for the view taken here may also be drawn from the Privy Council decision of Meridian Global Funds Management Asia Ltd v. Securities Commission.44 In that case, Lord Hoffman, for the purposes of determining whether knowledge of a person should be attributed to a company, drew a distinction between primary and general rules of attribution. The primary rules of attribution are generally to be found in a company’s constitution and ‘will say things such as … “the decisions of the board in managing the company’s business shall be the decisions of the company”’.45 Such rules may also be implied by company law, an instance being the unanimous decision of all the shareholders being the decision of the company.46 The general rules of attribution supplement the primary rules. The general rules allow the acts of others to be attributed to the company through the principles of agency and estoppel in contract and vicarious liability in tort.47 This description of the rules of attribution suggests a distinction between the board as an organ and individuals as agents, including individual directors not acting collectively as the board.48

MCA Records Inc v. Charly Records Ltd [2003] 1 BCLC 93 ¶¶ 49–50. Davies and Worthington, supra note 30, at 152 n.4; see also Grantham, supra note 30, at 384. 41 Moulin Global Eyecare Trading Ltd v. Commissioner of Inland Revenue [2014] 3 H.K.C. 323, ¶¶ 61–64 (C.F.A.) (H.K.). 42 Tesco Supermarkets Ltd v. Nattrass [1972] AC 153, 170 (UKHL) (appeal taken from Eng.). 43 See also the judgment of Hoffmann L.J. in El Ajou v. Dollar Land Holdings plc [1994] BCC 143, at 158–59 (Eng.) where the distinction between agents and organs of the company is accepted. 44 Meridian Global Funds Management Asia Ltd v. Securities Commission [1995] 2 AC 500 (UKPC) (appeal taken from N.Z.). 45 Id. at 506. 46 Id., referring to Multinational Gas and Petrochemical Co v. Multinational Gas and Petrochemical Services Ltd [1983] 1 Ch. 258 (Eng.). 47 Meridian Global Funds, 2 AC 500. 48 But see Watts, supra note 29, at ¶ 7.14; Lim, supra note 34, at 148–51. 39 40

144  Research handbook on corporate liability It is suggested further that the dicta of Diplock LJ in Freeman & Lockyer v. Buckhurst Park Properties (Mangal) Ltd49 is not inconsistent with this analysis. While Diplock LJ did refer to the board of directors having actual authority under the corporate constitution to manage the company’s business, his Lordship did not specifically refer to the board as an agent. Instead, he seemed to draw a distinction between the board and the agents that the board permitted to act on behalf of the company.50 Diplock LJ also used the term ‘actual’ authority to refer to the body of shareholders,51 though, as pointed out earlier, they are not generally recognised as corporate agents. It seems clear therefore that when Diplock LJ used the term ‘actual’ authority, he was simply referring to the constitutional power allocated to such organs of the company. The recent decision of the Supreme Court in Marex Financial Ltd v. Sevilleja52 may at first glance appear, however, to provide some support for the proposition that the organs of a company may also be agents, or at least the board of directors if not the shareholders in general meeting. In the judgment of Lord Sales JSC (with whom Lord Kitchin JSC and Baroness Hale of Richmond agreed), his Lordship in dicta referred to the liquidator as the relevant organ of a company in the liquidation.53 A liquidator is an agent of the company and has not been typically referred to as an organ.54 It is certainly possible for the courts to determine this as such but the basis for corporate liability is different depending on whether it is rooted in agency or in the organic theory. It is not clear how technically Lord Sales intended to use the term ‘organ’ and in particular if he meant to imply that an organ could also be an agent. This, if correct, would probably render the organic approach otiose. It is suggested that all his Lordship intended to convey is that a liquidator as agent displaces the board of directors in the management of an insolvent company. Although the board acting collectively is an organ of the company, this does not mean that the recognition of corporate personality should necessarily provide such directors with immunity from liability when they act in that role.55 This is apart from the fact that directors may have other concurrent relationships with the company that could attract liability such as when a director has acted deceitfully.56 For example, it has been held that directors acting as a board may be liable for procuring the commission of a tortious act by another person even though the board resolution that contained the libel was an act of the company.57 It is suggested that drawing the boundaries of personal liability in such a situation, as well as in other types of

Freeman & Lockyer v. Buckhurst Park Prop. (Mangal) Ltd (1964) 2 QB 480 (Eng.). Id. at 505–506. 51 Id. at 507. 52 Marex Financial Ltd v. Sevilleja [2021] AC 39 (UKSC) (appeal taken from Eng.). 53 Id. at 92. 54 I am grateful to my colleague, Wee Meng-Seng, for also pointing out that in some jurisdictions liquidators cannot exercise certain powers without the consent of others and this militates against seeing them as organs, and see also Wee Meng-Seng and Tan Cheng-Han, The Agency of Liquidators and Receivers, in Agency Law in Commercial Practice 119, ¶ 8.14 (Danny Busch, Laura Macgregor & Peter Watts eds., 2016). 55 See also Watson, supra note 30, at 765 where it is suggested that such immunity arises absent statutory provisions to the contrary and breaches of duty; and see also Grantham, supra note 30. 56 Standard Chartered Bank v. Pakistan National Shipping Corp (No 2) [2003] 1 AC 959 (UKHL) (appeal taken from Eng.); see also Watts, supra note 29, at ¶ 7.06. 57 Gabriel Peter & Partners v. Wee Chong Jin [1997] 3 SLR(R) 649 (Sing.). 49 50

Agency liability  145 cases involving the board as an organ, is ultimately a question of policy and immunity should not be assumed.58 While it is outside the scope of this chapter to enter into a detailed discussion of this vexed issue, it is broadly accepted that the key to personal liability for procurement of a tortious act is that the act of the directors (or individual officers) ought to be regarded as their own rather than that of the company because it can be said that the directors were personally involved in the commission of the wrongful act.59 This in turn depends on the level of involvement or participation by which it can be said that the wrongful act became an act of the directors.60 All this is somewhat abstract and gives rise to uncertainty, but it is submitted that such personal involvement will be made out where the directors either knew or ought to have known that what was being procured was likely to be wrongful. Such knowledge, including recklessness and indifference, makes an ostensibly corporate action a personal one, and is what justifies regarding the officer as a joint tortfeasor. This is the approach taken in cases such as Mentmore Manufacturing Co v. National Merchandise Manufacturing Co61 and White Horse Distillers Ltd v. Gregson Associates Ltd.62 Such an approach balances the twin policy goals of recognising that ‘it is in the interests of the commercial purposes served by incorporated enterprise that (shareholders, directors and officers) should as a general rule enjoy the benefit of the limited liability afforded by incorporation (while on) the other hand, there is the principle that everyone should answer for his tortious acts’.63 The organic conception of the board and its ability to delegate its powers to others should not mean that the board and persons to whom power has been delegated are to be seen as acting as co-principals rather than agents. Under this view, when directors make decisions as the company, they act as a principal and not as agent. This is also the case where individual directors exercise board powers that are delegated to them. In such instances they may as principals be liable for any wrongdoing that is committed against third parties. It is fallacious for a finding of corporate liability by use of the identification theory to be inconsistent with the

Mentmore Manufacturing Co v. National Merchandise Manufacturing Co (1978), 89 D.L.R. 3d 195, ¶ 23 (Can. Fed. C.A.). 59 Mentmore Manufacturing, 89 D.L.R. 3d, ¶ 25; C Evans & Son Ltd v. Spritebrand Ltd [1985] 1 WLR 317, 329 (Eng.); MCA Records Inc v. Charly Records Ltd (No. 5) [2002] BCC 650, 664 (Eng.). 60 Gabriel Peter [1997] 3 SLR(R), ¶ 35; Mentmore Manufacturing, 89 D.L.R. 3d, ¶ 25. 61 Mentmore Manufacturing, 89 D.L.R. 3d. 62 White Horse Distillers Ltd v. Gregson Associates Ltd [1984] RPC 61 (U.K.). 63 Mentmore Manufacturing, 89 D.L.R. 3d, ¶ 23. However, in C Evans & Son Ltd v. Spritebrand Ltd, [1985] 1 WLR 317, Slade LJ in dicta seemed not to accept such a requirement if the tort alleged was one in respect of which it was not incumbent on the plaintiff to prove a particular state of mind or knowledge. An analogous issue arose for consideration in Williams v. Natural Life Health Foods Ltd [1998] 1 WLR 830 where the House of Lords had to consider whether a director should be held liable for negligent advice given by a company that led to financial loss. Their Lordships held that as a company was a separate entity, such liability would only arise if there was an assumption of responsibility by the director towards the victim. However, the notion of assumption of responsibility in Williams appeared to be somewhat narrow, as involving (even though objectively) whether the director or anyone on his behalf had conveyed directly or otherwise to the victim that the director assumed personal responsibility towards the victim. Assumption of responsibility is arguably broader than this and could fall within the ‘threefold test’, see Caparo Industries plc v. Dickman [1990] 2 AC 605 (UKHL); Customs and Excise Commissioners v. Barclays Bank plc [2007] 1 AC 181 (UKHL); and see also Witting, supra note 30, at 361–62. The result might then have been different. 58

146  Research handbook on corporate liability liability of the directors themselves.64 This author agrees that non-liability is not the inevitable consequence of the board acting organically. It is suggested, however, that the board acting as a whole, or the individual delegate of the board’s power, should not be regarded as principals. To do so would mean that an organ of a company is regarded as a separate group of persons such that it can be a co-principal with the company. This would extend to a director or other person that the board may delegate its powers to. Beyond the fact that there is no authority for such a proposition, it would not generally be the objective intention of any of the parties to the transaction that the board or delegate would be a co-principal and therefore potentially a party to any contract that may arise. It would be unusual if a different proposition applied in tort. As indicated above, this is not to say that the board or delegate may not incur liability for such wrongdoing as may ensue, just that any such consequence is unlikely to be by creating a new category of principal. The board is neither principal nor agent and the delegate is either an agent in the broad sense or an agent in the legal sense.

V.

AGENCY AND VICARIOUS LIABILITY

Somewhat surprisingly perhaps, there is a reasonably substantial body of cases imposing liability on a principal (including corporate principals) for unauthorised tortious acts of an agent. The basis for this is said to be vicarious liability, even though in many of these cases the purported agent was clearly not an employee or in a position akin to employment.65 Accordingly, it has been said that ‘there can be no doubt that a principal is in some circumstances liable for the torts of a person who is not a servant’ but it is a difficult question whether these cases are illustrations of a general rule or isolated cases.66 Such cases are in addition to those in which a principal may be liable for the tort of an agent where the principal owes a ‘non-delegable’ duty to a third party, or where the principal has assumed responsibility towards a third party for the actions of the agent.67 Such instances do not strictly involve the law of agency (and therefore this chapter will not focus on them) as such liability may be imposed regardless of whether the tortfeasor is an agent. Nevertheless, in so far as they allow liability to be imposed on a defendant for the wrongful conduct of another, the effect is similar to vicarious liability. There are a number of circumstances in which vicarious liability is said to be the basis for liability to be imposed on a principal despite the absence of any authorisation of the agent’s wrongful act. One clear case involves partners who are agents for each other in the partnership firm. Section 10 of the Partnership Act of 1890 provides that the partners of a firm are liable for ‘any wrongful act or omission of any partner acting in the ordinary course of business of the

Witting, supra note 30, at 349–50. For some statements of general principle, subject to the caveat that the term ‘agent’ is apt to be used loosely and in a non-technical fashion in the older cases, see e.g. Mackay v. Commercial Bank of New Brunswick (1874) LR 5 PC 394 at 410–12 (UKPC); Credit Lyonnais Bank Nederland N.V. v. Export Credits Guarantee Department [2000] 1 AC 486, 494 (UKHL). 66 P.S. Atiyah, Vicarious Liability in the Law of Torts 99 (1967). Most commentators are of the view that it is the latter, see e.g. Paula Giliker, Vicarious Liability in Tort: A Comparative Perspective 110 (2010); Clerk and Lindsell on torts ¶ 6-66 (Michael A. Jones, Anthony M. Dugdale, & Mark Simpson eds., 22d ed. 2019). 67 Bowstead & Reynolds, supra note 2, at ¶ 8-177. 64 65

Agency liability  147 firm’ that has caused loss or injury to another person. In Dubai Aluminium Co Ltd v. Salaam68 the House of Lords explained that vicarious liability was the basis for the firm’s liability under section 10. According to Lord Millett, this was also part of the common law prior to the Act of 1890.69 While such partnerships are not corporate entities, the relevance is in demonstrating the application of vicarious liability outside of employment situations. Another prominent line of cases involves drivers of motor vehicles where the courts held that if a person drove a car as the agent of the owner, the owner would be vicariously liable for any damage caused by the agent’s negligent driving because the driver had express or implied authority to drive on the owner’s behalf notwithstanding the absence of authorisation from the owner to drive as the agent did. The matter was one of agency and not employment.70 This line of cases is applicable to corporations that allow non-employees to use a company vehicle or other means of conveyance for the corporation’s benefit. In ‘Thelma’ (Owners) v. University College School71 a school was held vicariously liable for the negligence of a student who was participating in a boat race where such negligence caused damage to the plaintiffs’ boat. Although the student was clearly not an employee, the court relied on the motor car cases to find an agency on which to fix the school with liability. Although the underlying basis for the motor car cases may be one of policy, now rendered largely redundant because of standard third party insurance for motor vehicles,72 the relevance of these cases in today’s context is that they illustrate the flexible use of agency reasoning to bring about what was regarded as a socially desirable outcome. The agency was ‘constructed’73 by the courts as it is difficult otherwise to see how the tortfeasor is an agent, properly speaking, of the owner. The fact that the owner may have requested and consented to the use of the chattel for the owner’s benefit ought not of itself to give rise to any agency consequences at law given the absence of actual or apparent authority, especially given that social requests are common. Nevertheless, the cases, which have never been overruled, show how agency can arise exceptionally despite the absence of authority (even of the apparent kind). Such flexible use of agency has the potential to broaden the circumstances in which corporate liability may arise. Other instances where agency has been used to impose liability or responsibility on another for the tortious act of an ‘agent’ include defamatory statements,74 fraudulent acts,75 wrongful

Dubai Aluminium Co Ltd v. Salaam [2003] 2 AC 366 (UKHL). Id. at 395. 70 See Hewitt v. Bonvin [1940] 1 KB 188, at 195. See also Ormrod v. Crosville Motor Services Ltd [1953] 1 WLR 1120 (EWCA); Morgans v. Launchbury [1973] 1 AC 127 (UKHL). 71 ‘Thelma’ (Owners) v. University College School [1953] 2 Lloyd’s Rep. 613 (Mayor’s and City of London Ct.). 72 Callinan J. in Scott v. Davis (2000) 204 CLR 333 ¶ 346 (Austl.) opined that the presence of an insurer, or the likelihood that usually the owner will better be able to pay than the driver, influenced the results and distorted the law. 73 G.E. Dal Pont, Law of Agency ¶ 22.41 (4th ed. 2020). 74 Colonial Mutual Life Assurance Co of Australia Ltd v. Producers’ and Citizens’ Cooperative Assurance Co of Australia Ltd (1931) 46 CLR 41 (Austl.); Zahir Monir v. Steve Wood [2018] EWHC 3525 (QB); De Ronde v. Gaytime Shops, Inc, 239 F.2d 735 (2d Cir. 1957); and see also Egger v. Viscount Chelmsford [1965] 1 Q.B. 248. 75 Dollars & Sense Finance Ltd v. Nathan [2008] NZSC 20, [2008] 2 NZLR 557. 68 69

148  Research handbook on corporate liability enforcement of judgments,76 false imprisonment,77 and misappropriation.78 For example, in Dollars & Sense Finance Ltd v. Nathan79 a finance company was found responsible for the wrongful act of its agent, who, in connection with a loan to such agent, had been asked to procure his parents’ execution of mortgage documents over their property as security for the loan. There was no suggestion of the finance company authorising the son to act wrongfully,80 and no apparent authority was involved as the finance company never made any representation to the mother (who became the sole owner of the property after the father passed away before trial). Notwithstanding this, the finance company could not enforce the mortgage because the son’s wrongful act of forging his mother’s signature was committed within the scope of the agency, though the more precise formulation according to the Supreme Court was ‘whether the conduct of the agent fell within the scope of the task which the agent was engaged to perform’.81 The court employed reasoning similar to that used today for vicarious liability82 and even generalised Dubai Aluminium Co Ltd v. Salaam83 beyond partnership situations by saying that the principles relating to vicarious liability in agency and employee situations were indistinguishable.84 Another significant decision is Colonial Mutual Life Assurance Co of Australia Ltd v. Producers’ and Citizens’ Co-operative Assurance Co of Australia Ltd,85 in which a principal was found liable for defamatory statements made by a non-employee agent86 within the scope of the agent’s role. As the agent’s statements were made in the context of canvassing business for the principal, for which the agent had been engaged, the principal was liable even though the agent had been prohibited expressly in the agreement with the principal from engaging in such conduct. Gavan Duffy CJ and Starke J seemed to think there was a de facto employer–employee relationship87 and therefore the matter was concluded by the decision 76 Atiyah, supra note 66, at 136–37; and see also Smart v. Hutton (1833) 8 Ad. & El. 568 (KB); Raphael v. Goodman (1838) 8 Ad. & El. 565 (QB); Jarmain v. Hopper (1843) 6 Man. & G. 827 (Ct. of Common Pleas); Gauntlett v. King (1857) 3 CB(NS) 59 (Ct. of Common Pleas); Haesler v. Lemoyne (1858) 5 CB(NS) 530 (Ct. of Common Pleas). 77 Dillon v. Sears-Roebuck Co., 253 N.W. 331 (Neb. 1934). In Simon v. Safeway, Inc., 173 P.3d 1031 (Ariz. Ct. App. 2007) a similar result was arrived at on the basis of a non-delegable duty on the part of the store to protect its invitees from the intentionally tortious conduct of those with whom it had contracted for security services, and the court considered Dillon v. Sears-Roebuck as an example of such a situation. It is also possible that the employee of the independent contractor could be regarded as a borrowed employee of the store, generally see Giliker, supra note 66, at Chapter 4. 78 Alfa Mutual Insurance Co. v. Richard Charles Roush 723 So.2d 1250 (Ala. 1998). 79 Dollars & Sense Finance, 2 NZLR 557. 80 Id. ¶ 31. 81 Id. ¶ 39. Usually, forgeries are a complete nullity but this involved land under the Torrens system which gave protection to registered proprietors even in respect of forgeries, see Dollars & Sense Finance, 2 NZLR, ¶ 42. 82 Id., especially at ¶¶ 35–40, citing inter alia Bazley v. Curry [1999] 2 SCR 534 (Can.); Lister v. Hesley Hall Ltd [2002] 1 AC 215 (UKHL). 83 Dubai Aluminium Co Ltd v. Salaam [2003] 2 AC 366 (UKHL). 84 Dollars & Sense Finance Ltd, 2 NZLR 557 ¶ 37. 85 Colonial Mutual Life Assurance Co of Australia Ltd v. Producers’ and Citizens’ Cooperative Assurance Co of Australia Ltd (1931) 46 CLR 41 (Austl.). 86 Not a paradigm or true agent but a canvassing agent who did not have authority to conclude contracts but only to solicit business. 87 See Colonial Mutual Life, 46 CLR 41 at 46 where they stated that the principal had some power of controlling and directing the agent as nothing in the agreement between them denied the principal

Agency liability  149 of the Privy Council in Citizens’ Life Assurance Company v. Brown.88 The learned judges nevertheless went on to state that a person is liable for another’s act if he has directed such person to perform the act or if he employs that other person as his agent and the act complained of is within the scope of the agent’s authority. It was not necessary that the particular act should have been authorised as long as the agent was put in a position to do the class of acts complained of.89 It is clear from this that the decision did not proceed on the basis of actual or apparent authority.90 In the absence of either, there was no basis to attribute the agent’s act to the principal.91 Nevertheless, the principal was responsible if the act complained of was within the class of acts that the agent was asked to perform. Although there was no specific reference to vicarious liability, it seems clear that analogous reasoning was employed.92 Dixon J, with whom Rich J agreed, put the matter slightly differently. In their view there was no evidence to support an employment relationship. Notwithstanding this, the principal was liable because it had asked the agent to stand in the principal’s place and act for it. The agent was the principal’s representative in certain aspects of the negotiation even if the agent did not have authority to conclude contracts binding on the principal.93 The principal must therefore be considered as itself conducting the negotiation. What the agent did fell within his actual authority and the slanders made by the agent arose from the erroneous manner in which the agent’s actual authority was exercised. The undertaking contained in the contract not to disparage other institutions was not a limitation of authority but a promise as to the manner of its exercise. With respect, it is debatable whether it was right to characterise the agent’s authority in this manner. If the principal has prohibited a specific mode of performance, it seems a stretch to say this can nevertheless fall within actual authority. If so, this suggests that even fraudulent acts intended to further the mandate can fall within actual authority.94 Nevertheless, for the purpose of this chapter it is only necessary to note that the ostensible basis relied upon by Dixon J and Rich J was actual authority and not vicarious liability in agency, although the reasoning mirrored the then subsisting ‘Salmond test’ for vicarious liability.95

the right to direct the agent when, where and whom he should canvass. Respectfully, even if some such ability existed, it merely reflected the principal’s desire that the marketing agent should canvass for business in a targeted manner. There is nothing unusual about such an arrangement that should lead to the finding of a de facto employment relationship. 88 Citizens’ Life Assurance Company v. Brown [1904] 1 AC 423 (UKPC) (a case involving libel by an employee). 89 Colonial Mutual Life, 46 CLR 41, at 46–47. 90 In any event, it is difficult for apparent authority to be invoked where the wrongful act arises unilaterally from the act of the agent without any reliance on the part of the victim (the UK position), or without any objective meeting of minds giving rise to mutual obligations (the US approach). 91 See Meridian Global Funds Management Asia Ltd v. Securities Commission [1995] 2 AC 500, 506–507 (UKPC) (appeal taken from N.Z.). 92 In Scott v. Davis (2000) 204 CLR 333 ¶ 59 (Austl.) McHugh J in his dissenting judgment understood Gavan Duffy CJ’s and Starke J’s judgment in this manner. 93 In Scott v. Davis, 204 CLR 33 ¶¶ 19 and 67–68, Gleeson CJ and McHugh J respectively explained Colonial Mutual Life, 46 CLR 41 on this basis, even though McHugh J acknowledged that Gavan Duffy CJ’s and Starke J’s judgment might support a wider proposition. 94 Accordingly, Evatt J and McTiernan J in Colonial Mutual Life, 46 CLR 41 were of the view that the principal’s liability was not established. 95 Namely that an employee’s tort falls within the course of employment if inter alia it is a wrongful and unauthorised mode of doing some act authorised by the employer.

150  Research handbook on corporate liability Collectively, these authorities raise the question of whether there is a more general principle of liability for the wrongful acts of agents.96 It is suggested here that there should be such a principle. One policy reason in favour of this is the increasing practice by companies and other businesses of avoiding traditional employment and providing more services through persons engaged on an ad-hoc contractual basis.97 Even if these persons are regarded as being engaged in such work on their own account so that they are independent contractors rather than employees,98 their roles may differ little from those of employees. In addition, unpaid volunteers often work alongside paid employees and may be indistinguishable to members of the public.99 The policy considerations mentioned in Dubai Aluminium Co Ltd v. Salaam100 that underlie vicarious liability for employees and partners101 would in principle appear equally applicable to independent contractors102 and volunteers103 in certain circumstances. With employees the doctrine of vicarious liability provides incentives to employers to take steps to reduce the likelihood of wrongdoing, while no such incentive exists when independent contractors are used. Outsourcing to independent contractors thus risks a race to the bottom in terms of pricing as tenders are generally awarded to the lowest bid, with the likely flow-on effect on quality and safety standards.104 Accordingly, it is suggested that agency, or at least agency reasoning,105 should not be ruled out as a broader solution to the phenomenon of a more flexible workforce, as well as emerging business models and non-commercial entities that are employee-light. Zahir Monir v. Steve Wood,106 where a candidate for a Parliamentary seat was found liable for a defamatory tweet made by the Vice-Chairman of a branch of the Party that the candidate represented, even though the candidate had not authorised the tweet and indeed had no knowledge of it, may be an illustration of the utility of such an approach. Another illustrative case is Vertical Leisure 96 Atiyah, supra note 66, at 107 and 110, thought the material on the whole to be fairly evenly balanced but ultimately concluded that no satisfactory solution had been arrived at and it was difficult to overcome the difficulties that would inevitably follow from imposing such liability. 97 See also Ong Han Ling v. Am. Int’l Assurance [2018] 5 SLR 549 ¶ 157 (SGHC) (Sing.). Admittedly, this is anecdotal as empirical research is lacking. 98 Market Investigations Ltd v. Minister of Social Security [1969] 2 QB 173, 184–85; Lee Ting Sang v. Chung Chi-Keung [1990] 2 AC 374 at 384 (UKPC); BNM v. National University of Singapore [2014] 4 SLR 931 (SGCA). 99 Phillip Morgan, Recasting Vicarious Liability, 71 Cambridge. L.J. 615 (2012) (suggesting that the twin axes of day-to-day control and discretion in role should determine all instances where a person is vicariously liable for the acts of another). 100 Dubai Aluminium Co Ltd v. Salaam [2003] 2 AC 366, 377 (UKHL). See also Lister v. Hesley Hall Ltd [2002] 1 AC 215, 243–44 (UKHL); Roman Catholic Episcopal Corporation of St George’s v. John Doe [2004] 1 SCR 436 (Can.); Skandinaviska Enskilda Banken AB v. Asia Pacific Breweries (Singapore) Pte Ltd [2011] 3 SLR 540 (SGCA). 101 For a useful summary of the theories of vicarious liability, see Nicholas J. McBride and Roderick Bagshaw, Tort Law 852–56 (6th ed. 2018). 102 See generally Ewan McKendrick, Vicarious Liability and Independent Contractors – A Re-Examination, 53 Mod. L. Rev. 770 (1990). 103 For instance, certain social enterprises may be run commercially with profits ploughed back to support worthy goals. Such enterprises may rely both on paid employees and unpaid volunteers. 104 Kumaralingam Amirthalingam, The Non-Delegable Duty: Some Clarifications, Some Questions, 29 Sing. Acad. L.J. 500, ¶ 28 (2017). 105 See further Francis Reynolds & Tan Cheng-Han, Agency Reasoning – A Formula or a Tool?, Sing. J. Legal Stud. 43 (2018). 106 Zahir Monir v. Steve Wood [2018] EWHC 3525 (QB).

Agency liability  151 Limited v. Poleplus Limited,107 where the defendant company denied initially that the tortfeasor was its employee. Although the denial was subsequently retracted, the court dealt with the agency issue as it had been pleaded as one of the grounds on which the defendant should be liable. Macon J held that the criteria to be applied to determine the liability of a principal for the tortious acts of his agent are analogous to those applicable to employee vicarious liability. Thus, it would have made no difference to the outcome even if the tortfeasor fell beyond the scope of employee vicarious liability. As has been demonstrated, agency is already a recognised means by which vicarious liability is imposed, and there are rather more cases over a diverse range of circumstances than many may realise. Recourse to agency would mean that vicarious liability is not limited to employment or employment-like relationships but will cover a broader range of circumstances where one person acts for another. Some commentators would construe the cases narrowly on their special facts, often informed by policy considerations,108 but this does not undermine, and indeed highlights, the potential that agency law’s flexibility brings. Others consider the concept of agency too vague, confusing and unpredictable to provide sufficient guidance.109 It is certainly true that agency often seems a conclusion rather than a characteristic which triggers liability.110 It has been mentioned earlier that an agent in this context often does not fit traditional notions of agency but reflects an agency that is constructed to reach a desired result, such as the imposition of liability to those working gratuitously for the defendant.111 It is difficult not to agree with the view that when the courts resort to agency here what they are really doing is ‘masking their dislike of the binary test of employee/independent contractor’.112 Agency as a broad notion going beyond traditional conceptions of authority provides a means for the courts to correct perceived limitations in the current state of the law. The difficulty is to determine where the line should be drawn when determining whether an agency should be constructively imposed. It cannot be the case that every intermediary is regarded as an agent for this purpose, even if the wrongdoing was committed for the benefit of the principal.113 It is submitted first that the cases suggest a non-employee intermediary may be regarded as an agent for the purpose of vicarious liability where such an intermediary is mandated to engage in activity that is intended to lead to contractual relations between the principal and a third party, regardless of whether the intermediary has actual authority to enter into such an agreement on the principal’s behalf, provided the intermediary’s tortious act took place in the course of attempting to bring about such contractual relations. The principal’s liability arises because the wrongful act emerges from the essence of what agency is intended to achieve, namely the facilitation of contractual relations. In addition to Colonial Mutual Life,

Vertical Leisure Limited v. Poleplus Limited [2015] EWHC 841 (IPEC). See, e.g., Bowstead and Reynolds, supra note 2, at ¶ 8-187 (referring to the motor car cases); Giliker, supra note 66, at 130–31 (discussing the New Zealand cases of S v. Attorney-General [2003] 3 NZLR 450 (CA) and Dollars & Sense Finance Ltd v. Nathan [2008] NZSC 20, [2008] 2 NZLR 557). 109 See, e.g., McKendrick, supra note 102, at 782; Giliker, supra note 66, at 132–33; Morgan, supra note 99, at 628. 110 Sweeney v. Boylan Nominees Pty Ltd (2006) 226 CLR 161 ¶ 19 (Austl.); Morgan, supra note 99, at 628. 111 S.J. Stoljar, The Law of Agency: Its History and Present Principles 9 (1961); Giliker, supra note 66, at 109. 112 Morgan, supra note 99, at 628. 113 James Scott Winter v. Hockley Mint Limited [2018] EWCA (Civ) 2480. 107 108

152  Research handbook on corporate liability this understanding of when vicarious agency liability comes about is consistent with a number of other cases such as Navarro v. Moregrand Ltd,114 Dollars & Sense Finance Ltd v. Nathan115 and De Ronde v. Gaytime Shops, Inc.116 It also finds support in Sweeney v. Boylan Nominees Pty Ltd where the majority in the High Court explained the result in Colonial Mutual Life on the basis that the defamatory statements had been made in the course of the tortfeasor’s attempt to induce persons to make proposals for life insurance by the company that had engaged him.117 According to them, Colonial Mutual Life established that if an independent contractor is engaged to solicit the bringing about of legal relations between the principal who engages the contractor and third parties, the principal will be held liable for slanders uttered to persuade the third party to make an agreement with the principal. It was a conclusion that depended directly upon the identification of the independent contractor as the principal’s agent (properly so called) and the recognition that the conduct about which complaint was made was conduct undertaken in the course of, and for the purpose of, executing that agency.118 The independent contractor-agent was engaged ‘to solicit for the creation of legal relationships between [the principal] and others’ and the principal should therefore be liable for the slanders uttered in the course of soliciting proposals by virtue of the close connection between the principal’s business and the conduct of the independent contractor.119 Further support for this proposition may be found in Hallmark Construction Pty Ltd v. Brett Harford, where the New South Wales Court of Appeal said that Colonial Mutual Life identified an exception where the independent contractor had authority to bind the principal contractually.120 As indicated previously, there was no actual authority. Nevertheless, if there is such an exception it means that, where an agent has authority to alter the principal’s legal position, such principal will be vicariously liable for tortious acts committed in the course of trying to achieve this. This would be narrower than, though consistent with, what is suggested here, which is that simply having the authority to facilitate agreements is sufficient. It is submitted further that an agency for the purpose of vicarious liability may arise where the agent’s unauthorised tortious act falls within the class of acts that the principal itself is or would ordinarily be engaged in as part of the principal’s enterprise, or is closely connected to such enterprise, so that the act of the agent in furtherance of the principal’s enterprise can be considered the principal’s act. This may be premised on the identification theory, which according to Stoljar was one of three historical lines for the law of agency. In the identification theory, the agent acted purely as an alter ego or substitute of the principal, a sort of automaton or tool that fitted the maxim qui facit per alium facit per se.121 This maxim has been seen by Viscount Dilhorne and Lord Pearson as the basis for the motor car cases,122 which a commen-

Navarro v. Moregrand Ltd [1951] 2 TLR 674 (EWCA). Dollars & Sense Finance Ltd v. Nathan [2008] NZSC 20, [2008] 2 NZLR 557. 116 De Ronde v. Gaytime Shops, Inc, 239 F.2d 735 (2d Cir. 1957). 117 Sweeney v. Boylan Nominees Pty Ltd (2006) 226 CLR 161 ¶ 17 (Austl.). 118 Id. at ¶ 22. 119 Id. at ¶ 24. 120 Hallmark Construction Pty Ltd v. Brett Harford [2020] NSWCA 41, ¶ 74. 121 Stoljar, supra note 111, at 15. See also L. Macgregor, The Law of Agency in Scotland ¶ 2-04 (2013); Gibson v. O’Keeney [1928] NI 66 (CA) 76. 122 Morgans v. Launchbury [1973] 1 AC 127, 140 (UKHL). 114 115

Agency liability  153 tator considers an example of liberal agency.123 A similar approach can be found in some cases from the United States.124 It is suggested that this approach is also one of the justifications for Colonial Mutual Life and Zahir Monir v. Steve Wood.125 Some of the cases discussed above, such as Dillon v. Sears-Roebuck Co126 and Alfa Mutual Insurance Company v. Richard Charles Roush,127 can also be explained along these lines. Gavan Duffy CJ and Starke J regarded the agent as being authorised to speak, and doing so, ‘with the voice of the defendant’.128 Dixon J described the agent as standing in the place of the defendant and acting in its right and not in an independent capacity. In so doing, the agent was a representative of the defendant who must be considered as conducting the negotiation in the agent’s person.129 Significantly, the majority in Sweeney v. Boylan Nominees Pty Ltd, while rejecting a wide notion of representation, accepted the proposition that where the tortious conduct of the independent contractor ‘agent’ was closely connected with the principal’s business, the principal may incur liability.130 The New Zealand decision of S v. Attorney General131 can also be understood in this manner. There, the government department in question was obliged by law to discharge the responsibility of ensuring proper care for the children committed to its care. The wrongs committed by the foster parents therefore took place in the course of discharging on behalf of the Crown the very responsibilities imposed on the Crown by law.132 Similarly, the procurement of a mortgage for a loan was well within the normal activity of the finance company and it should not matter whether this was done by an employee or an independent contractor or volunteer.133 The question of whether the agent’s unauthorised tortious act fell within the class of acts that the principal itself would ordinarily be engaged in as part of the principal’s enterprise, or is closely connected to such enterprise, is well within agency law’s capacity as it mirrors the reasoning used in apparent authority. The more common representations that can give rise to apparent authority consist of giving a person a task or placing a person in a position where such person would usually have the requisite authority. Part of the analysis in such cases relates to the nature of the task or position and the type of company or business in question, viewed from Christian Witting, Modelling Organisational Vicarious Liability, 39 Legal Stud. 694, 696 (2019). 124 Western Weighing & Inspection Bureau v. Armstrong, 281 S.W. 244, 253 (Tex. App. 1925); Lo Rayne Poutre v. George Sanders, 143 P.2d 554, 556 (Wash. 1943); Butler v. Bunge Corp, 329 F. Supp. 47, 56 (1971); Leo Sain v. ARA Manufacturing Company, 660 S.W.2d 499, 500 (Tenn. Ct. App. 1983). 125 Zahir Monir v. Steve Wood [2018] EWHC 3525 (QB). 126 Dillon v. Sears-Roebuck Co. 253 N.W. 331 (Neb. 1934). 127 Alfa Mutual Insurance Co. v. Richard Charles Roush 723 So.2d 1250 (Ala. 1998). 128 Colonial Mutual Life Assurance Co of Australia Ltd v. Producers’ and Citizens’ Cooperative Assurance Co of Australia Ltd (1931) 46 CLR 41 (Austl.). 129 Id. at 48–49. Broader use of agency is also suggested by Howard Bennett, Principles of the Law of Agency (2013), at [10-21] who suggests that Colonial Mutual Life, 46 CLR 41 and Sweeney v. Boylan Nominees Pty Ltd (2006) 226 CLR 161 (Austl.) support a concept of ‘representative agency’ capable of giving rise to vicarious liability where the duty of the independent contractor is to act as the voice of the principal and the tort is committed in the course, and for the purpose, of executing its commission. 130 Sweeney v. Boylan Nominees Pty Ltd (2006) 226 CLR 161 ¶ 24 (Austl.). 131 S v. Attorney-General [2003] 3 NZLR 450 (CA). 132 Id. at ¶ 66. 133 Dollars & Sense Finance Ltd v. Nathan [2008] NZSC 20, [2008] 2 NZLR 557. 123

154  Research handbook on corporate liability an objective standpoint. Accordingly, any inquiry into whether the intermediary’s acts objectively fall within the principal’s ordinary business enterprise is not an unfamiliar one in the law of agency. An analogy may also be drawn with Denning LJ’s dictum in Stevenson Jordan & Harrison Ltd v. MacDonald & Evans where he said that the author’s work, ‘although done for the business’, was ‘not integrated into it but [was] only accessory to it’.134 While this statement was made in the context of determining whether the author was an employee, it underscores the proposition being advanced here that considering whether a task performed for the principal was within the principal’s ordinary business rather than being accessory to it is a test that can be adopted.135 It is suggested further that imposing liability on a principal in such circumstances is logical based on the existing state of the law. For one thing, legal outcomes should aim to be broadly consistent and not turn on the ability of parties to ‘game’ the system. Taking Sweeney as an example, the majority pointed out that the respondent company, which was contractually responsible for maintaining a refrigerator in a service station, provided the tortfeasor mechanic with no uniform, no tools or equipment, and no vehicle in which to transport tools and equipment. Rather the mechanic’s van was marked with a name derived from the name of a company of which he was a director. Accordingly, the respondent was not vicariously liable for the mechanic’s negligence. Presumably, the majority felt the result could have been different if the mechanic had been closely identified with the respondent.136 Even in the absence of such identifiers, if the mechanic had an exclusive relationship only to take jobs assigned to him by the respondent, this may suffice to establish a relationship akin to employment. Yet it is all somewhat arbitrary. The negligent work was the same regardless of the status of the mechanic, the respondent was not likely to exercise any greater degree of control over the work, the victim never knew who serviced the refrigerator, and holding out is irrelevant in the context of wrongs not involving representations. Only the likely frequency of the work would differ between an exclusive relationship and one in which the respondent used a pool system. Ultimately, a well-advised business would simply have a rotating pool of freelancers to avoid liability.137 In addition, limiting vicarious liability in agency to instances where the agent, broadly understood, is pursuing an activity for the benefit of the principal that constitutes part of the principal’s enterprise or is closely connected to it ties in nicely with the idea of enterprise risk and relative blame that underlies much of the justification for vicarious liability. It is suggested in this regard that enterprise risk should not be understood only from a profit-making sense.138 The gains that an enterprise seeks to obtain ought not to be measured in monetary outcomes alone but should encompass activities that are of value to the enterprise. It should also stem

Stevenson Jordan & Harrison Ltd v. MacDonald & Evans [1952] 1 TLR 101, 111 (EWCA). In Lee Ting Sang v. Chung Chi-keung [1990] ICR 409, at 416, the Privy Council referred to Denning LJ’s dictum as being ‘no doubt of value’. 136 But see Ready Mixed Concrete (South East) Ltd v. Minister of Pensions and National Insurance [1968] 2 Q.B. 497 where outside of the context of vicarious liability it was held that a person who owned a lorry and could hire a competent person to drive it was an independent contractor even though he undertook to make the lorry available whenever it was wanted, to wear the company’s uniform, and to have the lorry painted in the company’s colours. 137 See also Bennett, supra note 129, at ¶ 10.18. 138 This was described as a major flaw of the enterprise risk theory by McBride and Bagshaw, supra note 101, at 855. 134 135

Agency liability  155 from the understanding that an enterprise requires scale and with scale comes more complexity and the greater likelihood of something going wrong since the directing mind and will of the enterprise cannot personally be involved in every aspect of it. It therefore seems fair that the price for scale comes with a corresponding obligation for the owners of the enterprise to bear the greater risk of employee or agent wrongdoing that the enterprise would itself have borne if not for its ability to engage intermediaries to perform acts for its benefit. Admittedly there will be difficult cases in drawing the line. However, this is no less true of employee vicarious liability where the law can hardly be considered a paragon of clarity, especially (arguably) after Lister v. Hesley Hall Ltd.139 This is not to suggest that the development of the law in such a manner is unwelcome but it has led to results such as Mohamud v. Wm Morrison Supermarkets plc140 with respect to which not too long ago the opposite result would have seemed clear as it was to the lower courts. Somewhat greater than usual uncertainty is perhaps the inevitable consequence of holding an ‘innocent’ party responsible for the act of another, not least because notions of ‘social justice’141 evolve over time. But, keeping the above suggestions in mind, namely whether the act of the ‘agent’ was in furtherance of bringing about a contractual relationship between the ‘principal’ and victim, or whether the act of the agent was one within the ordinary business of the principal or closely connected to it, can provide guidance on the parameters within which vicarious liability based on agency or agency reasoning may be imposed.

VI. CONCLUSION Corporations are ubiquitous as no other vehicle has been found to be as broadly conducive for business enterprise. By their nature, corporations are reliant on human persons to act for them and the law of agency will therefore continue to be an important aspect of corporate liability. This goes beyond the traditional agency doctrines of authority that include apparent authority and retrospective authorisation. It includes a flexible conception of what agency is and its capacity, at least in certain situations (though arguably capable of wider application as suggested in this chapter), to impose non-consensual liability on a ‘principal’ for the act of an ‘agent’. In this context, it may be worth noting that the protean nature of agency exists elsewhere also. For instance, canvassing agents often do not have actual or apparent authority to bind the parties they represent but this does not preclude some of the internal aspects of agency applying to such relationship, such as the imposition of fiduciary obligations.142 The malleability of agency in the realm of unauthorised torts is therefore not without precedent elsewhere.

Lister v. Hesley Hall Ltd [2002] 1 AC 215 (UKHL). Mohamud v. Wm Morrison Supermarkets plc [2016] AC 677 (UKSC). 141 Id. at ¶ 45. 142 Regier v. Campbell-Stuart [1939] Ch. 766; Headway Construction Co Ltd v. Downham (1974) 233 E.G. 675. 139 140

9. Attribution Ernest Lim1

I. INTRODUCTION Attribution is important to any analysis of corporate liability. Courts have to determine whether the acts or intentions of the relevant parties of the company (such as directors, officers or shareholders) should be attributed to it in order to impose liability on the company or to permit it to sue the defendant. Unsurprisingly, the topic of attribution in corporate law has received significant and sustained attention from courts and commentators in the English common law world.2 There have been at least seven decisions on this topic handed down by the highest appellate courts in four common law jurisdictions.3 There are three attribution issues that remain outstanding and warrant attention in this chapter. First, whether the context-specific approach to attribution should be replaced with or supplemented by a rule-based approach, and if so, what this should entail. Second, what the relationship between attribution and the illegality defence is. Finally and importantly, whether there should be attribution where two or more areas of law conflict.

II.

CONTEXTUAL VERSUS RULE-BASED APPROACH

Given that the company is an artificial legal person, the acts and intentions of the relevant persons or entities have to be attributed in order to hold the company contractually, tortiously and statutorily liable as well as to allow it to enforce its rights against the parties. Difficult questions of attribution arise when the acts or knowledge of the person have not been authorized by the board of directors or general meeting of shareholders (or their delegates). The question is whether that person’s acts or intent can be equated with those of the company so as to allow the company to sue or be sued. Another difficulty arises when a company brings a claim (whether against its insiders such as directors or employees or outsiders such as third parties) and the defendant raises the illegality defence – ‘no court will lend its aid to a man who

I am grateful to the editors for their helpful comments. The usual disclaimers apply. See, e.g., Eilis Ferran, Corporate Attribution and the Directing Mind and Will, 127 L. Q. Rev. 239 (2011); Ernest Lim, A Critique of Corporate Attribution: ‘Directing Mind and Will’ and Corporate Objectives, J. Bus. L. 333 (2013); Ernest Lim, Attribution in Company Law, 77 Mod. L. Rev. 794 (2014); Sarah Worthington, Corporate Attribution and Agency: Back to Basics, 133 Law. Q. Rev. 118 (2017). 3 In the UK, see, e.g., Crown Prosecution Service v. Aquila Advisory Ltd [2021] UKSC 49; Singularis Holdings Ltd v. Daiwa Capital Markets Europe Ltd [2019] UKSC 50; Bilta (UK) Ltd v. Nazir (No. 2) [2015] UKSC 23, [2016] AC 1; in Singapore, see, e.g., Red Star Marine Consultants Pte Ltd. v. Personal Representatives of Satwant Kaur [2019] SGCA 76; Ho Kang Peng v. Scintronix Corp. Ltd. [2014] SGCA 22; in Hong Kong, see, e.g., Moulin Global Eyecare Trading Ltd. v. Commissioner of Inland Revenue [2014] H.K.C.F.A. 22; in Trinidad and Tobago, see Julien v. Evolving Tecknologies & Enterprise Development Co., Ltd. [2018] UKPC 2. 1 2

156

Attribution  157 founds his action upon an illegal or immoral act’4 – to bar the company’s claim.5 To succeed, the defendant has to show that the company’s claim has been tainted by illegality, which requires the wrongdoing of the defendant or another person to be imputed to the company.6 The challenge in both situations is whether a principled and coherent approach can be devised to address those difficulties in a clear and predictable fashion. Two kinds of approaches – contextual (or purposive) and rule-based – will be critically assessed. A. Meridian’s Rules of Attribution The rules governing attribution – primary, general and special – have been set out by Lord Hoffmann in the widely cited Privy Council decision in Meridian Global Funds Management Asia Ltd v. Securities Commission.7 Of the three categories of rules, the special rule has been subject to the most extensive judicial treatment. In brief, the primary rules of attribution concern decisions made by the board of directors and the shareholders in general meeting. In so far as resolutions have been passed by the board or the general meeting, these decisions bind the company as they are attributed to it. General rules of attribution have been held to include agency and vicarious liability. As regards the former, where the board delegates its authority to committees or individuals, they have actual authority to enter into transactions and their decisions will generally bind the company. Even if there were no delegation, the relevant individuals may have apparent authority to undertake certain acts, which will be attributed to the company. As regards vicarious liability, neither the intentions nor the acts of the relevant individuals will be attributed to the company but only their liability. In most situations, the primary and general rules of attribution are sufficient to render the company liable under the relevant laws or to permit the company to enforce its rights. However, there will be certain situations in which neither the primary nor general rules of attribution will work satisfactorily because neither the board nor the general meeting has authorised the act; and it cannot be said that the relevant individual has actual or apparent authority to carry out the act. Thus, Lord Hoffmann came up with the special rule of attribution: ‘Whose act (or knowledge, or state of mind) was for this purpose intended to count as the act etc. of the company?’8 According to Lord Hoffmann, courts must examine the purpose and policy of the rule in determining whether to make an attribution. This contextual, purposive approach to attribution has been applied or cited with approval by the courts in a variety of common law

Holman v. Johnson [1775] 1 Cowp 341, 343. For examples of defendant directors or employees raising the illegality defence in response to a claim brought by the claimant company, see, e.g., Bilta [2015] UKSC 23; Scintronix [2014] SGCA 22; Red Star [2019] SGCA 76; and Safeway Foodstores Ltd v. Twigger [2010] EWCA (Civ) 1472. For examples of the defendant third parties raising the illegality defence, see Singularis [2019] UKSC and Stone & Rolls Ltd v. Moore Stephens [2009] 1 AC 1391. 6 The correct approach to the illegality defence is the range of factors approach laid down by the UK Supreme Court in Patel v. Mirza [2016] 3 WLR 399. For criticisms of this approach, see Ernest Lim & Francisco Urbina, Understanding Proportionality in the Illegality Defence, 136 Law. Q. Rev. 575 (2020). 7 Meridian Global Funds Management Asia Ltd v. Securities Commission [1995] 2 AC 500 (UKPC). 8 Id. at 507. 4 5

158  Research handbook on corporate liability jurisdictions in different contexts including cases in which companies (or their liquidators) bring claims against insiders (such as directors9 or employees10) or outsiders (such as banks11 and auditors12) for breaches of duties. Despite the seeming clarity and simplicity of the special rule of attribution, litigation concerning the issue of whether the acts or intentions of the company’s insiders should be attributed to the company continues to increase.13 One important reason for this is that the special rule of attribution does not tell us ex ante the conditions or circumstances under which the acts or intentions of persons will be attributed to the company. As a result, courts have to interpret the purpose and policy of the rule in question in each case and determine on a case-by-case basis whether there should be attribution. B.

Problems with Meridian’s Special Rule of Attribution

Problems associated with the special rule of attribution include uncertainty, inconsistency and unpredictability.14 By way of illustration, consider the significant UK Supreme Court decision in Bilta (UK) Ltd v. Nazir (No 2).15 In Bilta, the liquidator of a company sued the directors and their co-conspirators for breach of duty and dishonest assistance in connection with a carousel fraud on the HM Revenue and Customs (HMRC) – the defendants deliberately caused the company to become insolvent so that it could not pay value added tax owing to HMRC. The defendants argued that the company’s claim should be dismissed on the basis of the illegality defence – no court will give effect to a claim founded on an illegal or immoral act – because the fraud of the directors should be attributed to the company. The Supreme Court in Bilta laid down the rule that where the company was a victim of wrongdoing by its directors and where the company (or its liquidator) sues those directors for breach of duties, the wrongful acts or knowledge of the directors cannot be attributed to the company so as to bar the company’s claims against them.16 With respect to the problem of uncertainty, while all the justices agreed on the outcome, i.e. there should be no attribution so that the illegality defence did not apply, there was no agreement on the reasons for the outcome. Lord Sumption JSC took the view that attribution applies ‘regardless of the nature of the claim or the parties involved’.17 But he said that there is a breach of duty exception such as where agents breach the duties they owe to their principals; this exception exists in order to avoid injustice and absurdity.18 Lords Toulson and Hodge JJSC stated that the primary question was ‘whether [Bilta (UK) Ltd’s] claim against



See, e.g., Bilta [2015] UKSC 23. See, e.g., Red Star [2019] SGCA 76. 11 See, e.g., Singularis Holdings Ltd v. Daiwa Capital Markets Europe Ltd [2019] UKSC 50. 12 See, e.g., Stone & Rolls Ltd v. Moore Stephens [2009] 1 AC 1391. 13 Since the decision in Meridian, there have been at least eight decisions from the highest appellate courts on the application of the special rule of attribution: see the cases cited in supra note 3 and Stone & Rolls [2009] 1 AC 1391. 14 Rachel Leow, Corporate Attribution in Private Law 22–28 (2022). 15 Bilta (UK) Ltd v. Nazir (No. 2) [2015] UKSC 23, [2016] AC 1. 16 Id. at ¶ 7. 17 Id. at ¶ 86. 18 Id. at ¶ 71. 9

10

Attribution  159 the directors for breach of fiduciary duty [was] barred by the doctrine of illegality’.19 They said that to allow the illegality defence to succeed would defeat the object of the rule of law and would be contrary to the Companies Act 2006 (UK).20 They also said that, alternatively, allowing attribution would negate the directors’ duties. Lord Mance JSC said that to attribute would ‘ignore the separate legal identity of the company, empty the concept of duty of content and enable the company’s affairs to be conducted in fraud of creditors’.21 Lord Neuberger PSC (with whom Lords Carnwath and Clarke JJSC agreed) set out the rule clearly but without specifically expressing a clear preference for any of the other justices’ reasoning.22 Ultimately, Lord Neuberger PSC said that the answer to the question whether there should be attribution where a company (or principal) sues its directors (or agents) is ‘simply an open one’23 and ‘must depend on the nature and factual context of the claim in question’.24 The problem of unpredictability is that, despite the clear rule given in Bilta with respect to the issue of the company (or its liquidator) suing the delinquent directors for breach of duties that they owe to the company, the rule still cannot provide authoritative guidance on a similar (albeit not identical) factual situation such as in Safeway Foodstores Ltd v. Twigger (‘Safeway’)25 – in which a company sues its directors for breach of duties that they owe to the company in order to recoup the losses that it sustained as a result of the company’s infringement of a statutory provision caused by the directors’ wrongdoing. The Court of Appeal allowed the illegality defence (by implicitly attributing the wrongdoing of the delinquent directors to the company) because the court took the view that failure to do so would be contrary to the statute which imposed personal liability on the company.26 Lord Neuberger PSC in Bilta did not think that Safeway was incorrectly decided but he did not give any explanation for his stance.27 However, Lords Toulson and Hodge JJSC disagreed with the Court of Appeal’s reasoning. They took the view it would be unjust, absent any policy justification, to deprive a company of its rights to sue its directors for breach of duties where those directors’ actions caused the company to violate a statute and to suffer losses.28 Neither Lord Mance JSC nor Lord Sumption JSC opined on the correctness of the reasoning in Safeway. As for inconsistency, it has been observed29 that, on the one hand, the Supreme Court in Bilta accepted that the directors’ wrongdoing was attributed to the company in order to show that the company had suffered losses (which resulted in the company’s insolvency). On the other hand, the court held that the directors’ wrongdoing should not be attributed to the company to bar the liquidator’s claim against the directors for breach of duties.

Id. at ¶ 120. Id. at ¶ 130. 21 Id. at ¶ 42. 22 Id. at ¶ 9. 23 Id. 24 Id. 25 Safeway Foodstores Ltd v. Twigger [2010] EWCA (Civ) 1472. For a critique of Safeway, see Kelvin Kwok & Ernest Lim, Optimal Deterrence, Corporate Attribution and the Illegality Defence, 21 Eur. Bus. Org. L. Rev. 641 (2020). 26 Safeway [2010] EWCA (Civ) 1472 at ¶¶ 23, 36–37, 43. 27 Bilta (UK) Ltd v. Nazir (No. 2) [2015] UKSC 23, [2016] AC 1, at ¶ 31. 28 Id. at ¶¶ 159–64. 29 Leow, supra note 14. 19 20

160  Research handbook on corporate liability C.

Two Rule-based Approaches

In view of the problems of uncertainty, unpredictability and inconsistency, commentators have suggested using two rule-based approaches. The first is ‘attribution as allocated powers’, which ‘turns on the internal allocation and delegation of the company’s own powers to act under the company’s constitution. When these powers are properly exercised by those to whom they have been allocated or delegated, the company acts personally.’30 The second is a two-step test comprising (a) whether the purpose and scope of the defendant’s duties cover the losses sustained by the claimant, subject to any clear statutory restrictions or exceptions; and (b) whether allowing the claimant to sue will result in a wrongdoer (who may or may not be the same person as the defendant) profiting from its own wrongdoing.31 1. First rule-based approach: attribution as allocated powers Under the ‘attribution as allocated powers’ approach, ascertaining whether power is allocated or delegated is a matter of construction of the company’s constitutional documents. The basis for this approach is that, upon incorporation and in view of the separate legal personality doctrine, powers are allocated to the relevant entities and individuals via the corporate constitution. This approach, however, seems to be a reformulated and combined version of the primary and general rules of attribution. Recall that under the primary rules of attribution, the decisions of the board of directors and general meeting of shareholders are attributed to the company by virtue of the power conferred on these entities pursuant to the constitution and the statute. The general rules of attribution include agency and vicarious liability. Under the ‘attribution as allocated powers’ approach, the relevant persons have the power to act because they have been allocated or delegated such power. Admittedly, these powers can be ultimately traced to the constitution (and UK Companies Act 2006) because both documents allocate the power to the board of directors (and for certain matters, to the general meeting of shareholders), and when the board (or the general meeting32) decides, the decision is attributed to the company – this is the primary rule of attribution. When the board (or in unusual circumstances, the general meeting of shareholders) delegates its power – traceable to the constitution and statute – to a committee of directors or specific individuals in the company, that power is known as actual authority, which is part of the general rules of attribution. Thus, the primary and general rules of attribution, specifically agency law, are subsumed under the ‘attribution as allocated powers’ approach. However, three reasons have been given as to why the ‘attribution as allocated powers’ approach is different from and superior to agency law and why attribution should not be explained solely in terms of agency law.33 First, the groups to whom the power is constitutionally allocated – the board of directors and general meeting – are organs and not agents. Second, explaining attribution in terms of agency can lead to disputed consequences – namely, that the

Id. at 14. Ernest Lim, Attribution, in Challenging Private Law: Lord Sumption on the Supreme Court 287–89 (W. Day & S. Worthington eds., 2020). 32 To be clear, this has to be distinguished from the Duomatic principle (after Re Duomatic Ltd [1969] 1 All ER 161 (EWCA)) in which the informal unanimous assent of the general meeting is tantamount to a resolution of a properly convened general meeting. 33 Leow, supra note 14, at 37. 30 31

Attribution  161 general meeting owes fiduciary duties. Finally, agency analysis may lead one to conclude that it cannot apply to other areas of law such as tort and maybe restitution. To begin with, the law, as shown in Meridian, has not sought to explain attribution solely in terms of agency law. On the contrary, the ‘attribution as allocated powers’ approach seems to have explained attribution solely in terms of allocated powers; in doing so, the rules of agency (which are part of the general rules of attribution) and in particular, apparent authority, may not seem to have been adequately accounted for. This approach may not be able to explain apparent authority: why individuals who are not delegated power can still have their acts attributed and hence bind the company. Apparent authority is particularly important when the acts of corporate insiders have to be attributed to the company where a third party brings a claim against the company. As for the three reasons, the first one has been demonstrated to be problematic at best and fallacious at worst.34 The second is controversial but defensible.35 Regarding the last reason, it is unclear why adopting an agency law approach to attribution will lead one to conclude that it will not apply to tort law. Further, the ‘attribution as allocated powers’ approach, which traces all power back to the corporate constitution, may have difficulty providing a realistic explanation of the legal basis of the power wielded by mid-level or low-ranking employees within the company. These powers are better justified in terms of actual or apparent authority. Whether the acts of these persons should be attributed to the company depends on whether these persons have actual (express or implied) or apparent authority to bind the company to those transactions. Where there is no actual or apparent authority, recourse will be made to the special rule of attribution. Moreover, although it has been clarified that the attribution as allocated powers approach is not agency law, it seems to draw upon, presuppose or be based on agency law, the scope of which includes whether an individual has actual or apparent authority. This is because it is said that: Whether the power was properly delegated to an individual is also a question that courts focus on in analysing whether the individual had actual authority to do the act. In tort, the same question arises as to whether the individual was allocated the company’s power to do the act. The cases focus on whether the acts done by the individual were authorised or not.36

In any event, it has been asserted that the attribution as allocated powers approach is consistent with Meridian because the primary rules of attribution deal with powers that are allocated to the board and general meeting and general rules of attribution deal with powers that are delegated to individuals.37 If that is the case, while this approach can reduce uncertainty and unpredictability arising from the special rule of attribution, its distinctive value-added is not clear as it seems to be an amalgamation of the primary and general rules of attribution.

36 37 34 35

Ernest Lim, A Case for Shareholders’ Fiduciary Duties 146–51 (2019). Id. at 138–45, 153–59. Leow, supra note 14, at 41. Id. at 37–8.

162  Research handbook on corporate liability 2. Second rule-based approach: two-step test The second rule-based approach comprises a two-step test.38 The first step asks whether the purpose and scope of the defendant’s duties cover the losses sustained by the claimant, subject to any clear statutory restrictions or exceptions. The second step asks whether allowing the claimant to sue the defendant will result in a wrongdoer (who may or may not be the same person as the defendant) profiting from its own wrongdoing. If the answer to the first step is ‘yes’, the court moves to the second step. But if the answer to the first step of the framework is ‘no’, there is no need to move to the second step. If the answer to the first question is ‘yes’ and the second ‘no’, then the claimant should not be barred from suing the defendant on attribution grounds. Applying this two-part test to the situation of the company suing its insiders (such as directors, officers, employees or agents) or third parties, and where the illegality defence is raised by the defendant, the state of mind or acts of the company’s insiders should not be attributed to the company so as to preclude it from suing the defendant. But where a third party claimant sues the defendant company, the reverse happens: the acts and knowledge of the company’s insiders (such as the directors, agents or relevant persons) should be attributed to the company so as to render it liable. After all, where the defendant company is being sued for breach of duties, it cannot simply escape liability by arguing that the wrongful acts or state of mind of its delinquent insiders should not be attributed to itself. To hold otherwise would mean that a company can never be held liable. However, if the answer is ‘yes’ to both the first and second questions, then unless there is a mechanism that can prevent the wrongdoer from benefiting from its own wrongdoing under the second step of the two-part test, courts should hesitate before allowing the claimant to sue the defendant.39 Support for the first step of the test can be found in the ‘very thing argument’. In short, where a company sues its directors, agents or third parties for breach of duties and the defendant owes a duty to the claimant either to prevent harm (caused by someone other than the defendant) or to bring about a certain state of affairs, there should be no attribution of the wrongdoer’s state of mind or acts to the claimant so as to bar the latter from suing the defendant.40 To attribute will render the defendant’s duty otiose. The authority for the very thing argument is Reeves v Commissioner of Police of the Metropolis (‘Reeves’),41 cited with approval in Singularis.42 It was held in Reeves that, assuming that suicide was illegal, the illegality defence could not be used to preclude a claim against the defendant police for negligently allowing the prisoner to commit suicide. This was because suicide was the very thing that the police have a duty to prevent. In Singularis Holdings, Ltd v Daiwa Capital Markets Europe, Ltd, the Supreme Court endorsed and applied Reeves and held that the purpose of the Quincecare duty imposed on the defendant bank is to protect the bank’s customer (the claimant) from the harm caused by people for whom the customer is directly or indirectly responsible.43 The court said that the loss suffered by the claimant company was caused by the defendant bank’s breach of duty of care in not exercising reasonable care when it gave effect to the fraudulent instructions of the board chair and sole shareholder.

40 41 42 43 38 39

The analysis is drawn from Lim, supra note 31, at 287–95. Infra note 47 and accompanying text. Stone & Rolls Ltd v. Moore Stephens [2009] 1 AC 1391 ¶ 177 (per Lord Walker). Reeves v. Commissioner of Police of the Metropolis [2000] 1 AC 360 (UKHL). Singularis Holdings Ltd v. Daiwa Capital Markets Europe Ltd [2019] UKSC 50 ¶ 22. Id. at ¶ 22–23.

Attribution  163 The second step of the test is grounded upon the idea that it will be inconsistent with a central, well-established and widely accepted policy rationale of the illegality defence44 and it will be an affront to justice and fairness if, by allowing the claimant company to sue the defendant, the wrongdoer (who may or may not be the same person as the defendant) will profit from its own wrongdoing, in the sense that the wrongdoer who is also a shareholder or director will benefit derivatively (i.e. indirectly) from the compensation awarded to the claimant company. This derivative benefit can take the form of subsequent distribution of dividends, or an increase in share price or directors’ fees. But where a company sues a director for breach of duties, and that director is not a shareholder, and where all the shareholders are innocent (because they are not complicit in the director’s wrongdoing), there will be no concern that the defendant director will profit from his own wrongdoing because he is not a shareholder. In a different situation, where an insolvent company (through its liquidator) sues a director and he is also the sole shareholder, such as the case in Bilta, the director-shareholder will also not be able to profit from his own wrongdoing because the compensation that goes to the company will benefit the creditors. However, to be clear, the wrongdoer need not be the same person as the defendant, although it often is. For example, where a company sues a third party (such as an auditor or a bank) for breach of duties, the defendant third party may argue that the company should not be allowed to bring a claim against it because the wrongdoer who is a shareholder will profit from its own wrongdoing. This is because the shareholder may be complicit in the misconduct of the director, or the shareholder may also be the director, such as in the case of Stone & Rolls Ltd v Moore Stephens (‘Stone & Rolls’), a one-man company. There Lord Phillip raised such a concern.45 In response to Lord Mance’s and Lord Scott’s point that a (solvent) company should be allowed to bring a claim against its fraudulent director for breach of duties, Lord Phillips said that the company should not be barred from suing the director if all the shareholders are innocent, but if there are shareholders who are complicit in the director’s wrongdoing, it is unclear whether the company should still be allowed to sue the director.46 This is because the shareholders will profit from their wrongdoing as the shareholders will stand to gain, albeit derivatively, from the damages the court awards to the company. This problem can be addressed, as suggested by Lord Mance, by impounding the shareholder’s share of distribution if and when the company decides to distribute dividends.47 This two-step test is able to explain the outcome in the important and controversial cases as well as provide relatively clear and predictable answers in three situations: where the company sues its insiders (such as directors, agents or employees); where it sues a third party (such as auditors and banks) for breach of duties; and where a third party sues the company. Consider the first situation. Applying the first step of the test to Bilta, for example, the purpose and scope of the directorial duties to avoid unauthorised conflicts of interest and unauthorised receipt of profits cover the losses sustained by the company which were the result of the directors’ fraud. There are no applicable statutory restrictions or exceptions to the direc-

44 Patel v. Mirza [2016] 3 WLR 399 ¶¶ 22, 99, 143 (UKSC); Hounga v. Allen [2014] 1 WLR 2889 ¶ 43; Hall v. Hebert [1993] 2 SCR 159, 175–76, 179–80 (Can. S.C.). 45 Stone & Rolls, [2009] 1 AC ¶¶ 61–62. 46 Id. at ¶ 61. 47 Id. at ¶ 254, citing Re VGM Holdings, Ltd [1942] Ch. 235 and Selangor United Rubber Estates, Ltd v. Cradock [1969] 1 WLR 1773.

164  Research handbook on corporate liability tors’ duties. Applying the second part of the test, there was no possibility of the sole shareholder who was also one of the fraudulent directors profiting from his wrongdoing because the company was insolvent and all the damages or compensation that the court would award would go to the creditors. Consider also a controversial case that deals with the company suing its directors for breach of duties – Safeway.48 There the company sued its directors for breach of duties because their price-fixing activities caused the company to breach the Competition Act 1998 (UK) and to incur a hefty fine. The Court of Appeal held that the illegality defence applied because to hold otherwise would allow the company to recoup its losses from the fine, which would be inconsistent with the Competition Act which imposed liability only on the company and not on its directors and officers.49 Applying the first part of the test, the question is whether the Competition Act includes any restrictions or exceptions to the general and well-established principle that the company has a right to sue its directors for breach of duties which resulted in losses to the company; in other words, whether the Competition Act bars or limits the purpose or scope of director’s duties which are intended to allow the company to sue for the losses it sustained. Neither the Court of Appeal in Safeway nor the Supreme Court in Bilta suggested there were any. The fact that the Competition Act only imposed liability on the company and not on its directors or officers does not mean that the purpose or effect of the statute is to restrict the purpose and scope of directors’ duties under the Companies Act and common law. Applying the second part of the test, there was nothing on the facts to indicate that the directors were shareholders who could profit from the wrongdoing. Even if they were, their share of dividends can be impounded if and when the company decides to declare dividends. Now, consider the second situation – the company suing third parties, whether these be auditors, banks or others. In the UK Supreme Court decision in Singularis,50 the liquidator acting for the insolvent company sued the defendant bank for breach of its duties to exercise reasonable care and skill when it executed the orders from the company’s fraudulent director who was the sole shareholder. Applying the first step of the test, the purpose and scope of the defendant bank’s duty is to protect the company against just the sort of misappropriation of its funds as took place here. By definition, this is done by a trusted agent of the company who is authorised to withdraw its money from the account. To attribute the fraud of that person to the company would be, as the judge put it, to ‘denude the duty of any value in cases where it is most needed’.51

Applying the second step of the test, as the company was insolvent, there would be no possibility of the sole shareholder, who was the fraudulent director, profiting from his own wrongdoing. Finally, consider the third situation, a third party suing the company. For example, in Bank of India v Morris, the third party was the liquidator acting for a bank, BCCI. BCCI sued the defendants which included a financial institution, the Bank of India (BOI), for violating the Insolvency Act 1986 (UK) as BOI was a knowing party to the carrying on of BCCI’s business with the intent to defraud BCCI’s creditors. The Court of Appeal held that BOI was a knowing 50 51 48 49

Safeway Foodstores Ltd v. Twigger [2010] EWCA (Civ) 1472. Id. at ¶¶ 23, 36–37, 43. Singularis Holdings Ltd v. Daiwa Capital Markets Europe Ltd [2019] UKSC 50. Id. at ¶ 35.

Attribution  165 party because the senior manager’s fraud was attributed to BOI. Applying the first step of the test, the purpose and scope of the defendants’ duty (which was not to be a knowing party to the carrying on of the claimant’s business in order to defraud the claimant’s creditors) clearly covered the losses sustained by the claimant. And applying the second step of the test, because neither BOI nor the fraudulent manager could profit from their own wrongdoing (as all the damages the court awarded would go to the creditors), the claimant should be allowed to sue the defendant. For the reasons given above, the two-step test provides a relatively clear and predictable answer to the question of whether the acts and knowledge of the company’s insiders should be attributed to the company where it sues its insiders and third parties and where the latter sue the company. However, the second step of the two-step test may give rise to the issue of what the relationship is between attribution and illegality defence. To put it differently, why should a key rationale underlying the illegality defence – no one should profit from his or her wrongdoing – determine whether the intent or acts of a person should be attributed to the company, given that attribution and the illegality defence are conceptually distinct doctrines? The next section examines this relationship.

III.

THE RELATIONSHIP BETWEEN ATTRIBUTION AND THE ILLEGALITY DEFENCE

In the corporate context, the illegality defence usually arises when a company sues its directors or third parties for breach of duties. In order to bar the company’s claim against them, the defendants will bring up the illegality defence, a rule of public policy – no court will lend its aid to a man who founds his action upon an illegal or immoral act; in other words, the defendant will allege that the company’s claim was tainted with its illegality. To make this argument, the defendant directors will seek to attribute their wrongful acts or intent to the company, such as in Bilta. The delinquent third party will seek to attribute the wrongful acts or intent of the company’s insiders (such as the directors, officers, employees or shareholders) to the company, such as in Singularis. However, where the company is being sued by a third party for breach of duties, the illegality defence usually does not arise because it is the third party that will be seeking to attribute the wrongful acts or knowledge of the company’s insiders to the company in order to show that the company has breached its duties. A classic example in which the illegality defence played no part is Meridian52 where the third party (the Securities Commission of New Zealand, now known as the Financial Markets Authority) sued the company for violating the securities legislation for failing to disclose its share purchase when it knew or ought to have known that it was a substantial security holder. The Privy Council attributed the knowledge of the chief investment officer to the company and held that the company was liable. Thus, where the defendant (whether a corporate insider or outsider) is being sued by a company, in order for a defendant’s illegality defence to succeed, it first has to succeed in its argument on attribution. If this argument fails, then it is unnecessary to proceed to apply

Meridian Global Funds Management Asia Ltd v. Securities Commission [1995] 2 AC 500 (PC).

52

166  Research handbook on corporate liability the range of factors approach to the illegality defence, set out by the Supreme Court in Patel v Mirza (‘Patel’).53 In Crown Prosecution Service v Aquila Advisory Ltd (‘Aquila’),54 an issue arose as to whether the attribution rule laid down in Bilta remains good law after Patel. Counsel for the claimant in Aquila argued that, since the decision in Patel, the rules of attribution cannot be used to control the application of the illegality defence because the rules of attribution are not rules of illegality policy; thus, to ensure legal coherence between Bilta and Patel, the rule in Bilta has to be reconsidered.55 The Supreme Court rejected counsel’s argument on two grounds.56 First, the court said that Bilta remains goods law after Patel because Bilta was affirmed in Singularis, which was handed down after Patel. Second, the court said that the question of attribution had to be addressed first before applying the principles laid down in Patel. Given that attribution and the illegality defence are conceptually distinct, the question is why there is a need to show that the wrongdoer will not benefit from its own wrongdoing (the second part of the two-step test) which is one of the policy rationales underlying the illegality defence. Put differently, justification has to be given as to why the first step of the two-step test is insufficient for determining whether there should be attribution. It will be an affront to justice if, by allowing the company to sue its insiders or outsiders (once we determine that the answer to the first step of the two-step test is satisfied and we do not proceed to the second step), the wrongdoer will profit from its wrongdoing. For example, in the Singapore Court of Appeal decision in Red Star Marine Consultants Pte Ltd v Personal Representatives of Satwant Kaur d/o Sardara Singh (‘Red Star’),57 in which an essentially one-man company sued its fraudulent defendant employee, the court attributed the knowledge of the dominant director and shareholder of the company to the company as he consented to the employee’s fraud. The court said that the failure to attribute would mean the dominant shareholder and director would suffer no consequences for his wrongdoing, and it would ignore the fact that he was complicit in his secretary’s fraud. Where the company sues its director for breach of duties and is awarded compensation (or other types of remedies) by the court, the purpose is to vindicate the company’s rights vis-à-vis the miscreant director, which will ultimately benefit the company’s shareholders (and other stakeholders within the company). It will undermine directors’ duties, which exist to protect the interests of the company for the primary benefit of shareholders, if the defendant director, who is also the shareholder, stands to profit from the lawsuit against it. 53 Patel v. Mirza [2016] 3 WLR 399. The range of factors approach, also known as the policy-based approach, is summarized by Lord Toulson JSC at ¶ 120 as follows: ‘The essential rationale of the illegality doctrine is that it would be contrary to the public interest to enforce a claim if to do so would be harmful to the integrity of the legal system ...’. ‘In assessing whether the public interest would be harmed in that way, it is necessary a) to consider the underlying purpose of the prohibition which has been transgressed and whether that purpose will be enhanced by denial of the claim, b) to consider any other relevant public policy on which the denial of the claim may have an impact and c) to consider whether denial of the claim would be a proportionate response to the illegality, bearing in mind that punishment is a matter for the criminal courts.’ 54 Crown Prosecution Service v. Aquila Advisory Ltd [2021] UKSC 49. 55 Id. at ¶ 79. 56 Id. at ¶ 61. 57 Red Star Marine Consultants Pte Ltd v. Personal Representatives of Satwant Kaur [2019] SGCA 76 (Sing. C.A.); see Ernest Lim, Attribution: A New Controversy?, 84 Mod. L. Rev. 581 (2021).

Attribution  167 Where a solvent company sues a third party (such as a bank or auditor) for breach of duties, allowing the company to sue (by not attributing the wrongdoing of its delinquent director or shareholder to the company) will vindicate the company’s rights vis-à-vis the third party. But it is highly questionable to allow the wrongdoer who is also a shareholder of the claimant company to benefit from the lawsuit, even if derivatively. In other words, it is doubtful that the company should be permitted to sue the third party, if doing so would have the effect of rewarding the wrongdoer. However, barring the company from suing the third party will harm the interests of the innocent shareholders, albeit derivatively. To address this problem, where there are innocent shareholders, the court should still allow the company to sue the third party (assuming the answer to the first step of the test is in the affirmative) by not attributing the shareholder’s wrongful intent or acts to the company, but impound the share of that delinquent shareholder’s dividends. The foregoing analysis is consistent with two propositions derived from Stone & Rolls58 that were accepted in Bilta:59 the illegality defence is not available where there are innocent shareholders or directors; and the defence is available, albeit only on some occasions where there are no innocent shareholders or directors. The rationale is that it will be unjust and unfair to these innocent parties to bar the company from suing its miscreant insiders or outsiders.

IV.

CONFLICT BETWEEN TWO (OR MORE) AREAS OF LAW

A fresh and important problem arose from the recent UK Supreme Court decision in Aquila.60 The issue is whether the wrongdoing of the company’s directors should be attributed to the company in order to allow equitable principles to override the criminal law. Difficult issues of corporate attribution, criminal law and equity were all concurrently engaged. In Aquila, the former directors of the company, Vantis Tax Ltd (‘VTL’), were convicted of a criminal offence because they defrauded the Inland Revenue through tax avoidance schemes. Through these tax avoidance schemes, they made a gain of £4.55m. This sum also amounted to secret profits made by the former directors as they exploited a corporate opportunity and pretended to sell VTL’s intellectual property. It transpired that, at all material times, the transactions only benefited themselves. VTL sued these directors for breach of fiduciary duties and, through its administrator, assigned the claims to the defendant Aquila Advisory Limited (‘AAL’) with a view to securing the best possible return for VTL’s creditors. After securing the criminal convictions of the former directors at VTL, the Crown Prosecution Service (‘CPS’) proceeded to apply for confiscation orders, amounting to £4.55m, under the Proceeds of Crime Act 2002 (UK) (‘POCA’) against them. According to the laws governing fiduciaries, secret profits made by a fiduciary are held on a constructive trust for the principal. Given that the principal, in this case VTL, had assigned its claims against the fraudulent directors to AAL for breach of fiduciary duties, AAL therefore obtained the proprietary

Stone & Rolls Ltd v. Moore Stephens [2009] 1 AC 1391 (UKHL). Bilta (UK) Ltd v. Nazir (No. 2) [2015] UKSC 23, [2016] AC 1 ¶ 80 (per Lord Sumption JSC), ¶ 26 (per Lord Neuberger PSC). 60 Crown Prosecution Service v. Aquila Advisory Ltd [2021] UKSC 49. The analysis is drawn from Weiming Tan, The Law at an Intersection: A Meeting of Attribution, Criminal Law, and the Constructive Trust, 86 Mod. L. Rev. 536 (2023). 58 59

168  Research handbook on corporate liability rights over the secret profits. The CPS made two key arguments. It argued that the fraud of the directors should be attributed to VTL (and by extension AAL), and thus, AAL should be precluded from enforcing its constructive trust over the £4.55m on the basis of the illegality defence, particularly where the company suffered no losses but instead made a gain from the illegal profits.61 The CPS also argued that a denial of their confiscation order would undermine the POCA regime, which was intended to protect third parties who are bona fide purchasers for value without notice. In enacting POCA, Parliament must not have intended for third parties to benefit from criminal proceeds.62 Delivering the judgment on behalf of the Supreme Court, Lord Stephens JSC decided that the rule in Bilta is binding and applicable to the facts in Aquila.63 As discussed above, in Bilta, the Supreme Court held that the wrongdoing of the directors should not be attributed to the company where the company sues the directors for breach of their duties. But the CPS sought to distinguish Bilta from Aquila on the basis, among others, that the reason for not attributing the intent or actions of the defaulting directors is to protect the company from the losses resulting from the directors’ breach of duties. This was the situation in Bilta, where losses were in fact incurred by the company. On the other hand, in circumstances where the company stands to gain or benefit from the directors’ breach of duties and criminal law, such as the situation in Aquila, the CPS argued that the rule in Bilta should not be applicable.64 Lord Stephens JSC ruled in favour of AAL, holding that it made no difference to the reasoning in Bilta if the company sued the directors for losses suffered by it or the gains made by the directors. Furthermore, it would also not make a difference if both directors and the company benefitted from the fraud.65 Lord Stephens JSC was concerned that, if attribution were permitted, the directors’ duties owed to the company would be negated in cases where the company was barred from suing its directors for breach of their duties due to the operation of the illegality defence.66 His concern was a valid one. Fiduciary duties, which directors undoubtedly owe to their companies, are prophylactic in nature and serve a deterrent function.67 Such duties are put in place by equity in order to ensure that directors protect and safeguard the company’s interests. It flies in the face of legal orthodoxy to conceive of a director who has breached the no-conflict and no-profit rules as having benefitted his company by reason of the fact that the company stood to make a financial gain by enforcing these duties. The enforcement of a director’s duties, along with any windfall gains accrued by virtue of such an enforcement, is separate from the issue of whether a director has breached his fiduciary duties to the company. The CPS also attempted to distinguish Bilta from the facts in Aquila on the basis that the directors in the latter had dishonestly committed a criminal offence, unlike those in Bilta.68 As Lord Stephens JSC rightly observed, that in itself provided no justification to depart from the rule in Bilta. On the facts of Aquila, the directors were being sued by VTL for breach of fiduciary duties, and this came within the ambit of the rule as articulated in Bilta.69 Moreover, 63 64 65 66 67 68 69 61 62

Crown Prosecution Service v. Aquila Advisory Ltd. [2021] UKSC 49 ¶ 7. Id. Id. at ¶ 81. Id. at ¶ 70. Id. at ¶ 71–72. Id. at ¶ 71. Id. at ¶ 74–75. Id. at ¶ 67. Id.

Attribution  169 as Lord Stephens JSC rightly pointed out again, AAL’s claim of a constructive trust over the secret profits was a civil claim grounded on the directors’ breach of their fiduciary duties, and such a claim was not reliant on the directors’ criminal convictions. 70 Although Lord Stephens JSC’s observations were accurate, he should ultimately not have allowed AAL’s proprietary claim in respect of the secret profits given that the enforcement of AAL’s claim would in effect override the statutory regime provided for in POCA. Unlike in Bilta, on the facts of Aquila, not attributing the directors’ wrongdoing to AAL could expose AAL to a violation of a money laundering offence under s 329 of POCA. This is because the secret profits which AAL was trying to claim via a constructive trust are likely to constitute ‘criminal property’ within the scope of s 329 of POCA. Section 329(1) of POCA provides that a person is guilty of a criminal offence if he acquires, uses or has possession of criminal property. It therefore falls to be determined whether the secret profits of £4.55m acquired by AAL by way of enforcing its proprietary claim against the directors constituted ‘criminal property’. Section 340(3) of POCA defines ‘criminal property’ as that which (a) ‘constitutes a person’s benefit from criminal conduct or [which] represents such a benefit (in whole or part and whether directly or indirectly)’, and (b) ‘the alleged offender knows or suspects that it constitutes or represents such a benefit’. Further, section 340(4) provides that ‘[i]t is immaterial (a) who carried out the conduct; (b) who benefited from it …’. Lastly, section 340(5) provides that: ‘A person benefits from conduct if he obtains property as a result of or in connection with the conduct.’ Applying a natural reading of the relevant POCA provisions to the facts in Aquila, VTL/ AAL has indeed benefited from the criminal conduct of the directors as it obtained the property rights of the £4.55m as a result of or in connection with the criminal conduct of the directors.71 While Lord Stephens JSC noted that the directors obtained the £4.55m by abusing their positions and the assets of the company,72 he recognised that ‘the amount of £4.55m was also the benefit obtained by Mr Faichney and Mr Perrin from the crime of cheating the public revenue’.73 In addition, Lord Stephens JSC held that ‘[t]he scheme was fraudulent from the start, and thus the money paid by the clients wishing to take advantage of the scheme (from which the £4.55m can be directly traced) was money obtained as a result of or in connection with the offence of cheating the public revenue’.74 Simply put, the directors made the gain of £4.55m by concurrently breaching their fiduciary duties and from defrauding the HMRC. Nothing turns on the fact that the £4.55m was obtained by both a breach of civil duty (owed in equity) and a violation of criminal law since s 340(3)(a) provides that the benefit can be ‘in whole or part and whether directly or indirectly’. Furthermore, applying s 340(4), it is immaterial that VTL/ AAL did not itself commit the criminal conduct. It sufficed that the directors committed the criminal conduct, and that VTL/AAL was the party that benefited from it, so as to hold VTL/ AAL liable for acquiring the criminal property under s 329(1)(a). In light of the above reasons, it can be concluded that the £4.55m constituted or represented the benefit acquired by AAL from criminal conduct (thereby satisfying s 340(3)).

Id. at ¶ 68. Tan, supra note 60, at 541. 72 Aquila [2021] UKSC 49, at ¶ 1. 73 Id. at ¶ 2. 74 Id. at ¶ 29. 70 71

170  Research handbook on corporate liability To make out the elements of the s 329 offence, it must also be ascertained whether the alleged offender, AAL, knew or suspected that the £4.55m constituted or represented such a benefit under s 340(3)(b). On balance, it is likely that AAL knew or at the very least suspected that the sum of £4.55m represented criminal proceeds.75 The history of events tends to support this conclusion. In 2006, the HMRC conducted criminal investigations of the fraudulent tax avoidance schemes operated by the directors.76 In 2009, criminal proceedings were brought against the directors for their role in the tax avoidance schemes.77 Subsequently, in 2010, VTL sued the directors for breach of fiduciary duties for profiting from and misappropriating the company’s assets in connection with the tax avoidance schemes.78 In the same year, the administrators of VTL assigned VTL’s claims in the civil suit against the former directors to AAL with a view to securing the best possible return for VTL’s creditors.79 Under this assignment, VTL’s proprietary rights over the secret profits were transferred to AAL.80 The directors were eventually convicted of a criminal offence for defrauding the HMRC in 2012.81 In light of this criminal conviction, it is unlikely that AAL did not know or even suspect that the £4.55m were in fact proceeds from criminal conduct. Applying the preceding analysis to the facts of Aquila, the £4.55m amounted to ‘criminal property’ within the meaning of s 340(3). As a result, it could be argued that AAL, in enforcing its constructive trust claim over the £4.55m, acquired criminal property and therefore committed a money laundering offence under s 329(1)(a) of POCA.82 Although Lord Stephens JSC did not think it necessary to decide whether the directors’ profits made from defrauding the HMRC constituted a money laundering offence,83 he commented that ‘[i]t would be a surprising result if VTL or Aquila, in dealing with a beneficial interest that arises under a constructive trust could be said to have committed a money laundering offence given that POCA is not intended to interfere with existing third-party property rights’.84 The Parliamentary materials indicate that Parliament intended that certain third party rights should not be subject to confiscation or recovery under POCA. The rights debated by Parliament pertained to good faith purchasers of property with value without notice of its tainted orders; potential rights of the offender’s family members; and potential rights of the offender’s creditors, but there was nothing in Hansard on constructive trust.85 Although Parliament did mention (but without elaborating) that ‘other innocent interests’ should be protected, it would be a stretch to argue that this category includes the enforcement of constructive trust over unauthorised profits that were obtained in violation of the criminal law.86

Tan, supra note 60, at 541–42. Aquila [2021] UKSC 49 ¶ 40. 77 Id. at ¶ 40(g). 78 Id. at ¶ 40(b). 79 Id. at ¶ (40(d). 80 Id. 81 Id. at ¶ 40(g). 82 AAL would not have committed a s 329 offence if it had made an authorised disclosure under s 338. Nevertheless, there was nothing on the facts that showed that AAL had executed such a disclosure. 83 Aquila [2021] UKSC 49, at ¶ 86. 84 Id. at ¶ 85. 85 Tan, supra note 60, at 542–43. 86 Id. 75 76

Attribution  171 Further, while Lord Stephens JSC relied on s 281 of POCA to bolster his position that POCA is not intended to interfere with third party property rights, this section is unlikely to contemplate constructive trust.87 Section 281(3) provides that the court may declare that criminal property will not be recoverable by the public agencies if three conditions are satisfied: (a) the applicant was deprived of the property he claims, or of property which it represents, by unlawful conduct; (b) the property he was deprived of was not recoverable property immediately before he was deprived of it; and (c) the property he claims belongs to him. Assume that the fiduciary took bribes. Applying subsection (a), it is difficult to see how the receipt of the bribe, which constitutes a criminal offence, amounts to property of which the principal was deprived. For the principal to surmount this difficulty, he has to argue that he was deprived of the property because, once the fiduciary has received the bribes, English trust law would operate to automatically and immediately subject the bribes to constructive trust, thus conferring on the principal proprietary rights over the bribes. However, subsection (b) would defeat this argument because the principal has to show that the bribes were not recoverable property before he was deprived of them. But bribes are recoverable property under POCA because they are property obtained through unlawful conduct under s 241(1) of POCA, which refers to any conduct in the UK that is in violation of its criminal law. Lastly, Lord Stephens JSC cited Bowman v Fels88 (‘Bowman’) as an authority for the proposition that the POCA regime was not intended to interfere with existing third-party property rights.89 However, the facts in Bowman differed materially from those in Aquila. The main issue before the Court of Appeal in Bowman was whether s 328 of POCA90 applies to the ordinary conduct of legal proceedings or any aspect of such conduct. The specific issue concerned was whether a lawyer, while acting for a client in legal proceedings, who discovers or suspects anything in the proceedings that may facilitate the acquisition, retention, use or control (usually by his own client or his client's opponent) of ‘criminal property’, is required to notify the authorities of his belief in order to avoid being guilty of the criminal offence of being concerned in an arrangement which he knows or suspects facilitates such activity.91 In this regard, the Court of Appeal in Bowman held that s 328 is not intended to capture the situation of the ordinary conduct of litigation involving the resolution of the rights and duties of two parties given that such a situation does not amount to the carrying out of a transaction related to money laundering.92 Therefore, given the difference in context, Bowman ought not to be regarded as conclusively deciding in favour of the wider and more general assertion that POCA is not meant to interfere with third-party property rights. For all of the above reasons, it was incorrect for Lord Stephens JSC to exempt AAL’s proprietary interest over the illegal gains obtained in violation of the criminal law from POCA. As shown above, Parliament did not intend the protection of innocent third party rights to extend to the situation involving constructive trust over illegal gains. If that is the case, Lord Stephens JSC should not have allowed AAL to sue the fraudulent directors because that would Id. at 543–44. Bowman v. Fels [2005] EWCA (Civ) 226, [2005] 1 WLR 3083. 89 Aquila [2021] UKSC ¶ 85. 90 § 328(1) of POCA provides that ‘A person commits an offence if he enters into or becomes concerned in an arrangement which he knows or suspects facilitates (by whatever means) the acquisition, retention, use or control of criminal property by or on behalf of another person’. 91 Bowman, supra note 88, ¶¶ 20–21. 92 Id. at ¶ 62. 87 88

172  Research handbook on corporate liability be inconsistent with POCA. In other words, the rule in Bilta should not have applied to the facts in Aquila – the failure to attribute the fraud of the errant directors to the company had the effect of undermining POCA. Finally, even if we apply Meridian’s contextual, purposive approach or a rule-based approach such as the two-part test examined earlier, it is argued that we will still arrive at the same conclusion (namely the rule in Bilta should not apply). Under the special rule of attribution, the question is ‘Whose act (or knowledge, or state of mind) was for this purpose intended to count as the act etc. of the company?’ According to Lord Hoffmann, the court must examine the purpose and policy of the rule in determining whether to attribute. What is the purpose here? If the facts in Aquila were simply that of AAL suing the fraudulent directors for breach of fiduciary duties, there can be no doubt that Bilta would apply and the fraud of the directors would not and should not be attributed to the company. But the facts were far more complex. The claimant was the CPC. The defendants were not the fraudulent directors, but AAL. The CPC invoked POCA and sought to confiscate the criminal proceeds of £4.55m from the fraudulent directors who were convicted for cheating the HMRC. AAL argued that they had proprietary rights over the £4.55m because a constructive trust was imposed, in their favour as the principal, on these illegal gains. In such a context, the fraud of the directors should be attributed to AAL so as to bar the latter from asserting its civil claim in priority over the state, where, as argued above, AAL had committed money laundering offences under POCA.

V. CONCLUSION This chapter began by showing that Meridian’s special rule of attribution does not always yield certainty and predictability. This was followed by an evaluation of two proposed rule-based approaches – attribution as allocated powers and the two-step test. Although the former approach can lead to greater certainty and predictability in the law, it was argued that this approach may not adequately account for the rules of agency, especially apparent authority, and that the distinctive value-added of this approach is unclear. It was further argued that the two-step test can explain the outcome of the important cases and can provide relatively clear and predictable answers in three situations: where the company sues its insiders (such as directors, agents or employees) and where it sues a third party (such as auditors and banks) for breach of duties, and where a third party sues the company. The next section examined the relationship between illegality defence and attribution. It was argued that this issue usually arises where the company is a claimant and the defendant (whether an insider or a third party) seeks to impute its wrongdoing or that of another party to the company in order to bar the company’s claim. It was shown that, before the principles of the illegality defence can be applied, courts have to determine whether the wrongdoing of the relevant party should be attributed to the company. The final section analysed attribution in the context of conflict between two areas of law such as criminal law and equity. It was argued that, in so far as the failure to attribute has the effect of causing civil law to override or contradict criminal law, courts should refrain from doing so.

PART III PERSONAL LIABILITY

10. Directors’ and officers’ liability under securities laws Lisa M. Fairfax

I. INTRODUCTION Directors and officers play a critical role in the corporation. Executive officers, especially the CEO and CFO, are responsible for setting strategy and both managing and overseeing the overall affairs of the corporation, including its financial affairs. Every corporation must be managed under the direction of a board of directors, which means that directors are not only responsible for overseeing the corporation and its affairs, but also for overseeing top executives, especially the CEO. Importantly, directors, especially outside independent directors, have been tasked with increasingly greater responsibility for overseeing various critical corporate issues. There are a range of ways in which directors and officers may find themselves exposed to potential liability in relation to the exercise of those responsibilities under the Securities Act of 1933, as amended (the ‘Securities Act’) and the Securities Exchange Act of 1934, as amended (the ‘Exchange Act’ and together with the Securities Act, the ‘federal securities laws’). This includes potential liability under various sections of the Securities Act, such as Section 11, which prohibits misstatements or omissions in a public company registration statement.1 This also includes potential liability under various sections of the Exchange Act, most notably Section 10b and Rule 10b-5 of the Exchange Act, which collectively prohibit securities fraud and insider trading and are the provisions most often relied upon to hold individuals accountable for wrongdoing associated with the purchase and sale of securities.2 To be sure, whether the potential for liability under the federal securities laws translates into reality depends on a host of different factors. These factors include procedural hurdles such as pleading standards that may make it more difficult to bring challenges.3 They also include substantive rules that may pose hurdles for successful prosecution of individual directors and officers.4 In addition, whether or not the government prioritizes the prosecution of particular individuals or particular wrongful misconduct also impacts the risks of liability for directors and officers. At least in the past two decades, the federal government has prioritized individual responsibility and accountability. Indeed, corporate governance scandals often spotlight the desire for greater individual accountability, and hence have caused government officials to emphasize individual accountability. For example, after the corporate governance scandals

See 15 U.S.C. § 77k (2020). See 17 C.F.R. § 240.10b-5 (2021). 3 See Lisa M. Fairfax, Spare the Rod, Spoil the Director? Revitalizing Directors’ Fiduciary Duty Through Legal Liability, 42 Hous. L. Rev. 393 (2005). 4 See id. at 422–23. 1 2

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Directors’ and officers’ liability under securities laws  175 associated with Enron and WorldCom, Congress passed the Sarbanes-Oxley Act of 2002 (‘Sarbanes-Oxley’ or the ‘Act’),5 which then President George W. Bush proclaimed ushered in a ‘new ethic of personal responsibility in the business community’.6 This emphasis translated into new rules and new or enhanced penalties aimed at increasing individual responsibility and accountability. For example, Section 301 of Sarbanes-Oxley required companies to have an audit committee comprised solely of independent directors, and made the audit committee responsible for overseeing the work of auditors.7 Section 302 of Sarbanes-Oxley imposed new responsibilities on CEOs and CFOs to personally certify their responsibility for creating and maintaining internal controls, and to personally certify the accuracy of the financial information within their company’s annual and quarterly reports.8 Section 906 imposes penalties on officers who knowingly violate the certification.9 Moreover, in the last few decades, both the Securities and Exchange Commission (‘SEC’) and the Department of Justice (the ‘DOJ’) have emphasized the importance of individual accountability and have consistently brought a significant portion of securities actions against individuals.10 This emphasis on individuals is rooted in the notion that corporations act through individuals and thus individual accountability and liability is essential to corporate accountability. In particular, individual accountability and liability is essential to ferreting out corporate wrongdoing, holding the appropriate parties responsible for such wrongdoing, and to meeting the enforcement goals of general and specific deterrence.11 However, the emphasis on individual responsibility and accountability has not been shared equally. Instead, officers have a greater risk of liability under the federal securities laws than directors who have no employment or officer roles in their corporation – so-called outside directors. Research clearly shows that outside directors are less likely to be the subject of securities claims, less likely to be successfully prosecuted if they are named defendants, and less likely to pay out-of-pocket damages.12 This chapter not only explores this deferential treatment, but also examines its potential implication in the context of the recent rise in attention on matters related to environmental, social, and governance (‘ESG’) issues. 15 U.S.C. 7245 (2002). See Lisa M. Fairfax, Form Over Substance? Officer Certification and the Promise of Enhanced Personal Accountability Under Sarbanes-Oxley, 55 Rutgers L. Rev. 1, 2 (2002). 7 Sarbanes-Oxley Act of 2002, Pub. L. 107–204, § 301, 116 Stat. 745, 775. In order to be independent, an audit committee member may not accept any compensation from the issuer other than in her capacity as a board committee member and may not be affiliated with the company or its subsidiaries. See id. Audit committees must also contain at least one member who is a ‘financial expert’. Sarbanes-Oxley § 407. 8 See Sarbanes-Oxley §§ 302, 906. For a discussion of the impact of the certification requirement on officer liability see Fairfax, supra note 6. 9 See Sarbanes-Oxley § 906(c)(1). Officers face a maximum penalty of $1,000,000, a maximum prison term of ten years, or both. Previous versions of the Act only contained a $500,000 maximum fine and a five-year prison term, reserving the more significant penalties for willful violations. See Sarbanes-Oxley § 906(a) (July 15, 2002) (engrossed in Senate). Willful violators face a maximum $5,000,000 fine, a maximum of 20 years in prison, or both. See Sarbanes-Oxley § 906(c)(2). These sanctions represent an increase from previous versions of the Act which only subjected officers to a $1 million maximum fine and ten-year prison term for willful violations. See Sarbanes-Oxley § 906(c)(2) (July 15, 2002) (engrossed in Senate). 10 See infra Part II. 11 See id. 12 See id. 5 6

176  Research handbook on corporate liability Part II of this chapter is organized as follows. Section A assesses the liability landscape by pinpointing some of the most significant areas of the federal securities laws under which directors and officers may be held liable. Section B highlights the manner in which the federal securities laws have emphasized individual responsibility and accountability, and reveals the divergence in treatment between outside directors and officers. Section C examines this issue through the lens of ESG. Part III of this chapter concludes.

II.

OUTSIDE DIRECTOR AND OFFICER DEFERENTIAL TREATMENT UNDER THE FEDERAL SECURITIES LAWS

A.

The Liability Landscape

There are a host of ways in which the federal securities laws expose directors and officers to liability. This Part examines some of the most notable. It focuses especially on those laws that expose directors and officers to liability for the roles they play with respect to oversight and participation in corporate activities. It is worth noting that there are three categories of actors that can bring claims against directors and officers under the federal securities laws: (1) the SEC brings civil actions; (2) the DOJ brings criminal actions; and (3) private parties may bring actions so long as a private right of action has been granted under the relevant law. 1. Section 10(b) and Rule 10b-5 Perhaps the most well-recognized federal securities law pursuant to which directors and officers may be exposed to liability are Section 10(b) and Rule 10b-5 of the Exchange Act, which together prohibit securities fraud, broadly defined as the use of manipulation or deception in connection with the purpose of sale of a security. Section 10(b) provides: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange— … (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.13

Rule 10b-5 was promulgated under Section 10(b) to further define the general prohibition under Section 10(b).14 Rule 10b-5 forms the basis for the vast majority of securities fraud claims. Rule 10b-5 provides: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or 15 U.S.C. § 78j. See 17 C.F.R. § 240.10b-5.

13 14

Directors’ and officers’ liability under securities laws  177 (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.15

Rule 10b-5 focuses on two categories of activities: (1) misstatements and omissions, and (2) insider trading. Any violation of Rule 10b-5 must involve the use of interstate commerce, the mails, or any facility of any national securities exchange.16 The bar for this jurisdictional requirement is exceedingly low, and thus is easily satisfied so long as a means of interstate commerce is used in any phase of the securities transaction.17 Importantly, any use of the Internet during any phase of the securities transaction satisfies this requirement.18 While neither Section 10(b) nor Rule 10b-5 address private enforcement, it is now settled law that there is a private right of action under such rules. In addition, individual directors and officers may be subject to criminal or civil liability under Rule 10b-5. Insider trading refers to trading or passing securities on the basis of material nonpublic information in violation of a duty.19 Individual officers and directors can he held liable under Rule 10b-5 for engaging in insider trading.20 This section will focus on the elements needed to prove the relatively more straightforward securities fraud violation for misstatements and omissions. In addition to the jurisdictional requirement, the elements needed to establish a material misstatement or omission under Rule 10b-5 are: (1) a misstatement or omission, (2) scienter – state of mind, (3) materiality, and (4) a connection to the purchase or sale of securities.21 Any private action also must include (5) reliance, (6) causation, and (7) damages.22 Government actions need not prove these additional elements.23 As an initial matter, a Rule 10b-5 action involving a misstatement or omission must involve a problematic misstatement, omission, or both. With respect to omissions, silence on its own is not actionable; instead, silence or an omission is only actionable when there is a duty to speak.24 Rule 10b-5 does not create a duty to speak. However, once a statement is made, an omitted fact becomes actionable when that omission is ‘necessary to make the statements made, in light of the circumstances under which they were made, not misleading’.25 Courts also have concluded that Rule 10b-5 covers problematic opinions. An opinion gives rise to liability

See id. 17 U.S.C. § 78j. 17 See United States v. Kunzman, 54 F.3d 1522, 1526–27 (10th Cir. 1995) (jurisdictional requirement satisfied by use of highways, air, travel and withdrawals or deposits of checks); Richter v. Acha, 962 F.Supp. 31, 33 (S.D.N.Y. 1997). 18 See SEC v. Straub, 921 F. Supp. 2d 244, 262 (S.D.N.Y. 2013). 19 See e.g., Chiarella v. United States, 445 U.S. 222 (1980) (detailing ‘classical’ theory of insider trading); United States v. O’Hagan, 521 U.S. 642 (1997) (detailing ‘misappropriation’ theory of insider trading). See also Dirks v. SEC, 463 U.S. 646 (1983) (explaining tipper-tippee liability). 20 See e.g., Chiarella, 445 U.S. at 227–28 (describing classic insiders as officers and directors). 21 See 3 Thomas Hazen, Treatise on the Law of Securities Regulation § 12:19 (7th ed. 2016); Dura Pharmaceuticals, Inc v. Brouda, 544 U.S. 336 (2005). 22 See Hazen, supra note 21, § 12:19; Dura Pharmaceuticals, 544 U.S. at 336. 23 See Hazen, supra note 21 at § 12:19. 24 See Chiarella, 445 U.S. at 222. 25 See 17 C.F.R. § 240.10b-5(b). 15 16

178  Research handbook on corporate liability under Rule 10b-5, (1) if the speaker does not believe the stated opinion, or (2) the opinion is not well-grounded in facts.26 In 2011, in Janus Capital Group, Inc. v. First Derivative Traders,27 the Supreme Court held that an individual could not be held liable for fraud unless he or she was the ‘maker’ of a statement.28 The Janus Court defined ‘maker’ as ‘the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it’.29 Thus, someone who participates in the drafting of a statement or prepares a statement on behalf of another is not a maker. The Janus Court based its interpretation on subsection (b) of Rule 10b-5, which uses the word ‘make’. Such an interpretation sharply narrows the extent to which directors and officers can be held liable for securities fraud under Rule 10b-5(b). Indeed, with respect to public companies, generally the CEO and CFO are the only officers who sign off on public company statements or field documents.30 As a result, this interpretation appears to exclude most officers and outside directors even if they participate in drafting misleading statements. In 2019, the Supreme Court created a different opening for securities fraud liability for individuals, including officers and directors, who intentionally disseminated misstatements or omissions. In Lorenzo v. SEC, the Court found that, while someone may not be liable as the ‘maker’ of a statement under Rule 10b-5(b) when their only role is as a participant in a statement, they could nonetheless be liable under 10b-5(a) and (c) if they disseminated the statement because such dissemination violated prohibitions against fraudulent schemes and practices embedded in the language of Rule 10b-5(a) and (c).31 In Lorenzo, the Court relied on dictionary definitions of the language in such Rules to find that a person need not make a statement in order to be held liable for employing a scheme to defraud under Rule 10b-5.32 The decision in Lorenzo increases the likelihood that a broader range of officers and directors, including outside directors, will be exposed to liability under Rule 10b-5. To be sure, the Supreme Court noted that their opinion should not be viewed as imposing Rule 10b-5 liability on someone tangentially involved in disseminating false information such as a mailroom clerk.33 However, given their more hands-on role in document formation and dissemination, and their increased oversight responsibilities, Lorenzo likely can be viewed as increasing the potential liability for directors and officers. Assessing the materiality of a misstatement or omission depends upon the type of information at issue. If information involves the past or an objective fact, then materiality is assessed under TSC Indus. v. Northway, Inc., whereby it must be proven that there is a substantial likelihood that the information would impact the decision of a reasonable investor.34 This

See Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S. Ct. 1315 (2015). 27 Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011). 28 See id. 29 See id. 30 See Marc Fagel & Monica Loseman, Exchange Act Section 20(b): The SEC Enforcement Division Dusts Off an Old Weapon, 18 Wall St. Law. 9, Sept. 2014, at 1. 31 See Lorenzo v. SEC, 139 S. Ct. 1094 (2019). 32 See id. 33 See id. 34 See TSC Indus. et al. v. Northway, Inc., 426 U.S. 438, 449 (1976). 26

Directors’ and officers’ liability under securities laws  179 materiality standard is also referred to as altering the ‘total mix’ of information.35 If a misstatement or omission involves information relating to speculative, contingent or uncertain events, materiality is assessed under Basic v. Levinson, which requires judging the probability of an event against its anticipated magnitude.36 When assessing materiality, it is also important to be mindful of the distinction between specific statements and those deemed too vague to satisfy the materiality threshold. Courts view vague statements or general expressions of optimism as ‘puffery’ and thus immaterial.37 Scienter refers to the intent necessary to establish a securities fraud violation. In order to demonstrate a civil violation of Rule 10b-5, actions must be taken intentionally or at least recklessly.38 Thus, negligence or gross negligence is insufficient to establish scienter. For purposes of a criminal violation, ‘willfulness’ must be established.39 As stated, private actions not brought by the government must also demonstrate reliance, causation, and damages. Reliance must be established in transactions involving face-to-face interactions as well as those involving a class action.40 In face-to-face transactions, reliance can be proven by showing justifiable reliance.41 In class actions, Basic v. Levinson allows for a rebuttable presumption of reliance. The plaintiff must allege and prove four elements to trigger the presumption of reliance: (1) the defendant made public misrepresentations; (2) the misrepresentations were material; (3) the shares were traded in an efficient market (which requires the consideration of a number of factors); and (4) the plaintiff traded the shares between the time of the misrepresentations and the time the truth was revealed.42 This presumption can be overcome in several ways, including proof that a trading decision was made on the basis of factors not linked to any of the misrepresentations.43 The rebuttable presumption in Basic is based on the fraud on the market theory.44 That theory posits that ‘[b]ecause most publicly available information is reflected in market price, an investor’s reliance on any public material misrepresentations, therefore, may be presumed for purposes of a Rule 10b-5 action’.45 The fraud on the market theory has been questioned and thus the Supreme Court has had to grapple with whether or not to overturn the presumption embedded in Basic. Given that all securities fraud class actions rely on the rebuttable presumption, such an action would have effectively eviscerated securities fraud actions. Ultimately, the Supreme Court upheld Basic,46 thereby ensuring that securities class actions would be able to proceed. There are two forms of causation that must be proven: transaction causation and loss causation. Transaction causation relates to a ‘but for’ causation and is often viewed as synonymous

See id. See Basic v. Levinson, 485 U.S. 224, 238 (1988). 37 See Jennifer O’Hare, The Resurrection of the Dodo: The Unfortunate Re-Emergence of the Puffery Defense in Private Securities Fraud Actions, 59 Ohio St. L.J. 1697, 1707–708 (1998). 38 See Hazen, supra note 21, at § 12:19; Ernst v. Hochfelder, 425 U.S. 185 (1976). 39 See O’Hagan, 521 U.S. at 677 n.23. 40 See Amgen Inc. v. Conn. Ret. Plans & Trust Funds, 568 U.S. 455, 461 (2013); Basic, 485 U.S. at 243. 41 See Hazen, supra note 21, at § 12.18. 42 See id. at §12:19; Basic, 485 U.S. at 248 n.27. 43 See Hazen, supra note 21, at § 12:19. 44 See Basic, 485 U.S. at 241. 45 See id. 46 See Halliburton Co. v. Erica P. John Fund, Inc., 134 S.Ct. 2398, 2412–17 (2014). 35 36

180  Research handbook on corporate liability with reliance.47 Loss causation refers to the notion that the plaintiff must prove that the defendant caused her loss, and thus that the loss can be attributed to the defendant’s fraudulent behavior rather than the market, industry conditions, or some other cause extraneous to the fraud.48 Plaintiffs seeking damages under Rule 10b-5 must prove that they purchased or sold securities.49 Damages are assessed based on the out-of-pocket losses caused by the material misstatement or omission.50 2. Section 11 Directors and officers also may be subject to liability under Section 11 of the Securities Act.51 Section 11 not only imposes strict liability for corporations that issue securities under a registration statement in an effective public offering that contains a material misstatement of omission in the registration statement, but also makes certain officers and directors liable.52 Section 11 liability extends to the CEO, the CFO and all of the directors who sign the statement or are otherwise named in the registration statement.53 Any person who acquires a security covered by the registration can bring suit under Section 11. Such a person need only show that a material misstatement or omission exists in the registration statement and that she suffered damages. A Section 11 plaintiff does not need to prove causation or reliance on the statement or omission. As a general matter, Section 11 enables a purchaser to bring suit even if she bought the security on the secondary market after the initial offering. Indeed, as long as the purchaser can trace the purchase back to the initial offering and is within the statute of limitations, she can bring suit.54 Damages are limited to the difference between the price the purchaser paid for the security (but no more than the public offering price), and the value of the securities at the time of the lawsuit, or the price at which the person disposed of the security. While the issuing corporation has no defense and is thus strictly liable under Section 11, directors and officers have a ‘due diligence’ defense. For ‘expertized’ portions of the registration statement – those purporting to be made on the authority of an expert – a director or officer may avoid liability so long as she had no reasonable grounds to believe and did not believe that there were any material misstatements or omissions in the expertized portion of the registration statement. For any other portion of the registration statement, a director or officer may avoid liability if she, after reasonable investigation, had reasonable grounds to believe, and did believe, that there were no material misstatements or omissions in such portions. Research shows that outside directors, if they are held liable under securities laws, are most likely to be subject to out of pocket losses for claims under Section 11. To be sure, as this chapter later explains, outside director liability is exceedingly rare. Indeed, research indicates that there are no cases since 1980 that have held outside directors liable after trial under either See McCabe v. Ernst & Young, LLP, 494 F.3d 418, 425 (3d Cir. 2007). See Dura Pharmaceuticals, Inc v. Brouda, 544 U.S. 336, 342–46 (2005). 49 See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 737 (1975). 50 See Hazen, supra note 21 at § 12:19; Wool v. Tandem Computers, Inc., 818 F2d 1433 (9th Cir. 1987). 51 See 15 U.S.C. §77k. 52 See id. 53 See id. 54 See Barnes v. Osofsy, 373 F.2d 269 (2d Cir. 1967); see also Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076 (9th Cir. 1999). 47 48

Directors’ and officers’ liability under securities laws  181 Section 11 or Section 10(b).55 However, there are a few cases in which outside directors have been subject to out-of-pocket losses in connection with securities settlements.56 Research reveals that all of those cases were brought under Section 11. Researchers suggest that this finding results from the SEC’s policy against indemnification in Section 11 cases.57 3. Section 17(a) Directors and officers may also find themselves subject to liability for securities fraud under Section 17(a) of the Exchange Act.58 That Section prohibits fraudulent conduct in connection with a securities transaction. Section 17 makes it unlawful: (1) to employ any device, scheme, or artifice to defraud, or (2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or (3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.59

These prohibitions are very similar to Section 10(b) and Rule 10b-5. There are two noticeable differences. First, while some courts have recognized a private right of action under Section 17(a), in most jurisdictions, only the government may use Section 17(a).60 Second, for civil actions, there is no requirement to demonstrate scienter under Section 17(a).61 Criminal actions, however, do require proof of scienter or willfulness. The differences between Rule 10b-5 and Section 17(a) mean that Section 17(a) allows the pursuit of civil cases related to securities fraud under circumstances that would not be possible under Section 10(b) and Rule 10b-5. As a result, the SEC has demonstrated an increased willingness to rely upon Section 17(a).62 4. Control person liability and Section 20(a) Section 20(a) of the Exchange Act imposes liability on individual directors and officers who are deemed to control an entity found liable for securities fraud. Section 20(a) provides that a person who controls another person found liable for securities fraud under the Exchange Act is jointly and severally liable unless the controlling person acted in good faith and did not directly or indirectly induce the violation.63 Liability under Section 20(a) requires a primary violation by a ‘controlled’ person – which includes entities – and proof that the individual or entity being charged under Section 20(a) ‘controlled’ the primary violator. Some courts also require a showing of ‘culpable participation’ of the individual being charged as a control

See Bernard Black et al., Outside Director Liability, 58 Stan. L. Rev. 1055, 1089 (2006). See id. 57 See id. 58 See 15 U.S.C. § 78q. 59 See id. 60 See Nick Oberheiden, The Growing Risk of Securities Fraud Litigation Under Section 17(a), Nat’l L. Rev., Nov. 4, 2021, https://​www​.natlawreview​.com/​article/​growing​-risk​-securities​-fraud​ -litigation​-under​-section​-17a 61 See id. 62 See id. 63 See 15 U.S.C.§ 78(a). 55

56

182  Research handbook on corporate liability person.64 While it has always been clear that private persons could bring an action alleging control person liability under Section 20(a), courts were split as to whether the SEC could bring such an action.65 The Dodd-Frank Wall Street Reform and Consumer Protection Act (‘Dodd-Frank’),66 passed in 2010 as a response to the economic recession and global financial crisis of 2008, made clear that the SEC could enforce the control person provision.67 Both officers and directors can be held liable as control persons. While Section 20(a) does not define ‘control’, the SEC has defined ‘control’ as the power to direct or cause the direction of an entity.68 Control person liability does not depend upon the exercise of the control.69 Instead, it need only be proven that an individual has the power to exercise control.70 Courts generally presume that executive officers have this power and thus fall within the definition of control persons, subjecting such officers to control person liability.71 While not automatically presumed, courts also have concluded that outside directors may be viewed as control persons.72 For outside directors, there must be proof of some actual participation in corporate activities or influence over corporate affairs.73 Section 20(a) gives the SEC and private actors the power to pursue officers and directors even if they do not actively participate in wrongdoing. Thus, instead of proving that an individual engaged in misconduct, it need only be proven that an officer or director had the requisite control to impose liability. Section 20(a) was passed to prevent individuals from engaging in wrongdoing through their business entities or subordinates.74 Section 20(a) plays an important role in policing individual misconduct. One commentator indicated that virtually every securities fraud complaint includes an allegation of control person liability.75 Claims related to control person liability appear most frequently in Rule 10b-5 violations.76 However, control person liability claims also frequently accompany claims under Section 11.77

64 See Frank Kaplan, Control Person Liability – Is Pleading Proof of ‘Culpable Participation’ Required and What Does that Requirement Mean?, 135 Banking L.J. 399, 400–408 (2018); Brianna Gates, The SEC on a Forum Shopping Spree: SEC Enforcement Power and Control Person Liability After Dodd-Frank, 99 Iowa L. Rev. 393, 402–10 (2013). 65 See Gates, supra note 64, at 401. 66 Dodd-Frank Act of 2010, Pub. L. 111–203, 124 Stat. 1376 (2010) (codified in scattered sections of the U.S. Code). 67 See id. at 1865 (codified at 15 U.S.C.§ 78(a)); see also Gates, supra note 64, at 402. 68 See 17 C.F.R. § 230.405. 69 See IBS Financial Corp. v. Seidman & Associates, 136 F.3d 940 (3d Cir. 1998). 70 See id. 71 See Hazen, supra note 21, § 12:201. 72 See id. 73 See id.; see also Burgess v. Premier Corp., 727 F.2d 826, 832 (9th Cir. 1984). 74 See Gates, supra note 64, at 398. 75 See Kaplan, supra note 64, at 398. 76 See id. at 399. 77 See Black, supra note 55, at 1077 n.66.

Directors’ and officers’ liability under securities laws  183 B.

Distinguishing Individuals

1. DOJ and SEC focus on individuals Both the SEC and DOJ have emphasized individual liability. This emphasis is aligned with the view that holding individuals accountable is essential to overall corporate liability.78 The DOJ’s official enforcement policy has centered on prosecuting individual directors and officers. In 2015, the DOJ, under President Barak Obama, issued a memo, authored by Deputy Attorney General Sally Yates, announcing changes to its policies governing investigations of corporate misconduct.79 The so-called ‘Yates Memo’ was titled ‘Individual Accountability for Corporate Wrongdoing’. It notes: ‘One of the most effective ways to combat corporate misconduct is by seeking accountability from the individuals who perpetrated the wrongdoing.’80 The Yates Memo also insisted that focusing on individuals was critical because a corporation ‘only acts through individuals’, and thus focusing on individuals ensures that the goals of deterrence and accountability are met.81 The Yates Memo ensures that focusing on individuals is a core feature of any government prosecution. Indeed, the Yates Memo directs prosecutors to ‘focus on individual wrongdoing from the very beginning of any investigation’.82 The Yates Memo also directs companies seeking cooperation credit from the government to ‘identify all individuals involved in or responsible for the misconduct at issue, regardless of their position, status or seniority’. 83 In order to be eligible for cooperation credit, companies must provide all relevant facts about individuals involved in misconduct to the DOJ.84 Importantly, the Yates Memo indicates that both criminal and civil investigations should focus on individuals, and thus be subject to the policies outlined in the Yates Memo.85 The Yates Memo’s requirement that corporations identify all individuals involved in any aspect of alleged wrongdoing, regardless of their position, status, or seniority, expands the focus on corporate individuals beyond senior officers and directors, sweeping in mid-level and even rank-and-file employees. This sweeping focus was premised on the substantial challenges associated with pursuing individuals for corporate misdeeds, including the problems with establishing liability for high-level executives because of the difficulty in reconstructing wrongdoing and ferreting out information about those involved with the corporation’s daily activities.86 In other words, the Yates Memo insists that this sweeping focus is necessary to ensuring the most effective prosecutions of corporate misdeeds. The change in presidential administrations brought a shift in DOJ enforcement policy, although the emphasis on individuals was maintained. In 2018, the new Deputy Attorney General announced an enforcement policy aimed at relaxing the policies outlined under the

78 See SEC, 2020 SEC Div. Enf’t Ann Rep., https://​www​.sec​.gov/​files/​enforcement​-annual​-report​ -2020​.pdf [hereinafter Enforcement 2020 Annual Report]. 79 See Sally Q. Yates, Deputy Att’y Gen., DOJ, Individual Accountability for Corporate Wrongdoing, Memorandum (Sept. 9, 2015), https://​www​.justice​.gov/​archives/​dag/​file/​769036/​download [hereinafter Yates Memo]. 80 See id. at 1. 81 See id. at 4–5. 82 See id. at 4. 83 See id. at 3. 84 See id. at 3. 85 See id. at 3–4. 86 See id. at 2.

184  Research handbook on corporate liability Yates Memo.87 On the one hand, the memo proclaimed that pursuing individuals responsible for wrongdoing would remain a ‘top priority in every corporate investigation’, and that the ‘most effective deterrent to corporate criminal misconduct is identifying and punishing the people who committed the crimes’.88 However, the new policy also emphasized the importance of imposing penalties on corporations and questioned the ‘deterrent impact’ of seeking to focus on every individual involved in corporate wrongdoing.89 The new policy therefore focused on awarding cooperation credit to companies so long as a corporation identified individuals who played ‘significant’ roles in ‘setting a company on a course of criminal conduct’.90 The new policy emphasized that such a focus would capture wrongdoing by ‘senior officials, including members of senior management or the board of directors’.91 The new policy also decoupled criminal and civil investigations, indicating a desire to give more flexibility and discretion to attorneys focused on civil matters.92 The election of President Joseph A. Biden saw another change in presidential administration and another shift in enforcement policy focus. Hence, in October 2021, Deputy Attorney General Lisa Monaco announced that the DOJ was restoring the previous guidance under the Yates Memo.93 Monaco’s new policy recounted: ‘Accountability starts with the individuals responsible for criminal conduct. Attorney General Garland has made clear it is unambiguously their department’s first priority in corporate criminal matters to prosecute the individuals who commit and profit from corporate malfeasance’.94 Monaco’s policy restored the guidance under the Yates Memo associated with identifying ‘all individuals involved in the misconduct, regardless of their position, status or seniority’.95 In so doing, the policy made clear that companies can no longer limit their disclosure to the DOJ to those ‘substantially involved’ in misconduct, but instead must provide information about all of the ‘cast of characters involved in any misconduct’.96 Importantly, while the DOJ’s enforcement policy has shifted throughout the years, it has remained focused on individuals in general and directors and executive officers in particular. In this regard, the policy reflects a strong emphasis on holding directors and officers liable for misconduct. The SEC similarly has prioritized individual accountability. The Annual Report for the SEC’s Division of Enforcement has a section titled ‘Holding Individuals Accountable’.97 The 2020 Annual Report opens with the following statement: ‘We have long recognized that indi87 See DOJ, Deputy Attorney General Rod J. Rosenstein Delivers Remarks at the American Conference Institute’s 35th International Conference on the Foreign Corrupt Practices Act, Nov. 29, 2018, https://​www​.justice​.gov/​opa/​speech/​deputy​-attorney​-general​-rod​-j​-rosenstein​-delivers​-remarks​ -american​-conference​-institute​-0 88 See id. 89 See id. 90 See id. 91 See id. 92 See id. 93 See Lisa Monaco, Deputy Atty Gen., DOJ, Keynote Address at ABA’s 36th National Institute on White Collar Crime (Oct. 28, 2021), https://​www​.justice​.gov/​opa/​speech/​deputy​-attorney​-general​-lisa​-o​ -monaco​-gives​-keynote​-address​-abas​-36th​-national​-institute 94 See id. 95 See id. 96 See id. 97 See Enforcement 2020 Annual Report, supra note 78, at 4.

Directors’ and officers’ liability under securities laws  185 vidual accountability is critical to an effective enforcement program. Institutions act through their employees, and holding culpable individuals responsible for wrongdoing is essential to achieving our goals of general and specific deterrence and protecting investors by removing bad actors from our markets.’98 A former SEC Chair, put it this way: ‘A company, after all, can only act through its employees and if an enforcement program is to have a strong deterrent effect, it is critical that responsible individuals be charged, as high up as the evidence takes us.’99 In the SEC’s words, the SEC places a ‘premium’ on ‘establishing individual liability where appropriate.’100 This policy has translated into an enforcement focus on individuals. One study revealed that from 2000 to 2013, the SEC charged individuals in 93 percent of its fraud and financial reporting cases.101 An internal SEC staff analysis indicated that the SEC charged individuals in 83 percent of its actions.102 As former SEC Chair Mary Jo White noted, ‘cases where individuals are not charged are by far the exception, not the rule’.103 This focus on individuals has persisted in recent years. In its 2020 Annual Report, the SEC highlighted the fact that 72 percent of its standalone actions involved charges against individuals.104 The SEC also highlighted the fact that this percentage was aligned with charges brought against individuals in the last several years.105 Indeed, in 2017, 73 percent of the SEC’s standalone actions involved charges against individuals.106 In 2018, 72 percent of the SEC’s standalone actions involved charges against individuals.107 Subsequent years mirrored this trend. Thus, in 2021, 70 percent of standalone SEC enforcement actions involved at least one individual.108 2. Officers vs. Outside Directors To be sure, it is understandable that corporate liability would focus on individuals, especially officers and directors given their potential influence over corporate affairs. Executive officers such as the CEO and CFO have responsibility for setting strategy and overseeing the overall operations of the corporation. Directors, especially outside independent directors, have responsibility for overseeing the corporation and its affairs, and have been tasked with increasingly greater responsibilities in the past decades. However, the emphasis on corporate individuals has not had the same impact on officers and outside directors. Research shows that the likelihood of outside directors being targeted

See id. See Mary Jo White, Chair, SEC, Speech at NYC Bar Association’s Third Annual White Collar Crime Institute: Three Key Pressure Points in the Current Enforcement Environment (May 19, 2014), https://​www​.sec​.gov/​news/​speech/​2014​-spch051914mjw​.html 100 See Enforcement 2020 Annual Report, supra note 78 at 4. 101 See White, supra note 99; June Rhee, SEC Practice in Targeting and Penalizing Individual Defendants, Sept. 3, 2013, https://​corpgov​.law​.harvard​.edu/​2013/​09/​03/​sec​-practice​-in​-targeting​-and​ -penalizing​-individual​-defendants/​ 102 See White, supra note 99. 103 See id. 104 See Enforcement 2020 Annual Report, supra note 78, at 4, 21. 105 See id. 106 See SEC, 2018 SEC Div. Enf’t Ann Rep. at 2, 12, https://​www​.sec​.gov/​files/​enforcement​-annual​ -report​-2018​.pdf. 107 See id. at 2. 108 See Press Release, SEC, SEC Announces Enforcement Results for FY 2021 (Nov. 18, 2021), https://​www​.sec​.gov/​news/​press​-release/​2021​-238 98 99

186  Research handbook on corporate liability as defendants is exceedingly low. Most securities fraud litigation focuses on officers, rather than outside directors. For example, a study by Professors Hillary Sale and Robert Thompson revealed that the vast majority of securities fraud class actions name officers as defendants. Their study focused on securities fraud claims in 1999.109 Virtually all of the complaints (81 out of 82) that identified individuals as defendants focused on CEOs or CFOs.110 Only twenty-one of the complaints that identified an individual as a defendant named any outside director as a defendant.111 In other words, very few cases included any directors beyond those who were also officers.112 Another study of the period 1985–2005, similarly found that outside directors are rarely named as defendants.113 SEC enforcement mirrors this trend. Thus, the SEC’s 2020 year-end report reveals that, while more than 70 percent of their standalone actions targeted individuals, targeted individuals primarily are CEOs, CFOs, and chief operating officers.114 Indeed, a 2013 study covering cases from 2000–2013 found that the SEC targeted individuals in 93 percent of its cases, but that those targets were primarily CEOs, CFOS, and other executives.115 Those who have studied SEC enforcement actions agree that the likelihood of SEC enforcement actions against outside directors is very low.116 Alas, even if the SEC targets outside directors, it is very rare for directors to pay out-of-pocket damages. Thus, research reveals that outside directors’ risks of out-of-pocket damages is exceedingly low even when directors are named defendants and are successfully held liable for wrongdoing. Thus, one study covering a 25-year period from 1980 to 2005 found only 12 cases in which outside directors made out-of-pocket payments.117 Three of those cases involved situations in which outside directors were forced to settle for amounts outside of indemnification and insurance limits. 118 A follow up study confirmed the rarity of out-of-pocket payments for outside directors. That study found no cases resulting in outside directors’ out-of-pocket payments during the period between 2006 and 2010.119 This rarity stems from several factors. First, even when cases are filed, challenging pleading standards and substantive rules usually mean that very few make it past the pleading stage and fewer still go to trial.120 Second, corporate indemnification agreements ensure that corporations pay for any of the costs associated with securities actions so long as directors acted in good

See Hillary Sale & Robert Thompson, Securities Fraud as Corporate Governance: Reflections Upon Federalism, 56 Vand. L. Rev. 859, 890 (2003). 110 See id. at 895. 111 See id. at 896. 112 See id. at 896–97. 113 See Black, supra note 55, at 1064. 114 See Enforcement 2020 Annual Report, supra note 78, at 21. 115 See Rhee, supra note 101. 116 See David F. Larcker & Brian Tayan, Seven Myths of Boards of Directors, CGRP-51 Stan. Closer Look Series (2015), http://​papers​.ssrn​.com/​sol3/​papers​.cfm​?abstract​_id​=​2669629. 117 See id. at 3; Black, supra note 55, at 1063–64. 118 See Larcker & Tayan, supra note 116, at 3. 119 See id.; Michael Klausner et al., How Protective is D&O Insurance in Securities Class Actions? – An Update (PLUS Journal, May 2013, Stan. L. & Econs. Olin, Working Paper No. 446; Rock Ctr. Corp. Gov’n Stan. U., Working Paper No. 144, 2013), https://​ssrn​.com/​abstract​=​2260815. 120 See Christine Hurt, The Duty to Manage Risk, 39 J. Corp. L. 253, 267 (2014); see also Fairfax, supra note 3, at 422–23. 109

Directors’ and officers’ liability under securities laws  187 faith.121 Third, corporations carry director and officer liability insurance (D&O insurance), and such D&O insurance covers expenses associated with litigation and settlements, including any settlement payments levied against directors and officers.122 Irrespective of what happens in terms of out of pocket liability, it is clear that there is a sharp divergence between the treatment of officers and outside directors. There are likely many reasons for this divergence. First, outside directors are not as connected to the day-to-day operations of the company and thus may be less likely to engage in problematic activities, or even be aware of such activities.123 Second, even if outside directors have an awareness or otherwise participate in problematic activities, pleading standards may make it very difficult to establish the necessary culpability to hold them liable for such activities.124 These two factors may explain why outside directors do not have the same risks of liability as officers. That is, they may explain why decision makers may determine that the costs and risks of targeting outside directors far exceed the benefits, and why outside directors accordingly do not find themselves the targets of prosecution. Then too, many have insisted that extralegal factors diminish the need for legal liability, especially those associated with outside directors.125 In particular, scholars have argued that market factors as well as reputational sanctions are sufficient to ensure that outside directors pay heed to their responsibilities.126 As a result, these scholars maintain that liability is not necessary to achieve the optimal level of deterrence for outside directors.127 Others disagree and insist that there is a need for enhanced liability for outside directors commensurate with their increased responsibility for core company functions.128 Indeed, I have argued elsewhere that we need an appropriate combination of legal and extralegal factors to create optimal deterrence.129 The clear rarity of outside directors as targets of securities actions raises important questions about whether such deterrence has been realized. C.

Implications for ESG

Recent years have seen a rise in the focus on ESG. The growing focus on ESG within the corporate community is symbolized by the 2019 statement from the Business Roundtable, the leading association of the nation’s top CEOs, purporting to ‘redefine’ corporate purpose to include a commitment to all stakeholders and a focus on a range of environmental and

123 124 125 126 127 128 129 121 122

See Larcker & Tayan, supra note 116, at 3; see also Fairfax, supra note 3, at 426–27. See id. See Yates Memo, supra note 79, at 2. See id. at 2. See Fairfax, supra note 3, at 428–30 (discussing arguments related to reputation and markets). See id. See id. See id. at 430–32. See id. at 443–49.

188  Research handbook on corporate liability social issues.130 While the Business Roundtable statement sparked considerable controversy,131 surveys revealed that a majority of CEOs agreed with the concepts embodied in the statement.132 Other studies revealed that ESG was ‘almost universally’ a core focus for corporate officers and directors.133 Then too, a broad range of investors, including the nation’s most influential investors and asset managers, have called on corporations to prioritize ESG.134 Surveys also reveal that investment funds have increased their focus and advocacy around ESG issues.135 Proxy reports for the 2021 shareholder voting season show a rise in shareholder ESG proposals coupled with a rise in shareholder support for ESG proposals, including support from the largest institutional shareholders.136 Among other things, the rising focus on ESG has translated into increased pressure for disclosure related to ESG.137 Corporations have responded to this pressure in at least two ways. First, corporations have increased their ESG disclosures in mandated filings. Currently there is very little in the way of mandatory ESG disclosure around specific topics.138 However, corporations have increasingly incorporated ESG issues into their mandated reports based on their

130 See Business Roundtable, Business Roundtable Redefines the Purpose of a Corporation to Promote ‘An Economy that Serves All Americans’, Aug. 19, 2019, available at https://​www​.businessroundtable​ .org/​business​-roundtable​-redefines​-the​-purpose​-of​-a​-corporation​-to​-promote​-an​-economy​-that​-serves​ -all​-americans [hereinafter Business Roundtable Statement] (‘redefining’ corporate purpose to promote an economy that serves all Americans’). 131 See Lucian Bebchuk & Roberto Tallarita, The Illusory Promise of Stakeholder Governance, 106 Cornell L. Rev. 91, 124–25 (2020), https://​papers​.ssrn​.com/​abstract​=​3544978; Edward B. Rock, For Whom is the Corporation Managed in 2020? The Debate over Corporate Purpose (Eur. Corp. Gov. Inst., Law Working Paper No. 515/2020, Sept. 2020), https://​ssrn​.com/​abstract​=​3589951; Jesse Fried, The Roundtable’s Stakeholderism Rhetoric is Empty, Thankfully, Harv. L. Sch. F. on Corp. Gov’n (Nov. 22, 2019), https://​corpgov​.law​.harvard​.edu/​2019/​11/​22/​the​-roundtables​-stakeholderism​ -rhetoric​-is​-empty​-thankfully; see also Andrew Winston, Is the Business Roundtable Statement Just Empty Rhetoric?, Harv. Bus. Rev. (Aug. 30, 2019), https://​hbr​.org/​2019/​08/​is​-the​-business​-roundtable​ -statement​-just​-empty​-rhetoric. 132 See Ira T Kay et al., The Stakeholder Model and ESG, Pay Governance (Sept. 1, 2020), https://​ www​.paygovernance​.com/​viewpoints/​the​-stakeholder​-model​-and​-esg (citing Fortune survey demonstrating that 63% of CEOs agreed with Business Roundtable Statement). 133 See Robert G. Eccles & Svetlana Klimenko, The Investor Revolution, Harv. Bus. Rev. 106–16 (May–June 2019), https://​hbr​.org/​2019/​05/​the​-investor​-revolution (ESG issues were ‘almost universally’ at the top of the minds of executives). 134 See Podcast Interview with Sara Bernow & Robin Nutall, Why ESG is Here to Stay, McKinsey & Co. (May 26, 2020), https://​www​.mckinsey​.com/​business​-functions/​strategy​-and​-corporate​-finance/​our​ -insights/​why​-esg​-is​-here​-to​-stay. 135 See Evie Liu, Fund Companies Are Paying More Attention to ESG Matters, Survey Shows, Barron’s (Jul. 22, 2021), https://​www​.barrons​.com/​articles/​fund​-companies​-are​-paying​-more​-attention​ -to​-esg​-matters​-survey​-shows​-51626914577. 136 See Sidley Austin LLP, Environmental, Social, and Governance Disclosures in Proxy Statements: Benchmarking the Fortune 50 (Aug. 31, 2021), at 2 and 6–7, https://​www​.sidley​.com/​en/​insights/​ newsupdates/​2021/​08/​environmental​-social​-and​-governance​-disclosures​-in​-proxy [hereinafter Sidley Report]. See Sullivan and Cromwell LLP, 2021 Proxy Season Review Part 1: Rule 14a-8 Shareholder Proposals (Jul. 27, 2021), at 1, https://​www​.sullcrom​.com/​files/​upload/​sc​-publication​-2021​-Proxy​ -Season​-Review​-Part​-1​-Rule14a​-8​.pdf [hereinafter SC 2021 Proxy Report]. 137 See Era Anagnosti et al., ESG Disclosure Trends in SEC Filings, White & Case (Aug. 13, 2020), at 9 (investor pressure for ESG disclosure has resulted in greater ESG disclosure). 138 Mandatory disclosure is more common and significant outside of the US. See Jill Fisch, Making Sustainability Disclosure Sustainable, 107 Geo. L.J. 923, 942–43 (2019).

Directors’ and officers’ liability under securities laws  189 assessment around the materiality of such information. Indeed, the SEC has issued interpretive guidance encouraging corporations to think more critically about the materiality of their ESG information.139 Presumably in response to such guidance and investor pressure, corporations have increased disclosure around ESG issues in their periodic reports. A 2018 study found that almost 40 percent of S&P 500 companies included some ESG information in their annual reports, Form 10-K, or proxy statements.140 A 2020 survey of ESG disclosure in SEC filings of the top 50 companies revealed that every company increased its ESG disclosures in at least one category in their proxy statement, and 42 percent of such companies increased their ESG disclosures in their annual report.141 Second, corporations have dramatically increased voluntary ESG disclosure outside of periodic filings. According to a 2020 Government Accountability Study, 90 percent of S&P 500 companies published separate ESG reports in 2019, up from 86 percent in 2018, and less than 20 percent in 2011.142 In addition, 65 percent of Russell 1000 companies published sustainability reports, up from 60 percent in 2018.143 A 2018 study found that some 92 percent of S&P 500 companies had some type of ESG information on their websites, while some 78 percent issued an ESG report.144 These voluntary ESG reports have become increasingly more specific and detailed.145 Recent proxy reports reveal that 90 percent of large public companies voluntarily disclose ESG information on their websites.146 The SEC has responded to the increased focus on ESG in several ways. In February 2021, the SEC appointed a Senior Policy Advisor for Climate and ESG.147 On March 4, 2021, the SEC created a Task Force on Climate and ESG Issues to coordinate the use of resources to identify potential violations of the securities laws. 148 The Task Force is not only set to work closely with the other SEC Divisions, but also will evaluate and pursue tips and complaints

139 See Commission Guidance Regarding Disclosure Related to Climate Change, Release Nos. 33-9106; 34-61469, 75 Fed. Reg. 6289 (SEC, Feb. 8, 2010). 140 See Sustainable Investments Institute, State of Integrated and Sustainability Reporting 2018 (2018), https://​siinstitute​.org/​special​_report​.cgi​?id​=​77 141 See Anagnosti, supra note 137, at 3. 142 See Governance & Accountability Institute, Inc., 2020 Russell 1000 Research Report (2020), https://​www​.ga​-institute​.com/​research​-reports/​flash​-reports/​2020​-russell​-1000​-flash​-report​.html [hereinafter 2020 Flash Report]; Governance and Accountability Institute, Inc., 90% of S&P 500 Index Companies Publish Sustainability Reports in 2019, G&A Announces in its Latest Annual 2020 Flash Report (Jul. 16, 2020), https://​www​.globenewswire​.com/​news​-release/​2020/​07/​16/​2063434/​0/​en/​ 90​-of​-S​-P​-500​-Index​-Companies​-Publish​-Sustainability​-Reports​-in​-2019​-G​-A​-Announces​-in​-its​-Latest​ -Annual​-2020​-Flash​-Report​.html (86% in 2018). See also Fisch, supra note 138, at 944 (noting that in 2016, 82% of S&P 500 companies published sustainability reports). 143 See 2020 Flash Report, supra note 142. 144 See Sustainable Investments Institute, State of Integrated and Sustainability Reporting 2018 (2018), https://​siinstitute​.org/​special​_report​.cgi​?id​=​77 145 See Governance & Accountability Institute, Inc., Public Companies Disclosure of Environmental, Social and Governance Factors and Options to Enhance Them (July 2020), at 28, https://​www​.gao​.gov/​ assets/​710/​707967​.pdf [hereinafter GAO ESG Study]. 146 See Sidley Report, supra note 136, at 3. 147 See Press Release, SEC, Satyam Khanna Named Senior Policy Advisory for Climate and ESG (Feb. 1, 2021), https://​www​.sec​.gov/​news/​press​-release/​2021​-20 148 See Press Release, SEC, SEC Announces Enforcement Task Force Focused on Climate and ESG Issues (Mar. 4, 2021), https://​www​.sec​.gov/​news/​press​-release/​2021​-42

190  Research handbook on corporate liability on ESG-related issues.149 Finally, on March 21, 2022, the SEC proposed a sweeping new rule that would mandate significant additional climate-related disclosures.150 Among other things, the proposed rule would mandate a climate-related disclosure framework, disclosure of climate-related risks, disclosure regarding climate-related impacts on strategy, business model and outlook, and disclosure related to climate-related targets, goals, and transitions plans.151 The SEC’s focus on disclosure, along with its proposed climate-related disclosure rule, clearly has repercussions for director and officer liability. Indeed, any mandated disclosure brings with it the risks of liability associated with material misstatements and omissions related to that disclosure. Moreover, the new rule would require disclosures around board and management’s oversight of climate-related risks. This form of disclosure aligns with growing investor demand for such oversight. Indeed, in response to that demand, original research undertaken by this author reveals that a large percentage of companies have already increased their board oversight of ESG issues.152 Most notably, there is potential liability under Rule 10b-5 for ESG disclosure. Of course, the potential liability for disclosure in mandated reports is clear. However, there is also potential liability for ESG information contained in voluntary reports. The SEC has consistently made clear that the antifraud provisions of the securities laws apply to information provided in sources outside of periodic reporting.153 As early as 2000, the SEC noted that companies should be ‘mindful that they are responsible for the accuracy of their statements that reasonably can be expected to reach investors or the securities markets regardless of the medium through which the statements are made, including the Internet’.154 Then too, the SEC has taken the view that the voluntary nature of a corporation’s disclosure does not give the corporation license to engage in misleading or fraudulent disclosures.155 These expressions make it clear that officers and directors may be exposed to liability as a result of disclosures contained in voluntary reports, including voluntary ESG reports. More importantly, the information contained in voluntary ESG documents may reflect material information and thus information that may be subject to a securities fraud action. To be sure, some courts have found ESG information, even information contained in SEC filings, to constitute non-actionable puffery. For example, in Bondali v. Yum! Brands, Inc., the Sixth Circuit dismissed a Section 10(b) action against Yum! Brands (‘Yum’) that was based on Yum’s SEC filings in which Yum emphasized its commitment to ‘strict’ food quality and ‘food safety’.156 The Sixth Circuit concluded that the information was ‘too squishy, too untethered to anything measurable, to communicate anything that a reasonable person would deem See id. See SEC, The Enhancement and Standardization of Climate-Related Disclosures for Investors, Exchange Act Release Nos. 33-11042: 34-94478; File No. S&-10-22, 87 Fed. Reg. 29059 (Mar. 21, 2022), https://​www​.sec​.gov/​rules/​proposed/​2022/​33​-11042​.pdf 151 See id. 152 See Lisa M. Fairfax, Board Oversight and ESG Accountability, 12 Harv. Bus. L. Rev. 371 (2022). 153 See Commission Guidance on the Use of Company Websites, 73 Fed. Reg. 45,862, 45,869–70 (SEC, Aug. 7, 2008). 154 See id. 155 See Hillary Sale, Disclosure’s Purpose, 107 Geo. L.J. 1045, 1055 (2019); In re Hi-Crush Partners L.P. Sec. Litig., No. 12 Civ. 8557, 2013 WL 6233561, at *18 (S.D.N.Y. Dec. 2, 2013). 156 See Arun Bondali et al. v. Yum! Brands, Inc., 620 F. App’x (6th Cir. 2015); In re Yum! Brands, Inc. Sec. Litig., 73 F. Supp. 3d 846,862–63 (W.D. Ky. 2014), aff’d sub. nom. Bondali v. Yum! Brands, Inc., 620 F. App’x 483 (6th Cir. 2015). 149 150

Directors’ and officers’ liability under securities laws  191 important to a securities investment decision’.157 However, courts also have found that ESG information can constitute more than mere non-actionable puffery. A 2012 action brought under Section 10(b) against BP alleging securities fraud centered on ESG statements BP disclosed in its voluntary ESG reports and SEC filings. In this case, a District Court found such statements were specific enough to be actionable.158 The BP action makes it clear that ESG information, including information in voluntary ESG documents, cannot be simply dismissed as puffery. Voluntary ESG disclosures have become more specific and detailed. This fact increases the possibility that such disclosures may be viewed as material and thus fall within the reach of federal securities laws. Some may contend that ESG as a category should not be characterized as material, thereby disqualifying statements related to ESG from being deemed material. The SEC and its staff have taken the view that materiality should be judged primarily in terms of whether or not information would impact a company’s financial performance.159 Based on this view, some may assert that ESG has no impact on financial performance and thus should not be viewed as material. However, there is growing recognition that ESG information is material.160 To be sure, assessing materiality is complex. Financial materiality varies by industry and by company.161 Moreover, it is not entirely clear that our current definition of materiality aligns with current understandings of materiality. Indeed, the business community is beginning to recognize that materiality of ESG factors can change over time.162 Consistent with this recognition, the World Economic Forum first introduced the phrase ‘dynamic materiality’. This concept has been gaining in importance.163 Dynamic materiality refers to the notion that materiality – especially the financial materiality of ESG matters – is a concept that changes over time and thus assess See id. See In re. BP plc, Sec Litig., No. 4:12-cv-1256, 2013 WL 6383968 (S.D. Tex., Dec. 5, 2013) (noting that statements focus on all aspects of BP’s operations). 159 See Fisch, supra note 138, at 935. 160 See Daniel C Esty and Quentin Karpilow, Harnessing Investor Interest in Sustainability: The Next Frontier in Environmental Information Regulation, 36 Yale J. on Regul. 625, 625 (2019); Fisch, supra note 138, at 923, 936; Eccles & Klimenko, supra note 133; World Economic Forum, Embracing the New Age of Materiality: Harnessing the Pace of Change in ESG (Mar. 19, 2020), https://​www​.weforum​ .org/​whitepapers/​embracing​-the​-new​-age​-of​-materiality​-harnessing​-the​-pace​-of​-change​-in​-esg; Robert Eccles, Dynamic Materiality in the Time of COVID-19, Forbes, Apr. 19, 2020, https://​www​.forbes​.com/​ sites/​bobeccles/​2020/​04/​19/​dynamic​-materiality​-in​-the​-time​-of​-covid​-19/​?sh​=​11329154f072 161 See Virginia Harper Ho, ‘Comply or Explain’ and the Future of Nonfinancial Reporting, 21 Lewis & Clark L. Rev. 317, 323 (2017); Mozaffar Khan et al., Corporate Sustainability: First Evidence on Materiality, 91 Acct. Rev. 1697, 1698–703 (2016); McKinsey & Co, supra note 134 (noting that companies want to address ESG factors material to their industries and that relevant ESG factors vary according to industry); Ann Lipton, Not Everything is About Investors: The Case for Mandatory Stakeholder Disclosure, 37 Yale J. on Regul. 499, 531 (2020); Virginia Harper Ho & Stephen Kim Park, ESG Disclosure in Comparative Perspective, 41 U. Pa. J. Int’l L. 249, 260–61 (2019); Eccles & Klimenko, supra note 133. 162 See KKS Advisors and TCP, Covid-19 and Inequality: A Test of Corporate Purpose, September 17, 2020, at 30, https://​c6a26163​-5098​-4e74​-89da​-9f6c9cc2e20c​.filesusr​.com/​ugd/​f64551​_a5​5c15bb348f​ 444982bfd2​8a030feb3c​.pdf [hereinafter Test of Corporate Purpose] (referring to concept of dynamic materiality). 163 See id.; see also World Economic Forum, Embracing the New Age of Materiality: Harnessing the Pace of Change in ESG, March 19, 2020, https://​www​.weforum​.org/​whitepapers/​embracing​-the​-new​ -age​-of​-materiality​-harnessing​-the​-pace​-of​-change​-in​-esg 157 158

192  Research handbook on corporate liability ments of materiality must be fluid and adaptive.164 To be sure, the SEC has clearly recognized that ESG issues can be material because such issues may have an impact on corporate financial performance.165 Moreover, a sizeable majority of investors and business community leaders have recognized that ESG factors can be material to investors.166 Importantly, ESG matters can have both positive and negative impacts on financial matters, making risk management and assessment of ESG factors material to corporate performance.167 Recent ESG disclosure trends have been linked explicitly with economic and financial performance.168 Thus, failure to police the accuracy of ESG disclosures cannot be grounded in a blanket assessment that ESG information is not material or otherwise will not become material over time. Inaccurate information within voluntary ESG reports can impact the assessment of whether there are materially misleading statements or omissions in required filings. When disclosing information in required filings, companies are required to report information that may be necessary to ensure that their required statements are not materially misleading.169 As Professor Hillary Sale notes, omissions are key to the integrity of the disclosure regimes.170 The focus on omissions is a prohibition on misleading half-truths.171 The SEC assesses misleading statements or nondisclosures in a company’s public filings by examining information outside the filings, including information voluntarily disclosed on websites and in other arenas.172 In considering this assessment with respect to voluntary ESG reports, it is clear that those reports are important because they may reveal that information in required disclosures is materially incomplete or otherwise misleading. Importantly, the SEC has indicated a willingness to increase its enforcement efforts related to ESG. Indeed, in March 2021, the SEC launched an Enforcement Task Force focused on climate and ESG issues.173 The Climate and ESG Task Force led by the Deputy Director of the Division of Enforcement has the stated goal to ‘develop initiatives to proactively identify ESG-related misconduct consistent with increased investor reliance on climate and ESG-related disclosure and investment’.174 The Task Force uses sophisticated data analysis to assess information and identify potential violations including material gaps or misstatements 164 See Test of Corporate Purpose, supra note 162 at 30; World Economic Forum, supra note 163; Robert Eccles, Dynamic Materiality and Core Materiality: A Primer for Companies and Investors, Forbes, Jan. 17, 2020. 165 See Fisch, supra note 138, at 936. 166 See Esty & Karpilow, supra note 160, at 625; Fisch, supra note 138, at 923; Virginia Harper Ho, Nonfinancial Risk Disclosure and the Costs of Private Ordering, 55 Am. Bus. L. J. 407 (2018), at 407; Barnali Choudhury, Serving Two Masters: Incorporating Social Responsibility into the Corporate Paradigm, 11 U. Pa. J. Bus. L. 631, 625 (2009); Max Schanzenback & Robert Sitkof, Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee, 72 Stan. L. Rev. 381, 435 (2020). 167 See Eccles & Klimenko, supra note 133. 168 See Ho, supra note 166, at 416–17. 169 See 17 C.F.R. § 230.48; 17 C.F.R. § 240.12b-20. See also Ho, supra note 161, at 324. 170 See Sale, supra note 155, 1052–57. 171 See id. at 1052. 172 See GAO ESG Study, supra note 145, at 34–37. 173 See Press Release, SEC, SEC Announces Enforcement Task Force Focused on Climate and ESG Issues (Mar. 4, 2021), https://​www​.sec​.gov/​news/​press​-release/​2021​-42 174 See SEC, Spotlight on Enforcement Task Force Focused on Climate and ESG Issues (Jun. 27, 2022), https://​www​.sec​.gov/​spotlight/​enforcement​-task​-force​-focused​-climate​-esg​-issues

Directors’ and officers’ liability under securities laws  193 in company disclosures related to climate risks, and disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.175 The SEC website now includes a ‘spotlight’ on the Task Force that identifies ESG-related enforcement actions.176 This focus on ESG, however, begs a question about whether there will be a similar divergence around liability between officers and directors. Importantly, not only has there been an increased focus on officer responsibility for ESG activities, but also there has been increased focus on the board’s role in the oversight of ESG matters. These increased responsibilities may not be accompanied by increased liability for outside directors. If that occurs, we will once again be faced with grappling with whether our extralegal devices are sufficient to ensure optimal accountability for outside directors.

III. CONCLUSION Directors and officers play a pivotal role in the corporation and have significant responsibility to manage and oversee corporate affairs. In particular, outside independent directors have been tasked with increasingly more responsibility within the corporation. It should come as no surprise, therefore, that when there are concerns around corporate misdeeds, there is an emphasis on corporate individual liability. Both the SEC and DOJ have emphasized the importance of focusing on individuals and holding them accountable for corporate wrongdoing. This chapter examined some of the most significant ways in which the federal securities laws expose individual directors and officers to liability for actions related to corporate misconduct. However, while the federal government has prioritized a focus on individual responsibility and accountability, corporate individuals have not been treated the same. Instead, despite the focus on individuals, and the fact that federal securities laws have imposed an increasingly greater set of responsibilities on outside directors, the risks of liability for outside directors remains significantly lower than the risks of liability for corporate officers and executives. To be sure, the relatively lower level of liability risks faced by outside directors may be entirely appropriate. Despite their greater responsibilities, such directors do play a less involved role than executives, and thus may not have the same level of knowledge about corporate activities as executives. Then too, other factors such as reputational sanctions may be sufficient to incentivize directors to pay heed to their responsibilities. This chapter nonetheless highlights the discrepancy between officers and outsider directors so that we have a firm understanding of the liability environment in which individuals operate. The chapter also highlights the discrepancy so that we can engage with issues regarding whether, and to what extent, that liability environment is appropriate in light of the most recent demand for corporate responsibility and accountability related to ESG issues.

See id. See id.

175 176

11. Evolution of director oversight duties and liability under Caremark: using enhanced information-acquisition duties in the public interest Jennifer Arlen1

I. INTRODUCTION Large publicly-held corporations reside at the core of our society and can affect it for good or ill. Our legal system must address two separate concerns. The first is agency costs. Agency costs arise when corporate directors or senior executives use their control over their firms to benefit themselves at the shareholders’, firms’, and our economy’s expense. The second is externalities: companies in pursuit of profit regularly impose harm on others that they do not have to bear, directly or indirectly, and thus are inclined to ignore.2 These harms include those from activities society has prohibited, for example, environmental misconduct, price-fixing, corruption, securities fraud, healthcare fraud, and the knowing sale of unsafe products. Corporate law seeks to ameliorate both problems by imposing fiduciary duties on directors, the breach of which can lead to personal liability for damages. Corporate law primarily uses fiduciary duties to address agency costs, largely through doctrines designed to deter directors from favoring their own interests.3 Yet fiduciary duties also play an important role in deterring corporate misconduct. To be effective, such fiduciary duties need to induce directors to deter crime even when the company could profit from it. Delaware courts have long imposed liability on directors who knowingly cause their companies to commit corporate misconduct even when the misconduct benefits the firm. In addition, Delaware now imposes enhanced oversight duties on directors to obtain information about and appropriately respond to corporate misconduct that could materially harm society even when the firm might profit from it. These fiduciary duties are important to the effort to deter corporate crime because corporate criminal liability does not suffice to deter as a result of agency problems and under-enforcement. This chapter examines the recent evolution in Delaware law on directors’ fiduciary duties to deter corporate misconduct. It explains why society needs to impose fiduciary duties on directors designed to induce them to deter misconduct. It then explains why such duties must be specific and narrow. The chapter then examines Delaware’s historic approach, as set forth

I would like to thank Jeffrey Gordon, Robert Jackson Jr., Veronica Root Martinez, Martin Petrin, Leo Strine, Jr., and Christian Witting for their helpful comments. 2 Although companies can cause social harm in several ways, this chapter focuses on harms resulting from corporate misconduct. 3 These fiduciary duties include the duty to act in good faith on behalf of the firm, to avoid self-interested transactions that are not appropriately approved, and to take due care in the process of decision-making. 1

194

Evolution of director oversight duties and liability under Caremark  195 in In re Caremark International,4 and shows why Caremark failed to induce directors to take effective steps to deter corporate crime. It examines Delaware’s recent case law expanding Caremark and explains why Delaware is correct to impose enhanced duties on directors to adopt systems to inform them about – and to ensure they are informed about – detected misconduct and compliance deficiencies that are material to the firm or society. It also explains why such duties are needed to protect society, even when shareholders do not benefit materially from deterring corporate crime and may even profit from misconduct. Corporate law needs to impose fiduciary duties on directors designed to induce them to deter corporate misconduct in order to enable society to effectively deter misconduct. Society relies primarily on criminal liability for individual wrongdoers and their corporate employers5 to deter organizational misconduct.6 Under ideal circumstances, properly structured corporate criminal liability7 should suffice to deter by inducing companies to prevent, detect, investigate, and self-report misconduct, and share their information with enforcement authorities to increase the threat of individual liability.8 Yet in practice corporate criminal liability does not adequately deter as a result of two problems: agency costs and under-enforcement. Corporate criminal liability is ineffective in causing companies to actively deter misconduct, even when structured to ensure companies are better off when they deter misconduct, when corporate directors and senior managers obtain private benefits from the misconduct or weak internal controls.9 Corporate criminal liability also often fails to adequately deter because

In re Caremark International Derivative Litigation 698 A.2d 959, 967 (Del. Ch. 1996). Throughout this chapter, corporate criminal liability refers to corporate liability which shares the core features of corporate criminal liability: (1) expression by society that the conduct was immoral or unethical; (2) threat of substantial financial penalties; (3) possibility of serious collateral consequences such as debarment or exclusion; and (4) enforcement by an enforcement agency not directly subject to capture by the industry against whom the enforcement action is brought. Administrative corporate liability can, but does not always, have these features, and it may not carry the same expressive force. In addition, in some countries (such as the US), corporations can use their political influence to suppress enforcement intensity by administrative and civil authorities. See Jennifer Arlen, Countering Capture: A Political Theory of Corporate Criminal Liability, 47 J. Corp. Law 861 (2022). 6 See generally Jennifer Arlen & Samuel Buell, The Law of Corporate Investigations and the Global Expansion of Corporate Criminal Enforcement, 93 S. Cal. L. Rev. 697 (2020) (discussing law and practice of US liability for organizational misconduct); Samuel W. Buell, Capital Offenses: Business Crime and Punishment in America’s Corporate Age (2016) (same); Brandon L. Garrett, Structural Reform Prosecution, 93 Va. L. Rev. 853 (2007) (same). 7 See supra note 5. 8 For a discussion of why deterrence requires the imposition of both corporate and individual liability and the optimal structure of corporate liability, see infra Section II.A; see, e.g., Jennifer Arlen & Lewis Kornhauser, Battle for Our Souls: A Psychological Justification for Corporate and Individual Liability for Organizational Misconduct, 2023 U. Ill. L. Rev. 673 (2023); Jennifer Arlen, The Potential Promise and Perils of Introducing Deferred Prosecution Agreements Outside the U.S., in Negotiated Settlements in Bribery Cases: A Principled Approach 156 (Abiola Makinwa & Tina Søreide eds., 2020); Jennifer Arlen & Reinier Kraakman, Controlling Corporate Misconduct: An Analysis of Corporate Liability Regimes, 72 NYU L. Rev. 687 (1997). 9 For example, directors and officers of firms that are at risk of failing or are materially under-performing relative to their peers may benefit from committing or overlooking evidence of securities fraud designed to make the company look healthier than it is, even when shareholders are harmed by, and would want to deter, the misconduct. See Jennifer Arlen & William J. Carney, Vicarious Liability for Fraud on Securities Markets: Theory and Evidence, 1992 U. Ill. L. Rev. 691 (1992). In addition, companies may enable CEOs to assault employees or others for their personal benefit, even when such 4 5

196  Research handbook on corporate liability companies face such a remote risk of having their misconduct detected and sanctioned10 that they often expect to profit from misconduct. As a result, directors acting in their companies’ interests often structure their companies’ internal operations to promote productivity in ways that predictably induce corporate crime.11 Corporate law can, and should, counteract both problems by imposing fiduciary duties on directors (and officers) that are structured to induce them to actively deter misconduct.12 These duties should be structured to address both agency costs and under-deterrence by providing directors with a personal motive to act in society’s best interests by deterring misconduct even when the company would benefit from it. These duties also should be structured to promote a central goal of corporate liability: inducing firms to detect, investigate, terminate, and self-report detected misconduct.13 Director liability should not be predicated on traditional tort liability rules – such as strict liability for detected misconduct or negligence liability for their ineffective efforts to deter misconduct. The former would lead directors to devote excessive resources to deterrence and cause them to resist detection, self-reporting, and cooperation with respect to misconduct.14 The latter would have no effect if courts applied the Business Judgment Rule, or would be impracticable, as Delaware Courts do not have the information needed to effectively assess whether directors are adopting reasonable measures to deter misconduct.15 Nor should corporate law rely solely on its long-standing requirement that directors not knowingly cause the firm to violate the law, even if it would be profitable.16 Under Delaware law, companies cannot deliberately violate criminal laws in pursuit of profit. In turn, directors who knowingly cause companies to violate the law are deemed to have acted in bad faith – even if they did so to benefit the firm; they can be held personally liable for any losses the firm acts harm the firm, because other executives fear reprisals from the CEO should they intervene. Cf. Ken Auletta, Hollywood Ending: Harvey Weinstein and the Culture of Silence (2022). 10 One reason companies face a small risk of detection is that enforcement authorities are woefully underfunded. See Arlen, supra note 5; infra Section II.B; see also Eugene Soltes, The Frequency of Corporate Misconduct: Public Enforcement Versus Private Reality, 26 J. Fin. Crime 923 (2019) (presenting evidence of firms committing hundreds of violations a year, none of which were detected). Offenses eligible for whistleblower bounties can have a higher risk of detection and sanction, but SEC resource constraints undermine its whistleblower bounty program because only the SEC can bring the enforcement action; whistleblowers cannot proceed on their own. See generally, David F. Engstrom, Bounty Regimes, in The Research Handbook on Corporate Crime and Financial Misdealing 334 (Jennifer Arlen ed., 2018) (describing the SEC whistleblower bounty system). In addition, the sanctions imposed on those who are detected are not large enough to counteract the low probability of sanction. 11 For a discussion of how companies can increase productivity at the cost of an increased risk of corporate crime see Arlen & Kornhauser, supra note 8. 12 Director liability should supplement, not replace, corporate criminal liability. Arlen & Kornhauser, supra note 8. 13 See id. 14 See infra Section II.B. 15 Id. 16 See Kent Greenfield, Ultra Vires Lives! A Stakeholder Analysis of Corporate Illegality (With Notes on How Corporate Law Could Reinforce International Law Norms), 87 Va. L. Rev. 1279, 1281–82, 1316 (2001); Elizabeth Pollman, Corporate Disobedience, 68 Duke L.J. 710, 719–21 (2019); Leo E. Strine, Jr., et al., Loyalty’s Core Demand: The Defining Role of Good Faith in Corporation Law, 98 Geo L. Rev. 629, 648–55 (2010); Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125 (Del. 1963); see also Elizabeth Pollman, The History and Revival of the Corporate Purpose Clause, 99 Tex. L. Rev. 1423 (2021) (discussing the infusion of public aims through the duty of good faith).

Evolution of director oversight duties and liability under Caremark  197 suffers as a result.17 This duty and associated liability are essential to deterrence but are not sufficient because directors can boost corporate profits in ways that induce corporate crime without ordering it or creating evidence that they knew it would occur. Their ability to pursue profit through misconduct is greatest when they can avoid learning about detected misconduct, as such information would trigger their duty to terminate it.18 Thus, to enable society to benefit from directors’ duty not to knowingly violate the law, corporate law needs to impose oversight duties on directors that require them to ensure that the firm adopts systems to detect, and ensure that they are informed about, material misconduct; they also must be required to actively oversee their company’s response to detected suspected misconduct. Directors who intentionally neglect these duties should be liable for any resulting harm to the company. In order to be effective, however, directors’ oversight duties cannot be designed to address agency costs alone but should be structured to promote society’s interest in deterring misconduct. The limitations of oversight duties designed to only address agency costs are evident in Delaware’s original approach to oversight duties, as set forth in Chancellor William Allen’s 1996 decision in In re Caremark International.19 Caremark required directors to ensure that their companies adopted an information and reporting system designed to deter, detect, and inform them about corporate misconduct and to assert on-going oversight over the system, including by responding to red flags.20 Yet in formulating Caremark, Chancellor Allen assumed that directorial oversight duties were needed to address only one problem: agency costs.21 He assumed that directors could be granted full discretion over compliance once subject to a fiduciary duty and liability regime that muted agency costs – as his regime was intended to do. Specifically, he assumed that liability only needed to deter bad faith intentional neglect; absent bad faith, the Delaware court could induce directors to actively seek to deter corporate misconduct simply by expressing that directors have a duty to adopt and oversee an information and reporting system to ensure the firm’s compliance with the law, even without a material threat of liability.22 Given this premise, he imposed oversight duties on directors but gave them full discretion to decide what system to adopt and how to implement it, under the protection of the Business Judgment Rule.23 Yet Caremark did not induce most directors to adopt effective systems to deter corporate crime or to effectively oversee compliance or investigations for a simple reason: corporate crime is profitable and efforts to deter it are costly.24 Thus, directors acting in good faith to benefit their firms reasonably regularly use their discretion to adopt internal structures that promote productivity, even at the expense of increasing the risk of misconduct.25 They also can benefit their firms by remaining ignorant of detected misconduct thereby avoiding their duty to

See infra Section III.A. E.g., Allis-Chalmers Mfg. Co., 188 A.2d at 125; see infra Section III.A. 19 In re Caremark International Derivative Litigation, 698 A.2d 959, 959 (Del. Ch. 1996). 20 Id. 21 Jennifer Arlen, The Story of Allis-Chalmers, Caremark, and Stone: Directors’ Evolving Duty to Monitor, in Corporate Stories 323 (J. Mark Ramseyer ed., 2009). 22 Id. (presenting Chancellor Allen’s underlying assumptions in formulating Caremark, based on interviews with him). 23 Caremark, 698 A.2d at 959. 24 See infra Section IV & note 110. 25 See Soltes, supra note 10. 17 18

198  Research handbook on corporate liability terminate it. Caremark left them free to do so by giving them discretion to focus their oversight of compliance on inputs to compliance – such as policies and training – while allowing them to ignore both the impact of compensation and promotion policies on misconduct and the most important evidence on compliance effectiveness, information on detected suspected material misconduct. The Business Judgment Rule also enabled directors to satisfy their duty to oversee investigations by delegating to executives who could provide them status reports. Chancellor Allen was correct in concluding that director liability should be determined by a bad faith standard and not negligence.26 The central flaw in Caremark was his decision to give directors full discretion over the structure of the firm’s system for deterring misconduct and their oversight over it without imposing a duty on them to detect, and ensure they are informed about, material misconduct. Chancellor Allen was incorrect in assuming that directors would use their discretion to adopt compliance systems that ensure their companies’ compliance with the law for the simple reason that corporate crime is profitable, and compliance is costly. Thus, directors given discretion use it to benefit their firms, their shareholders and themselves by adopting internal structures that promote both profit and the risk of misconduct.27 To reduce externalities and promote corporate law’s prohibition on profit through unlawful means,28 corporate law needs to impose oversight duties on directors that are more precise – and constraining – than those imposed by the original Caremark decision; these duties must protect social interests and not just those of shareholders. Courts cannot simply require directors to take specific steps to deter corporate crime or to adopt an effective compliance function because they do not have the information needed to apply such a standard.29 Directors’ oversight duties should be more narrowly tailored and aimed at conduct that is undeniably optimal for directors. They also should promote a core goal of corporate criminal liability: to induce companies to detect, investigate and terminate misconduct and share their information with enforcement officials.30 Courts can enhance deterrence, without overly impinging on directors’ authority over internal corporate operations, by imposing fiduciary duties on directors to act in good faith to adopt systems to detect misconduct,31 and also to establish procedures to ensure that the board (or a designated committee) is informed about detected suspected misconduct and detected deficiencies in the firm’s internal systems for deterring misconduct with respect to types of misconduct whose deterrence is especially important to the firm or to society.32 Directors also should be required to exert direct oversight over investigations of material misconduct. Social interest can be determined based on both the harm sought to be avoided – for example, risk of personal injury or death – and whether the law expressed a strong interest in deterrence by imposing either enhanced regulatory oversight over the risk or a duty to report violations by the firm. See infra Section II.B. See infra note 56. 28 See infra Section III.A. 29 See infra Section II.B. 30 See infra Section II.A. 31 Directors should be subject to a baseline duty to act in good faith to detect misconduct – including by implementing an anonymous and well-publicized internal reporting system – because otherwise the imposition of a duty to become informed about detected misconduct, coupled with liability if they fail to terminate it, may perversely lead them to have the company not seek to detect misconduct. 32 See infra Section V. 26 27

Evolution of director oversight duties and liability under Caremark  199 These requirements would enhance deterrence for multiple reasons.33 First, compliance effectiveness is difficult, if not impossible, to determine from an assessment of inputs (e.g., policies, training, and practices) alone. Directors should be required to receive information about detected material misconduct in the firm because this information is the single best indicator of whether the firm’s internal systems induce or deter misconduct, and where in the firm any problems reside.34 Second, these duties should reduce the expected duration of misconduct by channeling information about misconduct to directors who have the power and legal obligation to terminate it.35 These duties also reduce management’s ability to undermine investigations and bury information about misconduct. Third, channeling information about misconduct to (independent) directors enhances the likelihood that the firm will self-report detected misconduct and fully cooperate with enforcement authorities as directors are less likely than management to face conflicts of interest.36 Finally, such duties would encourage directors to adopt more effective systems to deter misconduct by reducing the expected duration, and thus expected benefit to the firm, of detected misconduct while increasing its expected cost to directors.37 Recently, Delaware courts have issued a series of decisions in Caremark cases that impose such enforcement oversight duties on directors to obtain information about, and oversee the investigation of, certain types of detected misconduct.38 Consistent with the above analysis, these duties are only imposed for certain types of legal risk. The first cases only imposed these enhanced duties when oversight of the risk in question was essential to the firm’s financial health. Yet in more recent cases the court appears to apply enhanced duties to obtain information about detected misconduct that society has a strong interest in deterring: as evidenced by a threat to personal safety and the intensity of regulatory oversight that includes a self-reporting duty. Delaware law could enhance deterrence by adopting clear rules imposing such information-acquisition duties on directors when society has a heightened interest in compliance, notwithstanding shareholders’ preferences, thereby inducing directors to deter, detect, and terminate misconduct even when shareholders might prefer that it remain in the shadows. This chapter proceeds as follows. Section II explains why corporate law needs to supplement corporate liability for organizational misconduct, with personal liability imposed on directors arising from detected misconduct, and explains why neither strict respondeat superior nor negligence liability for suboptimal misconduct is efficient. It recommends the imposition of oversight duties on directors designed to protect both the firm and society. Section III discusses the directors’ duty not to knowingly cause the firm to violate the law and explains why it alone will not lead directors to actively seek to deter misconduct. Directors should also be subject to oversight duties. Section IV analyzes Delaware’s initial formulation of oversight duties, Caremark, which gives directors broad discretion to decide whether to become informed about detected misconduct or assert active oversight over investigations. 33 For a discussion of why shareholder derivative litigation based on harms to the company resulting from detected litigation operates to induce directors to deter misconduct even when, ex ante, shareholders benefit from allowing misconduct see infra Section V.C. 34 See infra Section V.A. 35 See infra Section III.A. 36 See infra Section V.A; see generally Arlen & Buell, supra note 6 (discussing these incentives). 37 See infra Section V.A. 38 See infra Section V.B.

200  Research handbook on corporate liability Directors afforded such discretion are unlikely to use it to exercise adequate oversight when companies profit from misconduct. Section V shows why directors should be subject to more precise duties to obtain information about, and oversee the investigation of, detected violations of laws in which the firm or society has a materially heightened interest in compliance. It then discusses the new Caremark 2.0 cases and shows how they create such duties and have laid the foundation for extending them to deterring legal risks to serve society’s interests. Section VI concludes.

II.

WHY DIRECTOR LIABILITY IS NEEDED TO DETER CORPORATE MISCONDUCT

This section explains why corporate criminal law cannot reliably deter organizational misconduct unless directors also face personal liability for their actions that enabled corporate misconduct. It shows that this liability must be structured both to protect shareholders from directorial agency costs and to promote social welfare by inducing directors to deter material organizational misconduct. This section then shows that director liability should not be governed by traditional tort doctrines, such as strict liability or negligence. Narrower duties targeted at enhancing directors’ information about misconduct, and incentives to deter, are superior. A.

Why Directorial Oversight Liability is Needed to Deter Corporate Crime

Organizational misconduct occurs regularly and causes serious harm to individual victims and society. Corporations and their employees regularly benefit from such misconduct. Companies benefit from enhanced sales or reduced costs resulting from corruption, antitrust violations, tax fraud, and environmental offenses; employees in turn benefit from the bonuses, promotions, or enhanced job security provided to employees who materially benefit the firm.39 Society relies primarily on corporate and individual criminal, civil, and regulatory liability to deter organizational misconduct. Individual liability can deter by imposing expected sanctions that exceed individuals’ benefit from crime.40 It also potentially deters by expressing society’s view that the misconduct violates social norms.41 Yet individual liability only deters For a discussion of how corporate compensation and promotion policies induce corporate crime see, e.g., Arlen & Kraakman, supra note 8; Arlen & Kornhauser, supra note 8; Max H. Bazerman & Ann E. Tenbrunsel, Blind Spots: Why We Fail to Do What’s Right and What to Do About It, Chap. 6 (2011). Beyond this, companies can promote misconduct by priming employees with repeated reminders about financial returns. E.g., Maryam Kouchaki, et al., Seeing Green: Mere Exposure to Money Triggers a Business Decision Frame and Unethical Outcomes, 121 Org. Behav. & Hum. Decision Making Processes 53 (2013); see also Yuval Feldman, Behavioral Ethics Meets Behavioral Law and Economics, in Oxford Handbook of Behavioral Economics and the Law (Eyal Zamir & Doran Teichman eds., 2014), at 216. 40 Gary S. Becker, Crime and Punishment: An Economic Approach, 76 J. Pol. Econ. 169 (1968); see Jennifer Arlen, The Potentially Perverse Effects of Corporate Criminal Liability, 23 J. Legal Stud. 833 (1994). 41 E.g., Arlen & Kornhauser, supra note 8. For an explanation of the implications for deterrence of the empirical psychological literature on human decision-making see Arlen & Kornhauser, supra note 8; see also Benjamin van Rooij & Adam Fine, The Behavioral Code: The Hidden Ways Law Makes 39

Evolution of director oversight duties and liability under Caremark  201 through these channels when employees face a threat of detection and sanctions that is sufficiently high to be salient to employees at the moment they are considering whether to violate the law.42 At present, employees generally do not consider their risk of punishment when contemplating criminal conduct because government enforcement authorities detect and sanction misconduct too rarely to create the requisite material risk of detection.43 The most effective way for enforcement authorities to increase the expected threat of sanction is to induce companies to use their informational advantage to detect, investigate, self-report, and provide evidence of misconduct.44 Companies also should be induced to deter by restructuring their compensation and promotion policies,45 internal job structures,46 internal controls,47 and culture to promote compliance.48 To induce such actions, companies need to be held criminally liable for their employees’ crimes,49 and subject to expected sanctions that ensure they do not profit from crime. Corporate liability also must be structured to incentivize companies to detect, investigate, self-report and fully cooperate with enforcement authorities.50 In the US, companies are criminally liable for their employees’ crimes committed in the scope of employment, and are subject to a corporate enforcement policy intended to induce them to detect, self-report and cooperate.51 This liability helps to deter but is not sufficient for at least two reasons: agency costs and under-enforcement. Companies fail to actively deter misconduct, even when they face optimal sanctions, when the people who control them – the board of directors and senior management – benefit from either misconduct or inadequate deterrence.52 Companies also often earn expected profits from misconduct and weak compliance because enforcement authorities rarely detect and sanction their misconduct.53 Thus, us Better … or Worse (2021); Yuval Feldman, The Law of Good People: Challenging States’ Ability to Regulate Human Behavior (2018). 42 See Arlen & Kornhauser, supra note 8 (discussing why salience is important). 43 See, e.g., id.; Arlen & Kraakman, supra note 8; see also supra note 10. 44 E.g., Arlen & Kornhauser, supra note 8 (explaining why the probability of sanction must be material and salient). Companies also can deter by reducing employees’ expected benefit from misconduct, Arlen & Kraakman, supra note 8, and altering their internal operations; Arlen & Kornhauser, supra note 8. 45 Arlen & Kraakman, supra note 8; Arlen, supra note 40. 46 Arlen & Kornhauser, supra note 8. 47 Arlen & Kraakman, supra note 8. 48 Arlen & Kornhauser, supra note 8; see supra note 39. 49 Arlen & Kraakman, supra note 8; Arlen & Kornhauser, supra note 8. 50 See, e.g., Arlen & Kornhauser, supra note 8; Arlen & Kraakman, supra note 8; Arlen, supra note 8. 51 See generally Arlen & Buell, supra note 6. 52 See, e.g., Arlen & Carney, supra note 9 (discussing how corporate liability will not reliably induce senior management to detect and terminate securities fraud by others if they also would be harmed were the firm’s true financial picture to become public); Jennifer Arlen & Marcel Kahan, Corporate Governance Regulation Through Non-Prosecution, 84 U. Chi. L. Rev. 323 (2017); John Armour et al., Taking Compliance Seriously, 37 Yale J. Reg. 1 (2020) (discussing how agency costs can lead firms not to adopt optimal compliance). But see Assaf Hamdani & Reinier Kraakman, Rewarding Outside Directors, 105 Mich. L. Rev. 1677 (2007). 53 See, e.g., Arlen, supra note 8 (discussing how corporate criminal enforcement cannot adequately deter because companies face too small a risk of detection); Roy Shapira, A New Caremark Era: Causes and Consequences, 98 Wash. U. L. Rev. 1857, 1889 (2021); see also Soltes, supra note 10. Under-deterrence is attributable, in part, to companies’ use of their political influence to induce

202  Research handbook on corporate liability companies can profit from structuring their compensation arrangements and internal systems to promote productivity and misconduct.54 They also regularly do not self-report detected misconduct, confident that it will not be detected if they keep silent.55 As a result, directors seeking to promote shareholders’ interests often can do so through weak compliance and internal structures that promote misconduct.56 Corporate law can and should intervene to reduce both problems by imposing fiduciary duties on directors designed to induce them to deter and terminate misconduct, coupled with a threat of personal liability. Unlike traditional fiduciary duties, which serve to reduce agency costs between directors and shareholders, these duties should also aim to serve society’s interests by providing directors with a self-interested motivation to deter misconduct even when it would profit the firm and its shareholders. B.

Scope of Directors’ Liability: Inefficiency of Strict Liability and Negligence

Before discussing the scope of liability, it is worth addressing why society should not rely on two traditional forms of tort liability: strict liability or negligence.

elected officials to undermine corporate enforcement. See, e.g., Daniel Richman, Federal Criminal Law, Congressional Delegation, and Enforcement Discretion, 46 UCLA L. Rev. 757, 760–83 (1998); Arlen, supra note 5; see also Daniel C. Richman, Corporate Headhunting, 8 Harv. L. & Pol’y Rev. 265, 273–74 (2014) (following the financial crisis, Congress publicly increased funding for corporate enforcement but then quietly refused to appropriate the money). 54 See Arlen & Kornhauser, supra note 8. The potential for companies to suffer costs from reputational damage resulting from organizational misconduct does not eliminate the under-deterrence problem. First, under-detection undermines deterrence, as firms do not suffer reputational damage costs from misconduct that is not detected. Second, companies generally do not suffer reputational damage costs from misconduct, such as environmental offenses, that do not harm their counter-parties, customers or suppliers. See Jonathan M. Karpoff & John R. Lott, Jr., The Reputational Penalty Firms Bear from Committing Criminal Fraud, 36 J.L. & Econ. 757 (1993). Finally, firms may not suffer material reputational damage costs if they can assuage counter-parties’ concerns about their future behavior by intervening post-crime to remediate the causes of the misconduct. See Cindy R. Alexander & Jennifer Arlen, Does Conviction Matter? The Reputational and Collateral Effects of Corporate Crime, in Research Handbook on Corporate Crime and Financial Misdealing (Jennifer Arlen ed., 2018); see also John Armour et al., Regulatory Sanctions and Reputational Damage in Financial Markets, 52 J. Fin. & Quant. Analysis 1429 (2017). 55 For a discussion of how companies can induce corporate crime through their quest for profits see Arlen & Kornhauser, supra note 8; see also Arlen & Kraakman, supra note 8 (discussing compensation systems); Bazerman & Tenbrunsel, supra note 39, at Chapter 6. 56 Companies’ ability to profit from misconduct likely explains why institutional shareholders do not use their influence to induce companies to improve compliance or risk management. See Leo Strine, Jr., One Fundamental Corporate Governance Question We Face: Can Corporations Be Managed for the Long Term Unless Their Powerful Electorates Also Act and Think Long Term?, 66 Bus. Law. 1, 13 (2010); see also Leo Strine, Jr., Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System, 126 Yale L.J. 1870, 1918–19 (2017) (pension fund activism does not seek to promote improved risk management and enhanced internal accountability that would benefit the funds’ employee beneficiaries). Company profit also incentivizes directors to undertake actions that boost productivity and misconduct, as they receive substantial stock compensation as a result of pressure from institutions and corporate governance activists. This compensation aligns directors’ interests with shareholders at the expense of society’s interest in deterrence.

Evolution of director oversight duties and liability under Caremark  203 Imposing strict liability on directors through directorial respondeat superior for all detected misconduct would be inefficient because it would give directors excessive incentives to deter misconduct at the expense of corporate productivity and profit. Directors would bear enormous personal costs should misconduct occur; they could reduce this risk by using corporate resources and changing internal operations in ways that reduce productivity, primarily at shareholders’ expense.57 Strict liability thus would give them excessive incentives to deter misconduct to protect themselves, reducing both corporate and social welfare. Strict liability would also create perverse incentives to reduce corporate efforts to detect or self-report58 misconduct, as both actions would increase directors’ expected liability.59 Directors also should not be liable for substantively negligent decisions to implement an ineffective compliance function.60 Neither courts nor regulators can reliably determine whether directors have implemented effective internal systems to deter misconduct because optimal deterrence requires a host of inter-dependent, firm-specific interventions at all levels of the firm, each of which involves trade-offs between productivity and deterrence.61 Some of the most important interventions – such as compensation, promotion, and disciplinary policies and practices reform – fall outside company compliance programs and involve interventions directed at line managers who are likely beyond directors’ full control.62 Courts’ assessment of compliance also risks being distorted by hindsight bias.63 Thus, negligence liability would likely either be ineffective or subject directors to an excessive threat of liability that they could not reliably avoid, thereby inducing them to do either too little or too much to deter miscon-

This problem could be addressed in theory by tying sanctions to directors’ proportionate shares of the benefit, yet this solution is not practicably viable. Courts cannot reliably determine directors’ shares of the benefit, as some of the benefit may take subtle forms, including retention on a board from which they otherwise might have been terminated. 58 For a discussion of why corporate enforcement policy should be structured to induce self-reporting, and an example of an enforcement policy structured to do so, see Am. L. Inst., Principles of the Law of Compliance and Enforcement (Am. L. Inst. 2022). 59 The analysis is reminiscent of why strict corporate liability deters corporations from detecting misconduct. Arlen, supra note 40. 60 In addition, such liability would be ineffective unless Delaware General Corporation Law (‘DGCL’) § 102(b)(7), Del. Code Ann. tit. 8 were not apply to such actions. 61 See Arlen & Kornhauser, supra note 8 (discussing the host of interventions that are needed). For a discussion of the distinction between the compliance function and a compliance program see Title 5, Compliance, Principles of the Law of Compliance and Enforcement for Organizations (Am. L. Inst. 2023). 62 See Arlen & Kornhauser, supra note 8; see also Arlen & Kahan, supra note 52. Consistent with this conclusion, the Department of Justice’s 20-page guidance on effective compliance identifies the features of the firm’s internal operations that enforcement officials should evaluate – including the firm’s compensation policies and promotion/termination practices – and questions that they should ask, without precisely specifying what constitutes effective compliance. US Department of Justice, Criminal Division, Evaluation of Corporate Compliance Programs (June 2020), https://​www​.justice​.gov/​criminal​-fraud/​ page/​file/​937501/​download. The American Law Institute’s newly adopted Principles of Compliance and Enforcement for Organizations also provide guidance on features that are important without providing specific recommendations about what is required for effective compliance. Am. L. Inst., Compliance, supra note 61. 63 See Hamdani & Kraakman, supra note 52; see also Miriam H. Baer, Organizational Liability and the Tension Between Corporate and Criminal Law, 19 J.L. & Pol’y 1 (2010) (observing that companies can be held criminally liable for corporate misconduct even if they took effective steps to deter misconduct and had a good culture). 57

204  Research handbook on corporate liability duct. Moreover, imposing liability on directors for substantively negligent compliance-related decisions, while affording Business Judgment Rule protection64 to other business decisions, would distort companies’ internal governance by inducing directors to give excessive focus to compliance to the detriment of business decisions.65 Finally, negligence liability also would undermine deterrence if directors could not be confident of their ability to avoid negligence liability should misconduct occur due to court error. This would mute directors’ incentives to have the firm detect misconduct and would lead them to resist the self-reporting of detected misconduct so vital to deterrence.66 C.

Inducing Information Production and Acquisition

A superior approach is to impose specific fiduciary duties on directors to eschew (or terminate) corporate crime and to act in good faith to ensure that the firm adopts effective systems to detect misconduct and provides the board with information about both compliance deficiencies and detected misconduct that is material to the firm or society. Boards also should act in good faith to ensure they obtain and devote sufficient attention to this information and retain ultimate oversight over investigations. These information enhancement duties have the advantage of inducing boards to leverage companies’ comparative advantage in detecting, investigating and terminating misconduct to deter, detect, investigate, self-report and cooperate with respect to, misconduct.67 These duties can be enforced by derivative suits to enable the company to recover losses from misconduct.68 These information-acquisition duties are only effective, however, if structured to serve society’s interests in deterring material misconduct even when companies might profit from it. The next sections evaluate why such duties are needed and examine Delaware’s approach to imposing such duties on directors.

III.

CORPORATE LAW’S FOUNDATIONAL FIDUCIARY DUTY TO PROTECT SOCIAL INTERESTS

Most fiduciary duties are designed to ameliorate agency costs between directors and shareholders. Yet corporate law has long imposed a duty on directors designed to protect society: the duty not to knowingly cause the firm to engage in, or to allow the firm to continue to commit, corporate crime, even when shareholders could benefit from crime. This section shows that 64 The Business Judgment Rule protects directors from being held liable for negligent substantive business decisions. 65 For a discussion of the inefficiencies that result when a principal needs an agent to perform two tasks but can only monitor and impose sanctions for negligent performance of one task, see Bengt Holmstrom & Paul Milgrom, Multitask Principal–Agent Analyses: Incentive Contracts, Asset Ownership and Job Design, 7 J.L. Econ. & Org. 24 (1991). 66 See supra Section II.A.; Arlen & Kornhauser, supra note 8; Arlen & Kraakman, supra note 8. 67 See Arlen & Kornhauser, supra note 8; Arlen & Kraakman, supra note 8. 68 Derivative suits have several advantages. They are brought before expert appointed judges. See infra Section VI. Derivative suit plaintiffs often have better and more expeditious access to information through DGCL § 220, Del. Code Ann. tit. 8 than do private plaintiffs. See infra Section V.C. Once the firm has suffered losses from misconduct, derivative plaintiffs will be motivated to sue even if, ex ante, they benefit from misconduct.

Evolution of director oversight duties and liability under Caremark  205 this duty is vital to the law’s ability to use directorial duties to deter corporate crime, but it is not sufficient. Directors also need to be subject to information-acquisition duties that ensure they are informed about misconduct, thereby triggering their duty to terminate it.69 A.

Directors’ Duty Not to Knowingly Cause or Permit Corporate Crime

Traditional fiduciary duties are designed to lead directors to act to benefit the firm, rather than themselves. Consequently, they do not suffice to deter directors from promoting corporate crime because companies regularly profit from corporate misconduct. Yet corporate law has never been structured purely to promote the pursuit of corporate profits. At its roots it contains injunctions designed to protect society’s interests, even at shareholders’ expense. Corporate law prohibits companies from pursuing profits through illegal conduct. It expressly requires companies to pursue profits within the bounds of the law, regardless of whether allegiance to shareholder welfare would counsel otherwise.70 Corporate law provides that a corporation may be organized to ‘conduct or promote lawful businesses or purposes’; the standard corporate purpose clause provides that the ‘purpose of the corporation is to engage in any lawful act or activity’.71 This duty to comply with the law enjoins unlawful conduct even when the company would profit from it.72 Corporate law effectuates this obligation not to violate the law by imposing a duty on directors not to knowingly cause the firm to violate the law and to terminate any misconduct they detect.73 This duty is enforced by the threat of personal liability to the firm for any losses sustained should directors breach this duty. Because companies act outside their lawfully granted The existence of this duty distinguishes oversight duties for legal risk from oversight duties for business risk. Caremark cases predicated on inaction require proof that the directors’ breach was the proximate cause of the firm’s losses. In re Caremark International Derivative Litigation, 698 A.2d 959, 959 (Del. Ch. 1996); accord Stone v. Ritter, 911 A.2d 362, 362 (Del. 2006). In the case of unlawful conduct, plaintiffs can establish directors’ breach caused harm by showing that directors would have learned of the misconduct but for their breach because directors who learn about misconduct must terminate it. By contrast, with business risk, evidence that directors would have learned about a material business risk but for the breach does not establish that they would have refrained from taking the risk as many risks are profitable; risk-taking decisions are covered by the Business Judgment Rule. 70 E.g., In re Massey Energy Company Derivative and Class Action, C.A. No. 5430-VCS (Del. Ch. 2011) (‘Delaware law does not charter law breakers. Delaware law allows corporations to pursue diverse means to make a profit, subject to a critical statutory floor, which is the requirement that Delaware corporations only pursue “lawful business” by “lawful acts”’); see, e.g., Leo E. Strine, Jr., et al., Loyalty’s Core Demand: The Defining Role of Good Faith in Corporation Law, 98 Geo. L. Rev. 629, 648–55 (2010); see also Robert C. Clark, Corporate Law § 1.2, 18 (1986) (corporate law provides that companies’ pursuit of profit is constrained by the requirement that the company must comply with its legal obligations to those affected by its activities); Einer Elhauge, Sacrificing Corporate Profits in the Public Interest, 80 NYU L. Rev. 733, 738, 745, 756–57 (2005) (‘[M]ost advocates of a duty to profit-maximize concede it should have an exception for illegal conduct’). 71 DGCL §§ 101(b), 102 Del. Code Ann. tit. 8; see Strine et al., supra note 70, at 650. 72 This obligation is in effect corporate law’s original recognition that companies owe obligations to society that constrain their pursuit of profit. This doctrine roots these obligations in injunctions established by society’s legal authorities. The recent ESG movement seeks to impose additional obligations on companies beyond those that society’s legislatures and regulators have imposed on firms. 73 See, e.g., Strine et al., supra note 70, at 650; John C. Coffee, Jr., Beyond the Shut-Eyed Sentry: Toward a Theoretical View of Corporate Misconduct and an Effective Legal Response, 63 Va. L. Rev. 1099, 1172–73 (1977). 69

206  Research handbook on corporate liability authority when they intentionally commit crimes, directors who knowingly approve a business plan that violates the law engage in ultra vires conduct even if it benefits the company financially.74 Consequently, directors have no recourse to the Business Judgment Rule, but instead are deemed to have acted in bad faith, leaving them personally liable for any harm befalling the firm as a result.75 Liability for bad faith is not covered by either indemnification policies or Directors and Officers (D&O) insurance. This duty and associated liability provides directors with a personal incentive to make decisions not to knowingly cause the firm to violate the law, and to terminate violations they are informed about,76 even when they and shareholders would profit from misconduct. In so doing, it reduces under-deterrence. While this duty predates Caremark, directors’ liability for knowingly causing or allowing misconduct is now treated as a form of Caremark liability.77 B.

Why This Duty is Not Sufficient

Society cannot rely solely on this duty to deter misconduct by large firms. Most forms of corporate misconduct – including environmental violations, price-fixing, corruption, and money laundering – result from actions taken by people deep within the firm.78 Directors (and senior officers) can enable the firm to profit from corporate crime, without ordering it or knowing that it would occur, by structuring the firms’ internal systems to lead employees to prioritize productivity and profit at all costs. For example, they can predicate compensation, promotion,

See Leo E. Strine, Jr., et al., Caremark and ESG, Perfect Together: A Practical Approach to Implementing an Integrated, Efficient, and Effective Caremark and ESG Strategy, 106 Iowa L. Rev. 1885, 1887 (2021); Strine et al., supra note 70, at 648–50. 75 Id., at 650–54; see, e.g., La. Mun. Police Employees’ Ret. Sys. v. Pyott, 46 A.3d 313 (Del. Ch. 2012) (directors who cause the company to violate the law are disloyal and liable for the harm they cause); Massey Energy, 2011 WL 2176479, at *20; Metro Comm’n Corp. BVI v. Advanced Mobilecomm Techs. Inc., 854 A.2d 121, 131, 163–64 (Del. Ch. 2004) (‘[u]nder Delaware law, a fiduciary may not choose to manage an entity in an illegal fashion, even if the fiduciary believes that the illegal activity will result in profits for the entity’); Guttman v. Huang, 823 A.2d 492, 506 (Del. Ch. 2003) (‘one cannot act loyally as a corporate director by causing the corporation to violate the positive laws it is obliged to obey’); see also Miller v. Am. Tel. & Tel. Co., 507 F.2d 759, 762 (3d Cir. 1974) (concluding that directors may not knowingly violate the law); Roth v. Robertson, 118 N.Y.S. 351, 353 (N.Y. Gen. Term 1909) (holding that directors and officers who knowingly cause corporate crimes engage in ultra vires acts and must be liable for any loss the company suffers as a result). 76 E.g., Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125, 125 (Del. 1963); In re Caremark International Derivative Litigation, 698 A.2d 959, 959 (Del. Ch. 1996). Directors who allow misconduct to continue face a material threat of liability even when misconduct benefits the firm because damages are based on the companies’ gross losses (independent of any profit), and, ex post, once misconduct is detected, shareholders (and their lawyers) benefit if they can use Caremark to shift the resulting losses to the directors. 77 Consistent with Delaware law, this chapter treats the directors’ duty not to knowingly engage in misconduct as a Caremark duty, but it predates Caremark and arguably has its roots in DGCL §§ 101(b), 102 Del. Code Ann. tit. 8; See, e.g., Strine et al., supra note 70, at 650–55 (discussing this source of liability); Teamsters Loc. 443 Health Servs. & Ins. Plan v. Chou, No. CV 2019-0816-SG (Del. Ch. Aug. 24, 2020) (concluding demand is excused due to well-pled allegations that the directors ignored red flags that AmerisourceBergen Corp. ‘operated as a criminal enterprise’). 78 See, e.g., Arlen & Kraakman, supra note 8. 74

Evolution of director oversight duties and liability under Caremark  207 and tenure on employees’ contribution to the firm’s profits,79 establish a culture that prioritizes loyalty to the firm and its financial welfare, widely disperse responsibility for decisions that could violate the law,80 and adopt a compliance program that neither effectively deters nor detects misconduct.81 They can avoid the injunction to terminate detected misconduct by establishing compliance programs, internal reporting, and investigation systems that do not channel information about detected suspected material misconduct to directors.82 Accordingly, corporate law needs to supplement the duty to not knowingly violate the law with directorial oversight duties that require them to ensure that the firm and directors acquire information about corporate misconduct. Directors should be subject to duties to act in good faith to have the firm detect misconduct, to establish systems to ensure that they are informed about detected misconduct that is material to the firm or society,83 to ensure that they actually receive and attend to such information, and to exert oversight over investigations.84 Information-acquisition duties that increase directors’ likelihood of learning about misconduct, coupled with both a duty to terminate misconduct and personal liability for deliberate breach, can reduce the expected duration and scope of misconduct by giving directors a personal incentive to detect and terminate misconduct even when it is likely to benefit the firm and themselves.85 These directorial oversight duties are superior to a more general duty to adopt an effective compliance program for two reasons. First, the duty to obtain information about detected material misconduct should be optimal for all firms, at least when limited to legal risks that are material to the firm or society. Boards cannot effectively assess or ensure their companies’ legal compliance unless they obtain the most important information available on compliance: information about material misconduct occurring within the firm.86 Thus, boards cannot satisfy a duty to ensure compliance unless they act in good faith to have the firm detect and ensure

79 Arlen, supra note 40; Arlen & Kraakman, supra note 8; Jonathan Macey, Agency Theory and the Criminal Liability of Organizations, 71 BU L. Rev. 315 (1991). 80 See Arlen & Kornhauser, supra note 8. 81 See id.; see also Donald Langevoort, Culture of Compliance, 54 Am. Crim. L. Rev. 933 (2017). For a discussion of why director and officer liability predicated on traditional criminal law doctrines will not suffice, see Samuel Buell, Criminally Bad Management, in The Research Handbook on Corporate Crime and Financial Misdealing (Jennifer Arlen ed., 2018). 82 Management also has a duty to terminate detected misconduct, but they regularly face greater incentives to allow it to continue. See supra text accompanying notes 36 & 86. 83 See infra Section V.A. Society has a sufficiently strong interest in deterring misconduct to justify requiring directors to act to ensure they are informed about the company’s on-going compliance with laws when (1) a legal violation presents a material risk of personal injury or death and (2) society subjects the activity to intensive regulation that includes a duty to report misconduct or risk of harm. 84 This latter duty gives authority over investigations to the firm’s least conflicted agents, the outside directors. 85 See supra note 56. 86 See, e.g., Eugene Soltes, Evaluating the Effectiveness of Corporate Compliance Programs: Establishing a Model for Prosecutors, Courts, and Firms, 14 NYU J.L. & Bus. 965 (2018) (assessment of compliance program effectiveness must be based on evidence on outputs, such as reported misconduct); Eugene Soltes, Measuring Compliance and the Emergence of Analytics, in Measuring Compliance (Melissa Rorie & Benjamin van Rooij, eds. 2022); see also Brandon L. Garrett & Gregory Mitchell, Testing Compliance, 83 Law & Contemp. Prob. 47 (2020) (prosecutors should attend more to outcome data in assessing compliance programs); Hui Chen, The Use and Measurement of Compliance Programs in the Legal and Regulatory Domains, in Measuring Compliance, supra (same).

208  Research handbook on corporate liability that they are informed about legal risks that are material to the firm or society. These duties channel information about detected suspected misconduct to agents of the firm (outside directors) who are less plagued by conflicts of interest in investigating and terminating misconduct than senior management is. Second, unlike duties to adopt a compliance program,87 courts can practicably implement these information-acquisition oversight duties because courts are equipped to assess the procedures, policies, and practices directors adopt to obtain and assess information about misconduct.88 They can reliably obtain information on whether directors established systems to inform themselves of detected material misconduct and ensured that they obtained this information, and, moreover, can assess whether directors asserted sufficient oversight to ensure a proper response. These information-acquisition duties are only effective, however, if structured to serve society’s interests in deterring material misconduct even when companies profit from it.

IV.

DELAWARE’S FOUNDATIONAL OVERSIGHT DUTIES: CAREMARK AND STONE

In 1996, in In re Caremark Int’l, Delaware took an important first step towards imposing fiduciary duties on directors designed to induce them to adopt systems to inform them about the firm’s compliance with the law and to maintain oversight of such systems.89 This section analyses the duties and liability rule imposed by Caremark, highlighting its positive contribution to corporate law and identifying the reasons why it failed to induce directors to either act proactively to deter corporate crime or to ensure that they were informed about misconduct. The next section assesses recent cases reforming Caremark in light of the reforms recommended in this chapter. A.

Caremark 1.0

In 1996, Chancellor William Allen revolutionized Delaware law on directors’ duties to oversee their companies’ compliance with the law when he used a negotiated settlement of In re Caremark International Inc. Derivative Litigation90 to impose on directors a duty to exercise oversight over their firms’ compliance with the law. Chancellor Allen concluded that the board cannot satisfy its duties to the firm unless it ensures that the firm has an information and reporting system reasonably designed to provide senior management and the board with accurate and timely information about the firm’s 87 See supra Section II.B. Some regulators do seek to assess corporate compliance ex ante. In some cases, compliance relates to a sufficiently narrow task that this is possible. But in many other cases, regulators do not assert effective oversight over compliance in part because they often fail to seek the right information – including information on the firm’s compliance and promotion practices and on detected misconduct. See Garrett & Mitchell, supra note 86 (discussing how to improve enforcement officials’ oversight of compliance). 88 Cf. Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). 89 In re Caremark International Derivative Litigation, 698 A.2d 959, 959 (Del. Ch. 1996). Caremark was eventually affirmed by the Delaware Supreme Court in Stone v. Ritter, 911 A.2d 362 (Del. 2006). 90 Caremark, 698 A.2d.

Evolution of director oversight duties and liability under Caremark  209 compliance with the law; the board must also assert ongoing oversight over the system and investigation of any material misconduct detected.91 To achieve this, Caremark imposed duties on the board to: (1) ensure that the firm adopts an information and reporting system designed to provide the firm, management, and directors with accurate and timely information about the firm’s compliance with the law; (2) exercise on-going oversight over the effectiveness of the firm’s compliance function and its system to detect and inform appropriate corporate actors about misconduct; (3) exercise good faith oversight over the firm’s investigation of suspected misconduct; and (4) terminate all detected misconduct.92 In selecting the liability rule to govern violations of these duties, Chancellor Allen rejected negligence liability on the grounds it risked subjecting directors to liability even when they took due care as a result of court error; this would induce them to take excessive care.93 He concluded that directors should only be liable if they acted in bad faith, as defined by deliberate and sustained neglect of their oversight duties.94 This bad faith liability standard could have provided directors with strong incentives to exert active oversight over corporate misconduct if Chancellor Allen imposed precise oversight duties on directors that required them to take specific actions. Chancellor Allen chose not to do so, however. Instead, he gave them full discretion to decide what systems to adopt to ensure compliance with the law, what information the board should obtain as part of its oversight of the firm’s compliance, and the precise level of oversight the board should exercise over investigations.95 As a result, directors who adopt a system, regularly obtain reports on the procedures and policies of the compliance program, and assert some oversight over investigations, are protected from liability by the Business Judgment Rule,96 even if the systems they adopted were inadequate and they failed to adopt processes to give them vital information about compliance: specifically information on detected misconduct. Directors only risk liability if they act in bad faith by utterly failing to adopt a system, failing to comply with a specific compliance mandate imposed by law, or engaging in intentional sustained neglect of their duties by not obtaining any information on the firm’s compliance or having no response to detected suspected misconduct.97 Chancellor Allen gave directors full discretion over how to satisfy their oversight duties because he assumed they would use it to deter corporate crime. This assumption was rooted in his unstated view that director oversight liability was only needed to address one problem: director-shareholder agency costs.98 He believed Caremark would do this. Chancellor Allen concluded that directors were potentially plagued by two types of agency costs. The first type is ‘hard agency costs’, arising when directors personally benefit from the

Id. Id. 93 Arlen, supra note 21, at 340–43. 94 Id. 95 See, e.g., id.; Armour et al., supra note 52, at 45–47. 96 Caremark, 698 A.2d at 959. See, e.g., Arlen, supra note 21, at 340–43. 97 Caremark, 698 A.2d at 959. 98 Arlen, supra note 21, at 340–43; see also Donald C. Langevoort, Caremark and Compliance: A Twenty-Year Lookback, 90 Temple L. Rev. 741–42 (2018) (concluding that while Caremark does not create strong duties, boards would face strong external pressure to respond appropriately). 91 92

210  Research handbook on corporate liability misconduct or weak compliance.99 Chancellor Allen concluded he could address hard agency costs by threatening directors with liability for bad faith on the theory that directors with a material conflict would be more likely to act in bad faith.100 The second type, which he thought was the dominant problem, is ‘soft agency costs’, which are reasons directors may fail to act in cases where the firm’s interests do not directly implicate their own financial self-interest. These include inertia and directors’ concern that they would undermine their relationship with senior management by adopting a system to oversee management’s compliance with the law when other firms do not.101 Chancellor Allen believed he could ameliorate soft agency costs by simply imposing a duty on all directors to exercise oversight over the firm’s compliance with the law. Following Caremark, directors who implement an effective information and reporting system could not be seen as casting aspersions on management; they would simply be doing their jobs.102 Given his assumptions that directors generally only suffered from soft agency costs and would have no reason not to actively seek to ensure that the firm adopted and maintained an effective compliance function if informed that they had duties to do so, Chancellor Allen concluded he could achieve his goal of inducing effective oversight while leaving directors with full discretion to determine what measures the firm and they should take to ensure the firm’s compliance with the law. B. Why Caremark Did Not Have its Desired Effect Caremark did not have Chancellor Allen’s intended effect. The threat of liability for bad faith did not operate to induce directors to adopt effective compliance programs or assert effective oversight.103 Large companies engaged in widespread and long-term misconduct104 that effective systems would likely have deterred or shortened. Caremark was ineffective for two interconnected reasons. First, the duties it imposed were so general that directors could avoid liability for bad faith without adopting an effective compliance function or exercising effective oversight over it. Directors could satisfy their Caremark duties by adopting some form of internal information and reporting system that provided them with some information about the system (e.g., information on policies and employee training) and by ensuring that they regularly received brief reports from compliance that included such information, even if they failed to adopt an effective compliance function, failed to ensure that the system provided them with information essential to their ability to effectively oversee compliance (such as information about detected misconduct) and failed to

99 Arlen, supra note 21; cf. Arlen & Kahan, supra note 52 (discussing such agency costs and steps that prosecutors can take to address them). 100 Arlen, supra note 21 101 Id., at 340–43. 102 Id. 103 For example, only 5 percent of boards have a compliance committee. John Armour et al., Board Compliance, 104 Minn. L. Rev. 1191 (2020). Others delegate compliance to the audit committee which often is too burdened with overseeing the firm’s financial statements to devote sufficient attention to other forms of compliance. 104 See Soltes, supra note 10 (presenting evidence of hundreds of violations, none of which were detected and determining that firms face a very low threat of having their misconduct detected and sanctioned).

Evolution of director oversight duties and liability under Caremark  211 devote the needed amount of time and attention to compliance oversight.105 Indeed, in Stone v. Ritter, directors avoided liability for bad faith because the firm had a compliance program and directors exercised on-going oversight over the firm’s ethics policies and its training programs, even though the compliance program was materially under-resourced and directors did not assert effective oversight over either detected deficiencies in the system or detected misconduct.106 Thus, Caremark relied on directors’ own commitment to deterring corporate crime. Second, Chancellor Allen erred in assuming that compliance and detecting misconduct was in companies’ best interests,107 and thus that directors exercising good faith business judgment would adopt effective compliance programs, seek to obtain information about detected misconduct, and terminate it upon discovery. Companies regularly profit from crime because they face only a remote likelihood of detection and sanctions.108 They also benefit from deficient compliance, as effective compliance is costly and can reduce productivity.109 Accordingly, directors given discretion to exercise their business judgment to serve their firms often favor suboptimal compliance measures; they also regularly do not seek to be informed about material misconduct, as the receipt of information about misconduct would obligate them to terminate it.110 105 Information on outputs of compliance – e.g., detected misconduct – is the most important information about compliance program effectiveness. See citations in supra note 86. Directors generally are only liable under Caremark in one of three situations, two of which are rooted in the pre-Caremark duty not to violate the law: first, when directors knowingly adopt a business plan that would have the firm violate the law (see supra Section III); second, where directors fail to act after being informed that the firm is likely violating the law (id.; see Stavros Gadinis & Amelia Miazad, The Hidden Power of Compliance, Minn. L. Rev. 2135 (2018)); and, finally, when directors fail to comply with a specific oversight duty imposed by an external legal source – such as duties imposed by federal law on audit committees. In re China Agritech, Inc. S’holder Derivative Litig., No. CIV.A. 7163-VCL, 2013 WL 2181514 (Del. Ch. May 21, 2013) (the audit committee violated its legal duties by failing to meet and having material conflicts). A rare pre-Caremark 2.0 case imposing liability beyond these situations involved a closely-held company whose directors exerted no oversight over the controlling shareholder. ATR-Kim Eng Fin. Corp. v. Araneta, No. CIV.A. 489-N (Del. Ch. Dec. 21, 2006), aff’d sub nom. Araneta v. Atr-Kim Fin. Corp., 930 A.2d 928 (Del. 2007). 106 See Stone v. Ritter, 911 A.2d 362, 362 (Del. 2006); see supra note 86 (discussing the importance of information on detected misconduct). 107 In re Caremark International Derivative Litigation, 698 A.2d 959, 959 (Del. Ch. 1996) (discussing the US Sentencing Guidelines reforms). 108 See supra Section III. In addition, because corporations profit from crime, directors will as well, giving them personal incentives to under-invest in compliance. See, e.g., Armour et al., supra note 52, at 38–39; Shapira, supra note 53, at 1891. 109 See Arlen & Kornhauser, supra note 8. 110 See supra Section III.A. By contrast, Professor Todd Haugh claims that Caremark materially enhanced compliance through its impact on directors’ intuitive choices. Todd Haugh, Caremark’s Behavioral Legacy, 90 Temple L. Rev. 611 (2018). Yet this is unlikely because directors personally benefit from crimes that profit the firm, and empirical studies show that people’s intuitive choices favor self-interest; indeed, they employ a host of mental tricks to enable them to select the self-interested choice and feel ethical. See Arlen & Kornhauser, supra note 8. Also, liability does not effectively deter self-interested choices when the threat of sanction is too low to be salient. See id. Haugh notes that evidence that corporate expenditures on compliance increased dramatically between 1996 and 2011, Haugh, supra, at 630. Yet there are a host of explanations other than Caremark. These include: (1) a dramatic increase in enforcement against firms engaged in foreign corruption after 2006; (2) increased corporate enforcement following the Department of Justice (DOJ)’s embrace of deferred- and non-prosecution agreements; and (3) the promulgation of federal laws imposing enhanced compliance program duties.

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V.

CAREMARK 2.0: ENHANCED AND SPECIFIC INFORMATION-ACQUISITION DUTIES

This section shows that director oversight liability could be improved by imposing specific duties on directors to adopt systems to ensure that they are informed about detected misconduct, assert sufficient oversight to obtain and assess this information, and actively oversee the investigation of misconduct, when the misconduct is the kind the firm or society has a material interest in deterring. It then discusses recent Delaware case law that imposes such duties for certain categories of legal risk and provides reasons to conclude that Delaware may be recognizing the need to impose such duties when deterrence would benefit society, even if the firm itself might not benefit. A.

Improving Director Liability

The central challenge for director liability is how to induce directors to deter misconduct that benefits the firm, without inducing them to either implement excessive measures or to deter the firm from detecting and self-reporting misconduct; director liability also should not impose due care requirements that courts cannot reliably assess.111 Director oversight liability can achieve these goals by imposing a set of specific, objectively verifiable duties on directors to undertake measures that generally are vital to boards’ ability to ensure compliance with the law. Given the range of demands on boards, these duties should be limited to situations in which the legal violation is sufficiently material to either the firm or society to justify requiring directors to exercise enhanced oversight over compliance. Although courts cannot practicably subject directors to a duty to adopt an effective compliance program,112 courts can materially enhance compliance by imposing duties on directors to (1) adopt internal systems designed to detect113 and to inform the directors about suspected violations of legal injunctions, (2) obtain regular and on-going reports about deficiencies in the firm’s oversight system and detected suspect material violations, and (3) oversee investigations of suspected misconduct in this category.114 Courts should impose a duty to detect and ensure that directors are informed about material misconduct because boards cannot reliably assess the effectiveness of their firms’ compliance programs unless they receive and assess information about detected material misconduct and its root causes.115 Moreover, ensuring that E.g., Sarbanes-Oxley Act of 2002, Pub. L. No. 107–204, 116 Stat. 745 (codified as amended in scattered sections of 15 U.S.C.); PATRIOT Act 2001, Pub. L. No. 107–56, 115 Stat. 272 (requiring financial institutions to implement effective systems relating to money-laundering). 111 See supra Section II.B. 112 See id. 113 See supra note 31. 114 Id. 115 See supra note 86. These duties are important even in firms that have an internal reporting system to detect misconduct because companies do not reliably ensure that information about material misconduct – and in turn the revealed deficiencies in the firm’s compliance function – reach the board. Chief Compliance Officers (CCOs) often do not provide directors with such information – or do not do so in a way that targets particularly material misconduct. CCOs can face implicit or explicit pressure from senior management to not highlight detected misconduct. In addition, boards (and audit committees) regularly do not devote sufficient time to CCO reports on compliance (beyond financial statements) or require CCOs to produce this information.

Evolution of director oversight duties and liability under Caremark  213 directors receive this information triggers the directors’ duty to terminate detected misconduct. These duties enable courts to limit liability to director bad faith while still imposing duties that can induce directors to enhance companies’ deterrence. These duties should not be limited to situations in which the company benefits from deterring misconduct. Companies regularly benefit from crime and from adopting systems that rarely detect misconduct. Yet such crimes often cause substantial harm to society. To adequately deter profitable crimes, society needs to supplement criminal liability with director oversight liability structured to induce directors to detect and terminate misconduct that imposes material costs on society. Thus, when misconduct is profitable, these enhanced director oversight duties should be used to effectively create – rather than eliminate – an agency cost, by providing directors with a personal incentive to implement measures likely to deter misconduct even when this is likely to reduce corporate profits. Yet courts should not require directors to become informed about every instance of misconduct. Companies are subject to a host of laws and regularly detect misconduct of varying significance to society.116 Directors’ time is precious and information about less important misconduct may deflect attention better allocated elsewhere. Thus, these duties should be restricted to information about misconduct that is sufficiently material to the firm or society to justify requiring directors to become informed about it and oversee the investigation. As an initial matter, courts could restrict the new enhanced oversight duties to legal risks whose violation presents a significant probability of serious personal injury or death,117 or where society has evidenced a heightened interest in compliance through intensive regulation, especially if it includes a duty to report detected violations or potential harms. Such information-acquisition duties can help deter by reducing the expected duration, and thus expected social cost, of misconduct. Directors informed about misconduct are legally obligated to terminate it.118 In addition, giving directors primary authority over investigations of suspected misconduct increases the likelihood that misconduct will be confirmed by reducing senior management’s ability to soft peddle the investigation to protect the firm’s and their own reputations or financial interests.119 These information-acquisition duties should also enhance deterrence by increasing directors’ ex ante incentives to implement more effective systems to deter misconduct. Directors gain less from enabling profitable misconduct when obligated to become informed about detected material misconduct because such information-channeling reduces the expected dura-

See Soltes, supra note 10. Deterring such crimes benefits both society and the firm in situations where the violation would harm customers who are able to determine that the firm caused their harm. See supra note 53 (discussing costs from reputational damage). It also can benefit the firm when the violation would harm shareholders. See Arlen & Carney, supra note 9 (discussing securities fraud). 118 Channeling information to the board is important even though officers also are required to terminate detected misconduct because directors face fewer conflicts of interest to comply with this duty. Officers are more likely to personally benefit from misconduct. See supra note 9. They also are more likely to suffer negative consequences, such as termination or the imposition of a monitor, from the revelation of serious misconduct. See, e.g., Arlen & Kahan, supra note 52 (discussing corporate management turnovers and acquisitions following detected misconduct as well as monitors); Alexander & Arlen, supra note 54 (same). 119 See supra note 118. 116 117

214  Research handbook on corporate liability tion and magnitude of any such misconduct.120 These duties also increase directors’ expected cost of misconduct because misconduct can trigger their liability under Caremark and risks reputational damage as a result of shareholders’ information rights.121 Thus, even when the company profits from misconduct, directors obligated to obtain information about detected misconduct may benefit from deterring it. Finally, information-acquisition duties should promote corporate self-reporting, thereby increasing individual wrongdoers’ expected cost of engaging in misconduct.122 Directors informed about misconduct are more likely than senior management to cause the firm to report to federal authorities as long as federal enforcement policy ensures such actions are in the company’s best interests123 because they are less likely than senior management to suffer personal costs as a result.124 Thus, unlike directorial respondeat superior or negligence liability, this duty operates to enhance corporate criminal liability’s ability to deter, rather than undermine it.125 B.

Caremark 2.0

Over the last few years, Delaware Courts started to modify the Caremark doctrine to impose duties on directors that appear to be consistent with, albeit not identical to, the regime set forth in Section V.A. In addition to the original Caremark duties, Delaware imposes enhanced, and more specific, oversight duties on directors in certain circumstances. Directors are required to adopt systems to ensure they are informed about detected misconduct; they are required to ensure they receive this information on a regular basis; and they are expected to ensure that they are informed about and oversee investigations. This section refers to these duties as Caremark 2.0 duties. Because these duties impose specific information-acquisition requirements that go beyond what many boards are doing, derivative plaintiffs’ claims have survived motions to dismiss in situations where defendants would have prevailed under Caremark’s original formulation.126

See supra text accompanying notes 114–19. Directors cannot avoid learning about it by delegating investigations to management, because this too would be a breach of duty under the proposed enhanced director oversight liability rule. 121 Misconduct is a precondition for potential liability, and directors face enhanced scrutiny. Moreover, as discussed below, directors face costs even absent liability because detected misconduct can provide a basis for shareholders to obtain detailed internal records – including directors’ emails – to determine whether this misconduct was attributable to mismanagement. See infra Section V.C. 122 Arlen & Kraakman, supra note 8; see supra Section II.A. 123 For a discussion of federal enforcement policy see Arlen & Buell, supra note 6. 124 See supra note 118. 125 See supra Section II.B. 126 Recent Caremark cases where plaintiffs have survived motions to dismiss for failure to make a demand include Marchand v. Barnhill, 212 A.3d 805 (Del. 2019); Chou, No. CV 2019-0816-SG; In re Clovis Oncology, Inc. Derivative Litig., No. CV 2017-0222-JRS (Del. Ch. Oct. 1, 2019); In re Boeing Co. Derivative Litig., No. CV 2019-0907-MTZ, 2021 WL 4059934 (Del. Ch. Sept. 7, 2021). Plaintiffs have prevailed in gaining the right to inspect corporate books and records under DGCL § 220, Del. Code Ann. tit. 8 based on claims of mismanagement arising from credible evidence of misconduct in the following cases: Lebanon Cty. Employees’ Ret. Fund v. AmerisourceBergen Corp., No. CV 2019-0527-JTL (Del. Ch. Jan. 13, 2020), aff’d, 243 A.3d 417 (Del. 2020); In re Facebook, Inc. Section 120

Evolution of director oversight duties and liability under Caremark  215 Delaware courts have not imposed these duties on all firms in all situations. Consistent with Section V.A, Delaware courts have only imposed these duties when compliance with the law is particularly important. Most of the cases predicate enhanced duties on evidence that oversight of compliance with the legal duty in question was mission critical to the firm. This is consistent with a shareholder-centric view of the role of these duties. But in recent cases Delaware courts appear to recognize that these enhanced oversight duties should be imposed when society has a strong interest in deterring misconduct, for example because the violation risks causing serious personal injury or death to multiple people. 1. Marchand v. Barnhill Delaware’s first case imposing enhanced and more specific information-acquisition oversight duties is Marchand v. Barnhill.127 Marchand involved a Caremark claim arising out of a listeria outbreak at an ice cream company, Blue Bell, that killed three people and sickened others. The plaintiff claimed the board breached its duties by not ensuring that they were informed about either a detected deficiency in the firm’s food safety systems or detected food safety problems (e.g., listeria). Applying Caremark, the Chancery Court dismissed because Blue Bell had a compliance program and thus did not intentionally neglect the duty to establish one. It also asserted regular oversight of it by receiving information about the firm’s procedures for ensuring food safety. This sufficed to preclude a finding of bad faith because Caremark vests the board with discretion to decide whether to ensure it is informed about detected compliance deficiencies or safety violations, even when, as here, the firm is legally obligated to report detected violations that may kill customers if they are not properly dealt with.128 The Delaware Supreme Court reversed, reasoning that Blue Bell’s compliance with its legal duty to ensure food safety was so vital – mission critical – to the firm that the board could not satisfy its oversight duties unless it implemented procedures to provide it with information about detected safety violations and ensured that it regularly receive such reports. The board also had to oversee the investigation and resolution of those problems. Having established these information acquisition duties, the Marchand court determined that the plaintiff had met the burden to establish that the board breached these duties in bad faith for purposes of surviving dismissal of the complaint. Although Blue Bell had a compliance program, the Blue Bell board had not adopted any procedures to ensure that it was informed about food safety violations, such as listeria outbreaks. Moreover, it did not actually obtain information about food safety violations: it was not informed of tests showing listeria in the firm’s ice cream.129 The court concluded that the plaintiffs created a reasonable belief that the board engaged in intentional sustained neglect of its duty to be informed about food safety violations because: (1) it neither delegated responsibility to oversee food safety to a committee of the board nor established protocols to ensure that management apprised the full board about food safety; (2) it did not establish a process to ensure that the board received

220 Litig., No. CV 2018-0661-JRS (Del. Ch. May 30, 2019), as revised (May 31, 2019), judgment entered sub nom. In re Facebook, Inc. (Del. Ch. 2019). 127 Marchand, 212 A.3d at 824. 128 Id. 129 Id.

216  Research handbook on corporate liability information about adverse events; and (3) there was no evidence in the board minutes that the board regularly discussed food safety.130 The court in imposing these duties to acquire information about detected violations did not impose similar duties on all firms. The Delaware Supreme Court rooted its new duties in the court’s traditional concern for corporate welfare and restricted these duties to situations where deterring the misconduct was essential to the firm. Blue Bell’s board could not provide effective oversight without ensuring it was apprised of food safety violations because food safety was an ‘essential and mission critical regulatory compliance risk’ for the firm. Blue Bell only made one type of product; its market would evaporate if its ice cream regularly killed customers.131 Yet the opinion indicates that such duties may be justified by society’s especially strong interest in legal compliance. The court noted that society has a heightened interest in ensuring companies’ compliance with laws designed to protect people from personal injury and death, as is expressed by subjecting this industry to heightened regulatory oversight that includes corporate duties to self-report detected violations.132 The court did not address whether Caremark 2.0 duties could be predicated on a strong social interest in deterring misconduct that presents a substantial risk of personal injury even when compliance failures were not a mission critical risk for the firm.133 2. Teamsters Local 443 v. Chou In 2020, the Delaware court imposed enhanced Caremark 2.0 duties in circumstances in which the primary justification for imposing these enhanced duties appears to be society’s interest in protecting people from death and serious permanent injury in Teamsters Local 443 v. Chou.134 Chou involved claims that the board of AmerisourceBergen Company breached its duties to ensure that its subsidiaries complied with laws governing the sale of cancer drugs.135 The board would not have been liable under Caremark’s original formulation because the board did not utterly neglect its duties: the firm had a compliance program, the Chief Compliance Officer

Id. at 822. Id. at 824 (stating ‘food safety was essential and mission critical’); see also id. at 822 (observing that food safety ‘has to be one of the most central issues at the company’ and ‘a compliance issue intrinsically critical to the company’s [monoline] business operation’). The determination of what constitutes a mission critical risk appears to focus on risks whose realization could materially threaten the firm’s future welfare. This is a narrower set of concerns than those that firms might describe as ‘mission critical’ in their statements to the public, such as diversity or protecting the climate. Compare with Veronica Root Martinez, The Diversity Risk Paradox, 75 Vand. L. Rev. En Banc 115, 116–17 (2022) (suggesting that such public statements about diversity might serve as the basis of a Caremark claim). 132 Id. 133 The next case, In re Clovis Oncology, Inc. Derivative Litig., did not resolve this issue as it again involved a company in a highly-regulated industry that made only one product, cancer treatments; but society also has heightened interest in ensuring compliance with these laws, as evidenced by both the intensity of the regulations and companies’ strong self-reporting duties, and also the nature of the potential harm, serious injury and death. In re Clovis Oncology, Inc. Derivative Litig., No. 2017-0222-JRS (Del. Ch. Oct. 1, 2019). 134 Teamsters Loc. 443 Health Servs. & Ins. Plan v. Chou, No. 2019-0816-SG (Del. Ch. Aug. 24, 2020). 135 Id. 130 131

Evolution of director oversight duties and liability under Caremark  217 (CCO) reported to the board on efforts to improve compliance, and the board hired an outside law firm to identify weaknesses. Yet, according to the plaintiff, the board breached its oversight duties because, upon receiving notice of problems at a subsidiary – and of a DOJ investigation – it did not obtain information about either the DOJ investigation or the success of efforts to bring the subsidiary into compliance.136 While under Caremark the board would have had discretion to decide what information to receive, the Delaware court decided to impose enhanced Caremark 2.0 duties, which included a duty to ensure that the board was informed about the firm’s response to remediating detected violations. The court justified the heightened duties by stating that lack of compliance with the laws in question were ‘mission critical risks’.137 Yet compliance with these laws does not appear to have been mission critical to the firm. The suit was against the board of the parent company; the oversight duties involved activities in a subsidiary that accounted for only a small portion of the parent’s revenues.138 Even debarment of the subsidiary following a conviction does not appear to have presented a mission critical risk for the parent. The imposition of enhanced duties here appears to rest on society’s strong interest in ensuring compliance with rules designed to protect pharmaceutical customers from risks to their persons. The court focused on the risk of personal injury or death that can result from violating these duties; it also noted that society had expressed its strong interest in ensuring compliance with these legal duties through the intensity of its regulation of this activity and the imposition of self-reporting requirements. 3. In re Boeing Company Derivative Litigation In Re Boeing Company Derivative Litigation139 is a case in which enhanced duties serve society’s interests, but arguably also serve shareholders’ interests. Yet the opinion appears to evidence a particular concern for society’s interest in customer safety. Boeing involved Caremark claims for damages to the firm resulting from the crash of two Boeing 737 MAX planes. The plaintiff alleged that the board: (1) failed to set up an effective system to enable it to oversee airplane safety; (2) failed to exercise on-going oversight of that system; and (3) failed to adequately oversee the investigation.140 The board would have faced little risk of liability under Caremark 1.0 because Boeing is well known for having a strong compliance program and the board received regular reports from the firm’s compliance officer. The company also investigated the first crash. The court in Boeing concluded that the Boeing board was subject to enhanced Caremark 2.0 duties for several reasons. First, Boeing operates ‘in the shadow of “essential and mission critical” regulatory compliance risk’. Second, Boeing’s products are widely distributed and used by consumers who can be killed by safety violations.141 Third, Boeing was subject to intensive regulation that included a duty to report detected safety problems.

Id. Id. 138 Shapira, supra note 53. 139 In re Boeing Co. Derivative Litig., No. CV 2019-0907-MTZ, 2021 WL 4059934 (Del. Ch. Sept. 7, 2021). 140 Id. 141 Id. at 26. 136 137

218  Research handbook on corporate liability The court found that the plaintiff could satisfy his burden to show that the board acted in bad faith because it failed both to establish a system to inform it about airplane safety and to obtain information about airplane safety. The board entirely neglected its duty to adopt systems to ensure it was informed about detected safety violations or misconduct because: (1) the board did not establish a committee charged with direct responsibility to monitor airplane safety; (2) the board did not itself monitor, discuss, or address airplane safety on a regular basis; (3) it did not establish a system to monitor for safety violations or ensure board oversight of detected problems; and (4) it did not establish protocols requiring management to apprise it of airplane safety problems. The Court found that scienter was established because the Board knew that there was no committee focused on safety, knew they had not scheduled meetings to discuss it, and knew that they were not receiving regular updates on it. The court also found that the plaintiff could meet his burden of showing the board utterly failed to exert ongoing oversight by obtaining information about plane safety violations.142 Following the crash of Boeing’s first 737 MAX aircraft, directors failed to immediately request information about the causes of the crash and passively accepted the information provided by management without requiring an independent assessment, even after newspaper articles revealed a likely technical flaw with the plane.143 4. Summary These Caremark 2.0 cases are consistent with the director liability regime set forth in Section V.A in imposing specific duties on directors to ensure that they are informed about and exert oversight over the outputs of compliance – specifically, direct evidence of deficiencies and evidence of detected suspected misconduct. These cases also appear to indicate that the Delaware court may be willing to extend these duties to situations in which compliance protects people from personal injury or death, or from risks that society has expressed a particularly strong interest in deterring. The resulting heightened information-acquisition duties can, if properly implemented, enhance deterrence in the ways discussed in Section V.A without risking the over-deterrence that would flow from the imposition on directors of either negligence liability for ineffective oversight or strict respondeat superior liability for corporate misconduct.144 Whether the court will consistently apply such duties to legal risks that primarily serve social interests remains to be seen. C.

Potential Threat to Directors of Caremark 2.0 Liability

Caremark 2.0 can enhance directors’ incentives to deter misconduct, even though it relies on actions brought by shareholders who regularly benefit from weak compliance. Even when shareholders benefit from crime ex ante, once misconduct has been detected and has produced losses for the firm, some shareholders will be motivated to leverage Caremark to shift those losses to directors if they can. Derivative plaintiffs are likely to be able to recover without having to establish bad faith by a preponderance of the evidence because directors do not take Caremark cases to trial on the merits. Caremark liability is predicated on bad faith, placing directors outside the protections Id. at 34. Id. 144 See supra Section III.B. 142 143

Evolution of director oversight duties and liability under Caremark  219 of Delaware General Corporation Law (‘DGCL’) § 102(b)(7) indemnification provisions or most D&O insurance. To induce settlement, plaintiffs simply need sufficient evidence to survive motions to dismiss the complaint on demand futility and the merits. The standard for demand futility is quite favorable to plaintiffs. Plaintiffs must provide evidence that creates a reasonable belief that directors knowingly neglected their duties. Courts in Caremark 2.0 cases allow plaintiffs to establish such neglect when boards, in response to plaintiffs’ request for books and records, do not produce evidence (such as board committee mandates and board minutes) demonstrating that the board or relevant board committee received information on detected suspected covered violations, obtained such information on an on-going basis, and asserted effective oversight over investigations.145 Moreover, corporate criminal liability is not a prerequisite to liability under Caremark. Directors are potentially liable for losses beyond penalties, including the costs of investigations and legal costs. While plaintiffs need to create a reasonable belief that these losses resulted from a legal violation, plaintiffs may be able to predicate this reasonable belief on the findings of government investigations that have not yet produced a criminal settlement.146 Finally, Caremark provides directors with an incentive to proactively deter misconduct to avoid reputational damage they may suffer when detected misconduct induces shareholders to request corporate books, records and emails under DGCL § 220 to determine whether the misconduct resulted from mismanagement.147 Shareholders who provide a credible basis for concluding that their company engaged in misconduct potentially attributable to mismanagement can obtain a broad range of records beyond official records, such as board minutes. These records include directors’ and senior officers’ email exchanges relating to the issue.148 The resulting revelations can damage directors’ reputations.149

VI. CONCLUSION Societies continue to struggle with how to effectively deter corporate crime without imposing excessive costs on legitimate productive enterprises. Corporate liability is essential to this effort, but it cannot optimally deter on its own. Managers and directors may fail to respond in corporations’ best interests because they personally benefit from crime or weak compliance. Alternatively, they may promote profitable misconduct when the threat of corporate enforcement is sufficiently low. E.g., Marchand v. Barnhill, 212 A.3d 805 (Del. 2019); Boeing, No. 2019-0907-MTZ. In re Facebook, Inc. Section 220 Litig., No. 2018-0661-JRS (Del. Ch. May 30, 2019); Lebanon Cnty. Emps.’ Ret. Fund v. AmerisourceBergen Corp., No. 2019-0527-JTL (Del. Ch. Jan. 13, 2020). 147 See Shapira, supra note 53, at 1877–79. 148 Shareholders can obtain corporate records, including relevant emails by management and directors, even if they cannot establish that the board is liable under Caremark. See AmerisourceBergen Corp. v. Lebanon Cty. Employees’ Ret. Fund, 243 A.3d 417 (Del. 2020); DGCL § 220 Del. Code Ann. tit. 8; see also In re Facebook, Inc. Section 220 Litig., No. CV 2018-0661-JRS, 2019 WL 2320842 (Del. Ch. May 30, 2019), as revised (May 31, 2019), judgment entered sub nom. In re Facebook, Inc. (Del. Ch. 2019). Notwithstanding reputational damage costs, directors’ costs of detection should be less than management’s as senior management is most likely to be implicated in any misconduct that could plausibly implicate directors, as, for example, allegedly is the case with both AmerisourceBergen and Facebook (now Meta). 149 E.g., Boeing, No. 2019-0907-MTZ. 145 146

220  Research handbook on corporate liability To promote social welfare, states need to leverage corporate law’s ability to deter through narrowly tailored duties imposed on directors, enforced by the threat of liability for bad faith. Corporate law requires directors not to knowingly commit misconduct and to terminate any they learn about. But this duty is not effective without additional duties designed to ensure that directors are informed about detected misconduct. Delaware’s primary doctrine for inducing director oversight over compliance, Caremark, neither imposes the requisite duties nor induces directors to obtain this information in situations where companies profit from misconduct. To efficiently deter corporate crime, directors must be required to ensure that they are informed about detected material misconduct and should oversee the investigation of this information. These duties can enhance deterrence if they are imposed (1) when compliance is vital to the firm and (2) in relation to laws designed to guard against serious permanent injury or death where society evidenced its strong interest in compliance by requiring companies to report detected safety problems. Such information-acquisition duties can give effect to Delaware’s directorial duty not to violate the law by increasing the likelihood that directors learn about misconduct and thus feel pressured to terminate it. One benefit of Caremark 2.0 liability is that it relies on private litigation by shareholders, which is less vulnerable to political capture by companies than public enforcement. Companies have considerable ability to leverage their financial resources to influence elected officials. In turn, both Congress and the White House regularly take actions that undermine federal corporate enforcement.150 Corporations cannot readily deploy their political influence to curtail Caremark litigation, which is brought by private litigants whose budgets lie beyond companies’ influence. Moreover, Caremark cases fall under the jurisdiction of Delaware Chancery Court judges who are appointed and have no need for companies’ campaign contributions. Corporations also cannot as successfully lobby the Delaware legislature to curtail Caremark derivative litigation because powerful institutional shareholders have the political influence and incentives to block efforts to limit directors’ liability for bad faith.

See, e.g., Arlen, supra note 5.

150

12. Fiduciary liability and business judgment Paul B. Miller

I. INTRODUCTION In broad outline, principles governing the fiduciary liability of corporate directors in America’s leading corporate law jurisdiction – the state of Delaware1 – are in alignment with those of civil law and other common law jurisdictions: corporate directors are understood to perform inherently fiduciary administrative functions; in consequence, their powers are constrained by fiduciary duties, and violation of these duties renders directors liable to pay or to perform court-ordered fiduciary remedies. However, America has charted its own course in the spirit and finer doctrinal detailing of its corporate fiduciary law. If any doctrine may be said to singularly reflect the spirit of American corporate law, it is the business judgment rule (the ‘rule’ for short). The business judgment rule is evocative of a distinctively American philosophy of corporate law, with its emphasis on enabling law-making and adjudicative postures, clear-eyed recognition of the risks inherent in business and investment, and belief in the relative superiority of market-based over legal discipline of managerial performance. The American corporate form shares constitutive elements with those of other jurisdictions, but American corporate law stands apart for the sheer breadth of latitude it asserts for managerial discretion. That assertion is made, and is thought to be policed, through the business judgment rule. The business judgment rule conveys something distinctive about American law partly in virtue of its apparent singularity. The rule appears anomalous when placed in two different comparative contexts. First, it seems anomalous within the context of American fiduciary law: as Julian Velasco has observed, there is no ‘fiduciary judgment rule’ applicable to all fiduciaries charged with administering the property or affairs of another, nor are there narrower cognate doctrines securing discretion in the exercise of fiduciary powers by agents, trustees, lawyers, or other fiduciaries2 – thus, the apparent singularity of the rule in what it signifies about the posture of American corporate law toward corporate fiduciary administration. Second, the rule seems anomalous as a matter of comparative corporate law. Setting to one side variants brought about by legal transplantation, most jurisdictions have done without a business judgment rule3 – thus, in turn, the apparent singularity of the rule in what it conveys 1 For present purposes, I shall attend only to Delaware law, setting to one side (sometimes significant) differences in choices made by state legislatures in other American states. Hence, unless otherwise noted, reference to ‘American’ corporate law is meant as a reference to Delaware corporate law. 2 Julian Velasco, Fiduciary Judgment Rules, 62 Wm. & Mary L. Rev. 1397 (2021). 3 See Douglas M. Branson, The Rule That Isn’t a Rule: The Business Judgment Rule, 36 Val. U. L. Rev. 631, 633 (2002) (explaining that, as of the time of writing, the business judgment rule ‘remains an exclusively American legal construct’ with the exception of ‘Australia, which, in 1999, based upon a well-known United States formulation of the rule, enacted the first … statutory version of the business judgment rule’). For exceptions and analyses advocating or charting the spread of the business judgment rule to other jurisdictions, see Douglas M. Branson & Low Chee Keong, Balancing the Scales:

221

222  Research handbook on corporate liability about the posture of American corporate law relative to the fiduciary administration of corporations. For better or worse, a reflex response to singularity is to treat that which is singular as normatively conspicuous. This tendency is seen in some reactions to the business judgment rule, but it cuts in different ways. In some quarters, the rule has spawned envy, admiration, and imitation, including in jurisdictions that have developed variants on the rule. In others, the rule has generated puzzlement, manifested constructively (e.g., through probing questioning) or critically (e.g., through cynicism about the politics of the rule). I do not propose to evaluate the varying responses to the business judgment rule because the rule itself remains surprisingly difficult to interpret. Thus, the ambition of this chapter is to clarify the nature of the business judgment rule and its relationship to principles governing the fiduciary liability of corporate directors. The aim is not to retrace the history of the rule across its many, inconsistent formulations.4 Instead, building on the work of others,5 my project is one of interpretation by way of rational reconstruction. That is, the project is one of determining what sense may be made of the business judgment rule, presented in its best light. The argument will unfold as follows. In Part II, I provide a brief overview of Delaware law on the fiduciary liability of directors. In Part III, I clarify the subject matter of the business judgment rule. In Part III, I present a rationally reconstructed interpretation of the content of the rule, drawing on the work of Stephen Bainbridge and Lyman Johnson. In Part IV, I return to the comparative context, asking whether and to what extent the reconstructed version of the rule is anomalous. I suggest, surprisingly, that it is not, save in respect of its being given doctrinal expression (i.e., being posited as a ‘rule’); fiduciary administration is, elsewhere, protected by implicit norms of deference to decisions lawfully made by fiduciaries. In turn, I ask whether the business judgment rule is substantively rational (i.e., whether the decision to give doctrinal expression to a norm that is elsewhere left implicit is, or might be, justifiable). My answer is that it is, in principle, but that in practice (as one retreats from rational reconstruction to confront the reality of unresolved doctrinal development of the rule) it has not proven to be. In Part V, I comment on the relationship between fiduciary liability and both the unreconstructed rule and the interpretation of it advanced in Part III. Finally, in the Conclusion, I ask whether the

A Statutory Business Judgment Rule for Hong Kong, 34 H.K. L.J. 303 (2004); Dan W. Puchniak & Masafumi Nakahigashi, A New Era for the Business Judgment Rule in Japan?, in Business Law in Japan: Cases and Comments (Moritz Bälz et al. eds., 2012); Carsten Gerner-Beuerle, The Duty of Care and the Business Judgment Rule: A Case Study in Legal Transplants and Local Narratives, in Comparative Corporate Governance 220, 221 (Afra Afsharipour & Martin Gelter eds., 2021) (noting that the business judgment rule ‘has diffused increasingly widely over the last few decades and can now be found … in eight European countries that all belong to the civil law tradition’, while emphasizing, with reference to the German variant of the rule, that ‘the inherent meaning of transplanted legal institutions is not necessarily transferred together with the text of the norm’). 4 That work has been done by others. See Lyman Johnson, The Modest Business Judgment Rule, 55 Bus. Law. 625, 626 (2000) (commenting critically on ‘an ambitious “burdening” of [the] rule with functions for which it was not designed and, indeed, is ill-suited’). See also D. Gordon Smith, The Modern Business Judgment Rule, in Research Handbook on Mergers and Acquisitions 83 (Claire Hill & Steven Davidoff Solomon eds., 2016), at 83 (‘The business judgment rule [has] had myriad formulations’) and 85 (noting that ‘current law is inconsistent and confusing’). 5 Johnson, supra note 4; Stephen M. Bainbridge, The Business Judgment Rule as Abstention Doctrine, 57 Vand. L. Rev. 83 (2004).

Fiduciary liability and business judgment  223 effectiveness of the business judgment rule in the United States – something achieved despite abiding inconsistency in its doctrinal formulation – and the reported ineffectiveness of the rule in other jurisdictions might suggest that causal factors shaping judicial behavior in conformity with the rule’s aims are primarily social rather than legal.

II.

FIDUCIARY LIABILITY

As noted earlier, American corporate law is similar in broad outline to that of many jurisdictions. It recognizes that corporate directors wield robustly discretionary fiduciary powers over corporations, exposing corporations and shareholders to significant risk of economic harm. It proves responsive to this risk by imposing fiduciary duties upon directors, leveraging the expressive function of duty-imposing rules in order to guide directors about what is required by way of proper performance of their mandates,6 while at the same time threatening liability for impropriety. And it makes ample use of equitable remedies in order to compel mandated performance, to restrain misconduct, to disgorge and trace property or profits improperly appropriated, and to force compensation for losses culpably visited upon a corporation and/or its shareholders. However, superficial cross-jurisdictional similarities belie important differences in the letter and the spirit of the law. To illustrate this, and to anticipate the analysis of the business judgment rule that will follow in Parts III–V, I shall presently comment briefly on four essential features of corporate fiduciary law: fiduciary status; fiduciary duties; exculpation and cleansing doctrines; and standards of review. American law tracks that of other jurisdictions in treating directors as fiduciaries as a matter of status.7 Properly appointed directors are granted wide and robustly discretionary power to administer the affairs of a corporation under Delaware law,8 including the power delegated to officers (subject to the Board’s retention of a duty to monitor). Even those acting as directors under a defective appointment are considered ‘de facto’ directors and deemed (pending removal) to enjoy powers that ground fiduciary status. In this, American law is conventional. However, press further and one finds significant differences in doctrinal detail. For instance, whereas many common law jurisdictions subject directors and officers to common fiduciary status, American jurisprudence on officers is less certain, with some arguing that even if the fiduciary status of officers is coextensive with that of directors under Delaware law,9 the implications of that status diverge in respect of matters like exculpation and standards of review.10

See Edward B. Rock, Saints and Sinners: How Does Delaware Corporate Law Work?, 44 UCLA L. Rev. 1009 (1997). 7 On the significance of status designations in the identification of fiduciaries more generally, see Paul B. Miller, The Idea of Status in Fiduciary Law, in Contract, Status, and Fiduciary Law 25 (Paul B. Miller & Andrew S. Gold eds., 2016) and Paul B. Miller, The Identification of Fiduciary Relationships, in The Oxford Handbook of Fiduciary Law 367 (Evan J. Criddle, Paul B. Miller, & Robert H. Sitkoff eds., 2019). 8 Delaware General Corporation Law (DGCL), Del. Code Ann. tit. 8, §141(a) (‘The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors’). 9 Gantler v. Stephens, 965 A.2d 695, 708 (Del. 2009). 10 See Lyman Johnson, The Three Fiduciaries of Delaware Corporate Law – and Eisenberg’s Error, in Fiduciary Obligations in Business 57 (Arthur B. Laby & Jacob Hale Russell eds., 2021). 6

224  Research handbook on corporate liability Furthermore, Delaware law considers controlling shareholders to be fiduciaries of minority shareholders in certain circumstances, albeit subject to liability rules that are different from those applicable to directors. In other work, I have questioned whether Delaware’s treatment of shareholders as fiduciaries is sound.11 However, for present purposes I shall set these complexities to one side, as our focus lies exclusively with the fiduciary liability of directors and the protection afforded them by the business judgment rule. The fiduciary liability of directors in Delaware is established by virtue of statutory codification of equitable obligations.12 Fiduciary duties constrain directors’ exercise of fiduciary powers so long as de jure directors remain in office and wherever de facto directors exercise the same powers, directly or indirectly. As is true of most jurisdictions, the primary fiduciary duties are those of care and loyalty, with the former duty requiring that directors act competently, and the latter requiring that directors avoid unauthorized conflicts of interest or duty. As I will explain, Delaware law has generated confusion over the standards of conduct associated with directors’ fiduciary duties, partly due to the confounding effects of doctrinal development of the business judgment rule. The duty of care is specified by way of a standard of ordinary negligence (reasonable care, assessed objectively),13 but in practice liability arises only upon proof of gross negligence.14 There is no parallel complexity in respect of the duty of loyalty, where liability is determined by the existence of unauthorized conflicts, subject to the invocation of cleansing doctrines described below. Few jurisdictions impose fiduciary duties other than those of care and loyalty. For some time, Delaware law seemed to blaze its own path here, too, with cases suggesting that directors are subject to additional fiduciary duties of good faith, disclosure, and oversight; however the trend has been toward recognition of these as mere entailments of duties of care or loyalty.15 Rules specifying what counts as compliance with fiduciary duties in specific circumstances (e.g., in directors’ handling of hostile bids and self-dealing transactions) are likewise to be understood not as isolated doctrines but rather as specifications of core duties aimed at providing more precise guidance on common governance issues. The enforcement of directors’ fiduciary duties is subject to applicable defenses, including exculpation and cleansing doctrines. While other common law jurisdictions include rough cognates of many of the doctrines developed in Delaware, the techniques differ, as do the upshots. On the whole, Delaware law is more enabling of exculpation and cleansing of conduct that would otherwise establish liability, with the result that the mandatory core of corporate fiduciary law – while still significant in absolute terms – is narrow when viewed in compar11 Paul B. Miller, Equity, Majoritarian Governance, and the Oppression Remedy, in Fiduciary Obligations in Business, supra note 10, at 171. 12 For discussion of the significance of the conjunctive phrasing through which the corporation and shareholders are identified as beneficiaries of directors’ fiduciary duties, see Andrew S. Gold, Dynamic Fiduciary Duties, 34 Cardozo L. Rev. 491 (2012). 13 Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125, 130 (Del. 1963). 14 Aronson v. Lewis, 472 A.2d 805, 812 (Del. 1984); McPhadden v. Sidhu, 964 A.2d 1262, 1274 (Del. Ch. 2008). 15 Compare Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993) and Stone v. Ritter, 911 A.2d 362 (Del. 2006). See Julian Velasco, Fiduciary Principles in Corporate Law, in The Oxford Handbook of Fiduciary Law 61, supra note 7, at 73, and for general discussion, see Robert H. Sitkoff, Other Fiduciary Duties: Implementing Loyalty and Care, in The Oxford Handbook of Fiduciary Law 419, supra note 7. For analysis of the relationship between oversight and good faith, see Elizabeth Pollman, Corporate Oversight and Disobedience, 72 Vand. L. Rev. 2013 (2014).

Fiduciary liability and business judgment  225 ative context. The mandatory core consists in loyalty-related standards requiring good faith, the avoidance of unauthorized conflicts, and compliance with the general law. The core is the residuum of the combined effect of §102(b)(7) of the Delaware General Corporation Act (a widely-invoked provision permitting corporations to adopt charter provisions exculpating directors from monetary liability for negligence, save where suggestive of bad faith)16 as well as several rules enabling the cleansing of conflicts properly disclosed and approved by shareholders, the Board, and/or a special committee established by the Board.17 Finally, and coming to our central foci, Delaware law charts a distinctive path in the ‘standards of review’18 it recognizes as modifying determinations of liability, depending on: (a) the nature of circumstances said to generate liability; (b) whether liability alleged is negligence or disloyalty; and (c) whether and which exculpation and cleansing doctrines apply. Where the facts are alleged to reveal negligence in the exercise of powers that implicate business judgments, the business judgment rule applies. What qualifies as a business judgement, and how the business judgment rule is to be understood are questions with which the rest of the chapter is concerned; suffice to say for now that successful invocation of the rule means that courts will adopt a posture of heightened deference, such that a plaintiff will have to present clear and convincing evidence of an obvious and marked departure from the standard of care to have a hope of prevailing. Where the circumstances are alleged to evince disloyalty, the business judgment rule will be successfully invoked only where a cleansing doctrine applies in virtue of a properly acquired approval from shareholders, the Board, or a special committee in which disinterested shareholders or Board members stood in the majority of those who cast votes. Otherwise, by default, allegations of liability that implicate alleged appropriation of business opportunities or self-dealing will be reviewed on the basis of the more demanding entire fairness rule, with the fiduciary charged with the burden of establishing procedural and substantive fairness.19 The entire fairness rule also applies in respect of allegations of disloyalty grounded on a conflict implicating a controlling shareholder in the context of a proposed merger, buyout or other transaction, save where appropriate use is made of a special committee of independent directors for review and approval of the conflict and the approval is properly obtained from minority shareholders.20 Finally, allegations of liability that implicate the Board’s handling of hostile bids will be subject to enhanced scrutiny under special standards set forth in Revlon21 and, where takeover defenses are deployed, Unocal.22

Enacted in the wake of Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). Gantler v. Stephens, supra note 9; Michelson v. Duncan, 407 A.2d 211 (Del. 1979). 18 In re Trados Inc. Shareholder Litigation, 73. A.3d 17, 35–36 (Del. Ch. 2013) (‘The standard of conduct describes what directors are expected to do … The standard of review is the test that a court applies when evaluating whether directors have met the standard of conduct’). For criticism of the distinction between standards of conduct and standards of review, see Johnson, supra note 10. 19 Liability for appropriation of business opportunities can also be avoided where a corporation has disclaimed the opportunity. Delaware General Corporation Law (DGCL), Del. Code Ann. tit. 8, § 122(17). 20 Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014). 21 Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). 22 Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985). 16 17

226  Research handbook on corporate liability

III.

WHAT ARE BUSINESS JUDGMENTS?

While it is not the only doctrinally distinctive standard of review developed by Delaware chancery judges, it is widely acknowledged that the business judgment rule has outsized importance in American corporate law.23 Despite this, it is rare to find academic commentary on the business judgment rule that is not critical. Often, criticism is focused on persistent inconsistency in the formulation of the rule by judges.24 A related worry is that the rule has been conflated with fiduciary liability rules. Both criticisms have merit and raise concerns about the rule’s function and scope. I begin with the latter, aiming to clarify the scope of the rule. Achieving clarity on the scope of the rule will help us to improve our understanding of its function. The business judgment rule is best understood as aimed at preserving discretion afforded to corporate fiduciaries in making and in acting on business judgments. The rule shields business judgments from undue judicial scrutiny. We shall return below to the question of what makes judicial scrutiny potentially undue. We will first consider what might, under a rational reconstruction of the rule, be meant by business judgment. We may start with the most elementary of questions: whose judgments attract the protection afforded by the rule? People occupying different roles make decisions for corporations, or decisions that shape the administration of corporations from within. For example, shareholders acting severally (i.e., on personal rights attached to their shares) and corporately (i.e., as a group, in meetings) make decisions for corporations or on matters directly germane to corporate administration. Similarly, employees at all levels make decisions about how to carry out assigned functions. They, too, make decisions that are administrative or that impact corporate administration. These are ‘business judgments’ in a colloquial sense, but they ought not to be treated as coming within the business judgment rule. And that is because the rule is meant to preserve the discretion afforded to those who enjoy powers emanating from fiduciary authority over a corporation.25 Only certain decision-makers – directors and, arguably, officers – have such authority. And that is why they alone are properly deemed fiduciaries of corporations.26 In turn, the law conditions the exercise of fiduciary powers by rendering directors liable as fiduciaries for misuse or abuse of power. The business judgment rule, being concerned to preserve discretion afforded to corporate fiduciaries in making authorized business judgments,

Velasco, supra note 15, at 61 (‘The key to understanding fiduciary duty in corporate law is the business judgment rule’). 24 Trenchant but careful criticism is found in Johnson, The Modest Business Judgment Rule, supra note 4, at 625 (‘Delaware courts both wrongly formulate the business judgment rule and unsoundly make it the centerpiece of corporate fiduciary analysis’). 25 Thus, the unassailable logic of Bainbridge’s emphasis on the original (undelegated) authority of the Board. See Bainbridge, supra note 5, and Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 Nw. U. L. Rev. 547 (2003). For the wider point that all fiduciaries are granted mandates under which they enjoy fiduciary authority and associated powers, see Paul B. Miller, The Fiduciary Relationship, in Philosophical Foundations of Fiduciary Law 63 (Andrew S. Gold & Paul B. Miller eds., 2014) and Paul B. Miller, Fiduciary Representation, in Fiduciary Government 21 (Evan J. Criddle et al. eds., 2018). 26 See Miller, supra note 11. 23

Fiduciary liability and business judgment  227 is hence properly understood as concerned only with business judgments made in the exercise of fiduciary powers. We now turn to a second question: what counts as a business judgment? Some formulations of the business judgment rule are so broad that one would be forgiven for thinking they encompass any decision that might ground liability. But these formulations are overbroad: directors can and do make decisions that are not business decisions and may face liability, fiduciary and otherwise, for them (e.g., a decision to steal corporate property, or to assault a co-worker). I suggest that a decision counts as a business judgment only if it bears a requisite nexus with a genuine corporate purpose.27 Thus excluded are decisions made in fraud of a corporation or in a purely personal capacity. The rationale is that the rule is meant only to protect fiduciaries in decisions they’ve been authorized to make for a corporation. It is a business judgment rule, not a fiduciaries’ whims-and-wishes rule. Put otherwise: the rule shields fiduciaries’ conduct from undue judicial scrutiny in order to protect corporate interests, not the fiduciary’s interest in being saved from liability. Now for a third and final question: what counts as a business judgment? As suggested above, it contemplates action that is rationally related to a corporate purpose. But what kind of action evinces judgment? As I have argued elsewhere, all fiduciaries are entrusted with legal powers on the understanding that they are to undertake discretionary judgment in making use of them.28 A fiduciary is not granted fiduciary powers in order to neglect or to act haphazardly on them.29 For the rule to be engaged, the actions of a fiduciary must be deliberative;30 that is, impugned conduct must be rationally related to a deliberative process that itself evinces deliberation (e.g., a resolution adopted during a Board meeting). This way of stipulating what qualifies as a ‘business judgment’ defines the scope of the rule in a way that is consistent with its rationale (again, preservation of discretion afforded to corporate fiduciaries in exercising fiduciary powers). Excluded are (a) non-deliberative inaction (e.g., inaction due to inadvertence or indifference); (b) action harried by indecision; and (c) non-deliberative action (i.e., action taken automatically or hastily).

IV.

WHAT IS THE BUSINESS JUDGMENT RULE?

Having clarified its scope, we now come to the vexed question of what the business judgment rule consists in. As I will explain in the Conclusion, the apparent impact of the rule on judicial behavior might owe as much to social forces as it does to the rule itself. However, if we are

27 Paul B. Miller, Corporate Personality, Purpose, and Liability, in Research Handbook on Corporate Purpose and Personhood 222 (Elizabeth Pollman & Robert Thompson eds., 2021). 28 Miller, The Fiduciary Relationship, supra note 25; Miller, The Identification of Fiduciary Relationships, supra note 7. 29 Aronson v. Lewis, 473 A.2d at 813 (emphasizing that the business judgment rule does not apply ‘where directors have either abdicated their functions, or absent a conscious decision, have failed to act’). 30 Casey v. Woodruff, 49 N.Y.S.2d 625, 643 (Sup. Ct. 1944) (‘When courts say that they will not interfere in matters of business judgment, it is presupposed that judgment – reasonable diligence – has in fact been exercised’); In re Walt Disney Co, 907 A.2d 693, 748 (2005) (‘in instances where directors have not exercised a business judgment … the protections of the business judgment rule do not apply’). See also Kenneth B. Davis, Jr., Once More, the Business Judgment Rule, 2000 Wis. L. Rev. 573, 576 (2000) (‘The BJR … is confined to cases where the board did in fact make a decision’).

228  Research handbook on corporate liability to interpret the rule as such – as is my present aim – we must take it at face value. And it is presented by lawmakers as a cornerstone doctrine of American corporate law. Hence, we ask: what does the business judgment rule require (if it requires anything at all31), and to whom is it addressed? This question is vexed because it has long eluded a clear and convincing answer in the authorities. Leading scholars agree that the rule has been reformulated in so many inconsistent ways in different cases that it is difficult to say what it requires.32 Each new formulation has tended to decrease rather than increase doctrinal clarity. It is precisely in these circumstances that rational reconstruction proves an adaptive method of interpretive analysis. Ordinary synthetic interpretation is difficult, if not impossible, where the law is inconsistent or incoherent. Given the unsettled state of the law, it should not be surprising that two dominant interpretations of the business judgment rule have emerged. Each might be viewed as the product of rational reconstruction. However, only one is sound, and despite that, it needs adjustment. After introducing both interpretations, I will introduce the adjustments to the interpretation I think preferable. The first interpretation – ascendant in Delaware jurisprudence – treats the business judgment rule as a liability rule, or as adjoined to liability rules, modifying their operation.33 More specifically, it treats the rule as a fiduciary liability rule, or as qualifying the enforcement of liability. Consider prominent statements that treat the rule as a presumption against fiduciary liability (i.e., as excluding or suspending the operation of fiduciary liability rules)34 and that treat it as indirectly modifying standards of liability (e.g., displacing an ordinary with a gross negligence standard of care,35 or a strict with a relaxed proscription on conflicts).36 An implication is that the rule should be understood as addressed to affected citizens (primarily directors, officers, and shareholders) much as it is to judges. It qualifies the general, ex ante, guidance supplied by fiduciary duties. This line of interpretation enjoys a claim to interpretive fidelity as it is grounded in select lines of authority. If it is to be disputed, it will be on the basis that it is unsound as a rational reconstruction of the rule (one that squares its practical point with wider, foundational precepts of fiduciary authority and liability).

31 See Branson, supra note 3, at 631 (‘The much misunderstood business judgment rule is not a “rule” at all. It has no mandatory content. It involves no substantive “do’s” and “don’ts” for corporate directors or officers’). 32 Supra notes 4 and 5. 33 Franklin A. Gevurtz, The Business Judgment Rule: Meaningless Verbiage or Misguided Notion?, 67 S. Cal. L. Rev. 287, 288 (1994) (‘many courts, writers, and now the American Law Institute, view the rule as imposing a substantive qualification upon directors’ liability for breach of the duty of care’); Bainbridge, supra note 5, at 87 (‘The business judgment rule commonly is understood today as a standard of liability by which courts review the decisions of the board of directors’). 34 As in Cede & Co. v. Technicolor, 634 A.2d at 361 (commenting on the business judgment rule as generating ‘a powerful presumption in favor of actions taken by the directors’); see also Parnes v. Bally Entertainment Corp., 722 A.2d 1243, 1246 (Del. 1999). 35 As ushered in by Aronson v. Lewis, 473 A.2d at 812 (‘under the business judgment rule director liability is predicated upon concepts of gross negligence’), aff’d in Smith v. Van Gorkom, 488 A.2d at 873. 36 For general discussion, see Gevurtz, supra note 33, at 288.

Fiduciary liability and business judgment  229 The second interpretation – developed most influentially by Stephen Bainbridge and Lyman Johnson – treats the business judgment rule as a rule of judicial review addressed to judges.37 So understood, the rule’s impact on fiduciary liability is indirect: it relaxes the level of scrutiny of managerial performance ex post in judicial review. Bainbridge suggests that the upshot is the exclusion of judicial review where the rule is engaged, memorably characterizing the rule as an ‘abstention doctrine’.38 His and Johnson’s analyses build on Eisenberg’s claim that Delaware law evinces a divergence of standards of conduct and standards of review.39 It is also consistent with Julian Velasco’s suggestion that, while the rule impacts determinations of liability, it does so without altering the ‘aspirational’ expressive function of fiduciary duties.40 As is true of its rival, this line of interpretation also enjoys a good claim to interpretive fidelity, being well-grounded in positive law (especially, but not only, pre-Cede case law in Delaware41). Recognizing that both lines of interpretation of the business judgment rule can stake a claim to interpretive fidelity, which is to be preferred? The first aims to reconcile something odd with something familiar; always a fraught strategy. Here, familiar terrain is that of fiduciary liability rules. Naturally, some have started – and concluded – their inquiries about the business judgment rule by examining its links with fiduciary duties, settling on the view that the rule is a ‘fiduciary’ construct. Consider claims that the rule is a ‘component’ of the duty of care or of good faith.42 But these strategies fail as rational reconstruction because they imply a persistent conflict or redundancy in the law (either the business judgment rule conflicts with fiduciary liability rules, or they prescribe the same thing). As Gevurtz has observed, the tendency to treat the business judgment rule as a presumption against fiduciary liability makes it redundant and arguably meaningless; directors already enjoy, by virtue of procedural rules on burden of proof, a presumption against liability that must be overcome.43 In turn, if lawmakers meant to eliminate a fiduciary duty (e.g., of care) or to adjust associated standards of liability, they could do so directly.44 Rational reconstruction, if it is to succeed, will articulate a practical point for a doctrine: its distinctive aim(s) and functions in guiding deliberation and conduct. The most promising candidate for rational reconstruction of the business judgment rule is the interpretation advocated by Bainbridge and Johnson. Both emphasize the sense in which the rule protects the lawful exercise of authority by directors by limiting overreach in judicial

37 Johnson, supra note 4, at 625 (arguing that the rule is ‘better understood as a narrow-gauged policy of non-review’) (original emphasis). 38 Bainbridge, supra note 5. 39 Melvin Eisenberg, The Divergence of Standards of Conduct and Standards of Review in Corporate Law, 62 Fordham L. Rev. 437 (1993). 40 Velasco, supra note 2. 41 Referring to Cede & Co., supra note 15. 42 The latter claim having been advanced in David Kershaw, The Foundations of Anglo-American Corporate Fiduciary Law 23–133 (2018). 43 Gevurtz, supra note 33, at 288 (‘[I]nterpretations of the business judgment rule fall into two broad categories. In the first category, the rule essentially stands for the proposition that directors are not liable for their decisions unless there is a reason to hold the directors liable … Needless to say, if this was the only interpretation of the business judgment rule, then any further discussion of the “rule” – not to mention the “rule” itself – would be largely pointless’). 44 See Gordon Smith: ‘The choice of the appropriate level of care is conceptually independent of the business judgment rule.’ Smith, supra note 4, at 89.

230  Research handbook on corporate liability review of fiduciary decision-making.45 The difficult interpretive question is how to characterize that function. Again, Bainbridge’s memorable suggestion is that the rule is one of abstention, understood as a refusal by judges to engage in judicial review of conduct that triggers the rule. Johnson’s position is similar.46 But we must be cautious: if abstention is to be understood as Bainbridge and Johnson suggest, the difference between their interpretation and that which treats it as a liability rule or element thereof collapses or becomes trivially thin.47 Their rendition of abstention implies that the rule effectively instructs judges to ignore liability claims that are well founded (i.e., that are good by the light of applicable standards of liability).48 As I will explain, Bainbridge and Johnson get us much of the way, but a rational reconstruction of the rule will place it at further remove from fiduciary liability rules. The business judgment rule is, I suggest, best understood as a jurisdictional abstention doctrine addressed to judges. Jurisdiction here, as elsewhere, is a matter of the absolute and relative scope of authority to exercise a legal power or set of powers. Jurisdiction is implied by the boundedness of legal authority: authority is lawfully exercised within a jurisdiction held, but not beyond it. To be without jurisdiction is to be without, because beyond, authority. In the present context, interpreted as a jurisdictional abstention doctrine, the business judgment rule requires judges, when exercising powers of judicial review, to (a) be mindful of, and to remain within, the limits of their jurisdiction (lawful authority) to review the conduct of corporate fiduciaries; and, correlatively, (b) to properly recognize and respect the jurisdiction (again, lawful authority) wielded by corporate fiduciaries in managing the affairs of a corporation.49 This interpretation departs from Bainbridge’s suggestion that judges stay their hands when invoking the rule, refusing to act on a power held, but it is simpatico with the emphasis on authority in his director primacy theory of corporate governance. Reframed in jurisdictional terms, the rule underscores differences in jurisdiction and hence aims to protect, by keeping separate, the decisional authority of courts and fiduciaries.50

45 See also Davis on Board ‘sovereignty,’ supra note 30, at 587 (‘the sovereignty rationale recognizes that … it is the board’s choice, not that of the judge or disgruntled shareholder, that must prevail’). 46 Bainbridge, supra note 5; see also Johnson, supra note 4, characterizing the rule as a policy of ‘non-review’. 47 Johnson, supra note 4, at 631 (arguing for his ‘modest’ formulation of the rule as ‘a judicial policy of not reviewing the substantive merits of a board of directors’ business decision for the purpose of determining whether directors breached or fulfilled their duty of care’). On the sense in which this line of interpretation walks a fine line, see Branson & Keong, supra note 3, at 309 (‘The standard of conduct is due care. It is not slight care or gross negligence. With that established, in the US the business judgment rule may be the de facto standard of conduct in cases in which directors are proactive’, and later suggesting that ‘The business judgment rule requires only some care’). 48 As is suggested by Velasco’s claim that the rule reflects ‘a policy of underenforcement of fiduciary duties’. Velasco, supra note 2, at 1400. 49 This is consistent with the view, I think wrongly disparaged as rendering the rule unimportant, that it ‘is simply another way of saying that the board has the statutory power to manage the corporation and the court will not interfere without some grounds’. Gevurtz, supra note 33, at 291. Compare Shlensky v. Wrigley, 237 N.E.2d 776, 778 (Ill. App. Ct. 1968) (‘the authority of the directors in the conduct of the business of the corporation must be regarded as absolute when they act within the law, and the court is without authority to substitute its judgment for that of the directors’). 50 For a recent ‘quasi-jurisdictional’ framing of abstention under the Corwin doctrine, see Lockton v. Rogers, 2022 WL 604011 at para. 11 (Del. Ch.). I am grateful to Lyman Johnson for bringing this case to my attention.

Fiduciary liability and business judgment  231 Notice that a risk of jurisdictional overreach attends judicial review of any and all forms of fiduciary decision-making. That risk might be heightened when judges assess the merits of a claim of fiduciary liability, but it attends the review of claims advanced on fiduciary and non-fiduciary grounds. Furthermore, a jurisdictional rule, properly understood, does not shift liability rules or their usual operation. It instead serves a notice function, warning judges not to overstep.51 Such a rule might be important where there is special reason to think judges might overstep and, in doing so, improperly exercise their powers (e.g., by making questionable findings of liability). If the business judgment rule is motivated thus, it proves responsive to these concerns by reminding judges that it is not their place to undo or otherwise interfere with decisions lawfully made in the exercise of a power that they lack.52 Judges heedful of the rule will think twice before making findings of liability that raise jurisdictional issues, especially where in order to make these findings, they must examine the reasons for which a fiduciary acted.53

V.

IS THE BUSINESS JUDGMENT RULE ANOMALOUS?

We may return now to the considerations with which we opened: the notion that the business judgment rule is of special interest because it is, at once, distinctive and emblematic of American corporate law. As noted, the rule appears singular in comparative context, there being no cognate doctrine elsewhere in American fiduciary law or in the corporate law of other jurisdictions, save those featuring transplants from American law. The conviction that the rule is anomalous has provoked criticism, imitation, and apologia.54 But is the business judgment rule truly anomalous? The answer is yes and no. If one takes it unreconstructed in its present state, it is clear that the rule is anomalous and that efforts to explain and justify it have done little to dispel the skepticism that doctrinal incoherence naturally invites. The mere fact that there are so many different, still unresolved, formulations of a single doctrine makes it anomalous in all the wrong ways. Thus, arguments aimed at defusing criticism of the rule fall flat.55 Consider, for example, familiar arguments

Bearing in mind that, as noted by Johnson, ‘the legislatively enacted corporations statute places the business and affairs of a corporation under the “direction” of a board of directors, not the court.’ Johnson, supra note 4, at 648. 52 This interpretation aligns with Gordon Smith’s presentation of the ‘traditional’ version of the business judgment rule, according to which ‘when the board of directors is careful, loyal, and acting in good faith, courts refuse to second-guess the merits of the board’s decisions, even if the corporation or its shareholders are harmed by those decisions.’ Smith, supra note 4, at 85. See also his citation, id. at 86, of Percy v. Millaudon, 8 Mart. (n.s.) 68, 77–78 (La. 1829) (‘the adoption of a course from which loss ensues cannot make the [director] responsible, if the error was one into which a prudent man might have fallen’) and Hodges v. New England Screw Co., 3 R.I. 9, 18 (1853) (‘a Board of Directors acting in good faith and with reasonable care and diligence, who nevertheless fall into mistake, either as to law or fact, are not liable for the consequences of such mistake’). 53 Consistent with an observation in Shlensky, supra note 49, at 778 (a ‘court of equity will not undertake to control the policy of business methods of a corporation although it may be seen that a wiser policy might be adopted and the business might be more successful if other methods were pursued’). 54 These are usefully canvassed in Davis, supra note 30. 55 As noted by Gevurtz, supra note 33, at 289 (each of the oft-cited rationales for liability-shifting variants of the rule ‘fail to justify a differentiation between directors and other prospective tort defendants who can and do assert similar arguments for more lenient treatment’) and Davis, supra note 30, at 51

232  Research handbook on corporate liability that the rule is rooted in disparities of expertise between fiduciaries and courts that disfavor judicial review; that it deters opportunistic litigation; that it is a crucial incentive for fiduciary undertakings; and that it corrects for the risk of hindsight bias in judicial review. Each of these arguments fails to explain or justify a doctrine that alters fiduciary liability rules in the absence of a cognate doctrine in the corporate law of other jurisdictions, where identical concerns attend judicial review. And the same may be said of other areas of American law that feature judicial review of fiduciary decision-making. If, however, one adopts the reconstructed version of the rule, the appearance of anomaly and associated negative inferences can be dispelled while retaining and clarifying the sense in which the rule is distinctively emblematic of American law. Let me first explain how the reconstructed rule is familiar and so not anomalous, situated comparatively. Remember that, rationally reconstructed, the business judgment rule is a jurisdictional abstention doctrine: it preserves undiminished the authority afforded to fiduciaries under mandates granted to them, and does so by putting judges on notice of the need to respect jurisdictional boundaries that demarcate their authority to undertake judicial review from fiduciaries’ authority to exercise their mandates. The core idea – that judicial review ought not to be carried out so as to narrow fiduciary authority – is not in any way foreign to the fiduciary law of the United States56 or the corporate law of other jurisdictions.57 Rather, it is deeply familiar. All enabling law that provides for formation of fiduciary mandates depends for its practical effectiveness on the willingness of judges to respect authority vested in fiduciaries. Necessarily, the performance of fiduciary mandates is subject to judicial review, raising a universal risk of overreach through review that presses for more ‘accountability’ than the law requires. Where the risk is managed through judicial self-restraint, we may say that there is an informal practice of jurisdictional abstention. Where it is managed openly through substantive doctrine or procedural rules, we may say that there is a formal (rule-governed) practice of jurisdictional abstention. The reconstructed business judgment rule is an example of the latter. Whether the response to the risk of overreach is formal or informal, it is important to recognize that reasons for judicial restraint are formal and juridical as contrasted with considerations traceable to contestable policy calls involving line-drawing and trade-offs.58 Juridical reasons

581 (‘upon close examination, [these arguments] have in common the ring of post hoc rationalization rather than compelling explanations for why the BJR developed in the first place’). 56 On which, see Evan J. Criddle, Fiduciary Law’s Mixed Messages, in Research Handbook on Fiduciary Law 15, 17 (D. Gordon Smith & Andrew S. Gold eds., 2018) (‘the business judgment rule is hardly unique. Courts traditionally apply a healthy dose of deference to fiduciary decision-making in a variety of other settings’). Criddle suggests that courts ought to apply the rule where judicial review presents a higher risk of arbitrariness than does fiduciary decision-making. In my view, the rule ought to be understood jurisdictionally, meaning that courts are not invited to determine whether they or fiduciaries are in the best position to decide a matter in the interests of a beneficiary. Evidence of arbitrariness in fiduciary decision-making, where it exists, goes to establishing fiduciary liability (depending on the circumstances, bad faith, negligence and/or disloyalty). 57 Consider the jurisdictional import of an early formulation of the business judgment rule in Canada in Maple Leaf Foods Inc. v. Schneider Corp. (1998), 42 O.R. (3d) 177, 192 (‘The court looks to see that the directors have made a reasonable decision not a perfect decision. Provided the decision is taken within a range of reasonableness, the court ought not to substitute its opinion for that of the board even though subsequent events may have cast doubt on the board’s determination’). 58 For insightful presentation of these policy considerations, see Lyman P.Q. Johnson, Corporate Officers and the Business Judgment Rule, 60 Bus. Law. 439 (2005).

Fiduciary liability and business judgment  233 for restraint lie in the recognition that all fiduciaries, including directors, have been lawfully granted mandates under which they enjoy fiduciary powers to pursue stipulated purposes. The execution of fiduciary mandates is reviewable on the basis of applicable legal and equitable constraints. But, because judges ordinarily review conduct undertaken by litigants in a purely personal capacity, and so may be unused to explicitly adverting to jurisdictional issues raised by the grant of authority to a fiduciary, there is a latent formal concern about risk of jurisdictional overreach in judicial review of all fiduciary decision-making. These considerations provide a cohesive juridical basis for reframing otherwise disparate ‘policy’ arguments for the business judgment rule. For example, in lieu of a general ‘policy’ of incentivizing risk-taking and entrepreneurship,59 the argument advanced here emphasizes respect for mandates lawfully granted to directors. In place of a generic ‘policy’ concern about disparities in expertise that disfavor judicial review, the analysis presented here emphasizes that fiduciary authority has been granted to directors and not judges, often on the basis of the former’s expertise. In turn, sweeping ‘policy’ concerns about hindsight bias60 may be usefully reframed as material to the extent that they influence a judge to ignore the jurisdictional limits of judicial review. If the notion of jurisdictional abstention is familiar in judicial review of fiduciary decision-making in other fields, and in other jurisdictions, why has it mostly remained informal there but been made formal in American corporate law? For it is this – the decision to formalize jurisdictional abstention as doctrine – that is distinctive, and, in that sense, makes the business judgment rule anomalous in comparative context. One can only speculate. However, a good place to start is with a key difference between informal and formal recognition of norms: to render a norm explicit in law – to formalize it by reducing it to language in which it is expressed as a norm of general application – is to promulgate and affirm the norm publicly as law, and thereby to deliberately establish it as a binding standard. Here, judges themselves make law but do so, perhaps, to assuage a watchful public. The formalization of jurisdictional abstention through the business judgment rule has an expressive function in addition to its regulative function. In respect of the latter, it requires judicial restraint; in respect of the former, it provides public assurance that restraint will be shown. But why has it been felt necessary to commit to, and to signal, restraint formally, where elsewhere we are plainly contented with informal judicial self-restraint? If the benefits of the specialism claimed by Delaware courts are as real as the specialism is widely known, one might think worries about overreach are overblown. But the worries themselves might nonetheless be real, and so one might ask further: why is the risk of overreach of special concern to American lawyers and judges in respect of corporate fiduciaries, but not of similar concern where the rule or a cognate is absent? The answer, I think, lies in the actual and assumed risk preferences of shareholders.61 Most beneficiaries of most fiduciary mandates have fairly conservative risk preferences, consistent Id. at 455–56 (reflecting the tendency of those given to framing the rule in terms of economic policy to talk about socially optimal risk taking and the incentives and disincentives created by the law in respect of the same). See, similarly, Lawrence A. Hamermesh & A. Gilchrist Sparks, Corporate Officers and the Business Judgment Rule: A Reply to Professor Johnson, 60 Bus. Law. 865, 870 (2005) (‘a principal justification for the business judgment rule is to encourage directors to serve and cause the corporation to take on business risks’). 60 Johnson, supra note 58, at 456–57. 61 Consistent with the observations of Judge Winter in Joy v. North, 692 F.2d 880, 885 (2d Cir. 1982) (‘[S]hareholders to a very real degree voluntarily undertake the risk of bad business judgment’). See also 59

234  Research handbook on corporate liability with typical mandate objects – the preservation or maintenance of a person or property. Many fiduciaries are authorized to make judgments in circumstances of endemic uncertainty and risk, as is true of corporate fiduciaries. But often significant risks have already ripened – as with a sick patient, or client in legal jeopardy – and the fiduciary is expected to manage existing risk and/or to minimize future risk. Pretty much the opposite is true of corporate law. In robust market-based economies, investment risk is understood to attend investment reward, and shareholders and managers alike are chasing reward.62 Not that there is no concern for economic sustainability, but low, sustainable returns are not the dominant preference. Instead, corporate fiduciaries are hired to take calculated but significant risks, and beneficiaries expect them to, even if they sometimes irrationally discount those risks and, with equal irrationality, attempt to avoid or reallocate them ex post through litigation. If all of this is right, one can appreciate why American lawmakers (a) would be especially sensitive to concerns about overreach, and (b) attempt to mitigate that worry by formalizing restraint.63

VI. CONCLUSION I have argued that the business judgment rule is best interpreted via rational reconstruction as a jurisdictional abstention doctrine. So understood, the rule does not create or vary fiduciary liability rules; rather, it prohibits liability determinations that are overreaching in the sense that they narrow – ex post – authority lawfully vested in directors. The risk of overreach arises wherever fiduciary decision-making is subject to judicial review. But it is, arguably, of heighted concern in judicial review of corporate fiduciary decision-making for negligence precisely because negligence is concerned with the propriety of risk-imposition and because corporate fiduciaries are hired to take significant calculated risks for others in circumstances of endemic uncertainty.64 An overzealous judge might erroneously see negligence in the mere Bainbridge, supra note 5, at 111 (‘All else equal, shareholders … prefer high return projects. Because risk and return are directly proportional, however, implementing that preference necessarily entails choosing risky projects’). It should be emphasized that the proportional relationship of risk and return encompasses calculated risk, not risk in aggregate. 62 Gerner-Beuerle notes that the social and political economy of German corporate law is different, and that these factors might explain the tendency of German courts to invoke the German variant of the rule less frequently. Gerner-Beuerle, supra note 3, at 239–41. 63 As was evident in In re Citigroup Inc. Shareholder Derivative Litigation, 964 A.2d 106, 126–131 (Del. Ch. 2009) (‘The essence of the business judgment of managers and directors is deciding how the company will evaluate the trade-off between risk and return. Businesses … make returns by taking on risk; a company or investor that is willing to take on more risk can earn a higher return. Thus, in almost any business transaction, the parties go into the deal with the knowledge that, even if they have evaluated the situation correctly, the return could be different than they expected … It is well established that the mere fact that a company takes on business risk and suffers losses – even catastrophic losses – does not evidence misconduct, and without more, is not a basis for personal director liability’). 64 As is reflected in Chancellor Allen’s opinion in In re Caremark Int’l, 698 A.2d 959, 967, n.16 (Del. Ch. 1996) (‘The vocabulary of negligence … is not well-suited to judicial review of board attentiveness …Where review of board functioning is involved, courts leave behind as a relevant point of reference the decisions of the hypothetical “reasonable person”, who typically supplies the test for negligence liability. It is doubtful that we want business men and women to be encouraged to make decisions as hypothetical persons of ordinary judgment and prudence might. The corporate form gets its utility in large part from its ability to allow diversified investors to accept greater investment risk. If those in charge of the corpo-

Fiduciary liability and business judgment  235 realization of a calculated risk of loss. The business judgment rule forbids exactly this kind of eventuality, reminding judges that they must abide by the limits of their own authority while respecting that granted to corporate fiduciaries. My ambitions here have been interpretive: the aim has been to offer a rational reconstruction of the business judgment rule that places it in its best light doctrinally while acknowledging and clarifying the sense in which it is distinctively situated in comparative terms. I think that aim has been met. Yet there remain important, unanswered questions at the periphery. One is about the practical effectiveness of the rule as a rule: if the unreconstructed rule is a shambles, doctrinally, and yet is reasonably thought to be effective in shaping judicial behavior, how does (or might) it achieve its effectiveness? Another question is about the reported practical ineffectiveness of transplanted versions of the rule abroad. Allowing for the fact that different jurisdictions have had different experiences, in at least some – notably, Australia65 – there are reports of disappointment. There, the transplant is reported not to have taken well.66 The rule is said to be rarely invoked in Australia, and, where invoked, not often successfully from the point of view of directors. These questions are distinct and it may be that satisfactory answers will diverge. Notwithstanding the mystery surrounding the apparent effectiveness in the United States of a doctrine that most would predict would be hamstrung by persistent doctrinal irresolution, let us suppose that the business judgment rule qua doctrine is primarily responsible for its own fate, and that prospects for transplants depend significantly on how they are formulated, understood, and acted upon by judges. With these suppositions in place, it might be that transplanted variants on the rule in Australia and elsewhere have not taken hold because of some deficiency in legal technique. Perhaps unanticipated contingencies associated with a change in the formulation of the rule, or its interaction with other, local, doctrines, have impaired the rule’s effectiveness. These and other possibilities cannot be ruled out. Yet it is also possible that our two questions admit of a single answer. The coincidence of an American success story about a doctrine that seems unfit for success as a doctrine with an indication that transplanted variants have struggled to keep up naturally makes one wonder: is the business judgment rule successful in spite of itself? Might the positive impact attributed to the rule be properly attributable, in the main, to non-legal, or at least, non-doctrinal, forces that supervene on the practices of judicial review that the rule qua rule is meant to shape? If the business judgment rule has proved successful in the United States primarily for reasons having little or nothing to do with its content, it should be less surprising that those successes have been won despite persistent doctrinal irresolution and incoherence. But if that’s right, the positive impact pinned on the rule is wrongly attributed to it as a rule (again, as

ration are to be adjudged personally liable for losses on the basis of a substantive judgment based upon what persons of ordinary or average judgment and average risk assessment talent regard as “prudent”, “sensible” or even “rational”, such persons will have a strong incentive at the margin to authorize less risky investment projects’). 65 See Jennifer Varzaly, Protecting the Authority of Directors: An Empirical Analysis of the Statutory Business Judgment Rule, 12 J. Corp. L. Stud. 429, 434 (2012) (noting that Australian ‘courts have not interpreted the similarly worded Australian BJR in a manner consistent with its US origins’, and reviewing cases which indicate that courts refuse to treat the rule as adjusting or excluding the application of standards of fiduciary liability). 66 For discussion of the intentions and expectations of Australian legislators, see Branson & Keong, supra note 3, at 316–17.

236  Research handbook on corporate liability a doctrine that successfully shapes or guides behavior). Instead, the rule might be emblematic of deeper economic, political, cultural and other social forces that themselves are the primary drivers of the impact usually attributed to the rule.67 What forces, though? This is purely speculative, but they might include a wider non- or cross-partisan political ideology of free markets; diffuse civic pride in American capitalism and a ready association between it and policies fostering entrepreneurialism; a belief that private law is fundamentally enabling of private ordering and that the appropriate default posture of judicial review in private law matters (other than tort) is one that emphasizes deference to party choice; a policy of constructive attribution of liberal rather than conservative risk preferences to investors; and a professional comity that joins specialist corporate lawyers and judges, especially in Delaware, in a shared commitment to managerialism generally, and to the belief that vices associated with wide managerial discretion are best checked other than by seeking judicial review (e.g., by market discipline, or by a reallocation of power within the corporation). If these or other currents pervade the contexts within which American corporate law is made, and is made use of, by American judges, a doctrine meant to channel them need not be fully resolved doctrinally in order to be effective; it need only be understood as emblematic of an ethos built and sustained by convergent social forces that press toward the same end (i.e., protecting undiminished the authority granted to corporate directors). In turn, if these social forces are muted or absent in other jurisdictions, or indeed if they are overwhelmed by other social forces that favor seeking judicial review or a preference for informal restraint, it should be unsurprising that transplanted versions of the business judgment rule have failed to take root. There must be at least minimal compatibility between donor and recipient for a transplant to work, and the de minima for compatibility rise where functionality is attributable to legal-systemic conditions rather than, or in addition to, isolable legal constructs. Put otherwise, and more simply, the business judgment rule might be a poor candidate for transplantation for reasons having little to do with doctrinal specification of the rule as such and much to do with social forces that influence judicial review but can be little moved by the importation of foreign legal constructs, however skillfully adapted.

67

See generally Gerner-Beuerle, supra note 3.

13. Review of directors’ business judgments Joan Loughrey1

I. INTRODUCTION In 2019, ClientEarth, a shareholder in the Polish state-controlled company Enea brought an action against Enea in the Polish courts. It successfully challenged the validity of a shareholder resolution supporting the construction of a coal-fired power station. The basis of ClientEarth’s challenge was that the initiative lacked commercial merit: it would harm Enea’s economic interests and pose an indefensible financial risk to investors in the face of rising carbon and falling renewables prices.2 The case marked a growing trend in climate-related corporate litigation, including a small but growing number of claims brought against directors personally.3 However, a claim against directors that mirrored the facts of ClientEarth v. Enea, namely that directors were in breach of duty for authorizing a business project the commercial merits of which were disputed, would fail in several jurisdictions on the basis that it challenged directors’ business judgment and so is protected from review by the courts.4 This is termed the Business Judgment Rule (BJR). It has different formulations but essentially provides that, if a director’s action or inaction can be categorized as a business judgment, then, provided that certain criteria are met, they will not be liable for what has been done or not done. These criteria are usually that the decision was made in good faith in the interests of the company, the director had no conflict of interest, and the decision was an informed one. The BJR is often used to shield directors from liability for breach of their duty of care but is not confined to those situations.5 The UK has no formal BJR but it is often said that an informal one exists because as a matter of practice the courts will not review directors’ business judgments.6 This is not, however,

I am grateful to the AHRC, which funded the project on Business Judgment and the Courts (Project Number: AH/N008863/1). The Principal Investigator was Professor Joan Loughrey and the Co-Investigators Professors Andrew Keay and Terry McNulty, Dr Francis Okanigbuan and Ms Abigail Stewart. I am grateful to Professor Andrew Keay for his comments on this chapter. All errors and omissions are mine alone. 2 See ClientEarth v. Enea, Report No 26/2019 (Poznan Reg. Ct.), as recounted in Grantham Rsch. Inst. on Climate Change & Env’t, https://​climate​-laws​.org/​geographies/​poland/​litigation​_cases/​ clientearth​-v​-enea (last visited Jul. 21, 2022). 3 Joana Setzer & Catherine Higham, Global Trends in Climate Litigation: 2021 Snapshot 29 (2021). See also Alexia Staker & Alice Garton, Commonwealth Climate Law Initiative: Directors’ Liability and Climate Risk: United Kingdom – Country Paper 53 (2018). 4 See, e.g., in the UK, ClientEarth v. Shell plc [2023] EWHC 1137 (Ch). 5 For the UK see, e.g., Howard Smith v. Ampol Petroleum [1974] A.C. 821, 835 (PC) (proper purposes); Devlin v. Slough Estates Ltd [1983] B.C.L.C. 497, 503–504 (derivative action); Birdi v. Specsavers Optical Group Ltd., [2015] EWHC 2870 (Ch.) ¶ 246. For the US, see Stephen M. Bainbridge, The Business Judgment Rule as Abstention Doctrine, 57 Vand. L. Rev. 83, 88 (2004). 6 Id. 1

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238  Research handbook on corporate liability strictly so: the courts do review the substance of directors’ decisions7 but they rarely impose liability in the absence of some failure in the decision-making process, such as failing to take advice, failing to take into account salient considerations, failing to exercise independent judgment or failing to exercise any judgment at all.8 Arguments over review of business judgment are closely linked to the broader debate over the appropriate balance to be struck between director authority and director accountability. The BJR is considered central to this debate, given its role as a mechanism to protect director authority, and shield directors from accountability.9 Given this, this chapter will analyze arguments for and against review of business judgment through the prism of accountability. Accountability, for present purposes, refers to a process by which a person is required to explain and justify what they have done to a third party who evaluates and passes judgment on their actions and explanation, with the possibility of consequences following.10 In the context of judicial review of business judgment by the courts, these consequences will either be legal liability or exoneration. It is often argued that the BJR is necessary because of the negative impact that judicial review would have on directors and their decision-making. However, a previous qualitative study involving interviews with directors from the UK, US and Australia and other UK market participants challenged the idea that these impacts would materialize, or that, if they did, they would be negative in nature.11 For example the view is frequently expressed that greater review could deter well-qualified people from taking up directorships, but the study found that even directors who had been held liable in the courts took up directorships again, because it was a job they enjoyed, albeit in private companies or less regulated sectors; and board head-hunters thought that even if some were deterred this would potentially increase board diversity.12 That paper concluded that normative positions underpinned empirical claims about the impact of review, the implications of which had been neglected in the previous debate, and that future research needed to identify and engage with these. This chapter takes up that challenge. It explains that economic and non-economic values underpin arguments both for and against review of business judgment and sets out the factors to be weighed in determining whether review should occur. It moves the debate beyond the present impasse by proposing a new and more nuanced framework for assessing whether directors’ business judgments should be subject to review. The chapter is structured as follows. It first considers and challenges the dominant welfare maximization arguments for the BJR – namely that non-review of business judgment is necessary to align directors’ risk-taking with the risk appetite of diversified shareholders and to avoid sub-optimal risk aversion. Next, considering claims that directors are rationally risk averse, the following section reviews empirical data regarding directors’ risk appetite. It finds 7 Re Welfab Engineers Ltd. [1990] B.C.C. 600; Sharp v. Blank [2019] EWHC 3096 (Ch); Bishopsgate Contracting Solutions Ltd. v. O’Sullivan [2021] EWHC 2103 ¶¶ 195–215 (QB) (obiter). 8 E.g., Angelmist Properties Ltd v. Leonard [2015] EWHC 1858 (Ch); Re DKG Contractors Ltd. [1990] B.C.C. 903, 912–13; Re Brian D. Pierson (Contractors) Ltd. [1999] B.C.C 26 ¶¶ 5–6. 9 Bainbridge, supra note 5, at 104. 10 Andrew Keay & Joan Loughrey, The Framework of Board Accountability in Corporate Governance, 35 Legal Stud. 252, 266–67 (2015). 11 Andrew Keay et al., Reviewing Directors’ Business Judgment: Views From the Field, 47 J.L. & Soc’y 639 (2020). 12 Id. at 659–61.

Review of directors’ business judgments  239 that, contrary to orthodox assumptions, many studies of director risk-taking suggest a tendency to over-confidence and excessive risk. Consequently, insofar as review of business judgment reduced risk-taking this would not necessarily be a negative outcome. The chapter then turns to arguments against review that are based on values other than welfare. It focuses primarily on two: the lack of judicial competence to review decisions and the risks of hindsight bias: these can be categorized as fear of the courts wrongly finding directors liable.13 Not all arguments against review can be canvassed in detail in the confines of this chapter, and these are very common objections that illustrate under-examined arguments about fairness and justice to directors that can underpin opposition to review. Even less attention has been given to the other side of the coin, namely arguments for review based on: considerations of fairness and justice to those adversely impacted ex post by directors’ business judgments; as well as social welfare and public policy considerations including the urgent need to alter corporate behavior ex ante in the face of significant global challenges such as the climate crisis. These will be considered in the penultimate section, before concluding.

II.

WELFARE ARGUMENTS AND THE BJR

An important argument for the BJR is that it is necessary to encourage directors to take socially optimal risks, by shielding them from liability that might otherwise discourage such risk-taking. It is feared that if judges reviewed directors’ decisions this would cause boards to be more risk averse, resulting in sub-optimal risk-taking behavior, thus stifling innovation and entrepreneurialism to the detriment of society. More specifically it is argued that socially optimal risk-taking is risk-taking that aligns with the presumed risk appetite of diversified shareholders14 and that is directed at the goal of maximizing shareholder wealth.15 It is assumed that directors’ risk appetite does not align with that of diversified shareholders because of directors’ substantial human capital investment in their companies that cannot be diversified. Should managers take a risk that turns out badly for the company, they could lose their jobs and income. Shareholders, on the other hand, are protected through limited liability. Moreover, diversified shareholders are not concerned with firm-specific risk because, assuming that they have a broad enough portfolio, this risk will be hedged. As the degree of risk taken is correlated with the rate of return, it is assumed that diversified shareholders will want managers to take higher risks that will maximize their returns.16 Diversified shareholders therefore have a greater risk appetite than both directors and undiversified shareholders.17 The BJR addresses the assumed resulting misalignment of interests between the risk-taking presumed to be favored by diversified shareholders and that 13 David Rosenberg, Supplying the Adverbs: The Future of Corporate Risk-Taking and the Business Judgment Rule, 6 Berkley Bus. L.J 216 (2008), available at https://​ssrn​.com/​abstract​=​1266723. 14 Frank H. Easterbrook & Daniel R. Fischel, The Economic Structure of Corporate Law 29–30, 339­–40 (1991); Bainbridge, supra note 5, at 111–12 15 Henry Hansmann & Reinier Kraakman, The End of History for Corporate Law, 89 Geo. L.J. 439, 449 (2001). 16 Bainbridge, supra note 5, at 111–13; John Armour & Jeffrey N. Gordon, Systemic Harm and Shareholder Value, 6 J. Legal Analysis 35, 36–37 (2014). 17 I. Anabtawi, Some Skepticism about Increasing Shareholder Power, 53 UCLA L. Rev. 561, 583–85 (2006).

240  Research handbook on corporate liability favored by directors which would be exacerbated should directors face the prospect of legal liability for decisions that go badly. This argument is based on two assumptions: (i) that the risk appetite of diversified shareholders is socially optimal; and (ii) that directors are sub-optimally risk averse (and that the removal of the BJR would exacerbate this). The following sub-sections will consider these assumptions. A.

Socially Optimal Risk-taking and Diversified Shareholders

Commentators justify the pursuit of shareholder wealth maximization by turning to Milton Friedman’s assertion that ‘there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game’.18 This links to arguments for shareholder primacy, that is, that a company should be run in the interests of shareholders alone. The economic argument for shareholder primacy is that, unlike other corporate constituents, shareholders are unable to protect themselves by contract against managerial delinquency. Given this, and as the company’s residual risk bearers, they have the greatest incentives of all corporate stakeholders to monitor corporate management.19 To incentivize shareholders to carry out this monitoring role the company must be run in their interests and in accordance with their risk preferences, presumed to require shareholder wealth maximization as reflected in share prices.20 Requiring managers to focus on shareholder interests alone and on the goal of shareholder wealth maximization keeps agency costs lower, thus allowing social wealth to rise, thereby potentially benefitting all constituencies.21 Importantly it is not the role of corporate law (on this view) to be concerned with the mechanisms of distributing such wealth, and the costs attached to creating it.22 This chapter is not concerned with the shareholder primacy debate per se. Rather it is concerned with the idea that the theoretical risk appetite of fully diversified shareholders justifies a BJR, whose intended purpose is to promote the pursuit of risky ventures that disregard firm-specific risk and externalities. Although the BJR is often justified as protecting entrepreneurial decision-making, this is not socially optimal entrepreneurial risk-taking. As argued elsewhere,23 entrepreneurial risk-taking is not concerned with risk-taking per se, but with risk-taking that balances risk against economic reward. This balancing exercise is different with regard to entrepreneurs and diversified shareholders. Entrepreneurs’ exposure to, and lack of insulation from, downside risks moderates their risk-taking to socially optimal levels and it is this that drives innovation and economic growth.24 They are ‘responsible’ owners.25

Milton Friedman, The Social Responsibility of Business is to Increase its Profits, N.Y. Times, Sept. 13, 1970. See e.g., Armour & Gordon, supra note 16, at 37. 19 Armen A. Alchian & Harold Demsetz, Production, Information and Economic Organization, 62 Am. Econ. Rev. 777, 782–83, 788 (1972); Hansmann & Kraakman supra note 15, at 449. 20 Armour & Gordon, supra note 16, 36. 21 Id. at 37. 22 Leo Strine Jr., The Dangers of Denial, 76 Wake Forest L. Rev. 761, 787–93 (2015). 23 Andrew Keay & Joan Loughrey, The Concept of Business Judgment, 39 Legal Stud. 36 (2019). 24 Joseph A. Schumpeter, The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle 76–78 (1934). 25 Frank Knight, Risk, Uncertainty, and Profit 271 (1921). 18

Review of directors’ business judgments  241 But because of the lack of downsides for diversified shareholders, the risk-taking that is justified by the BJR is anything but that of the socially optimal risk-taking of the entrepreneurial owner. Even from the shareholders’ perspective such risk-taking is problematic as it disregards the fact that shareholders’ interests are not unified and that they have varying risk appetites and investment horizons.26 It assumes that diversified shareholders are unconcerned about firm-specific risks and seek the pursuit of shareholder wealth regardless of the costs to others, which may not be the case.27 Viewing such risk-taking as optimal also disregards the costs it imposes on parties other than shareholders. Shareholder primacy theorists are not ignorant of this but consider that these costs should be dealt with through other mechanisms. The orthodox position is that negative externalities that arise from corporate risk-taking should be addressed, not by requiring directors to modify their pursuit of shareholder value to take account of the impact of decisions on others, but through the mechanisms of contract, tort and regulation.28 In theory these mechanisms will force companies to internalize the costs of corporate activity. But it follows that the risk-taking that aligns with the diversified shareholder is not per se a societal good – rather it is that such risk-taking is optimal provided it is located within a structure that is effective in requiring companies to internalize the costs and distribute the benefits that result. This is the framework within which arguments for a BJR need to be assessed. However, ‘[i]t’s not news’29 that these extraneous structures do not work perfectly, or, in some instances, at all.30 This has led some to argue for a relaxation of the BJR in certain circumstances. For example, Licht has argued, in the context of insolvency, that when the company is effectively trading with creditor funds and there is a conflict between risk-taking that would carry the greatest benefits for shareholders and risk-taking that is in creditor interests, the BJR can be relaxed to encourage directors to exercise more cautious judgment, focusing on the preservation of assets and loss minimization.31 Others have supported a weakening of the BJR to protect shareholder interests in the face of systemic risks because shareholders cannot diversify risks that affect the entire market and because these create a conflict of interest between managers and shareholders that relaxing the BJR could mitigate.32 This could not only benefit shareholders but also have socially beneficial effects for example in the case of systemic risks related to climate change and pandemics.33 There is moreover evidence that diversified shareholders are concerned with environmental impacts that create significant systemic climate-related risk and want these to be addressed

26 Anabtawi, supra note 17; Stavros Gadinis & Amelia Miazad, Corporate Law and Social Risk, 73 Vand. L. Rev. 1401, 1452–58 (2020). 27 See Madison Condon, Externalities and the Common Owner, 95 Wash. L. Rev. 1 (2020). 28 Hansmann & Kraakman, supra note 15, 441. 29 Armour & Gordon, supra note 16, 37. 30 For an overview of the problems see Andrew Johnston et al., Corporate Social Responsibility as Obligated Internalisation of Social Costs, 170 J. Bus. Ethics 39, 41–43 (2021). 31 Amir Licht, My Creditor’s Keeper: Escalation of Commitment and Custodial Fiduciary Duties in the Vicinity of Insolvency 2, 18 (Eur. Corp. Gov. Inst., Law Working Paper No. 551/2020, Nov. 3, 2020). 32 Armour & Gordon, supra note 16, at 38–39. 33 As to why these should be categorized as systemic risks see Barnali Choudhury, Climate Change as Systemic Risk, 18 Berkeley Bus. L.J. 52 (2018).

242  Research handbook on corporate liability by companies.34 Even so, the ideal level of externality reduction in the face of such threats is likely to be less for shareholders than for the general population.35 Schwarcz goes further and argues that the BJR can be relaxed in the context of systemic risks that impact on the public. This is justified because ‘systemic externalities’ cause more harm than other externalities, to a wider range of people and in unforeseeable ways (so they cannot be addressed through tort ex post or regulation or contract ex ante)36 that impact on the real economy and cause widespread poverty and unemployment.37 In such cases the level of risk-taking that is deemed appropriate cannot be measured by reference to the shareholders’ risk appetite, because it is the public, not shareholders, who bear the costs. The BJR can therefore be relaxed to encourage a lower level of risk-taking.38 Systemic risk, defined as a ‘shock, either exogenous or endogenous, to the economic system that impairs the flow of capital and threatens the stability of the economy’39 could include risks created by actions that contribute to climate change. However, a great deal of corporate risk-taking imposes externalities and third parties and society can be seriously harmed by risks that are not systemic, namely risks that develop gradually over time, that have very significant social or environmental impacts and that, whilst affecting a smaller group of people, have grave consequences for them. Once it is accepted that more accountability for business judgment is justified in the context of systemic externalities to reduce risk-taking that leads to costs that are not, or cannot be, effectively internalized through other mechanisms,40 it is unclear why this would not justify review to address risk-taking that results in externalities that have the same effects on a smaller scale. One possibility is that this position is justified by a cost-benefit analysis: there are risks attached to weakening the BJR which are outweighed in the case of systemic externalities by the costs of failing to deter conduct that disregards social costs, given the degree of potential harm involved. However, leaving aside concerns that greater review would result in directors’ risk appetite diverging from that of diversified shareholders,41 what are the risks attached to enabling more scrutiny by the courts of business judgments? One is that allowing greater review could counter-productively increase pressure upon directors from shareholders. Learned commentators have argued that shielding directors from shareholder pressure allows directors to take account of a wider group of interests than shareholders alone, including environmental considerations.42 But market incentives and, in the UK, Condon, supra note 27. Id. at 68. 36 Steven Schwarcz, Misalignment: Corporate Risk Taking and Public Duty, 92 Notre Dame L. Rev. 1, 17, 20 (2016). 37 Id. at 17–18. 38 Id. at 42. 39 Choudhury, supra note 33, at 57. 40 Schwarcz, supra note 36, at 21. For clarity the point is not that liability for business judgment will result in ex post internalization of social costs and it is unlikely that directors’ wealth or D&O insurance would be sufficient to adequately compensate those harmed by a decision. Rather, it is that the potential for review would act as a deterrent, shaping decision-making ex ante. My thanks to the editors for raising this point. 41 As for arguments that review would deter people from becoming directors see supra text accompanying notes 10–11. For concerns over the competence of the courts see infra. 42 Margaret Blair & Lynn A. Stout, A Team Production Theory of Corporate Law, 85 Va. L. Rev. 247, 303–309 (1999); Kent Greenfield & John Nilsson, Gradgrind’s Education: Using Dickens and 34 35

Review of directors’ business judgments  243 disciplinary mechanisms such as the power shareholders possess to remove directors,43 are such that a formal or informal BJR is unlikely to insulate directors from shareholder pressure, particularly from larger diversified institutional shareholders who – due to the comparative size of their shareholding and market position – are likely to wield greater influence than other shareholders. Permitting challenges to business judgment could, though, facilitate accountability by non-diversified shareholders who will have a lower risk appetite more aligned with the model entrepreneur (because they will be concerned about firm-specific risk). It would enable directors to be held to account by activist shareholders who may take action if, for example, directors have taken unduly risky decisions that harm both the company and the environment. Thus it might, incidentally, reduce the social costs of corporate activity. Another concern is that greater scrutiny of business judgment could create managerial accountability problems by enabling directors to disguise self-serving behavior or hide behind the excuse of serving multiple objectives.44 The idea that directors act in these ways is contested,45 but in any event it is suggested that assuming they can disguise self-interested behavior under the cloak of promoting stakeholder interests underestimates the pressure of the witness box and the extent to which judges scrutinize the reasons provided by directors for their behavior, seeking a rational explanation, the absence of which can be taken as a proxy for bad faith.46 The prospect of greater scrutiny of decisions by the courts, and the need to provide an account of how and why those decisions were reached, could mitigate any tendency to be self-serving, as well as potentially impacting on the degree of risk-taking. B.

Directors and Risk Aversion

Turning now from considering the risk appetite of diversified shareholders to considering directors’ risk appetite, as outlined previously a core argument for the BJR is that directors are sub-optimally rationally risk averse. This tendency would be exacerbated if they were vulnerable to litigation for bad business decisions. The present section examines the evidence for these empirical claims about director behavior. Research investigating whether there is evidence of agency conflicts between directors and shareholders (including the notion that left to their own devices managers will shirk and pursue their own interests) does support the view that, in the absence of mitigating measures, directors display a value-destroying disposition to risk averseness. Illustrative findings include that insulating boards from the market discipline of hostile takeovers led to CEOs and CFOs taking value-destroying decisions,47 and that corporate governance reforms introduced by the US Sarbanes Oxley Act (specifically, the requirement for an independent compensation

Aristotle to Understand (and Replace?) the Business Judgment Rule, 63 Brook. L. Rev. 799, 831–32 (1997). 43 Companies Act 2006, c. 46, § 168 (U.K.). 44 Armour & Gordon, supra note 15, at 37. 45 Lynn A. Stout, In Praise of Procedure: An Economic and Behavioural Defense of Smith v Van Gorkom and the Business Judgment Rule, 96 Nw. U. L. Rev. 675, 683–87 (2002). 46 David Rosenberg, Galactic Stupidity and the Business Judgment Rule, 32 J. Corp. L. 301, 309 (2007). 47 Todd A. Gormley & David A. Matsa, Playing it Safe? Managerial Preferences, Risk, and Agency Conflicts, 122 J. Fin. Econ. 431 (2016).

244  Research handbook on corporate liability committee) mitigated agency conflicts and led to companies taking more risky decisions that were value-enhancing.48 In contrast however another study found that whilst the Sarbanes-Oxley Act did indeed lead to value-enhancing activity, this was due to restraining CEO over-confidence and risk-taking.49 This finding derives from a body of literature that examines the impact of managerial over-confidence on firm performance and finds that managers, and particularly successful CEOs, are more prone to be over-confident than the general population. While measures of over-confidence do not necessarily measure risk appetite, those who are over-confident are likely to take greater risks because they do not assess risk accurately.50 Over-confident managers tend to believe that outcomes are largely controllable and that projects under their supervision are less risky than is actually the case.51 Over-confidence can have positive outcomes52 and can result in innovation and growth that promotes firm value,53 but it can also result in the destruction of shareholder value.54 Turning to evidence regarding the impact of personal liability on risk-taking, empirical studies on the role of Directors’ and Officers’ (D&O) insurance found that the degree of exposure to personal liability in shareholder litigation does impact on directors’ risk-taking behavior.55 More specifically, when D&O insurance insulates directors from the financial consequences of personal liability for their decisions, they take riskier value-destroying decisions: they are more likely to take over-valued companies public;56 lead companies that overpay for target firms in takeovers;57 and engage in aggressive earnings management,58 leading to

Oksana Pryshchepa, Disciplining Entrenched Managers through Corporate Governance Reform: Implications for Risk-taking Behavior, 29 Corp. Gov. Int’l Rev. 328 (2021). 49 Suman Banerjee et al., Restraining Overconfident CEOs through Improved Governance: Evidence from the Sarbanes-Oxley Act, 28 Rev. Fin. Stud. 2812 (2015). See also David Hillier et al., How did the Sarbanes–Oxley Act Affect Managerial Incentives? Evidence from Corporate Acquisitions, 58 Rev. Quant. Fin. & Acc. 1395 (2021). 50 Mark Simon & Susan M. Houghton, The Relationship between Overconfidence and the Introduction of Risky Products: Evidence from a Field Study, 46 Acad. Mgmt. J. 139, 140–41, 146 (2003). 51 See James G. March & Zur Shapira, Managerial Perspectives on Risk and Risk Taking, 33 Mgmt. Science 1404, 1412–14 (1987). 52 Barbara Burhard et al., A Meta-Analytic Approach to Understanding the Effects of CEO Over-confidence on Firm Performance, 2018 Acad. Mgmt. Proc. 12894 (2018). 53 David Hirshleifer et al., Are Overconfident CEOs Better Innovators?, 67 J. Finance 1457 (2012). 54 Ulrike Malmendier & Geoffrey Tate, Who Makes Acquisitions? CEO Overconfidence and the Market’s Reaction, 89 J. Econ. Persp. 20 (2008); Itzhak Ben-David et al., Managerial Miscalibration, 128 Q.J. Econ. 1547 (2010); Ulrike Malmendier & Geoffrey Tate, Behavioural CEOs: The Role of Managerial Overconfidence, 29 J. Econ. Persp. 37 (2015); cf. Ivana Vitanova, Nurturing Overconfidence: The Relationship between Leader Power, Overconfidence and Firm Performance, 32 Leadership Q. 101342 (2021). 55 Benjamin van Rooij & Megan Brownlee, Does Tort Deter? Inconclusive Empirical Evidence about the Effect of Liability in Preventing Harmful Behaviour, in The Cambridge Handbook of Compliance ch 22 (Benjamin van Rooji & D. Daniel Sokol eds., 2021). 56 John M.R. Chalmers et al., Managerial Opportunism? Evidence from Directors’ and Officers’ Insurance Purchases, 57 J. Finance 609, 633 (2002). 57 Chen Li et al., Directors’ and Officers’ Liability Insurance and Acquisition Outcomes, 102 J. Fin. Econ. 507 (2011). 58 M. Martin Boyer & Sharon Tennyson, Directors’ and Officers’ Liability Insurance Corporate Risk and Risk Taking: New Panel Data Evidence on the Role of Directors’ and Officers’ Liability Insurance, 48

Review of directors’ business judgments  245 earnings restatements; and are less likely to disclose bad news to the market.59 Admittedly this literature examines director behavior when the prospect of personal liability decreases, rather than increases as a result of more review of business judgment, but one study found that when overconfident CEOs were the subject of securities class actions they moderated excessive risk-taking.60 Another study, examining the introduction of limited liability for US bank managers in the nineteenth century, found not only that reduced exposure to personal liability led to riskier and more harmful decisions61 but also that when bank managers had unlimited liability this did not lead to banks reducing investment in innovation. In other words, greater exposure to liability did not appear to lead to undesirable risk averseness.62 In the context of insolvency, when directors are required to take more cautious decisions to protect creditor interests,63 it has been suggested that directors’ risk appetite may increase because an escalation in commitment to prior courses of action can come to the fore and lead to irrational judgments.64 There is empirical data that in financially distressed family-controlled firms directors take highly risky decisions at the expense of other stakeholders.65 It has also been suggested that directors underestimate systemic risks such as those caused by climate change due to biases that impair decision-making. 66 This leads to boards under-estimating the downsides of ESG risks, and the likelihood of a crisis affecting their company, and over-estimating their and their company’s ability to withstand any crisis.67 However, it has also been found that exposure to personal liability in climate litigation causes managers to be more attentive to environmental concerns.68 In sum, highly contestable empirical assumptions underpin the orthodox position that protecting business judgment from review is welfare enhancing. There are conflicting findings regarding: whether directors, particularly CEOs, are naturally inclined to excessive risk-taking or are unduly risk adverse; whether insulation from, or exposure to, shareholder, board, or market discipline increases or decreases risk-taking; and whether any effects are value-enhancing or reducing. The evidence does suggest though that insulating directors from accountability for their decisions can adversely impact desirable levels of risk-taking. This 82 J. Risk & Insur. 753, 781–82 (2015); Irene Kim, Directors’ and Officers’ Insurance and Opportunism in Accounting Choice, 7 Acct. & Tax’n 51, 62 (2015). 59 Boyer & Sharon, supra note 58; Zhiyan Cao & Ganapathi S. Narayanamoorthy, The Effect of Litigation Risk on Management Earnings Forecasts, 28 Contemp. Acct. Rsch 125, 164 (2011). See also Dain V. Donelson & Christopher G. Yust, Litigation Risk and Agency Costs: Evidence from Nevada, 57 J.L. & Econ. 747 (2014). 60 Suman Banerjee et al, Executive Overconfidence and Securities Class Actions, 53 J. Fin. & Quant. Analysis 2685, 2702 (2018). 61 Peter Koudijs et al., For Richer, for Poorer: Banker’s Liability and Risk Taking in New England, 1867–1880, 76 J. Finance 1541 (2021). 62 Id. at 1584–85. See also Patricia A. McCoy, A Political Economy of the Business Judgment Rule in Banking: Implications for Corporate Law, 47 Case Wes. Res. L. Rev. 1, 80 (1996). 63 West Mercia Safetywear Ltd (in liq.) v. Dodd (1988) 4 B.C.C 30; BTI 2014 LLC. v. Sequana [2019] EWCA (Civ) 112. 64 Licht, supra note 31. 65 Luis R. Gómez-Mejía et al, Socioemotional Wealth and Business Risks in Family-Controlled Firms: Evidence from Spanish Olive Oil Mills, 52 Admin. Science Q. 106, 106–107 (2007). 66 Choudhury, supra note 33, at 70–72. 67 Id. See also Gadinis & Miazad, supra note 26, at 1462–63. 68 Carl J. Kock et al., Corporate Governance and the Environment: What Type of Governance Creates Greener Companies?, 49 J. Mgmt. Stud. 492, 498, 502, 507–509 (2012).

246  Research handbook on corporate liability could be viewed as supporting theoretical arguments that greater director accountability would be value-enhancing and promote social welfare. These arguments include that accountability could: mitigate agency problems, deterring directors from pursuing their own interests and engaging in shirking;69 and improve the functioning of boards by encouraging more careful socially optimal decision-making which would also serve the public interest in having well-run companies.70 Accountability could also counteract structural incentives for directors to be unduly risk adverse, such as pay structures that give directors an ownership stake in the firm, or their own firm-specific investments.71 Because personal accountability in the form of scrutiny and potential liability for business judgment would be highly visible, it could off-set less visible market incentives both to take riskier decisions that have high-profile positive payoffs for directors and shareholders and to avoid decisions not to take highly risky courses of action, the benefits of which (avoided losses) will not be visible or rewarded. Nevertheless, it has been pointed out that even vastly expanded empirical research on the benefits and detriments of corporate risk-taking is unlikely to settle the debate regarding the appropriate degree of review of business judgment and the balance to be struck between authority and accountability. This is because this is ‘not just a debate over what set of policies will maximize net corporate output’.72 Rather it is a normative debate about what values count, with economic considerations being promoted by those who oppose review of business judgment above other values.73 However, whilst economic considerations are emphasized by proponents of the BJR, other values are in play, as explored next.

III.

FAIRNESS ARGUMENTS AGAINST REVIEW

Even commentators who support some weakening of the BJR are cautious about the extent to which this should occur. Some of their concerns relate to the idea that this might cause sub-optimal decision-making that undermines welfare, a concern that has been canvassed above, but others are linked to considerations of fairness and justice. For example it has been argued that the courts lack the competence to review directors’ business judgments,74 and that their decisions will be infected by hindsight bias.75 The fear is that the courts will there-

Andrew Keay, Exploring the Rationales for Board Accountability in Corporate Governance, 29 Aust. J. Corp. L. 115 (2014). See also Jennifer Lerner & Philip Tetlock, Accounting for the Effects of Accountability, 125 Psych. Bull. 255, 257, 263 (1999) (on the ex ante effects of accountability on decision-making). 70 Andrew Keay, Board Accountability in Corporate Governance 107 (2015). 71 Holger Spamann, Monetary Liability for Breach of the Duty of Care?, 8 J. Legal Analysis 337, 352 (2016). 72 Brett McDonnell, Professor Bainbridge and the Arrowian Moment: A Review of the New Corporate Governance in Theory and Practice, 34 Del. J. Corp. L. 139, 187 (2009). 73 Id. 74 Brian R. Cheffins, Company Law: Theory, Structure and Operation 543 (1997). 75 Hal Arkes & Cindy Schipani, Medical Malpractice v the Business Judgement Rule: Differences in Hindsight Bias, 73 Or. L. Rev. 587, 588 (1994); William T. Allen et al., Realigning the Standard of Review of Director Due Care with Delaware Public Policy: A Critique of Van Gorkom and its Progeny as a Standard of Review Problem, 96 Nw. U. L. Rev. 449, 455 (2002). 69

Review of directors’ business judgments  247 fore incorrectly find directors liable, which would be unfair to directors.76 Others argue that imposing liability upon directors for errors of judgment would be unfair because the level of damages awards that this would expose directors to would be disproportionate to their degree of fault, or the reward they derive for their services.77 Fairness can encompass a wide range of ideas. Concerns about the disproportionate impact of large awards on directors given their individual wealth and whether they can bear (or insure against) these focus on who the director is rather than what she has done and pertain to distributive justice,78 that is, the debate about the fair allocation of resources in society. These are important considerations that have been dealt with elsewhere: one imperfect response to this particular objection is to limit the amount of damages that can be awarded against directors to a percentage of their remuneration or personal wealth.79 Concerns that courts will reach the wrong decision due to hindsight bias or lack of competence to assess business judgments seem to be of a different nature, focusing more on procedural and individualized justice. By individualized justice I mean justice theories at the core of which is a focus on what the director has done, the impact of that conduct on the interests of others, and whether that warrants sanction.80 Individualized justice is implicated if directors are undeservedly sanctioned because the courts mistakenly determine that their business judgments have been negligent. Whilst these arguments for the BJR have been discussed elsewhere, the notion that they are underpinned by individualized justice concerns has not been highlighted, nor has there been any consideration of the weight that should be attached to these. It is generally recognized though that the argument that judges lack the expertise to review business decisions is weak. Courts can and do review decisions and actions taken in highly complex commercial disputes and their competence to do so is not questioned.81 Nevertheless the context in which directors take decisions, namely in highly pressurized situations and under conditions of uncertainty, may make their decisions more challenging to review than those of other individuals.82 It has been argued that the situation facing directors differs from the normal negligence scenario. For example, in the case of a road traffic accident, only one reasonable decision could have been taken, and if harm has resulted it will usually be because an unreasonable course of action was adopted. In contrast, the choices facing directors involve multi-layered risks and there will not necessarily be a clearly right course of action. There is therefore a greater risk for

76 Melvin A. Eisenberg, The Divergence of Standards of Conduct from Standards of Review in Corporate Law, 62 Fordham L. Rev. 437, 443–44 (1993). 77 John C. Coffee Jr., Litigation and Corporate Governance: An Essay on Steering between Scylla and Charybdis, 52 Geo. Wash. L. Rev. 789, 799 (1984); John C. Coffee, No Exit? Opting Out, the Contractual Theory of the Corporation, and the Special Case of Remedies, 53 Brook L. Rev. 919, 928 (1988). 78 George P. Fletcher, Fairness and Utility in Tort Law, 85 Harv. L. J. 537, 547 n.40 (1972). 79 Coffee, supra note 77, 820–26. My thanks to the editors for suggesting the latter point. 80 Catherine P. Wells, Corrective Justice and Tort Liability, 69 S. Cal. L. Rev. 1769, 1773 (1997); Benjamin C. Zipursky, Civil Recourse, Not Corrective Justice, 91 Geo. L.J. 695, 735–36 (2003); Gregory C. Keating, The Priority of Respect over Repair, 18 Legal Theory 293, 336–37 (2012). 81 E.g., Madoff Securities International Securities Ltd v. Raven [2013] EWHC 3147 (Comm); Allen v. Bernhard [2019] EWHC 2885 (Ch); Sharp v. Blank [2019] EWHC 3096 (Ch). 82 Spamann, supra note 71, at 360–61.

248  Research handbook on corporate liability directors, compared with other groups, that they will unfairly be found liable when negative consequences materialize.83 However, the BJR does not exclude courts from reviewing and imposing liability for a poor process leading up to a final decision, such as failing to seek out relevant information or advice. It is thought that the courts are better at evaluating the process leading to a decision than the decision itself.84 Yet leaving aside whether, in the context of the dynamics of the boardroom, outcome and process can be so neatly separated, process also requires judgments which could not only be categorized as business judgments that balance the cost of seeking information (for example) against the benefits of not doing so,85 but which are also taken under the same conditions of pressure and uncertainty that found objections to review of the final decision. As Spamann puts it: It is exceedingly difficult to reconstruct a decision-making context with all its conflicting demands on directors’ and managers’ time and attention. Of the countless bits of information that directors and managers receive, which ones should they question? When can they rely on prior knowledge and/ or intuition, and when must they investigate further? It is not clear that courts are any more able to assess these types of decisions around process than the final decision of what action to take at the end of the process.86

Yet most commentators do not suggest that the courts cannot review the process leading to a decision, though this may also lead to mistaken assessments of liability. In part this may be because such review serves the purpose of detecting whether the impugned process is, or can be presumed to be, motivated by self-serving behavior.87 However, UK courts impose liability even when this is not the case. For example, while in Rubin v. Gunner Etherton J. found that the directors’ belief that a rescue step would occur was ‘fantastic’,88 he also found that they may have believed it would occur.89 Review of process but not substance might be viewed as an attempt to balance, on the one hand, protecting directors’ business judgments to promote (on the orthodox view) socially optimal risk-taking against and, on the other hand, deterring a degree of sub-optimal risk-taking, at least as far as it results from poor process. Nevertheless, this approach tolerates the risk of wrongful findings of liability and thus unfairness to individual directors. It may, in fact, exacerbate unfairness, in terms of treating like cases unalike, by creating the risk that some directors who were not negligent in making process judgments could be found liable, whilst directors who have been negligent by taking excessively risky action after following a due process would be protected. Similar considerations arise in relation to objections based on the risk of hindsight bias. This is the tendency to ‘assign an erroneously high probability of occurrence to a probabilistic

Eisenberg, supra note 76, at 443–44. Stout, supra note 45, at 689. 85 See, e.g., ARB International Ltd. v. Baillie [2013] EWHC 2060 (Comm) ¶ 51 (decision whether to get legal advice was a matter of judgment for the director). Contrast however Angelmist Properties Ltd. v. Leonard [2015] EWHC 1858 (Ch) ¶¶ 104–107; Micra Contracts (in liq.) [2016] B.C.C. 153 ¶ 103. 86 Spamann, supra note 71, at 360–61. 87 See, e.g., Singla v. Hedman [2010] EWHC 902 (Ch) ¶¶ 102–107. 88 Rubin v. Gunner [2004] EWHC 315 (Ch) ¶ 112 and also ¶ 117. 89 Id. at ¶ 119. 83 84

Review of directors’ business judgments  249 event simply because it ended up occurring’.90 The concern is that, if judges review directors’ business judgment, knowing that there has been an adverse outcome, hindsight bias will lead them to erroneously and unfairly conclude that directors have been negligent.91 The difficulty with this argument is that hindsight infects all adjudication and it is unclear why directors should be treated differently from others.92 A common response asserts, again, that directors’ decisions are different from those of other groups: they involve deliberately taking riskier decisions, rather than seeking to mitigate risk, and under greater conditions of uncertainty, leading to more adverse consequences. A common comparator is doctors, who, it is asserted, are not expected to take very risky decisions, and are guided by established methodologies. But these assumptions are challengeable: the human body is unpredictable; risk-taking is an inherent part of clinical judgment; and ‘the art of medicine has not – yet, anyway – been reduced to rigid guidelines and protocols’.93 Furthermore UK judges are very conscious of the dangers of hindsight bias and seek to address it by exercising restraint in imposing liability for business judgments.94 Moreover, whilst doctors do get sued for negligence, cases against directors challenging business judgments and involving negligence allegations remain few and far between, and in the UK, practically non-existent for directors of large public companies.95 Cases of liability for negligent decisions are fewer still.96 Partly this is because of impediments to bringing claims, including the need for court permission before a derivative claim can be pursued,97 and the difficulties for shareholders in accessing evidence to establish a case on the balance of probabilities. These difficulties would remain if there were greater review of business judgments and make it unlikely that hindsight bias would expose directors to a greater risk of unfair erroneous findings of liability than other groups. Furthermore, even if greater review of business judgment did cause more directors to be found liable than others, erroneous findings of civil liability because of hindsight are tolerated within the legal system. More specifically, this risk to individual directors is already accepted: hindsight bias can also affect process review. This suggests that concerns about fairness to individual directors (and others involved in a litigation process) can be overridden by counter-veiling considerations in favor of review. Fairness therefore is not an absolute value and may be outweighed by social welfare considerations, for example, if greater accountability

90 Bainbridge, supra note 5, at 114. See also Arkes & Schipani, supra note 75, at 588; Allen et al., supra note 75, at 455. 91 Allen et al., supra note 75. 92 On judges and hindsight bias see John C. Anderson et al., Evaluation of Auditor Decisions: Hindsight Bias Effects and the Expectation Gap, 14 J. Econ. Psych. 711, 732 (1993); Chris Guthrie et al., Inside the Judicial Mind, 86 Cornell L. Rev. 777, 801–805 (2001). 93 Jeffrey O’Connell & Andrew S. Boutros, Treating Medical Malpractice Claims Under a Variant of the Business Judgment Rule, 77 Notre Dame L. Rev. 373, 401 (2002). 94 E.g., Wessely v. White [2018] EWHC 1499 (Ch), ¶¶ 43–44; Re Sherborne Associates Ltd. [1995] B.C.C. 40, 54; Sharp v. Blank [2019] EWHC 3096 (Ch) ¶¶ 3–6, ¶¶ 660–62. 95 There have been a small cluster of cases arising out of the financial crisis, brought by shareholders on their own behalf against directors personally, in relation to rights issues and acquisitions that have challenged directors’ judgments. See, e.g., Sharp v. Blank [2019] EWHC 3096 (Ch). 96 Andrew Keay, Joan Loughrey, et al., Business Judgment and Director Accountability: A Study of Case-Law Over Time, 20 J. Corp. L. Stud. 359, 371, 374–75 (2020). 97 Companies Act 2006, c. 46 § 261 (UK).

250  Research handbook on corporate liability for business judgment could deter excessively risky decisions, or if, as discussed below, considerations of justice and fairness to others point towards review.

IV.

FAIRNESS ARGUMENTS FOR REVIEW

Arguments for more review of business judgments can also be linked to ideas of fairness and justice,98 and just like fairness arguments against review this encompasses a range of ideas including distributive, procedural and individualized justice. Thus, when corporate risk-taking passes costs onto third parties that they do not contract for, distributional justice becomes relevant. Meanwhile individualized notions of justice can underpin arguments that director accountability for business judgments is needed to address shareholder vulnerability, legitimize the exercise of power by boards, and address uses and abuses of power. 99 Moreover it has been argued that accountability is necessary when someone has been harmed by the wrongful conduct of another, because it affirms and vindicates the moral worth and standing of the injured person by making the person who wronged them acknowledge what they have done, explain it and have judgment passed on that explanation.100 In the context of negligence-type liability, the relevant wrong is not harm alone, but harm that results from disregarding the risk to others from a course of conduct or by taking disproportionate risks in pursuit of the another person’s ends without the consent of those whose interests are thereby disregarded.101 By offering a platform for those affected to voice their grievances and for those responsible to account for themselves and justify or excuse their conduct, or suffer the prospect of sanctions if they cannot, the ability to bring suit demonstrates that the injured parties’ interests count.102 As Bovens has asserted: ‘Public account giving is … important as a mechanism to collectively identify and address injustices and obligations to right wrongs and to heal and put things right’.103 Holding a person to account for the harm they have caused performs an expressive and performative function, vindicating the interests of those harmed.104 In addition, by providing a channel through which accountability can be sought for business judgment, judicial scrutiny can serve procedural justice. When procedures are perceived to be fair, this encourages the perception that outcomes are fair and, in this context, can support the perception that the power exercised by directors is legitimate.105 The idea that accountability for business judgment should promote these values in the commercial sphere will be controversial. Mashaw for example has argued that accountability arising out of our reciprocal obligations to each other generally belongs not in the market

98 Melvin A. Dubnick, Accountability as a Cultural Keyword, in The Oxford Handbook of Public Accountability 32 (Mark Bovens et al. eds., 2014). 99 Keay, supra note 70, at 89. 100 Jason M. Solomon, Equal Accountability through Tort Law, 103 Nw. U. L. Rev. 1765, 1793–95, 1806 (2009) (referencing the arguments of Stephen Darwall, The Second-Person Standpoint: Morality, Respect, and Accountability (2006)). 101 Id. at 1787–88. 102 Id. at 1795, 1797–98. See also Keating, supra note 80, at 318–19. 103 Mark Bovens, Two Concepts of Accountability, 33 W. European Pol. 946, 954–55 (2010). 104 Keating, supra note 80, at 321. 105 On the role of accountability in promoting legitimacy in the corporate governance context see Marc Moore, Corporate Governance in the Shadow of the State 31–36 (2013).

Review of directors’ business judgments  251 sphere but in the social,106 accountability in the former being concerned with pursuit of efficiency and allocation of resources to their highest value uses.107 But this proceeds on the basis that the goal of well-functioning markets is that of allocative efficiency108 which is not only contestable,109 but, given that markets are not allocatively efficient and the external impact of corporate activity is not adequately internalized, unavoidably raises issues of both distributive and individualized justice. Within the present framework of corporate law however there are obstacles to conceptualizing judicial accountability for business judgment as individualized justice vindicating the interests of those harmed by those judgments. The ‘vindication of interests’ justification focuses on the relationship between the person who harms and the person harmed. It functions to recognize the moral agency and autonomy of both persons. In the corporate context these aspects are lost or diluted. Directors owe their duties to the company and breach is a harm to the company, whose moral agency and autonomy is contested.110 Whilst directors can be subject to direct liability in certain circumstances, such as securities litigation, litigation against directors personally for business decisions must usually be conducted derivatively on behalf of the company. Third parties also generally cannot sue directors in tort but must pursue the company. In addition, most theories of individualized justice require a making good or giving back, but in corporate law, compensation for breach of duty is paid to the company. These are not only practical challenges to promoting individualized justice through judicial accountability for business judgment, but some also weaken the normative case for doing so. For example, repair of any harm to human shareholders, or other stakeholders, is indirect (and even more so in the case of institutional investors) and the interests most likely harmed will be economic, which carries less weight than harm to physical interests. In addition, as far as UK shareholders are concerned, section 172 of the Companies Act 2006 requires directors to act in the interests of the company for the benefit of its members as a whole: in other words, business judgments – even those that go wrong – are decisions aimed at benefitting shareholder interests, albeit, as we will see, the fact that in doing so they must have regard to a range of other interests could be important for the protection of those interests. Shareholders also have access to other accountability mechanisms, such as voting at the general meeting and director removal under section 168 of the Companies Act 2006. Although all these mechanisms have shortcomings,111 they provide shareholders with alternative procedures to vindicate their interests. But much depends on context. Shareholders do not have homogenous interests and a particular decision may benefit one group rather than another (such as a decision that disregards firm-specific risk to the detriment of undiversified shareholders). Harm to retail investors may directly impact on the interests of human beings and

Jerry L. Mashaw, Accountability and Institutional Design: Some Thoughts on the Grammar of Governance in Public Accountability: Designs, Dilemmas and Experience 123–24, 153 (Michael W. Dowdle ed., 2006). 107 Id. at 119. 108 Id. at 133. 109 Riz Mokal, On Fairness and Efficiency, 66 Mod. L. Rev. 442, 457–58 (2003). Note that Mashaw, supra note 106, acknowledges that markets ‘ultimately serve (other) social purposes’. Id. at 124. 110 Nick Friedman, Corporations as Moral Agents: Trade Offs in Criminal Liability and Human Rights for Corporations, 83 Mod. L. Rev. 255, 263–67 (2020). See also dicta of Lord Sumption in Bilta (U.K.) Ltd. (in liq.) v. Nazir (No. 2) [2015] UKSC 23 ¶ 66. 111 For a discussion see Keay, supra note 70, at ch 7. 106

252  Research handbook on corporate liability these investors may not have the power to utilize other accountability mechanisms. In closely held companies the relationships between the human shareholder-directors could support a vindication of interests rationale for scrutiny of business judgment utilizing, for example, the unfair prejudice/oppression remedy, although as the interests affected are economic, this would weaken the normative case for review.112 Even so, shareholders are not the most vulnerable group affected by directors’ actions. Other stakeholders are more vulnerable: in contrast to shareholders, generally corporate risk-taking is not directed at promoting these other interests;113 institutional creditors aside, other stakeholders are unable to adequately bargain for, or adequately protect themselves against the risks that directors’ decisions expose them to; and corporate law generally does not provide other stakeholders with alternative mechanisms to hold directors to account. There is therefore a stronger individualized justice case for accountability to stakeholders adversely affected by business judgments in order to vindicate their interests. The question is: which stakeholders would count for these purposes? As far as the UK is concerned, section 172(1) of the Companies Act 2006 provides an answer. This requires directors to have regard to a range of factors including the interests of the company’s employees, the need to foster the company’s business relationships with suppliers, customers and others, and the impact of the company's operations on the community.114 These listed factors are not exclusive – rather directors must have regard to them ‘amongst other matters’. Thus, what other matters – including whose interests – directors ought to have regard to, and so who the relevant stakeholders are, will vary with context and the nature of the decision, and include, it is suggested, those who would be foreseeably adversely impacted by it. Advocating judicial scrutiny of business judgment for harm caused to stakeholder interests is not (necessarily) a form of stakeholderism and arguably could be accommodated within the current legal framework. To explain, it is generally thought that the term ‘having regard to’ in section 172 means that directors must take account of stakeholder interests if, but only if, this promotes shareholder value such that in cases of conflict between stakeholder and shareholder interests, directors must promote shareholder value regardless of the impact on other stakeholders.115 An alternative, admittedly highly unorthodox, interpretation of the phrase is that it requires that the success of the company should be pursued for the benefit of its members in a way that meaningfully takes account of the interests that directors must have regard to. This would not require directors to positively pursue the interests of other constituencies over those of shareholders. Rather it would impose a negative restraint upon directors not to pursue a course of action to promote shareholder interests that carries an excessive risk of harm to others. 116

Companies Act 2006, c. 46 § 994 (UK). Unless a company is insolvent, bordering insolvency or is likely (in the sense of probably) to enter into an insolvent liquidation or administration when directors must take account of creditor interests. Companies Act 2006, c. 46 § 172(3) (UK); West Mercia Safetywear Ltd. (in liq.) v. Dodd (1988) 4 B.C.C. 30; BTI 2014 LLC v. Sequana SA [2022] UKSC 25. 114 Companies Act, 2006, c. 46 § 172(1)(b)(c)(d) (UK). 115 See, e.g., Andrew Keay, Having Regard for Stakeholders in Practising Enlightened Shareholder Value, Oxford U. Commonwealth L.J. 118 (2019). 116 For an account of how such an approach could fit a shareholder primacy model from an ethical perspective see Joseph Heath, Morality, Competition, and the Firm: The Market Failures Approach to Business Ethics ch 1 (2014). See also Kenneth E. Goodpaster, Business Ethics and Stakeholder 112 113

Review of directors’ business judgments  253 It should be noted that individualized justice considerations have no part to play when business judgments cause no immediate direct harm to others, as in the case of environmental degradation or the climate crisis: leaving aside the debate over whether the environment can be a legal person, it is artificial to view it as a moral person whose interests require vindication. But this is not to say that the courts should refrain from scrutinizing these business judgments: rather that the justifications for doing so lie elsewhere.

V.

CONCLUSION: SHOULD THE COURTS REVIEW DIRECTORS’ BUSINESS JUDGMENTS?

It has been contended that arguments for and against review of business judgment are underpinned not only by welfare considerations, but also by concerns with justice and fairness. To assess whether the courts should review directors’ business judgment all these factors should be balanced, with their weight varying with context. Reasonable people will disagree about how to conduct this balancing exercise, but identifying what is in play clarifies what is at stake and ensures that those on both sides of the debate are not talking at cross purposes. Turning to social welfare considerations, it has been argued that the risk-taking that the BJR protects – namely that which aligns with the risk appetite of diversified shareholders – is not, by itself, socially optimal, because it takes no account of downside risks and creates negative externalities, including climate change risks and environmental degradation. Whilst the usual solution is to propose that mechanisms beyond corporate law should be utilized to mitigate social costs, address distributive justice concerns and facilitate individualized justice for those harmed, it is well recognized that these mechanisms are imperfect. The orthodox prescription is to strive to make these more effective, in preference to addressing corporate risk. But this is based on contestable empirical assumptions about the impact of review on directors that pay little regard to empirical data suggesting that directors are as, or more, likely to take value-destroying risky decisions than be risk averse. Therefore, if reviewing directors’ business judgment reduced risk-taking, this could promote social welfare, particularly in the context of decisions that affect stakeholders other than shareholders, and could protect public goods, such as the environment. It is important to note that the BJR is shaped on assumptions that do not take either this conflicting evidence or the potential benefits of review into account. Given this, and given that any risk to shareholder wealth has to be balanced against the societal costs of corporate risk-taking and the pursuit of important social goals such as climate crisis mitigation, there is room to shift the dial towards greater review. Considerations of justice and fairness feature on both sides of the debate. Review of business judgment could lead to directors being wrongly found liable for risks that go badly through no fault on their part. Whilst this risk is not materially different from that faced by other defendants, and whilst even those who support the BJR tolerate it to a degree by accepting process review,117 it can create unfairness for individual directors. Directors might also have a greater chance of incurring undeserved liability than others, given the uncertain and complex nature of corporate decision-making. Meanwhile the case for accountability to serve the ends of indiAnalysis, Bus. Ethics Q. 53, 67–69 (1991) and Steven L. Schwarcz, Excessive Corporate Risk-Taking and the Decline of Personal Blame, 65 Emory L.J. 533, 565–67 (2015). 117 Stout, supra note 45, at 681, 689; David Kershaw, Company Law in Context 455 (2d ed. 2012).

254  Research handbook on corporate liability vidualized justice to vindicate shareholder interests is weakened because directors in fact seek to promote shareholder interests through business judgments, shareholders have alternative accountability mechanisms with which to vindicate their interests, and shareholders may often be institutions, rather than human beings. As a result, on fairness grounds, the balance may tip away from greater review of business judgment when shareholders are affected. However, justice considerations are stronger in the context of closely held companies when the majority – who are often directors – act in ways that unfairly prejudice minority shareholders who often cannot utilize other accountability mechanisms. Similar arguments operate in the context of creditors – as sophisticated institutional creditors can protect themselves through contract, whereas smaller trade creditors are less able to do so.118 Individualized justice considerations are weak in the case of the former and stronger in the latter. Justice considerations are strongest in the context of other stakeholders and, it is suggested, outweigh concerns over unfairness to directors, particularly when the resulting harms are physical rather than economic, because the more fundamental the human interests affected by a decision, the greater the need for accountability from the human beings responsible. Further research is needed to identify and assess the mechanisms by which this more nuanced approach to business judgment review could be achieved, paying attention to costs and effectiveness, but it would not necessarily require significant changes to the current corporate accountability framework. For example, greater review of business judgment would be possible in the context of oppression/unfair prejudice litigation, which, in the UK, is predominantly brought in private companies, and already has a broader scope of application in quasi-partnerships.119 It would also be possible for business judgments to be scrutinized more rigorously in shareholder-brought litigation, including that brought by activist shareholders in relation to environmental issues, for example, in order to advance welfare and the public interest.120 Legislative reforms would be needed to protect stakeholders further, for example by enabling stakeholders such as employees to bring derivative claims on behalf of the company; or to enable more review of business judgment in regulatory actions against directors on the basis of the public interest, such as, for example, through greater use of the disqualification regime for unfitness under the UK Company Directors’ Disqualification Act 1986. Disqualification could vindicate stakeholder interests whilst avoiding the problem of disproportionate liability for directors, though whether and when public resources and enforcement should be utilized to vindicate private interests requires further consideration. Instituting greater judicial scrutiny of directors’ business judgment when stakeholders have been adversely impacted does not require directors to promote stakeholder interests. It aims to ensure, rather, that while promoting the company/shareholder interests they do not expose 118 Andrew Keay, Directors’ Duties to Creditors: Contractarian Concerns Relating to Efficiency and Over-Protection of Creditors, 66 Mod. L. Rev. 665, 689–92, 695–97 (2003). 119 Companies Act 2006, c. 46 § 994 (UK); see O’Neill v. Phillips [1999] UKHL 24, [1999] B.C.C. 600, 608–609. Quasi-partnerships are closely held owner-managed companies in which relationships between the parties are based on trust and confidence: Ebrahimi v. Westbourne Galleries Ltd [1973] A.C. 360, 379 (UKHL). 120 There are precedents for using existing corporate governance mechanisms and shareholder powers to indirectly promote public objectives. Barnali Choudhury & Martin Petrin, Corporate Governance that Works for ‘Everyone’: Promoting Public Policies through Corporate Governance Mechanisms, 18 J. Corp. L. Stud. 381 (2018).

Review of directors’ business judgments  255 others to excessive risk of harm. It reflects the obligation that we all have: that we are at liberty to pursue our own interests – or in the case of directors, our principal’s interests – save where this would cause excessive harm to others.121

121 See Goodpaster, supra note 116, at 68, arguing that the moral obligations of directors cannot be less than those of the company or shareholders.

14. Joint liability Joachim Dietrich

I. INTRODUCTION The liability of companies for wrongs raises complex legal issues, in part because a ‘company is autonomous in law but not in fact. Its decisions are determined by its human agents … This gives rise to problems which do not arise in the case of principals who are natural persons.’1 A company has a separate legal personality, but this does not create a barrier or ‘veil’ around the company shielding it from liabilities with other actors (corporate or natural).2 As with any individual, a company can act, alongside others, in ways that create joint liability.3 This chapter considers the liability of companies, jointly with their human agents, for private law remedies; it does not consider corporate criminal responsibility that may arise alongside that of human actors. A company may be jointly liable in at least four ways: 1. 2. 3. 4.

via rules of vicarious liability and attribution; via the process of ‘piercing the corporate veil’; as an accessory to another’s primary wrong; and by imposition of joint liability on directors for companies’ primary wrongs.

This chapter briefly considers the first three before focusing on the fourth. ‘Directors’ (or ‘Ds’) is here used to include any officers having a management or control function (even without necessarily holding formal office).4 Importantly, in the corporate context, judges and commentators, both within and across different legal systems, have taken different approaches as to the relevant tests for directors’/agents’ liability. As seen below, uniformly applicable conclusions as to the relevant law are elusive.5 Nonetheless, this chapter seeks to provide some clarity on how analysis of the relevant issues should proceed. The focus of this chapter is on English and Australian case law, although it also refers to other common law jurisdictions.

Bilta (UK) Ltd (in liq) v. Nazir (No 2) [2016] AC 1 ¶ 66 (UKSC) (Lord Sumption JSC). See Christian Witting, Piercing the Corporate Veil, in Challenging Private Law: Lord Sumption on the Supreme Court 325, particularly 335–339 (William Day & Sarah Worthington eds., 2020). 3 Id. at 338. 4 See, e.g., MCA Records Inc v. Charly Records Ltd [2001] EWCA (Civ) 1441; [2002] FSR 26 (employee de facto controller of company as nominee of its parent company). 5 See generally Justice Ashley Black, Directors’ Statutory and General Law Accessory Liability for Corporate Wrongdoing, 31 Company. & Sec. L.J. 511 (2013). 1 2

256

Joint liability  257

II.

LIABILITY VICARIOUSLY AND BY ATTRIBUTION

A company may be found to have committed a wrong, be it a breach of contract, tort, equitable, statutory, or other wrong, because of the conduct of its agents, employees and directors. The law uses the concepts of vicarious liability and attribution (of knowledge/states of mind/ conduct) for that purpose. Those concepts are discussed elsewhere in this book.6 It is necessary only to reiterate, in simple terms, the key differences. If all elements of a primary wrong are made out against an employee or agent acting in the course of employment or within the scope of authority, respectively, then the company is vicariously liable for the wrong jointly with the person committing it. At common law, liability is strict: it is not based on the wrongdoer’s state of mind being attributed to the company. Thus, although vicarious liability is sometimes described as the attribution of liability, it is preferable to avoid the language of attribution in that context.7 By way of contrast, where the rules of attribution are applied, a corporation may be personally or ‘directly liable for [the] conduct of its agents’.8 Liability is not ‘indirect’ or vicarious.9 In such a case, the corporation may be the only personal, direct or primary wrongdoer (PW); that is, if it is not possible to establish all the elements of a wrong against any individual, there is no joint primary liability. For example, where a company purchases and purports to obtain title to a claimant’s goods, the conversion might only have been carried out by the company.10 Indeed, some wrongs, ‘cannot be done by a person other than the company itself’,11 for example, where a company imports or sells infringing goods in breach of copyright.12 Such a conclusion does not preclude the possibility, however, of accessory liability on the part of others, such as directors. Further, a company may also be an accessory to others’ wrongs, giving rise to joint liability, discussed below. That said, the interrelationships between attribution and vicarious liability are not always clearly spelt out and, further, both concepts raise complex issues as to their operation and ambit. For example, the relevantly applicable rules of attribution differ13 according to whether the purpose is to ‘apportion responsibility between a company and its agents [or as] between

See Chapters 9 and 15 in this volume. See, e.g., Edelman J in Commonwealth Bank of Australia v. Kojic (2016) 341 ALR 572 ¶ 92 (Austl.). 8 Moulin Global Eyecare Trading Ltd v. Commissioner of Inland Revenue [2014] H.K.C.F.A. 22 ¶ 64 (Lord Walker NPJ) (H.K.). 9 Bilta (UK) Ltd (in liq) v. Nazir (No 2) [2016] AC 1 ¶¶ 185–86, 205 (UKSC) (Lords Toulson and Hodge JJSC); and see also Hamilton v Whitehead [1988] 166 CLR 121 (Austl.). 10 Johnson Matthey (Aust) Ltd v. Dascorp Pty Ltd [2003] VSC 291; (2003) 9 VR 171. Contrast Wah Tat Bank Ltd v. Chan Cheng Kum [1975] AC 507, 514–15 (PC) (Lord Salmon). 11 Keller v. LED Technologies Pty Ltd [2010] FCAFC 55; (2010) 185 FCR 449 ¶ 384 (Jessup J). 12 Sporte Leisure Pty Ltd (ACN 008608919) v. Paul’s International Pty Ltd (ACN 128 263 561) (No 3) [2010] FCA 1162; (2010) 88 IPR 242 ¶ 105 (Federal Court of Australia) (Nicholas J). 13 See generally Meridian Global Funds Management Asia Ltd v. Securities Commission [1995] 2 AC 500 (PC) (on primary, general and special rules of attribution); and the threefold taxonomy of attribution by Lords Toulson and Hodge JJSC in Bilta, [2016] AC 1 ¶¶ 187–90. See also Moulin [2014] HKCFA 22 ¶ 61 onwards, especially ¶ 106 (Lord Walker NPJ); Jennifer Payne, The Attribution of Tortious Liability Between Director and Company, 153 J. Bus. L. 160 (1998) drawing a distinction between attribution of a state of mind and of acts. 6 7

258  Research handbook on corporate liability the company and a third party’.14 One aspect of this is the scope of the ‘fraud exception’ or (since the rule is not limited to fraud) ‘breach of duty exception’ to attribution.15 The rule, in general terms, is that, in a claim by a principal against its agents, ‘knowledge is not attributed to the principal where it is acquired by an agent who is defrauding the principal in the same transaction’,16 even if the agent’s knowledge is attributable in other contexts. Another ongoing difficulty concerns when it is appropriate to aggregate the knowledge of several employees or agents for the purposes of establishing a company’s commission of a wrong where no individual alone has sufficient knowledge to have committed a wrong.17

III.

PIERCING (LIFTING) THE CORPORATE VEIL

‘Piercing the veil’ is a metaphorical description of when ‘some rule of law produces apparent exceptions to the principle of the separate juristic personality of a body corporate’.18 Where a company is controlled by wrongdoers, that is, is merely an alter ego of directors or shareholders,19 or is used as a façade to conceal their wrongdoing,20 then this is one circumstance (among others) in which ‘the court will pierce the veil … to provide a remedy for the particular wrong which those controlling the company have done’.21 Such power is very limited, however, and to be used only rarely.22 Since the legal effect is to ‘disregard’ either the separate legal existence of the corporate vehicle, or alternatively, its limited liability,23 and to equate the company

Bilta, [2016] AC 1 ¶ 92 (Lord Sumption JSC); compare Lords Toulson and Hodge JJSC at ¶ 208 and Lord Neuberger PSC at ¶ 7. 15 Id. at ¶¶ 71–72 (Lord Sumption JSC); and see Lord Neuberger PSC at ¶ 9, preferring that the former label be abandoned. 16 See Peter Watts & F.M.B Reynolds, Bowstead and Reynolds on Agency ¶ 8-207 (22d ed. 2021); qualifications at [8-213] and the statement of general principle in Bilta [2016] AC 1 ¶ 181 (Lords Toulson and Hodge JJSC). 17 See, e.g., the discussion of authorities, in the context of whether a bank committed unconscionable conduct in breach of statute, in Commonwealth Bank of Australia v. Kojic (2016) 341 ALR 572, by Edelman J, rejecting aggregation of knowledge in that case (Allsop CJ and Besanko J agreeing, with one reservation). 18 Prest v. Petrodel Resources Limited [2013] 2 AC 415 ¶ 106 (UKSC) (Lord Walker of Gestingthorpe). 19 TS & B Retail Systems Pty Ltd v. 3Fold Resources Pty Ltd (No 3) [2007] FCA 151; (2007) 239 ALR 117 ¶ 187 (Finkelstein J); Townsend v. Haworth (Sir George Jessel MR), reported as a note to Sykes v. Haworth (1875) 48 LJ Ch (NS) 770, 772. 20 VTB Capital Plc v. Nutritek International Corp [2013] 2 AC 337 ¶ 128 (UKSC), though Lord Neuberger PSC (Lord Wilson JSC agreeing) left open whether such general jurisdiction exists: id. at ¶ 130; compare in the Court of Appeal, VTB Capital Plc v. Nutritek International Corp [2012] 2 Lloyd’s Rep. 313 ¶ 80 (EWCA) (Lloyd, Rimer and Aikens LJJ). 21 VTB Capital Plc [2012] 2 Lloyd’s Rep. 313 ¶ [78] citing Ben Hashem v. Ali Shayif [2008] EWHC 2380 (Fam); [2009] 1 FLR 115. See Robert Miles & Eleanor Holland, Shams and Piercing the Corporate Veil, in Sham Transactions ¶ 11.13 (Edwin Simpson & Miranda Stewart eds., 2013). 22 See Prest, [2013] 2 AC 415, discussing the limited scope of the relevant principles, and Miles & Holland, supra note 21, at ch 11. 23 See Witting, supra note 2. Christian Witting has argued, alongside other commentators whose views are summarised in his article, that shareholder liability for corporate torts, especially mass torts, is justified and does not undermine the rationales for limited liability. See Christian Witting, Liability for Corporate Wrongs, 28 U. Queensland L.J. 113 (2009). 14

Joint liability  259 with its shareholders or controllers,24 this makes it difficult to identify the conceptual bases or doctrinal foundations for imposing liability on the controllers.25 In any case, two very different situations may be encapsulated within the label of ‘veil piercing’. One is where owners or controllers are held personally liable for their company’s obligations; and another is ‘where it is sought to convert the liability of the owner or controller into a liability of the company’.26 It has been suggested that only the former situation may require ‘veil piercing’ and that cases of the latter type, where, for example, an owner seeks to evade their personal liabilities, may best be resolved by resort to other contractual, tort, statutory or equitable principles, such as agency.27 Given these complexities and the rarity with which courts will justify liabilities on principles of ‘veil piercing’ (whatever these may be), the focus of this chapter is on joint liability arising on the basis of accessorial principles. Certainly, some cases of veil piercing might be explicable on such grounds, but not others. In some cases, the law appears to treat the controllers as primary wrongdoers and not accessories to the company’s conduct, since it attributes the company’s acts to them,28 as ‘agents’ of the controllers. Further, disregarding the corporate vehicle may result in either joint liability of both the company and its controller(s),29 or in liability on the part of the controller only. Aspects of the law of veil piercing are considered elsewhere in this book.30

IV.

CORPORATE JOINT LIABILITY AS AN ACCESSORY TO ANOTHER’S PRIMARY WRONG

A company, acting through its directors, officers or employees may be jointly liable as an accessory to another’s wrong. Indeed, corporate accessories to equitable wrongdoing committed by fiduciaries, often trustees, are common in equitable accessory liability cases.31 For example, a company may knowingly assist trustees or fiduciaries in breach of their duties. This topic need not be explored in depth here as, in theory at least, the principles that apply to determining accessory liability generally also apply to the corporate entity, albeit that such liability will need to be established via attribution (or vicariously). In some cases, special attribution rules may apply, where, for example, statutory provisions establish the relevant accessory liability rules.32

Miles & Holland, supra note 21, at ¶ 11.03. Alan Dignam & Peter Oh, Rationalising Corporate Disregard, 40 Legal Stud. 187 (2020). 26 Hurstwood Properties (A) Ltd v. Rossendale Borough Council [2021] UKSC 16 ¶ 68, citing Baroness Hale in Prest [2013] 2 AC 415 ¶ 92; Edwin C Mujih, Piercing the Corporate Veil: Where is the Reverse Gear?, 133 Law Q. Rev. 322 (2017); Witting, supra note 2. 27 See Hurstwood Properties (A) Ltd v. Rossendale Borough Council [2021] UKSC 16 ¶¶ 68–76; Mujih, supra note 26; and Witting, supra note 2. Mujih prefers the label ‘reverse piercing’ to describe the latter situations. 28 See generally Dignam & Oh, supra note 25. 29 E.g., Gilford Motor Co Ltd v. Horne [1933] Ch 935 (EWCA). 30 See Chapter 16 in this volume. 31 See, e.g., Grimaldi v. Chameleon Mining NL (No 2) (2012) 200 FCR 296 ¶ 243 (FCAFC), citing numerous examples, including Cook v. Deeks [1916] 1 AC 554 (PC). 32 See, e.g., under the Competition and Consumer Act 2010 (Cth), statutory attribution rules in s 84. 24 25

260  Research handbook on corporate liability That said, the cases are sometimes confusing as to the precise justification of a company’s liability and whether it is primary or accessorial.33 Often, where a company is within the fiduciary’s complete control – where it is ‘the corporate creature, vehicle, or alter ego of wrongdoing fiduciaries who use it to secure the profits of, or to inflict the losses by, their breach of fiduciary duty’34 – the company, and its liability, are treated as essentially indistinguishable from the fiduciary (often the company’s director) and his or her liability.35 Liability is sometimes justified in the language of ‘lifting [piercing] the corporate veil’,36 discussed above. Other courts reject the corporate veil approach and treat the company as having ‘jointly participated in the breach of trust’;37 or, in the terminology of Viscount Haldane in John v. Dodwell & Company Limited,38 as having a ‘transmitted’ fiduciary obligation. This latter terminology could misleadingly suggest that the company becomes a fiduciary in its own right; alternatively, it could support vicarious liability for breach of fiduciary duty, which possibility has been noted but has not yet received significant judicial attention.39 This lack of clarity in analysis is unhelpful. Courts should spell out whether a company is being held jointly liable as an accessory or as a primary wrongdoer and, if the latter, on what basis. Importantly, in the context of proceedings by a claimant (C) against a company (Co A) for accessory liability, the knowledge of a company’s agent who breaches fiduciary duties owed towards C will be imputed to the company, as the fiduciary’s principal, even though the breach may also constitute fraudulent conduct towards Co A. That is, the ‘fraud exception’ to attribution noted above does not apply.40

V.

DIRECTORS’ LIABILITY FOR CORPORATE WRONGDOING

A. Introduction Where a company has committed a wrong, a director may be found liable for his or her involvement or role in that wrong. The first question that needs to be answered is: What should be the relevant test (or tests) of liability? More specifically, what key elements need to be satisfied to establish such liability? These questions will be addressed below, though as

The authorities below are from Pauline Ridge, Constructive Trustees, Accessory Liability and Judicial Discretion, in Principles of Proprietary Remedies 73 (Elise Bant & Michael Bryan eds., 2013). 34 Grimaldi (2012) 200 FCR 296 ¶ 243. 35 See, e.g., Cook v. Deeks [1916] 1 AC 554 (UKPC). 36 See, e.g., Gencor ACP Ltd v. Dalby [2000] 2 BCLC 734 ¶ 26 (EWHC) (Rimer J). 37 See, e.g., CMS Dolphin Ltd v. Simonet [2002] BCC 600 ¶¶ 98–104 (Collins J); Fyffes Group Ltd v. Templeman [2000] 2 Lloyd’s Rep. 643, 669–70 (Toulson J). 38 John v. Dodwell & Co. Ltd. [1918] AC 563, 569 (PC) in the context of partnership; followed by the NSW Supreme Court in Queensland Mines v. Hudson (1975–76) CLC 40-266. See also Club of the Clubs Pty Limited v. King Network Group Pty Limited (No 2) [2007] NSWSC 574 ¶ 58 (Bergin J). 39 See Ancient Order of Foresters in Victoria Friendly Society Ltd v. Lifeplan Australia Friendly Society Ltd. [2018] HCA 43; (2018) 265 CLR 1 ¶ 5 (Kiefel CJ, Keane and Edelman JJ) noting vicarious liability for equitable wrongs more generally (Majrowski v. Guy’s & St Thomas’s NHS Trust [2006] UKHL 34; [2007] 1 AC 224, 229 ¶ 10) and ¶ 64 (Gageler J). 40 See, e.g., Grimaldi v. Chameleon Mining NL (No 2) (2012) 200 FCR 296 ¶¶ 282–83 (Austl.); see generally Bilta (UK) Ltd (in liq) v. Nazir (No 2) [2016] AC 1 (UKSC). 33

Joint liability  261 a preliminary point, it is important to note that different accessory liability principles and rules apply depending on the wrong in question: whether it is a tort, equitable wrong or statutory wrong. Directors’ liability for breaches of contract raises its own distinct problems that will be considered first. Although the focus of the discussion is on directors’ liability, many of the same issues arise, and the same principles of law apply, to non-director agents acting on behalf of a company or other principal. B.

Liability of Directors for a Company’s Breach of Contract

If the primary wrong committed by a company is a breach of contract, then the court will not directly or indirectly enforce that obligation against directors other than in exceptional circumstances. The court will not directly enforce the contract against D unless D expressly guarantees the performance of the contract, or otherwise has contracted personally rather than on behalf of the company.41 Certainly, where the company’s name appears on any written contractual documents, it is difficult to argue that D has contracted personally.42 D as agent has not, according to the rules of contract law itself, contracted with the claimant and therefore is not liable, although in some circumstances, such as insolvent trading, statute may impose direct liability on directors for a company’s breach of contract.43 Where liability on the part of a director does arise (rare as this is), it is not accessorial; D is liable as a party to the contract. Further, a court will not indirectly enforce such a contract against directors, by imposing liability in tort for inducing breach of contract. It has been repeatedly held that directors are not liable in that tort for acting in their capacity as organs of a company causing the company to breach its contracts.44 Although some cases have criticised this view,45 to hold otherwise would be to undermine completely the principle that only the company is liable for the breach of the company’s contractual obligations.46 The inducing tort ‘cannot be used to sidestep important

See, e.g., Re International Contract Company (1871) 6 Ch App 525; VTB Capital Plc v. Nutritek International Corp [2013] 2 AC 337 (UKSC). In Fairline Shipping Corporation v. Adamson [1974] 2 All ER 967 (EWHC) arguments that the contractual obligations had passed to D by novation failed. 42 See generally Lexa Hilliard QC, Liabilities of Directors to Third Parties, in Company Directors: Duties, Liabilities and Remedies ch 24, ¶¶ 24.06–24.11 (Simon Mortimore QC ed., 3d ed. 2017) and on pre-incorporation contracts, id. at ¶ 24.12 onwards. 43 See id. at ¶¶ 24.59–24.60; e.g., Corporations Act 2001 (Cth) pt 5.7B (Austl.) especially section 588G, which makes directors liable for company’s debts incurred while insolvent. 44 See, e.g., Said v. Butt [1920] 3 KB 497; Tsaprazis v. Goldcrest Properties Pty Ltd [2000] NSWSC 206; (2000) 18 ACLC 285 ¶ 11; Pittmore Pty Ltd v. Chan [2020] NSWCA 344 ¶¶ 165–66; Realtek Holdings Pty Ltd v. Wetamast Pty Ltd [2019] NSWSC 1869 ¶¶ 242–46; Armstrong Strategic Management and Marketing Pty Ltd v. Expense Reduction Analysts Group Pty Ltd (No 9) [2016] NSWSC 1005 ¶ 178. 45 See, e.g., Cook Straight Skyferry Ltd v. Dennis Thompson International Limited [1993] 2 NZLR 72; Ridgeway Maritime Inc v. Beulah Wings Limited (The Leon) [1991] 2 Lloyd’s Rep 611; and also the doubts expressed in Welsh Development Agency v. Export Finance Co Ltd [1992] BCLC 148, 173 (Dillon LJ), 179 (Ralph Gibson LJ) and 191 (Staughton LJ) (EWCA), though ultimately, the authority of Said v. Butt [1920] 3 KB 497 was accepted. 46 Root Quality Pty Ltd v. Root Control Technologies Pty Ltd [2000] FCA 980; (2000) 177 ALR 231; Keller v. LED Technologies Pty Ltd [2010] FCAFC 55; (2010) 185 FCR 449. Note, however, the failed attempt to indirectly enforce the contract against directors in Tsaprazis v. Goldcrest Properties (2000) 18 ACLC 285, 288 (Hodgson CJ in Eq), via the imposition of a duty of care to ensure the company fulfilled its contract. 41

262  Research handbook on corporate liability contract principles’47 nor, it should be added, principles of separate corporate personality. These limitations generally play no role where liability for wrongs unrelated to contract is at issue, since victims of such wrongs have not chosen to have dealings with the company.48 It has, however, been suggested that perhaps the same strictures against liability ought to deny the liability of directors for inducing a breach of trust by a trustee company.49 In exceptional circumstances, liability for economic losses negligently caused by a director may arise where they have ‘assumed responsibility’ such that a duty of care arises towards a party dealing with D’s company,50 although such liability is, strictly speaking, tortious and not contractual. C.

Directors’ Primary Liability for Other Wrongs and ‘Dis-attribution’

Leaving aside situations of lifting the corporate veil from sham companies, a company is not the agent of its directors or shareholders, and a director is not liable for corporate wrongdoing as a result only of his or her status.51 This is uncontroversial. Contrary to the arguments by some judges and commentators,52 however, this does not mean that a director, when acting as an agent, ought not to be liable for his or her own acts since these have been attributed to the company. Such arguments often focus on (but are not limited to) situations in which attribution is based on the concept of identifying higher-ranking corporate agents, and particularly directors, as the company itself or as its directing mind and will.53

47 Christopher Wood, Liability of Directors as Joint Tortfeasors in Intellectual Property Matters, 21 Austl. Intell. Prop. J. 164, 172 (2010). 48 Johnson Matthey (Aust) Ltd v. Dascorp Pty Ltd [2003] VSC 291; (2003) 9 VR 171, 227 ¶ 199 (Redlich J). 49 Pittmore Pty Ltd v. Chan [2020] NSWCA 344 ¶¶ 168–70 (Leeming JA, Bell P and Brereton JA agreeing), leaving the question open, though suggesting an inclination to that view, whilst also noting the contrary view that directors who cause their company to breach its trust are ‘peculiarly vulnerable’ to liability for knowing assistance (Australian Securities Commission v. AS Nominees Ltd [1995] FCA 1663; (1995) 62 FCR 504, 523 (Finn J), as illustrated, e.g., by Royal Brunei Airlines Sdn Bhd v. Tan [1995] 2 AC 378 (PC)). 50 See, e.g., Fairline Shipping Corporation v. Adamson [1974] 2 All ER 967; the relevant principles are set out in Williams v. Natural Life Health Foods [1998] 2 All ER 577 (rejecting liability in that case). See also Hilliard, supra note 42, at ¶¶ 24.31–24.34. 51 See, e.g., British Thomson-Houston Co Ltd v. Sterling Accessories Ltd [1924] 2 Ch 33; (1924) 41 RPC 311. 52 See, e.g., Trevor Ivory Ltd v. Anderson [1992] 2 NZLR 517, 520 (Cooke P) and also extra-judicially, Lord Cooke of Thorndon, Turning Points of the Common Law 18 (1997); Ross Grantham & Charles Rickett, Directors’ ‘Tortious’ Liability: Contract, Tort or Company Law?, 62 Mod. L. Rev. 133 (1999). See also Ross Grantham, The Limited Liability of Company Directors, 3 Lloyd’s Maritime. & Com. L.Q. 362 (2007) and Ross Grantham, Attributing Responsibility to Corporate Entities: A Doctrinal Approach, 19 Company. & Sec. L.J. 168, 178–79 (2001). This assumption may underlie some of the cases supporting the ‘make the wrong his or her own’ test (below). 53 See, e.g., Brooks v. New Zealand Guardian Trust Co Ltd [1994] 2 NZLR 134 (NZCA). The point was not discussed on appeal: New Zealand Guardian Trust Co Ltd v. Brooks [1995] 1 WLR 96 (PC).

Joint liability  263 This ‘disattribution heresy’54 or ‘fallacy’55 has, for the most part, been rejected in modern law56 as a bar to directors’/agents’ liability and lacks logical appeal. An agent does not lose their legal identity when acting for a company (or for any other principal) such that personal liability for their own acts cannot arise.57 Not privileging an agent’s acts is not, contrary to the view of some commentators, ‘to deny the company’s very existence’.58 As Campbell and Armour have concluded, ‘as a matter of principle, there is no convincing reason why the company being liable should exclude or immunise the agent from being liable’.59 Similarly, the House of Lords in Williams v. Natural Life Health Foods (‘Williams’) stated: the issue is not peculiar to companies. Whether the principal is a company or a natural person, someone acting on his behalf may incur personal liability in tort as well as imposing vicarious or attributed liability upon his principal.60

Similarly, arguments for special rules to maintain the limited liability of, and separate legal identity of, shareholders61 are not relevant as these protect shareholders and not directors. Directors acting as agents raises altogether different concerns: ‘construing the agency situation as involving corporate veil considerations misses the point’.62 Indeed, to apply more limited liability rules only to directors would lead to the stark injustice that employees acting on behalf of a corporation may be liable (on ordinary principles) for the company’s wrong in circumstances where the same conduct by directors may be excused. Therefore, a director can be potentially liable for wrongdoing even when acting for the company. It is important to disentangle two distinct situations, however. D may be personally liable for committing a primary wrong, such as a tort; this is determined by application of the

Neil Campbell & John Armour, Demystifying the Civil Liability of Corporate Agents, 62 Camb. L.J. 290, 292 (2003) and see also the discussion id. at 292–96. 55 Stefan Lo, Dis-attribution Fallacy and Directors’ Tort Liabilities, 30 Austl. J. Corp. L. 215 (2016). 56 The authorities are numerous, but see, e.g., Standard Chartered Bank v. Pakistan National Shipping Corporation (No 2) [2003] 1 AC 959; 1 All ER 173 ¶¶ 22, 40 (UKHL); C Evans & Sons Ltd v. Spritebrand Ltd [1985] 1 WLR 317; [1985] 2 All ER 415 (EWCA). See also Peter Watts, The Company’s Alter Ego – A Parvenu and Imposter in Private Law, N.Z. L. Rev. 137 (2000), and an early statement in Ferguson v. Wilson (1866–67) LR 2 Ch App 77, 89–90 (Cairns LJ). In a statutory context, see Houghton v. Arms [2006] HCA 59; (2006) 225 CLR 553. 57 See Stefan H.C. Lo, Liability of Directors as Joint Tortfeasors, J. Bus. L. 109 (2009), 127 et seq. See also Peter Watts et al., Company Law in New Zealand ¶ 11.2.2 (2d ed. 2015) (in relation to the authorities on company deeds). 58 Grantham & Rickett, supra note 52, at 139. 59 Campbell & Armour, supra note 54, at 295–96. See also Peter Watts, Trevor Ivory v. Anderson: Reasoning from Outer Space, N.Z. L.J. 25 (2007). 60 Williams v. Natural Life Health Foods [1998] 2 All ER 577, 582. See also Johnson Matthey (Aust) Ltd v. Dascorp Pty Ltd [2003] VSC 291; (2003) 9 VR 171, 227 ¶ 198 (concluding that the Australian position is similar, although see below). 61 See, e.g., John H. Farrar, Personal Liability of Director for Torts of Company, 71 Austl. L.J. 20, 21 (1997) and Susan Watson, Who Hides Behind the Corporate Veil? Finding a Way out of ‘The Legal Quagmire’, 20 Company. & Sec. L.J. 198, 205 (2002) and see also references above cited supra note 52. Cf. Keller v. LED Technologies Pty Ltd [2010] FCAFC 55; (2010) 185 FCR 449 ¶ 403. Contrast Lo, supra note 57, at 120 onwards. 62 See Miles & Holland, supra note 21, at ¶ 11.13. 54

264  Research handbook on corporate liability rules of civil liability relevant to the wrong in question63 and whether all the elements of that wrong can be made out against D.64 Where D drives negligently, or trespasses on a claimant’s land, in the course of their employment or within the scope of their agency, D has breached a duty of care or is a trespasser, respectively. Further, the company’s joint liability for that wrong is uncontroversial, subject to the application of rules of vicarious liability. Rules of attribution (of knowledge/conduct) are of less relevance if the transfer of full liability is at stake. However, where a director is the primary contravener of a statutory provision, a company may be liable as an accessory to that director’s contravention via attribution.65 D.

Directors’ Liability as Accessories

In the second situation – where a director has not personally committed a wrong – liability for a corporate wrong may be imposed because of D’s involvement in it as an accessory. Primary and accessory liability are distinct: a director cannot be liable on both grounds. Unfortunately, some cases do not make the distinction clear when applying some tests of directors’ liability to individual circumstances.66 This can lead to confusion.67 For example, the test of whether D has ‘assumed responsibility’ for a company’s acts has sometimes been described as a general test of directors’ (primary or secondary) liability in Australia and New Zealand,68 but this is a test of primary responsibility of whether a duty of care (generally to prevent pure economic loss) is owed by a director (or other party).69 In the second situation, in which a director has not committed a primary wrong, English law has taken the approach that courts should apply general principles of accessory (secondary) liability. But the issue has not received uniform treatment across other jurisdictions and other more restrictive tests of liability to determine directors’ liability have been applied. In short, there is no settled common law position. (I do not propose to consider directors’ liability under statutory provisions, for example, for breaches by companies of corporation legislation

See Campbell & Armour, supra note 54, at 298–99. O’Brien v. Dawson (1942) 66 CLR 18, 32 (Starke J) (Austl.). 65 See, e.g., Corporations Act 2001 (Cth) and Re Krypton Nominees Pty Ltd [2013] VSC 446 ¶¶ 13, 290 in the context of misleading and deceptive conduct under s 1041H of that Act. 66 Fairline Shipping Corporation v. Adamson [1974] 2 All ER 967 and Allen Manufacturing Co Pty Ltd v. McCallum & Co Pty Ltd (2001) 53 IPR 400 are examples. 67 E.g., Microsoft Corporation v. Auschina Polaris Pty Ltd [1996] FCA 1069; (1996) 71 FCR 231; (1996) 36 IPR 225 seemingly is treated in Sydneywide Distributors Pty Ltd v. Red Bull Australia Pty Ltd [2002] FCAFC 157; (2002) 55 IPR 354 ¶ 160 (Weinberg and Dowsett JJ) as a case of D being liable as primary wrongdoer, but the exact opposite characterisation is adopted by Jessup J in Keller v. LED Technologies Pty Ltd [2010] FCAFC 55; (2010) 185 FCR 449 ¶ 384: D was only liable as an accessory since the company was the relevant seller and importer that infringed. 68 E.g., Pioneer Electronics Australia Pty Ltd v. Lee [2000] FCA 1926; (2001) 108 FCR 216 ¶ 45 (Sundberg J) and Livingston v. Bonifant (1995) 7 NZCLC 96-658; [1994] BCL 1024 (Doogue J, NZ HC) and Banfield v. Johnson (1994) 7 NZCLC 260 ¶ 140. 69 It is therefore inappropriate to apply ‘assumption of responsibility’ to other wrongs, a point forgotten in Standard Chartered Bank v. Pakistan National Shipping Corporation (No 2) [2000] 1 Lloyd’s Rep. 218 (EWCA), which applied the test to fraud, an error corrected by the House of Lords in Standard Chartered Bank v. Pakistan National Shipping Corporation (No 2) [2003] 1 AC 959. 63 64

Joint liability  265 or consumer law.70) Before turning to the case law, it is necessary to give a brief overview of accessory liability more generally. First, as already noted, different accessory liability rules apply according to the wrong at issue. For example, there are different rules for torts (and statutory wrongs) and for equitable wrongs. Secondly, accessory liability requires both a conduct element – some positive involvement in the primary wrong – and a mental element, generally knowledge of the essential elements of the conduct that make it wrongful and that constitutes the wrong (but not knowledge of the relevant law rendering the conduct wrongful).71 Although knowledge is generally required and some rules explicitly incorporate it (for example, ‘knowing assistance’), not all liability rules clearly do so. It is argued below that, if accessorial liability principles are properly understood, and the requisite elements properly identified, then such secondary liability is difficult to prove and generally rare. That should assuage concerns about excessive liability for directors in the corporate context. Nonetheless, there will always be some practical difficulties in applying accessory liability rules to corporate wrongs, since both a company’s conduct and mental state can only be determined by reference to the conduct and accompanying mental states of human actors. When D pursues his or her objectives through a corporate vehicle wrongdoer, PW Co (itself acting through employees and other agents), D may be accessorily involved in PW Co’s wrongs, wrongs only committed because of those acts of its employees and agents, including D. In the corporate context, therefore, accessory liability has an element of circularity. E.

Directors’ Accessorial Liability in English Law: ‘Common Design’ and ‘Direct or Procure’

In English law, directors’ liability for corporate wrongdoing is determined on reasonably settled principles. D is either personally liable as a primary wrongdoer, if all the elements of a specific wrong can be established, or else is liable as an accessory based on the application of general accessory principles.72 D will be liable when he or she directed or procured the wrong, or was a party to a common design to commit the wrong.73 The English position has been accepted in Hong Kong.74 Most cases concern statutory intellectual property infringements,

In the UK, see, e.g., the Financial Services and Markets Act 2000, c. 8, §§ 380, 382 and 384, which authorise orders for any contraventions of the Act, including against parties who are ‘knowingly concerned in the contraventions’. See, e.g., Financial Services Authority v. Martin [2005] EWCA 1422; [2006] PNLR 11. In Australia, e.g., under the Corporations Act 2001 (Cth) persons may be liable as accessories to breaches by companies: e.g., id. at § 208 and § 209. Australian Consumer Law and Competition and Consumer Act 2010 (Cth) similarly imposes civil liability on parties ‘involved in the contravention’ of various provisions. 71 See Joachim Dietrich & Pauline Ridge, Accessories in Private Law ¶ 1.1, ch 3 (2016); Paul S. Davies, Accessory Liability (2015). 72 MCA Records Inc v. Charly Records Ltd [2001] EWCA (Civ) 1441; [2002] FSR 26 ¶ 41. 73 Handi-Craft Company v. B Free World Ltd [2007] EWHC B10 (Pat) ¶ 214. Note, however, the use in some cases of ‘assumption of responsibility’ as a further test for liability. As argued above, however, this should only be used as a test of primary liability to establish a duty of care in tort. 74 See Yakult Honsha v. Yakuda, [2004] 1 H.K.C. 630 (C.F.I.); Tai Shing v. Maersk, [2007] 2 H.K.C. 23 (C.F.I.). 70

266  Research handbook on corporate liability in which it is well established that the general principles of joint tortfeasance apply.75 Recent English cases assume that the rules set out by the Supreme Court in Sea Shepherd v. Fish & Fish Ltd76 for establishing a common design are relevant to the liability of directors as accessories to companies’ torts, though that case did not concern directors’ liabilities.77 To establish liability for a common design, D must have assisted in the commission of an act by the primary wrongdoer (PW), pursuant to a common design of D and PW that the act be committed; and that act must constitute a tort.78 However, applying the common design test in the corporate context seems somewhat artificial if the common design between D and the primarily liable company is based on the attribution of D’s knowledge and conduct to the company. D may be found liable for a common design essentially entered into with himself or herself, at least where he or she is the sole director. That artificiality is acknowledged in some cases.79 Indeed, since a common design can be implied, that artificiality is increased absent any genuine actual agreement or meeting of minds. The direct and procure test of accessorial liability is probably better suited to the factual context of directors’ liability. The application of this test, specifically to directors, is derived from obiter statements by Atkin LJ (relying on earlier authorities) in Performing Right Society Limited v. Ciryl Theatrical Syndicate Limited:80 Prima facie a managing director is not liable for tortious acts done by servants of the company unless he himself is privy to the acts, that is to say unless he ordered or procured the acts to be done. … If the directors themselves directed or procured the commission of the act they would be liable in whatever sense they did so, whether expressly or impliedly.81

The test requires some deliberate course of conduct on the part of D that furthers, via the corporate vehicle, the commission of the wrong. However, the courts have not spelled out what precise acts of involvement might satisfy the test. It is not limited to procuring, that is, seeking to bring about the very act that is a wrong. The use of the verb ‘direct’ is potentially broader. What is clear, however, is that liability does not follow merely from the relationship of D with the company and the degree of control that D has over the company’s affairs:82 ‘in every case … it is necessary to examine with care what part [D] played personally in regard to the act or

Going back at least to Performing Right Society Limited v. Ciryl Theatrical Syndicate Limited [1924] 1 KB 1 (EWCA). 76 Sea Shepherd UK v. Fish & Fish Ltd [2015] AC 1229 (UKSC). 77 Those principles are viewed as consistent with those set out in MCA Records [2001] EWCA (Civ) 1441, which did concern directors. See, e.g., Federation Internationale De L’Automobile v. Gator Sports Ltd [2017] EWHC 3564 (Pat) (Burns J); National Guild of Removers Ltd v. Luckes [2017] EWHC 3176 (IPEC) (Judge Hacon). 78 Fish & Fish Ltd [2015] AC 1229 ¶ 57 (Lord Neuberger PSC); compare id. ¶ 21 (Lord Toulson JSC) and id. ¶ 37 (Lord Sumption JSC). 79 Societa Esplosivi Industriali SpA v. Ordnance Technologies (UK) Ltd (No 2) [2007] EWHC 2875 (Ch); [2008] 2 All ER 622 ¶ 96 (Lindsay J). 80 Performing Right Society [1924] 1 KB 1 (EWCA). 81 Id. at 14–15, approved by the Privy Council in Wah Tat Bank Ltd v. Chan Cheng Kum [1975] AC 507, 514–15 (Lord Salmon). See also Microsoft Corporation v. Auschina Polaris Pty Ltd (1996) 71 FCR 231, 243–44; (1996) 36 IPR 225, 237 (Lindgren J). 82 C Evans & Sons Ltd v. Spritebrand Ltd [1985] 1 WLR 317, 329A–C (Slade LJ); Johnson Matthey (Aust) Ltd v. Dascorp Pty Ltd [2003] VSC 291; (2003) 9 VR 171, 227 ¶ 198. 75

Joint liability  267 acts complained of’.83 In some cases it appears to be assumed that liability may arise where D merely directs certain specific acts that are or lead to infringements, as opposed to knowingly directing certain infringements.84 In other words, the test is applied without reference to any mental state such as knowledge. In most cases, however, even where knowledge is not explicitly alluded to, it is nonetheless critical to liability. This is discussed further below. If the ‘direct or procure’ test is interpreted to include a mental element – D must generally knowingly direct – then liability is appropriately limited. This may provide a basis for reconciling the test with cases that support ‘narrower’ tests of liability. F.

Tests for Liability in Other Jurisdictions

1. Uncertainty in Australia In other jurisdictions, courts have accepted that directors/corporate agents may be liable in some circumstances, and some cases have applied the ‘direct or procure’ test noted above (and on occasions, the common design test),85 but other tests have also been applied that set higher thresholds of liability. The predominant Australian view is reflected by Gummow J in obiter, in considering the necessary involvement of directors to generate personal liability for a company’s torts: Those questions are not immediately answered by principles dealing with ‘authorisation’ or joint tortfeasance. Rather, recourse is to be had to the body of authority which explains the circumstances in which an officer of a corporation is personally liable for the torts of the corporation.86

The assumption that special rules need to be applied to determine the liability of directors underlies many key cases in New Zealand,87 Canada88 and Australia.89 Indeed, one Canadian case, Pater International Automotive Franchising Inc v. Mr Mechanic Inc, went so far as to suggest that the question of directors’ liability ought to be determined according to whether, from all the circumstances, ‘as a matter of policy, they call for personal liability’.90 To be sure,

PLG Research Ltd v. Ardon International Ltd [1993] FSR 197, 238 and 239. See, e.g., Sporte Leisure Pty Ltd (ACN 008608919) v Paul’s International Pty Ltd (ACN 128 263 561) (No 3) [2010] FCA 1162; (2010) 88 IPR 242 ¶ 109 (Nicholas J). 85 E.g., in LED Technologies Pty Ltd v. Elecspess Pty Ltd [2008] FCA 1941; 80 IPR 85, 128–29 ¶¶ 171–75 (Gordon J); however, the decision on directors’ liability was overturned on appeal: Keller v. LED Technologies Pty Ltd [2010] FCAFC 55; (2010) 185 FCR 449 (Austl.). 86 WEA International Inc v. Hanimex Corporation Ltd (1987) 17 FCR 274, 283; (1987) 10 IPR 349, 359; approved in Microsoft Corporation v. Auschina Polaris Pty Ltd [1996] FCA 1069; (1996) 71 FCR 231; (1996) 36 IPR 225, 233 (Lindgren J), a case that, unlike WEA, concerned that question. 87 E.g., Trevor Ivory Ltd v. Anderson [1992] 2 NZLR 517 (Cooke P). 88 E.g., Mentmore Manufacturing Co Inc v. National Merchandising Manufacturing Co Inc (1978), 89 D.L.R. 3d 195 (Can. Fed. C.A.). 89 E.g., King v. Milpurrurru (1996) 66 FCR 474, 495–501; 136 ALR 327, 346–51 (Beazley J) (Austl.); Root Quality Pty Ltd v. Root Control Technologies Pty Ltd [2000] FCA 980; (2000) 177 ALR 231 (Austl.); Keller, [2010] FCAFC 55. 90 Pater International Automotive Franchising Inc v. Mr Mechanic Inc, [1990] 1 F.C. 237, 242, discussed by David Debenham, Return to the Beaten Path? Directors’ and Employees’ Liability for Intellectual Property Torts after Mentmore, 16 Intell. Prop. J. 527 (2003), who argues that the English approach should be adopted in Canada, contrary to the current vague Mentmore-based approaches to liability. 83 84

268  Research handbook on corporate liability policy considerations may be relevant in setting the appropriate tests of liability, but this does not mean that individual cases should be determined on the basis of (unspecified) policy. In Australia at least, the state of the law is uncertain91 and the authorities are in ‘some disarray’.92 Most recent cases in Australia view the competition as between ‘two relevant lines of authority’93 that determine D’s liability for corporate wrongs; those authorities usually concern tort liability and intellectual property (statutory) infringements. Some judges have suggested that ‘the clear preponderance of authority, especially in … [Federal] Court, favours the [direct or procure] approach’.94 If that were so, then Australian law would largely align with English authorities.95 Other cases give weight to the overarching concerns of limiting liability captured in formulations such as the ‘make the wrong (or tort) his or her own’. The Australian position remains open, however, and many cases apply the latter test and ‘direct or procure’ in the alternative.96 Indeed, some authorities have said that there may be little difference in outcomes between the two tests, that the differences between them are ‘more apparent than rea[l]’.97 Other judges have stated that that conclusion ‘goes too far’.98 2. ‘Makes the wrong his or her own’ test Let us turn, then, to the ‘makes the wrong his or her own’ test, which originated in the Canadian Federal Court of Appeal case of Mentmore Manufacturing Co Inc v. National Merchandising Manufacturing Co Inc.99 This concerned claims against D for patent infringements by D’s company. Problematically, however, it is unclear from the shorthand formulation what

See generally Robert P. Austin & Ian M. Ramsay, Ford’s Principles of Corporations Law ¶ 16.080.3 (17th ed., 2018). 92 Universal Music Australia Pty Ltd v. Sharman License Holdings Ltd [2005] FCA 1242; (2005) 65 IPR 289 ¶ 433 (Wilcox J). 93 E.g., Cooper v. Universal Music Australia Pty Ltd [2006] FCAFC 187; 156 FCR 380 ¶ 160 (Kenny J, French J agreeing). See also Allen Manufacturing Co Pty Ltd v. McCallum & Co Pty Ltd (2001) 53 IPR 400 and Sydneywide Distributors Pty Ltd v. Red Bull Australia Pty Ltd [2002] FCAFC 157; (2002) 55 IPR 354. It has been suggested in some recent cases (e.g., Inverness Medical Switzerland GmbH v. MDS Diagnostics Pty Limited [2010] FCA 108 ¶ 179 (Bennett J)) that a further test may also be relevant, namely the principle stated by Finkelstein J in TS & B Retail Systems Pty Ltd v. 3Fold Resources Pty Ltd (No 3) [2007] FCA 151; (2007) 239 ALR 117 ¶¶ 185–87 and Root Quality [2000] FCA 980 ¶ 146, but it is unlikely that Finkelstein J intended to promulgate a distinct test; more likely, it was merely a further elaboration of the ‘make the wrong his or her own’ test: see Root Quality [2000] FCA 980 ¶ 146. 94 Pioneer Electronics Australia Pty Ltd v. Lee [2000] FCA 1926; (2001) 108 FCR 216 ¶ 46. 95 See Lo, supra note 57, at 131. After a comprehensive overview of the competing authorities in Johnson Matthey (Aust) Ltd v. Dascorp Pty Ltd [2003] VSC 291, (2003) 9 VR 171, Redlich J adopted conclusions that are broadly consistent with those in English law and that are followed in this chapter, while also endorsing Gummow J’s statement above supporting a sui generis approach to directors’ liability. 96 E.g., AMI Australia Holdings Pty Ltd v. Bade Medical Institute (Australia) Pty Ltd (No 2) [2009] FCA 1437, (2009) 262 ALR 458 (Flick J); Inverness Medical Switzerland GmbH v. MDS Diagnostics Pty Limited [2010] FCA 108 ¶¶ 179–92 (Bennett J); Hoath v. Connect Internet Services [2006] NSWSC 158 (White J). 97 Allen Manufacturing Co Pty Ltd v. McCallum & Co Pty Ltd [2001] FCA 1838; (2001) 53 IPR 400 [43]; and see JR Consulting & Drafting Pty Ltd v. Cummings (2016) 329 ALR 625 (Fed. Ct. Austl.) ¶ 350. 98 TS & B Retail [2007] FCA 151 ¶ 185 (Finkelstein J). 99 Mentmore Manufacturing Co Inc v. National Merchandising Manufacturing Co Inc (1978), 89 D.L.R. 3d 195 (Can. Fed. C.A.). 91

Joint liability  269 needs to be proven in order for the test to be satisfied, though judges that have favoured the Mentmore test consider that it is a ‘more stringent’ or ‘stricter’ or ‘higher’ test100 that ‘requires some further involvement’101 than the direct or procure test. The test fails to explicitly separate out the necessary conduct by D and the requisite mental state when so acting, such that without further elaboration, it is fair to conclude that it is ‘indeterminate and possibly circular’.102 Its supporters have conceded that it is not an easy test to apply. The commonly made, but unhelpful, statement that it is a ‘question of fact to be decided on the circumstances of each case’ does not address these inadequacies103 and it is not unfair to say that many cases applying it merely assert as conclusions that D did (or did not) jointly infringe. In Mentmore itself, Le Dain J (jointly with Urie and Ryan JJ) suggested that there needs to be something in the nature of a ‘deliberate, wilful and knowing pursuit of a course of conduct that was likely to constitute infringement or reflected an indifference to risk of it’. ‘It is unnecessary for him to know, or have the means of knowing, that the act or conduct is tortious. It is enough if he knows or ought to know that it is likely to be tortious.’104 This suggests a focus on a high state of knowledge, but earlier, Le Dain J also stated that: I do not think we should go so far as to hold that the director or officer must know or have reason to know that the acts which he directs or procures constitute infringement. That would be to impose a condition of liability that does not exist for patent infringement generally.105

These statements appear contradictory: D must engage in ‘deliberate, wilful and knowing’ conduct that is likely to constitute infringement, and yet D need not ‘know or have reason to know’ that the acts D procures are infringing. As Nourse LJ noted in White Horse Distillers Ltd v. Gregson Associates Ltd,106 it is not easy to reconcile all the passages in Mentmore. There is an obvious tension here, one that ought to be resolved in favour of an explicit acknowledgment of a knowledge requirement, exceptional cases (noted below) aside. Accessory liability generally requires culpable conduct on the part of the accessory; the accessory must involve themselves in the company’s wrong with knowledge of the conduct that constitutes the infringement. In the corporate context, where a director knowingly involves themselves in the company’s infringing conduct, liability should follow.107 Conversely, a person ought not generally be liable if he or she believes that company’s conduct is innocent. In the words Lo, supra note 57, at 111, 132, noting a ‘stricter approach’, which is ‘more difficult to satisfy’; Hoath v. Connect Internet Services [2006] NSWSC 158 (White J), noting a ‘more stringent’ (id. ¶ 88), ‘higher test’ (id. ¶ 92). See also White Horse Distillers Ltd v. Gregson Associates Ltd [1984] RPC 61, 91–92 (Nourse LJ). 101 Sydneywide Distributors Pty Ltd v. Red Bull Australia Pty Ltd [2002] FCAFC 157; (2002) 55 IPR 354 ¶ 161 (Weinberg and Dowsett JJ). 102 John H. Farrar, The Personal Liability of Directors for Corporate Torts, 9 Bond L. Rev. 102, 108 (1997). 103 Mentmore, (1978) 89 D.L.R. 3d at 203 (Can. Fed. C.A.). 104 Id. at 204–205. 105 Id. at 204. 106 White Horse Distillers Ltd v. Gregson Associates Ltd [1984] RPC 61, 91. 107 This is also to reject the notion that a further requirement is necessary, that D ‘stands apart’ from the company, directing or procuring it as a ‘separate entity’ (whatever, with respect, that may mean): Keller v. LED Technologies Pty Ltd [2010] FCAFC 55, (2010) 185 FCR 449 ¶ 88 (Emmett J), and ¶ 404 (Jessup J). Or that there be more than a ‘coincidence of roles’ as suggested in JR Consulting & Drafting Pty Ltd v. Cummings (2016) 329 ALR 625 ¶ 347. 100

270  Research handbook on corporate liability of Bennett, Greenwood and Besanko JJ in JR Consulting & Drafting Pty Ltd v. Cummings, ‘[t]he question is whether the director knowingly pursued a course of conduct which, judged objectively, led to infringement or was likely to … or reflected indifference to the risk of infringement’.108 This sets out an appropriate test of knowledge; interestingly, it was formulated after reference to both the ‘direct or procure’ test and the Delphic ‘make the wrong his or her own’ test. Importantly, most cases can be rationalised by reference to a need to show knowledge of the conduct that leads to infringement, even where such knowledge is not set as an element of liability. In many of the cases, D either knew precisely of the infringements,109 or that they were substantially likely to follow.110 In other cases, the question of knowledge was a hypothetical one.111 Further, in many cases in which D did not know some essential matters going to the company’s infringement, courts have rejected liability, including in Mentmore, which denied liability because of uncertainty as to the scope and application of the claimant’s patent claim.112 A rigorously applied knowledge element also alleviates concerns about directors being held liable for merely acting in their constitutional role. Courts have often raised the important ‘policy’ of needing to protect directors from the dangers of a broad liability regime, when, for example, voting at Board meetings.113 Liability is very unlikely to arise from such conduct, however, as directing the carrying on of a business is not the same as knowingly directing infringements.114 That said, however, one further difficulty remains, to which we now turn. G.

Knowledge and the Difficult Question of Strict Liability Wrongs

In the corporate context, many of the cases deal with infringements of intellectual property rights by companies, infringing copyright, trade marks and patents, and the like. Significantly,

JR Consulting (2016) 329 ALR 625 ¶ 344 (Fed. Ct. Austl.). See also Hoath v. Connect Internet Services [2006] NSWSC 158 ¶ 88 (White J). 109 E.g., Microsoft Corporation v. Auschina Polaris Pty Ltd [1996] FCA 1069, (1996) 71 FCR 231; (1996) 36 IPR 225, 240; Oakley Inc v. Oslu Import and Export Pty Ltd [2001] FCA 385; seemingly the director had such knowledge in Handi-Craft Company v. B Free World Ltd [2007] EWHC B10 (Pat), although knowledge is not directly adverted to in many of the factual findings. 110 Compare the state of knowledge of D in Societa Esplosivi Industriali SpA v. Ordnance Technologies (UK) Ltd (No 2) [2007] EWHC 2875 (Ch); [2008] 2 All ER 622, 649–50 ¶ 95 (Lindsay J). 111 C Evans & Sons Ltd v. Spritebrand Ltd [1985] 1 WLR 317; [1985] 2 All ER 415 (EWCA) (strike-out application). 112 Mentmore Manufacturing Co Inc v. National Merchandising Manufacturing Co Inc (1978) 89 D.L.R. 3d 195, 205. See also, e.g., Root Quality Pty Ltd v. Root Control Technologies Pty Ltd [2000] FCA 980, (2000) 177 ALR 231 and Keller [2010] FCAFC 55, where knowledge played a critical role, even if not a determinative one, in all three judgments. 113 E.g., MCA Records Inc v. Charly Records Ltd [2001] EWCA (Civ) 1441, [2002] FSR 26 ¶¶ 49, 50. 114 However, this does not mean that Boards of Directors are immune from liability. See Lo, supra note 57, at 137–38 who argues that D may be liable for Board decisions where the Board authorises or directs specific infringing acts, such as a tortious policy. And see T Oertli AG v. EJ Bowman (London) Ltd (No 3) [1956] RPC 282 (Ch) (Roxburgh J) (all directors liable for passing off, but overturned on appeal on the basis that there was no passing off: T Oertli AG v. EJ Bowman [1959] RPC 1 (UKHL)). 108

Joint liability  271 many IP infringements, though not all,115 give rise to strict liability on the primary infringer to remedy the infringement. The wrongdoer need not be aware of the existence of the patent, copyright or trade mark, or may, for example, reasonably be disputing the claimant’s claim of right. Such situations pose particular problems for accessory liability rules. If the primary wrongdoer can be strictly liable, can the same apply to an accessory? To put this into the corporate context, where D uses a corporate vehicle (or its employees and agents) to achieve targeted and specific outcomes, it could be argued that it would be unfair if an innocent ‘agent’ of D is liable, whereas D is not. As Slade LJ observed, making an attractive appeal to fairness, in C Evans & Sons Ltd v. Spritebrand Ltd: In my judgment, it would offend common sense if … the law of tort were to treat the director of the company any more kindly than the servant, who took his orders from the director; … if one postulates the case of a servant of a company who in all innocence has trespassed on another’s land … on the specific orders of a director who was present on the spot when the trespass occurred, though he did not cross the boundary but was equally innocent. Since this is a tort of absolute liability, the employee must be liable. Why should the director himself escape scot-free, even if he was unaware that his order would give rise to a trespass?116

The imposition of potentially strict liability has been justified partly on the basis that the accessory’s knowledge merely needs to be commensurate with, or parallel to, that of the primary infringer.117 The predominant view in the context of IP wrongs appears to be that D need not necessarily know that the company’s conduct is wrongful, that it is tortious or infringing. Indeed, as Lindgren J stated in Microsoft Corporation v. Auschina Polaris Pty Ltd,118 that proposition seems to be uncontroversial and was accepted even in Mentmore.119 Imposing strict liability on D in the absence of knowledge that the acts are wrongful or infringing conduct is only fair, I would argue, in one type of scenario. This is where D has procured that very act or outcome for which the company is liable; that is, where the company is, in effect, an ‘agent’ of D. In MCA Records Inc v. Charly Records Ltd, for example, the party had exercised control over the company and induced the company ‘to ensure those acts were done’. Liability was therefore justified even in the absence of knowledge of infringement.120 If,

115 E.g., Sections 37 and 38 Copyright Act 1968 (Cth) have a knowledge requirement for primary infringement. 116 C Evans & Sons Ltd v. Spritebrand Ltd [1985] 1 WLR 317, [1985] 2 All ER 415 (EWCA). 117 Id. at 424. This does not necessarily follow, since the policy reasons that may support imposing liability on an innocent primary wrongdoer do not apply equally to the accessory, who has not committed the wrongful acts: see Dietrich & Ridge, supra note 71, ¶ 3.4.3.6. 118 Microsoft Corporation v. Auschina Polaris Pty Ltd (1996) 71 FCR 231, (1996) 36 IPR 225, 235. Slade LJ’s view has been followed in many cases, e.g., in Handi-Craft Company v. B Free World Ltd [2007] EWHC B10 (Pat), but also rejected in others, e.g., in Root Quality Pty Ltd v. Root Control Technologies Pty Ltd [2000] FCA 980, (2000) 177 ALR 231 ¶ 136. 119 Mentmore Manufacturing Co Inc v. National Merchandising Manufacturing Co Inc (1978) 89 D.L.R. 3d 195. 120 MCA Records Inc v. Charly Records Ltd [2001] EWCA (Civ) 1441, [2002] FSR 26 ¶ 61 (Chadwick LJ); see also id. at ¶¶ 54–55. Applying these principles to Keller v. LED Technologies Pty Ltd [2010] FCAFC 55, (2010) 185 FCR 449, one of the directors ought to have been held liable, given his very active role in the company’s infringement and that he had actually designed the infringing products and had knowledge of C’s designs, even absent knowledge that the designs actually infringed. See Besanko J, id at [292], whose judgment, dissenting on this point, is to be preferred.

272  Research handbook on corporate liability by way of contrast, D seeks to achieve some general objective or tasks, leaving the employees and agents of the company the choice as to how to achieve those objectives, then knowledge ought to be critical. If D’s involvement falls short of procuring, then involving oneself in acts that D believes are innocent is not wrongful. Despite general statements that D should be strictly liable where the company (through its employees and agents) is strictly liable, knowledge should be seen as a critical element of liability, aside from circumstances where D directly procures infringing conduct. Many cases are not inconsistent with that conclusion, as already noted. As Nicholas J stated in the Federal Court of Australia, observing that D will need to have done something more than causing or directing the company to perform acts: The extent of the director’s personal involvement in the commission of the infringing acts is no doubt critical. But his or her state of mind is itself an important aspect of that involvement. That does not mean that knowledge that the relevant acts are infringing is a prerequisite to liability. The authorities are clear in holding that it is not. Even so, a finding that a director who held an honest belief that the acts which he or she directed or procured were not unlawful is a significant consideration telling against the director’s liability [and in this case is decisive].121

Apart from the procuring of specific acts, knowledge that the company’s conduct is wrongful or infringing or that infringement is substantially likely to follow ought to be required.

VI. CONCLUSION Courts need to be clear about which test or tests set an appropriate balance in establishing the joint liability of directors for corporate wrongdoing. Ideally, the test would not treat directors any differently from other agents and accessory wrongdoers, albeit that the relevant requirements set by any test need to be applied in the factual context of corporate wrongdoing. Of course, in some cases, the relevant test(s) of liability must be sensitive to contexts that present unique problems, such as directors acting together in Board meetings.

121 Sporte Leisure Pty Ltd (ACN 008608919) v Paul’s International Pty Ltd (ACN 128 263 561) (No 3) [2010] FCA 1162, (2010) 88 IPR 242 ¶ 118; the non-liability of the director was not at issue in the unsuccessful appeal: Paul’s International Pty Ltd (ACN 128 263 561) v Sporte Leisure Pty Ltd (ACN 008608919) (No 3) [2012] FCAFC 51, (2012) 91 IPR 151.

PART IV VICARIOUS LIABILITY AND EXTENDED LIABILITY

15. Vicarious liability and corporations Paula Giliker

I. INTRODUCTION The doctrine of vicarious liability is a familiar feature of common law legal systems.1 It renders a defendant (usually an employer) strictly liable for the tortious behaviour of another party (usually an employee) provided that party was acting in the course of his or her employment. In Various Claimants v Catholic Child Welfare Society (CCWS),2 the UK Supreme Court adopted a two-stage formulation of the test which has proven influential. Vicarious liability will arise where the claimant can establish: (1) a relationship between D1 (the tortfeasor) and D2 (the defendant being held strictly liable) that is capable of giving rise to vicarious liability; and (2) a close connection that links the relationship between D1 and D2 and the act or omission of D1. A number of key characteristics may be immediately identified. Liability arises without any finding of fault by D2, although D2 may be able to claim an indemnity from D1 as a joint tortfeasor.3 The stage one relationship will generally be that of employer and employee, although changes in employment practices have forced the courts to consider more liberal ways of interpreting what we mean by ‘employee’. The stage two test of close connection has not been universally adopted across common law systems, but the question asked will be the same: to what extent is the tort so linked to the relationship between the tortfeasor and the defendant that it would be fair and just to render the defendant strictly liable? In this chapter, I will examine vicarious liability in tort from the perspective of the corporate defendant.4 After identifying why corporations are frequent targets of vicarious liability claims, this chapter will examine the application of the two-stage test for vicarious liability before considering in more detail how policy arguments, such as enterprise risk, have shaped the current law. As we will see, enterprise risk reasoning resonates strongly with the stereotypical image of the corporation as a profit-making enterprise, benefiting from the labour of others, and which is either insured against risk or able to self-insure. This chapter will explore

US law, however, adopts a somewhat distinctive approach in that principals are held jointly and severally liable for the wrongs committed within the ‘scope of employment’ by agents whose behaviour they have the legal right to control. Restatement (third) of Agency §§ 2.04 (Respondeat Superior) and 7.07 (Employee Acting Within Scope of Employment) (Am. L. Inst. 2006). See Christian A. Witting, Liability of Corporate Groups and Networks § 12.2.4 (2018). 2 Various Claimants v. Catholic Child Welfare Society (CCWS) [2012] UKSC 56, [2013] 2 AC 1. 3 Where the employee has been negligent, in practice employers rarely seek an indemnity. See, e.g., the restrictions placed on the English authority of Lister v. Romford Ice and Cold Storage Co [1957] AC 555 (UKHL), helpfully detailed in R Merkin & J Steele, Insurance and the Law of Obligations § 5.6.1.2 (2013). Alternatively, there may be statutory restrictions: e.g., the Australian Insurance Contracts Act 1984 (Cth) s 66. 4 This chapter will therefore not address the vicarious liability of unincorporated associations or specific provisions dealing with the liability of partnerships. 1

274

Vicarious liability and corporations  275 the extent to which reasoning based on ideas of enterprise risk has shaped the modern law and provided a means to justify imposing greater levels of strict liability on corporations for torts intentionally and negligently committed by their workforce.

II.

VICARIOUS LIABILITY AND CORPORATIONS: THE LAW IN PRACTICE

Lord Phillips commented in CCWS that ‘in the majority of modern cases the defendant is not an individual but a corporate entity’.5 The reason is not difficult to identify. One of the justifications recognised by the courts for vicarious liability is the so-called ‘deeper pockets’ argument. Litigants will be aware that a corporate employer is more likely to have the means to compensate the victim than the employee tortfeasor and can be expected to be insured, or self-insured, against that liability. Glanville Williams cynically commented that ‘[h]owever distasteful the theory may be, we have to admit that vicarious liability owes its explanation, if not its justification, to the search for a solvent defendant’.6 While modern vicarious liability has developed more sophisticated explanations of the doctrine, Lord Reed JSC commented in 2017 in Armes v Nottinghamshire CC that vicarious liability will only be of practical relevance where the principal tortfeasor is not worth suing and the person sought to be made vicariously liable is able to compensate the victim of the tort. 7 The leading cases on vicarious liability validate such reasoning. The North of England-based company, Morrisons Supermarkets plc, for example, in 2020, even when drastically hit by the Covid-19 pandemic, had annual pre-tax profits of £201m on sales of £17.5bn.8 Two of the leading UK cases on vicarious liability in the last ten years have been against Morrisons. The first, Mohamud,9 concerned a vicious assault by a Morrisons employee on a customer who had entered the store to enquire about printing facilities. The second, brought as a group action, 10 concerned a senior Morrisons auditor who had released on the internet personal information of over 9,000 employees apparently in response to disciplinary proceedings against him for which he bore a grudge. In both cases, there was no doubt that Morrisons could satisfy the compensation claim, raising the issue for the court whether it should satisfy the claim. The Court of Appeal in the first case of Mohamud11 noted the need for courts to distinguish between natural sympathy for the victim and the fact that enterprises should not be held vicariously liable simply by virtue of contact between the victim and the employee in the workplace.12 The Supreme Court in Mohamud adopted, however, a more generous approach. By responding to a customer inquiry in a foul-mouthed and violent way, the employee had still

CCWS, [2012] UKSC 56 ¶ 34 (Lord Phillips PSC). G Williams, Vicarious Liability and the Master’s Indemnity, 20 Mod. L. Rev. 220, 232 (1957). 7 Armes v. Nottinghamshire CC [2017] UKSC 60, [2018] AC 355 ¶ 63. 8 Zoe Wood, Morrisons Profits Fall by Half in 2020 as Costs of Covid Pandemic bite, Guardian (Mar. 11, 2021), https://​www​.theguardian​.com/​business/​2021/​mar/​11/​morrisons​-profits​-fall​-2020​-covid. Their latest financial results may be found at: https://​www​.morrisons​-corporate​.com/​globalassets/​ corporatesite/​about​-us/​biographies/​final​-annual​-report​.pdf. 9 Mohamud v. Wm Morrison Supermarkets Plc [2016] UKSC 11, [2016] AC 677. 10 WM Morrison Supermarkets Plc v. Various Claimants [2020] UKSC 12, [2020] AC 989. 11 Mohamud v. WM Morrison Supermarkets Plc [2014] EWCA (Civ) 116, [2014] 2 All ER 990. 12 Id. ¶¶ 48–49 (Treacy LJ). 5 6

276  Research handbook on corporate liability been operating within the field of activities assigned to him by his employer.13 Inexcusable and abusive behaviour, therefore, by an employee who purported to act about his employer’s business was sufficiently connected to the employment relationship for vicarious liability to arise. While the Supreme Court in the second Morrisons case was more circumspect and refused to accept that conduct directed at harming the employer would satisfy the test for vicarious liability, the Court nevertheless accepted that wrongful conduct that was closely connected with acts the employee was authorised to do can fairly and properly be regarded as within the ordinary course of employment.14 In denying vicarious liability, the Supreme Court noted that it had cost Morrisons more than £2.26m in dealing with the immediate aftermath of the data disclosure, a significant element of that sum having been spent on identity protection measures for its employees. 15 It would seem, therefore, that the employee had succeeded in his vendetta even without the intervention of vicarious liability. The two Morrisons judgments demonstrate that vicarious liability will often arise in the corporate context. They also highlight two questions that need examining in more detail. First, to what extent should corporations be held liable for the tortious actions of those they employ to operate their businesses? This issue splits neatly into two halves: (i) to what extent are corporations responsible for workers, be they full-time, temporary, on loan or even independent contractors, assisting them to meet their corporate goals?; and (ii) should they be held responsible for all the torts these workers commit while working for the employer? A second, and related question, relates to how we justify contemporary vicarious liability. Justifications for the doctrine have changed over time, from early ideas of blaming the master for his inability to control the actions of his servants to more sophisticated ideas of enterprise risk theory. It will be argued that the modern dominance of enterprise risk theory as an explanation for vicarious liability can be attributed to its ability to provide a principled basis for an expansion of the vicarious liability of corporations, but that it nevertheless remains a flawed rationale for the doctrine.

III.

VICARIOUS LIABILITY AND CORPORATIONS: THE RELATIONSHIP TEST

We will start, however, with the first of these questions: for whom is the corporation vicariously liable? In the vast majority of cases, the relationship giving rise to vicarious liability will be that of employer and employee.16 This, as we saw above, was the situation in both the Morrisons cases. However, as the courts have come to note, different business models bring new ways of hiring. The advent of the ‘gig’ economy has given rise to pressing questions about the employment status of workers who work, albeit loosely, with a particular

Mohamud [2016] UKSC 11 ¶ 47 (Lord Toulson JSC). Morrison Supermarkets [2020] UKSC 12 ¶ 47. 15 Id. at ¶ 8. 16 Various Claimants v. Catholic Child Welfare Society (CCWS) [2012] UKSC 56, [2013] 2 AC 1 ¶ 35 (Lord Phillips PSC). 13 14

Vicarious liability and corporations  277 employer.17 Are they independent contractors for whom vicarious liability is inapplicable18 or employees despite not bearing many of the characteristics of the traditional employee? The initial response to changing patterns of employment was to develop an economic reality (or entrepreneur) test, which asked whether the worker could be said to be performing as a person in business on his own account.19 If not, he or she would be classified as an employee. In Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance,20 therefore, the English High Court determined that owner-drivers of lorries, delivering concrete for the defendant, were independent contractors on the basis that the economic reality was that they were small businessmen who owned their own assets and incurred both the chance of profit and the risk of loss.21 A more recent example of the operation of the economic reality test may be seen in the Australian vicarious liability case of Hollis v Vabu Pty Ltd.22 Mr Hollis had been injured due to the negligence of a bicycle courier who was identifiable only by his uniform which bore the name of the owners of the courier business. The couriers had a degree of independence, being able to deal with the company as sole traders or members of partnerships. They were paid fixed rates per job and were required to use their own vehicles. The company, however, exercised a high degree of control over the cyclists.23 The majority of the High Court of Australia applying the economic reality test found them to be employees. No measures had been taken to render the uniformed couriers, who had been presented to the public as emanations of Vabu, personally identifiable. The Court found that the effect of Vabu’s system of business was to encourage pedestrians to identify the couriers as a part of Vabu’s own working staff.24 In so doing, the High Court concluded that, where the couriers effectively performed all of Vabu’s operations in the outside world, it would be unrealistic to describe them as anything but employees for the sake of vicarious liability. Vicarious liability has therefore had to adjust to new patterns of flexible working.25 McKendrick in 1990 in an influential article had noted that traditional perceptions of ‘employment’ did not take account of the emergence of an ‘atypical’ workforce consisting of the Consider, for example, the dilemma in the recent Uber litigation: should drivers given work via a smartphone app operated by Uber which enabled customers to contact them for bookings be treated as workers under the relevant employment legislation? See Uber BV v. Aslam [2021] UKSC 5, [2021] ICR 657. 18 D & F Estates Ltd v. Church Comrs [1989] AC 177, 208 (UKHL) (Lord Bridge); Salsbury v. Woodland [1970] 1 QB 324, 336 (EWCA) (Widgery LJ). 19 Market Investigations v. Minister of Social Security [1969] 2 QB 173, 184–85 (EWHC) (Cooke J). 20 Ready Mixed Concrete (South-East) Ltd v. Minister of Pensions and National Insurance [1968] 2 QB 497 (EWHC). 21 This was not uncontentious given that the vehicles had been obtained via a finance organisation associated with the company, were painted in company colours, and drivers, obliged to wear the company uniform, had to obtain the company’s permission to hire replacement drivers and were prohibited from operating as carriers of goods except under contract. 22 Hollis v. Vabu Pty Ltd (2001) 207 CLR 21. The economic reality test had been recognised by the HCA in Stevens v. Brodribb Sawmilling Co Pty Ltd (1986) 160 CLR 16. 23 Hollis (2001) 207 CLR 21 ¶ 57 (‘Vabu’s whole business consisted of the delivery of documents and parcels by means of couriers. Vabu retained control of the allocation and direction of the various deliveries. The couriers had little latitude’) (Gleeson CJ, Gaudron J, Gummow J, Kirby J and Hayne J). 24 Id. at ¶ 52. 25 Phillip Morgan, Revising Vicarious Liability: A Commercial Perspective, Lloyd’s Maritime. & Com. L.Q. 175, 175–76 (2012). 17

278  Research handbook on corporate liability self-employed, casual workers and temporary workers.26 The later Taylor Review of Modern Working Practices27 found in 2017 that a more flexible labour market had led to increasing numbers of workers engaged in ‘atypical work’28 and argued that there was a need for the legal system to recognise an intermediate category of worker covering casual, independent relationships, which it termed ‘dependent contractors’.29 While the Taylor Review focused on labour law issues,30 McKendrick highlighted that such changes have a knock-on effect on the doctrine of vicarious liability, creating a danger that, if these atypical workers are not treated as ‘employees’ or equivalent to employees, the doctrine will be curtailed and its policy justifications potentially undermined. He correctly predicted that such changes were not transient but represented a global change in employment practices. A.

Identifying The Quasi-Employee

The UK and Canadian courts have responded to such changes, albeit initially their response was directed at difficulties in bringing vicarious liability claims against the Catholic Church, where the torts had been committed by priests who are technically office-holders and so not ‘employed’ by the Church.31 These courts now accept that relationships ‘akin to employment’, while technically not founded upon contracts of employment per se, will satisfy the relationship test for vicarious liability. In so doing, the courts have created the notion of a quasi-employee for whom corporations will be vicariously liable. Traditionally, corporations have been able to avoid the imposition of vicarious liability by sub-contracting work to independent contractors. As indicated above, this led a number of commentators to express concern that casualisation and contracting-out practices would limit the scope of the doctrine and its ability to compensate victims harmed by workers acting on behalf of employers. In E v English Province of Our Lady of Charity,32 the Court argued that, in applying the economic reality test, the question should be whether the worker was more like an employee than an independent contractor and that tort law should not be afraid to adjust its tests in response to changing times. The question, therefore, was not simply the form that the

26 Ewan McKendrick, Vicarious Liability and Independent Contractors – A Re-examination, 53 Mod. L. Rev. 770, 784 (1990); see also Richard Kidner, Vicarious Liability: For Whom should the ‘Employer’ be Liable?, 15 Legal Stud. 47 (1995). 27 Department for Business, Energy & Industrial Strategy, Good Work: The Taylor Review of Modern Working Practices (2017) (UK). 28 This includes part-time work, agency work, temporary work, zero hours contracts, multi-jobs and gig economy work. 29 Such an idea is not new and can be seen in the North American context. See, e.g., G Davidov, The Three Axes of Employment Relationships: A Characterisation of Workers in Need of Protection, 52 U. Toronto L.J. 357 (2002), who characterises ‘dependent contractors’ as workers who are in a position of economic dependence upon, and under an obligation to perform duties for, an employer. 30 It is accepted that there are good reasons for treating the issue of employment status separately in labour and vicarious liability law in that, for the latter, the interests of third parties – tort victims – are at stake (Zoe Adams et al., Deakin and Morris’ Labour Law § 2.6 (7th ed. 2021); Baroness Hale in Barclays Bank plc v. Various Claimants [2020] UKSC 13, [2020] AC 973 ¶ 29). 31 See E v. English Province of Our Lady of Charity [2012] EWCA (Civ) 938, [2013] QB 722 (citing McKendrick and Kidner, supra note 26) and Doe v. Bennett, 2004 SCC 17, [2004] 1 S.C.R. 436 (Can.). 32 E [2012] EWCA (Civ) 938 ¶ 60.

Vicarious liability and corporations  279 parties’ relationship takes but rather what were the details of the parties’ relationship. Here, function should triumph over form.33 The UK Supreme Court in CCWS confirmed that vicarious liability should apply to relationships ‘akin to that between an employer and an employee’ where the same policy incidents applicable to employment relationships indicated that it would be fair and just to impose vicarious liability.34 These were listed as deeper pockets, delegation of task by the employer to the employee, enterprise liability, enterprise risk, and control.35 Such relationships were characterised as those where the victim had been harmed by a worker who had been carrying on activities as an integral part of the defendant’s business activities and for its benefit, rather than carrying out activities entirely attributable to the conduct of a recognisably independent business of his own.36 On this basis, a prisoner working in a prison kitchen might be regarded as ‘akin to a prison employee’37 when his work was integrated into the operation of the prison, in this case the provision of meals for prisoners. Equally (and controversially),38 foster parents volunteering to care for children placed under local authority control might be considered ‘akin’ to local authority employees in that they provide care to children as an integral part of the local authority’s organisation of its childcare services. 39 Thus, they could not be regarded as carrying on an independent business of their own. The scope of this category of worker is, inevitably, controversial. Australia has yet to accept the notion of quasi-employees, regarding the distinction between employees and independent contractors as ‘too deeply rooted to be pulled out’40 and has been critical of reliance on policy arguments such as enterprise risk and enterprise liability to extend the scope of vicarious liability.41 This position has been maintained even in the context of abuse claims against religious institutions where the stumbling block to vicarious liability was that priests are not ‘employed’ by the Catholic Church.42 More recently, the UK Supreme Court in Barclays Bank plc v Various

33 In so doing, the Court of Appeal accepted that the concerns raised in relation to a vicarious liability claim were distinct from those raised in unfair dismissal and taxation claims and so no common test was required. 34 Various Claimants v. Catholic Child Welfare Society (CCWS) [2012] UKSC 56, [2013] 2 AC 1 ¶ 47. As stated above, this is also the case in Canada and has been accepted in Singapore. Ng Huat Seng v. Munib Mohammad Madni [2017] SGCA 58, [2017] 2 S.L.R. 1074 ¶ 66. 35 CCWS [2012] UKSC 56 ¶ 35 (Lord Phillips PSC). They will be examined in more detail in Section V below. 36 Cox v. Ministry of Justice [2016] UKSC 10, [2016] AC 660 ¶ 24 (this test draws on the dual vicarious liability case of Viasystems (Tyneside) Ltd v. Thermal Transfer (Northern) Ltd [2005] EWCA (Civ) 1151, [2006] QB 510 ¶ 79 (Rix L.J.) and E [2012] EWCA (Civ) 938). 37 Cox [2016] UKSC 10. 38 Note the different position taken in Canada: KLB v. British Columbia, 2003 SCC 51, [2003] 2 SCR 403 (foster parents are independent contractors). 39 Armes v. Nottinghamshire CC [2017] UKSC 60, [2018] AC 355 ¶ 60 (Lord Reed JSC). 40 Sweeney v. Boylan Nominees Pty Ltd (2006) 226 CLR 161 ¶ 33 (Gleeson CJ, Gummow, Hayne, Heydon and Crennan JJ). For criticism, see J Burnett, Avoiding Difficult Questions: Vicarious Liability and Independent Contractors in Sweeney v. Boylan Nominees, 29 Sydney L. Rev. 163 (2007). Note also the position in the United States: see Restatement (Third) of Agency § 7.07, Comment b (Am. L. Inst. 2006). 41 Prince Alfred College v. ADC [2016] HCA 37, (2016) 258 CLR 134 ¶ 45. 42 See Trustees of Roman Catholic Church v. Ellis [2007] 70 NSWLR 565, [2007] NSWCA 117. This position was challenged, however, in the recent case of Bird v. DP (a pseudonym) [2023] VSCA 66. In 2018, NSW passed legislation to allow the term ‘employee’ in the context of vicarious liability

280  Research handbook on corporate liability Claimants43 has emphasised, however, that acceptance of the ‘akin to employment’ test does not signify that the distinction between employees (which now includes quasi-employees) and independent contractors ceases to exist. In the case, Barclays Bank had required job applicants to obtain health checks from a nominated doctor prior to joining its workforce. Dr Bates had been paid a fee per examination and asked to complete the ‘Barclays Confidential Medical Report’. It was during these health checks, undertaken as a minor part of the doctor’s private practice, that sexual abuse had taken place. The Court of Appeal had argued that the law should be applied in the light of changes in the structures of employment, with operations intrinsic to a business enterprise now routinely performed by independent contractors. It went so far as to question the existence of any ‘bright line’ test between independent contractors and employees for the sake of vicarious liability.44 The UK Supreme Court45 disagreed and firmly asserted that extending vicarious liability to relationships ‘akin to employment’ did not erode the key distinction between employees and independent contractors.46 On the facts, the doctor was not anything close to an employee, but rather equivalent to a window-cleaner hired to clean the bank’s windows or an auditor hired to audit its books: ‘He was in business on his own account as a medical practitioner with a portfolio of patients and clients. One of those clients was the Bank’. 47 Such case-law emphasises that what is important about the ‘akin to employment’ test is its ability to identify relationships that factually resemble those of employment, even if, as a matter of form, they are not strictly classified as such: The question therefore is, as it has always been, whether the tortfeasor is carrying on business on his own account or whether he is in a relationship akin to employment with the defendant … [T]he key … will usually lie in understanding the details of the relationship.48

claims against organisations for child abuse to include an individual who is akin to an employee (see Civil Liability Act 2002 (NSW) Part 1B ss 6G–6H), but this has not been implemented in all States e.g. Victoria (for criticism, see L Griffin and G Briffa, Still Awaiting Clarity: Why Victoria’s New Civil Liability Laws for Organisational Child Abuse Are Less Helpful Than They Appear, 43 U.N.S.W. L.J. 452 (2020)). It is notable that development has been by statute, not case-law. 43 Barclays Bank plc v. Various Claimants [2020] UKSC 13, [2020] AC 973. 44 Barclays Bank plc v. Various Claimants [2018] EWCA (Civ) 1670; [2018] IRLR 947 ¶ 61. See Allison Silink, Vicarious Liability of a Bank for the Acts of a Contracted Doctor, 34 J. Pro. Negl. 46 (2018). 45 Barclays Bank [2020] UKSC 13, drawing support at [26] from the Singapore Court of Appeal: Ng Huat Seng v. Munib Mohammad Madni [2017] SGCA 58, [2017] 2 S.L.R. 1074 ¶ 63 (noted by David Tan, Taking Two Bites at the Cherry: Vicarious Liability and Non-Delegable Duty, 134 L.Q. Rev. 193 (2018)) that vicarious liability should only apply to relationships which, when whittled down to their essence, possess the same fundamental qualities of employer/employee relationships. 46 Barclays Bank [2020] UKSC 13 ¶¶ 22–24. For more detailed analysis, see James Lee, The Supreme Court, Vicarious Liability and the Grand Old Duke of York, 136 L.Q. Rev. 553 (2020); Paula Giliker, Can the Supreme Court Halt the Ongoing Expansion of Vicarious Liability? Barclays and Morrison in the UK Supreme Court, 37 Tottel’s J. Pro. Negl. 55 (2021); Craig Purshouse, Halting the Vicarious Liability Juggernaut: Barclays Bank plc v. Various Claimants, 28 Med. L. Rev. 794 (2020). 47 Barclays Bank [2020] UKSC 13 ¶ 28. 48 Id. at ¶ 27 (Baroness Hale).

Vicarious liability and corporations  281 Discussions of policy should, said the Court, be confined to ‘doubtful cases’ (a category which seems to include the ‘difficult’ case of Armes).49 It remains to be seen whether English cases will adhere to this advice. Nolan has also questioned whether the focus in Barclays Bank on the substance, rather than the form, of the relationship may inadvertently encourage employers to seek to pre-empt vicarious liability by dressing their workers in the clothing of contractors rather than employees.50 B.

The Relationship Test and Corporations

The question remains whether Barclays Bank will encourage the UK courts and other jurisdictions that follow the ‘akin to employment’ test to adopt a more restrictive approach to relationships ‘akin to employment’ in the corporate context. The recent case of SKX v Manchester CC51 provides an interesting perspective on this question. Here the defendant was a local authority but, on a variation of the facts of Armes, children in its care had been placed in privately-run children’s homes and not with foster parents. The High Court held this to be a classic client/ independent contractor relationship between the local authority and the company. The company was not part of the local authority’s organisation nor integrated into its structure.52 It was an independent business, and it would be unfair, said the Court, to vest the local authority with vicarious liability for the tortious actions of the company’s Chief Executive. Extending the category of ‘employee’ to those ‘akin to employees’ has permitted the courts to expand the relationships covered by vicarious liability and, in so doing, respond to structural change in the employment market. It is uncertain whether Australia can continue to resist the pressure for change. However, the role being played by policy as an impetus for change has proven controversial. The UK Supreme Court in Barclays Bank recognised, in particular, the role that enterprise risk reasoning has played in permitting a more expansive interpretation of the ‘akin to employment’ test, but nevertheless sought to curtail this role. This will be discussed further in Section V below.

IV.

VICARIOUS LIABILITY AND CORPORATIONS: THE CLOSE CONNECTION/COURSE OF EMPLOYMENT TEST

Stage two of the test for vicarious liability determines the extent to which defendants are responsible for the torts committed by their employees (or quasi-employees) in the course of their employment. In CCWS,53 the UK Supreme Court made clear that what is critical at this stage is the connection that links the relationship between the tortfeasor and the employer and the employee’s tort. The connection test, first stated by the Supreme Court of Canada in Id.; Armes was termed ‘the high-watermark for an expansionist approach to the imposition of vicarious liability’ in Blackpool Football Club Ltd v. DSN [2021] EWCA (Civ) 1352 ¶ 132 (Stuart-Smith LJ). 50 Donal Nolan, Reining in Vicarious Liability, 49 Indus. L.J. 609, 616 (2020). 51 SKX v. Manchester CC [2021] EWHC (QB) 782, [2021] 4 WLR 56. 52 The Company was an independent business, with a well-defined corporate structure and a turnover of several million pounds per year. 53 Various Claimants v. Catholic Child Welfare Society (CCWS) [2012] UKSC 56, [2013] 2 AC 1 ¶ 21. 49

282  Research handbook on corporate liability Bazley v Curry,54 was adopted by the House of Lords in Lister v Hesley Hall Ltd55 in 2001 and subsequently by a number of Commonwealth countries.56 It replaces the traditional Salmond test57 which had confined liability to those torts that could be said to be expressly or impliedly authorised by the employer or were wrongful and unauthorised modes of fulfilling tasks authorised by the employer. Under the close connection test, vicarious liability would arise where the employee’s torts could be said to be so closely connected with his or her employment that it would be fair and just to hold the employers vicariously liable.58 Yet a test of close connection raises the question just how ‘close’ the connection should be to trigger liability.59 In Bazley, McLachlin J had argued that vicarious liability would generally be appropriate where there was ‘a significant connection between the creation or enhancement of a risk [of injury] and the wrong that accrues therefrom, even if unrelated to the employer’s desires’.60 Such reasoning links the connection test with that of risk creation, in other words enterprise risk policy reasoning. Lord Toulson JSC in the 2016 case of Mohamud61 sought to offer guidance by offering a simplified version of the test, having accepted that the risk of an employee misusing his or her position was one of life’s unavoidable facts. Courts, he advised, should ask: (i) what functions or ‘field of activities’ have been entrusted by the employer to the employee, or, in everyday language, what was the nature of his job; and (ii) whether there was a sufficient connection between the position in which the tortfeasor was employed and his wrongful conduct to make it right for the employer to be held liable under the principle of social justice.

In the case itself, Lord Toulson JSC found that a racist attack on a Morrisons customer by a kiosk attendant amounted to a foul-mouthed and violent means of ensuring the victim, Mohamud, left the employer’s premises and was thus sufficiently connected to the attendant’s

54 Bazley v. Curry, [1999] 2 S.C.R. 534, 174 D.L.R. (4th) 45, This provides an interesting example of Canadian law influencing UK law, assisted no doubt by a case note on Bazley in a major UK law journal: Peter Cane, Vicarious Liability for Sexual Abuse, 116 L.Q. Rev. 21 (2000). For its status as a flawed legal transplant, see Paula Giliker, Rough Justice in an Unjust World, 65 Mod. L. Rev. 269 (2002). 55 Lister v. Hesley Hall Ltd (Lister) [2001] UKHL 22, [2002] 1 AC 215, although the court claimed that the germ of the Bazley close connection test could be traced back to the traditional Salmond test: Id. at ¶ 15. Lord Steyn referred to Bazley as a ‘luminous and illuminating’ judgment which would henceforth be the starting point for consideration of similar cases. Id. at ¶ 27. 56 See, e.g., Ming An Insurance Co (HK) Ltd v. Ritz-Carlton Ltd, (2002) 5 H.K.C.F.A.R. 569 (C.F.A.) (H.K.); Skandinaviska Enskilda Banken AB (Publ) Singapore Branch v. Asia Pacific Breweries (Singapore) Pte Ltd [2011] SGCA 22, [2011] 3 SLR 540 (Sing.). Australia again remains an outlier: Prince Alfred College v ADC [2016] HCA 37, (2016) 258 CLR 134. 57 See John W. Salmond, The Law of Torts 83–84 (1907) and repeated in later editions. 58 Lister [2001] UKHL 22 ¶ 28 per Lord Steyn. Under this more generous test, vicarious liability could extend to intentional torts such as sexual abuse which would have been difficult, if not impossible, to achieve under the Salmond test. 59 As noted by Lord Nicholls in Dubai Aluminium Co Ltd v. Salaam [2002] UKHL 48, [2003] 2 AC 366 ¶¶ 25–26. 60 Bazley v. Curry, [1999] 2 S.C.R. 534, 174 D.L.R. (4th) 45 ¶ 41. 61 Mohamud v. Wm Morrison Supermarkets Plc [2016] UKSC 11, [2016] AC 677 ¶¶ 40, 44–45.

Vicarious liability and corporations  283 job. Lord Toulson JSC’s judgment suggested a move to a more generous test of ‘sufficient’ (rather than ‘close’) connection in UK law that claimants would find easier to satisfy. 62 The UK Supreme Court responded to these concerns in the later Various Claimants case in which it rejected the view of the Court of Appeal that the release of confidential data by a senior Morrisons auditor with the intention to harm his employers was within the field of activities assigned to him by Morrisons. This was an act of personal revenge. Only wrongful conduct that was ‘so closely connected with acts which he was authorised to do that, for the purposes of Morrisons’ liability to third parties, it c[ould] fairly and properly be regarded as done by him while acting in the ordinary course of his employment’ would give rise to vicarious liability.63 While denying that Mohamud had been wrongly decided,64 the UK Supreme Court sought to correct any ‘misunderstandings’ that Mohamud might have created. It specifically denied that Mohamud had created a more generous test based on sufficient, rather than close, connection,65 but found it helpful to reformulate the test by directing courts not to Lord Toulson JSC’s simplified test but rather to the ‘close connection’ test as stated by Lord Nicholls in the earlier Dubai Aluminium case. On this basis, vicarious liability would arise where the conduct is so closely connected with acts the employee is authorised to do that the wrongful conduct may fairly and properly be regarded as done by the employee while acting in the course of his employment.66 The Supreme Court in Various Claimants also took the view that policy should not generally influence the application of the test. In the case itself, policy was ‘nothing to the point’.67 Judges should rather adopt a principled approach and seek guidance from decided cases to identify factors or principles that point towards or away from vicarious liability. In so doing, however, the Court did suggest that case-law authority that the close connection test would be satisfied where the defendant, in operating its business or furthering its own interests, has created or significantly enhanced the risk of an employee sexually abusing the victim would still stand. Later authority has clarified however, that the Various Claimants test should apply in all cases. While there is no need for courts to turn back continually to examine the underlying policy reasons for liability, in difficult cases, the Supreme Court advised, it might be a useful final check to consider whether the outcome is consistent with underlying policy.68 While the clarification of the law undertaken in the Various Claimants case will be welcomed by corporations, it does raise a more general question: to what extent can employers avoid vicarious liability by arguing that the employee was, to use the classic phrase, on a frolic

62 See, e.g., Phillip Morgan, Certainty in Vicarious Liability: A Quest for a Chimaera?, 75 Camb. L.J. 202 (2016). The High Court of Australia in Prince Alfred College v. ADC [2016] HCA 37, (2016) 258 CLR 134 rejected the test on this basis: id. at ¶ 83. 63 WM Morrison Supermarkets Plc v. Various Claimants [2020] UKSC 12, [2020] AC 989 ¶ 47 (Lord Reed PSC). 64 Id. at ¶¶ 17, 26 (per Lord Reed PSC). 65 Understandably some commentators have been sceptical of this version of events. See Giliker, supra note 46; Lee, supra note 46; and Nolan, supra note 50, at 620. 66 Dubai Aluminium Co Ltd v. Salaam [2002] UKHL 48, [2003] 2 AC 366 ¶ 23. 67 Various Claimants [2020] UKSC 12 ¶ 31. 68 Trustees of the Barry Congregation of Jehovah’s Witnesses v. BXB [2023] UKSC 15; [2023] 2 WLR 953, [58], overturning [2021] EWCA (Civ) 356.

284  Research handbook on corporate liability of their own,69 so the tort committed was not closely connected to his or her employment? This question will be examined in more detail below. A.

The Limits of the Close Connection Test

Inevitably cases such as Lister and Bazley that accept that intentional sexual abuse can be regarded as connected to the work of a carer giving rise to vicarious liability have triggered concerns as to the limits of the close connection test. Mohamud indicated that even acts of violence triggered by racism could be sufficiently connected to the employee’s job to give rise to vicarious liability. Various Claimants, however, reiterated that personal vendettas, here the employee trying to damage his employer against whom he held a grudge, would not be within the course of his employment.70 In so doing, the Supreme Court drew on the distinction drawn by Lord Nicholls in Dubai Aluminium71 between a case where the employee has ‘misguidedly’ engaged in furthering the employer’s business by doing an act of a kind he or she is authorised to do (into which Mohamud could be loosely fitted) and cases where the employee is only pursuing his or her own interests. Pranks and horseplay in the workplace therefore fall into the latter category.72 This is consistent with Commonwealth authority such as Deatons v Flew.73 B.

The Close Connection Test and Corporations

While the new UK ‘principled’ approach indicates that the courts will review the boundaries of the tortfeasor’s employment more cautiously in future, in relation to sexual abuse claims, it seems likely that corporations whose work involves the care of vulnerable parties will be more at risk of vicarious liability than those that do not.74 In Canada the Bazley close connection test is still regarded as generally authoritative, utilising enterprise risk reasoning in all cases.75 Australia in Prince Alfred College v ADC76 favoured a different test again, examining Joel v. Morrison (1834) 172 ER 1338, 1339 (Parke B). See also Attorney General of the British Virgin Islands v. Hartwell [2004] UKPC 12, [2004] 1 WLR 1273 ¶17 (Lord Nicholls) (police officer using gun for his own ends); Vaickuviene v. J Sainsbury Plc [2013] CSIH 67, 2013 SLT 1032 (where the Scottish Inner House drew the line at murder of a fellow supermarket worker). For the difficulties experienced by the courts in drawing this line, see Weddall v. Barchester Healthcare Ltd; Wallbank v. Wallbank Fox Designs Ltd [2012] EWCA Civ 25, [2012] IRLR 307. 71 Dubai Aluminium [2002] UKHL 48 ¶ 32. 72 As recognised post-Various Claimants in Chell v. Tarmac Cement and Lime Ltd [2022] EWCA Civ 7 (practical joke). See Joshua Cainer, Horseplay, Affray and Going Astray – Vicarious Liability for Intentional Wrongdoing in the Workplace, 37 J. Pro. Negl. 108 (2021). 73 Deatons Pty Ltd v. Flew [1949] HCA 60, (1949) 79 CLR 370 (barmaid throwing glass treated as act of personal resentment), although subjected to criticism by Lord Toulson JSC in Mohamud [2016] UKSC 11, [2016] AC 677 ¶ 30. Contrast Pettersson v. Royal Oak Hotel Ltd [1948] NZLR 136. 74 Much will depend on the nature of the enterprise and the extent to which its operations are deemed to confer authority on its personnel over vulnerable parties. 75 See Jason W. Neyers, Vicarious Liability, in Fridman’s The Law of Torts in Canada (Erika Chamberlain & Stephen Pitel eds., 4th ed. 2020). 76 Prince Alfred College v. ADC [2016] HCA 37, (2016) 258 CLR 134; see James Goudkamp & James Plunkett, Vicarious Liability in Australia: On the Move?, 17 Oxford U. Commonwealth L.J. 162 (2017); Desmond Ryan, From Opportunity to Occasion: Vicarious Liability in the High Court of Australia, 76 Camb. L.J. 14 (2017). 69 70

Vicarious liability and corporations  285 whether the apparent performance of the employee could be said to provide the ‘occasion’ for the abuse. In determining this question, certain features may be taken into account, such as authority, power, trust, control and the ability to achieve intimacy with the victim.77 While the ‘occasion’ test is seen as distinct from the tests stated in Bazley and Lister, at the very least overlapping factors may be identified. It remains the strong view, of at least the Canadian and UK courts,78 that tort law should continue to utilise vicarious liability as a means to assist sexual abuse victims who are realistically, due to the passage of time or the impecuniosity of the perpetrators, unable to recover compensation from anyone bar the institutions that employed their abusers. More generally we can note that, in the last 20 years, the move from the Salmond test to a test of ‘close connection’ has led to a significant extension of the scope of vicarious liability for corporations in many common law jurisdictions. This generous approach has been facilitated by the courts’ willingness to apply, at its height, a test of ‘sufficient’ connection. However, it has also been assisted by reference to policy justifications such as risk creation and enterprise liability which support an expansion of vicarious liability. This approach has not only been adopted in Canada and the UK, but also in other common law jurisdictions such as Hong Kong and Singapore – Australia remaining the outlier. While UK law now seeks to confine policy debates to difficult cases, it cannot be denied that policy-led reasoning has played a significant role in the operation of the close connection and relationship tests since Lister was decided in 2001. The most significant policy influence has undoubtedly been that of enterprise risk reasoning. As shall be explored in the next section, this has a particular resonance for corporations in that it is the very nature of the enterprise, taken broadly, that provides both the explanation and justification for wide-ranging vicarious liability.

V.

CORPORATIONS AND ENTERPRISE RISK REASONING

In CCWS, Lord Phillips argued that there were five contemporary justifications for vicarious liability:79 i) ii) iii) iv) v)

The employer is more likely to have the means to compensate the victim than the employee and can be expected to have insured against that liability [the deeper pockets argument]; The tort will have been committed as a result of activity being taken by the employee on behalf of the employer [delegated task argument]; The employee’s activity is likely to be part of the business activity of the employer [enterprise liability argument]; The employer, by employing the employee to carry on the activity will have created the risk of the tort committed by the employee [enterprise risk argument]; The employee will, to a greater or lesser degree, have been under the control of the employer [control argument].

Prince Alfred College v. ADC [2016] HCA 37, (2016) 258 CLR 134 ¶ 81. The different position in Australia has been noted above. Several Australian States have, nevertheless, legislated on the question of vicarious liability for sexual abuse: see Christine Beuermann, Vicarious Liability in Australia, in Vicarious Liability in the Common Law World (Paula Giliker ed., 2022). 79 Various Claimants v. Catholic Child Welfare Society (CCWS) [2012] UKSC 56, [2013] 2 AC ¶ 35. 77 78

286  Research handbook on corporate liability This list underplays, however, the influence of the enterprise liability and risk arguments. Such arguments had featured prominently in Bazley and the idea of using risk as a justification for vicarious liability can be traced back to early-nineteenth-century authority such as Duncan v Findlater that relied on the simple logic that: … by employing him I set the whole thing in motion, and what he does, being done for my benefit and under my direction, I am responsible for the consequences of doing it.80

However, it was recognition of Bazley by UK and other national courts not only as a source of inspiration for creating a test of close connection, but as a justification for extending vicarious liability beyond its previous limits, that rendered enterprise risk reasoning a dominant influence in early-twenty-first-century vicarious liability law. In Bazley v Curry, the Supreme Court of Canada argued that, as a matter of basic principle: … where the employee’s conduct is closely tied to a risk that the employer’s enterprise has placed in the community, the employer may justly be held vicariously liable for the employee’s wrong … When those risks materialize and cause injury to a member of the public despite the employer’s reasonable efforts, it is fair that the person or organization that creates the enterprise and hence the risk should bear the loss. This accords with the notion that it is right and just that the person who creates a risk bear the loss when the risk ripens into harm.81

Thus conceived, it was argued that vicarious liability would have associated normative effects, notably acting as a deterrent, inducing employers to exercise a greater degree of care in relation to the appointment and supervision of employees and ensuring ‘fair and efficient’ compensation for wrongs.82 Brodie, writing in 2010, argued that Bazley can be seen as a common law response to corporate social responsibility.83 In this section, I will examine to what extent enterprise risk reasoning has proven a useful means to render it more acceptable for the enterprise to be held strictly liable for the torts of its employees. A.

Enterprise Risk as a Principled Explanation for Vicarious Liability

As we have seen, corporations are obvious targets for vicarious liability given their assumed solvency and the fact that it is often easier to identify the enterprise rather than an individual employee. Yet the ‘deeper pockets’ argument has long been regarded as a pragmatic, rather than principled, justification for the imposition of liability.84 Enterprise risk reasoning, in contrast, provides a principled justification for vicarious liability. Our sense of justice, Keating argues, requires us to hold business enterprises liable for accidents which may fairly be said

80 Duncan v. Findlater (1839) 6 Cl & Fin 894, 910; (1839) 7 ER 934, 940. See also Andrew Bell, Scope of Employment: Connecting Closely with the Past, 137 Law Q. Rev. 254, 275 (2021). 81 Bazley v. Curry, [1999] 2 S.C.R. 534, 174 D.L.R. (4th) 45 ¶¶ 22, 32 (McLachlin J). 82 Id. at ¶ 46; see also Alan O. Sykes, The Boundaries of Vicarious Liability: An Economic Analysis of the Scope of Employment Rule and Related Legal Doctrines, 101 Harv. L. Rev. 563, 577–78 (1988). 83 Douglas Brodie, Enterprise Liability and the Common Law 180 (2010). See also Bastian Reinschmidt, The Law of Tort: A Useful Tool to Further Corporate Social Responsibility?, 34 Co. Law. 103 (2013). 84 See Cox v. Ministry of Justice [2016] UKSC 10, [2016] AC 660 ¶ 20 (Lord Reed JSC). The same may be argued in relation to the ease of identification justification.

Vicarious liability and corporations  287 to be characteristic of their activities.85 Corporations, Deakin contends, are well-placed to absorb enterprise-specific risks through a combination of managerial control, insurance (which permits loss spreading) and pricing.86 Tan agrees, arguing that if an enterprise faces the prospect of vicarious liability, a further benefit will be that it will be incentivised to locate and discipline potentially errant actors, and will seek to reduce tort costs through screening measures, training programmes and closer monitoring.87 It is the sophistication of enterprises, then, that makes enterprise risk reasoning so appealing. Such reasoning also provides the means to address fears raised in corporate governance scholarship that corporations are increasingly seeking to avoid liability in tort by drawing organisational boundaries.88 Thompson, for example, has argued that, where the corporate form is being used to shift the cost of wrongdoing back to the victims, enterprise risk reasoning provides a means to condemn the enterprise for externalising part of its costs of doing business. Without tort liability, it is asserted, enterprises will have incentives for excessive risk-taking by, for example, not investing sufficiently in safety.89 Reliance on enterprise risk reasoning may therefore serve to justify holding parent companies vicariously liable for the torts committed by its subsidiaries’ employees despite the fact they are distinct entities in terms of corporate law.90 While tort law has, as yet, not gone this far, its potential in the corporate context to encourage the undertaking of greater safety and accident prevention measures has not gone unnoticed. The appeal of enterprise risk liability as an explanation and justification for vicarious liability can thus be easily explained. Corporations as profit-making entities are encouraged to internalise the costs of their enterprises including the costs of employees making mistakes and, more controversially, deliberately harming others.91 This provides a principled justification for holding businesses strictly liable – in contrast to the pragmatism of the deeper pockets approach – whilst permitting the courts to extend vicarious liability to an extent they judge fair and just. It also overcomes the limitations of alternative justifications such as control whose usefulness is widely regarded as diminished due to changes in employment practices giving workers greater autonomy and discretion in their actions.92 It gives, therefore, a theoretical justification for the extension of vicarious liability to those parties the enterprise uses to meets its 85 Gregory C. Keating, The Idea of Fairness in the Law of Enterprise Liability, 95 Mich. L. Rev. 1266, 1279 (1997). 86 Simon Deakin, 2017 Allen & Overy Annual Law Lecture at the University of Cambridge: The Evolution of Vicarious Liability (Nov. 8, 2017) at 6, although he argues also for a wider category of organisational liability including non-delegable duties. See also Simon Deakin, ‘Enterprise Risk’: The Juridical Nature of the Firm Revisited, 32 Indus. L.J. 97 (2003). 87 David Tan, Internalising Externalities: An Enterprise Risk Approach to Vicarious Liability in the 21st Century, 27 Sing. Acad. L.J. 822, 848 (2015). 88 See, e.g., Rory Van Loo, The Revival of Respondeat Superior and Evolution of Gatekeeper Liability, 109 Geo. L.J. 141, 144 (2020) and the literature cited therein. 89 Robert B. Thompson, Unpacking Limited Liability: Direct and Vicarious Liability of Corporate Participants for Torts of the Enterprise, 47 Vand. L. Rev. 1, 14 (1994). 90 This has been discussed by Witting, supra note 1, at § 12.2.3 and Phillip Morgan, Vicarious Liability for Group Companies: The Final Frontier of Vicarious Liability?, 31 J. Pro. Negl. 276 (2015), albeit coming to different conclusions. 91 On this basis, it is far more difficult to justify in terms of non-profits (the actual context of Bazley). See Robert Stevens, Tort and Rights 259 (2007). Brodie argues that, nevertheless, the key element of undertaking activities that create the risk of wrongdoing justifies vicarious liability even for non-profits, although a measure of caution might be needed. Brodie, supra note 83, at 11–13. 92 Cox v. Ministry of Justice [2016] UKSC 10, [2016] AC 660 ¶ 21.

288  Research handbook on corporate liability economic goals (those ‘akin to employment’ or even beyond) and who commit torts within the field of activities entrusted to them by their employer for the employer’s own financial gains (the connection test). In CCWS the Court found strong echoes of the ‘enterprise risk’ approach of the Canadian Supreme Court in UK law.93 B.

Vicarious Liability as a Flawed Form of Enterprise Risk Reasoning

And yet enterprise risk reasoning is not without its flaws, not least if we question the legitimacy of the private law courts mandating new forms of corporate social responsibility in lieu of government. It also lends itself more easily to the stereotypical large or medium-sized enterprise, rendering it more difficult to justify in terms of smaller enterprises and non-profit/ charitable organisations. Further, even its strongest advocates concede that enterprise risk reasoning takes us potentially beyond the current test for vicarious liability. If, for example, liability is triggered by a person harming another while acting on behalf of the risk-creating employer, why does vicarious liability not apply to independent contractors who are also performing tasks on behalf of the employer?94 Also, enterprise risk reasoning logically extends liability for any risk-producing activity traditionally covered by insurance whose risk should be internalised – there is no reason to limit it to conduct classified as a tort.95 It has also been queried whether vicarious liability is actually the most efficient way of distributing losses caused by wrongful employee behaviour (are employers always the better risk-bearers?),96 and indeed whether the courts are best placed to appraise this question.97 Full endorsement of enterprise risk would therefore require the courts to reshape vicarious liability and reconfigure its role in the law of torts. This has not occurred even in Canada. The Phillips policy justifications outlined above represent, in fact, a compromise – taking the benefit of enterprise risk reasoning to expand vicarious liability while retaining other ideas such as delegation of duty and the old perennials of deeper pockets and control. While the UK Supreme Court in Cox suggested that the latter two factors might be less significant,98 in its decision in Armes one year later it relied on all these factors in finding a local authority

93 See also John Bell, Vicarious Liability for Child Abuse, 69 Camb. L.J. 440, 442 (2010) (‘the ultimate justification of vicarious liability is really the risk which an employer creates for those who encounter his business or enterprise’). 94 Douglas Brodie, Enterprise Liability: Justifying Vicarious Liability, 27 Oxford J. Legal Stud. 493. However, it is possible to give an economic justification for the distinction between employees and independent contractors. See Eric A. Posner, The Economic Basis of the Independent Contractor/ Employee Distinction, 100 Texas L. Rev. 353, 383–84 (2021). 95 Claire McIvor, The Use and Abuse of the Doctrine of Vicarious Liability, 35 Common L. World Rev. 268 (2006). 96 Henry Hansmann & Reinier Kraakman, Toward Unlimited Shareholder Liability for Corporate Torts, 100 Yale L.J. 1879 (1991) argue that enterprise liability can only justify liability to the extent that corporations appear to be the cheapest cost avoiders and/or insurers. Id. at 1918–19. 97 Merkin & Steele, supra note 3, at 204. It is also problematic that vicarious liability renders the tortfeasor and the employer jointly liable, meaning that it permits the employer (subject to legal and practical limitations) to shift liability back to the actual tortfeasor as a joint tortfeasor at law. For a detailed critique of enterprise risk reasoning, see A Gray, Vicarious Liability: Critique and Reform Ch. 6 (2018). 98 Cox v. Ministry of Justice [2016] UKSC 10, [2016] AC 660 ¶¶ 20–21 (Lord Reed JSC).

Vicarious liability and corporations  289 vicariously liable for the physical and sexual abuse of its foster carers.99 English law has therefore never fully committed to enterprise risk reasoning. Baroness Hale in Barclays Bank was critical, in particular, of ‘a tendency to elide the policy reasons for vicarious liability with the application of the law’.100 Vicarious liability can therefore at best be described as a flawed form of enterprise liability.101 One might also question the extent to which vicarious liability has the deterrent effect envisaged by Bazley. Witting contends that a more sophisticated (I would say realistic) approach is needed. He recognises that while small companies are less likely to be deterred due to their tendency to keep costs down by doing the minimum necessary to comply with the law, ‘bureaucratic’ medium- and large-sized corporations with in-house compliance units and corporate governance arrangements are much more likely to respond to such incentives.102 Witting accepts, however, that his model of the ‘deterrable organisation’ is likely to need bolstering in order to ensure that organisations take effective action to prevent the commission of employee wrongs.103 At a very basic level, deterrence reasoning faces a number of obstacles. First, there is limited empirical evidence to support the contention that vicarious liability does act as an incentive for change.104 It has been argued, for example, that the existence of insurance serves to dampen the impact of vicarious liability, although Merkin and Steele have counter-argued that this underestimates the sophistication of insurance contracts which do actively manage the risks to which the insurers are exposed.105 Conclusive evidence is, however, lacking. Second, and perhaps as a result of this, deterrence reasoning has as yet made little impact on how courts decide cases save in providing notional reassurance that the imposition of strict liability on an innocent party may act as an inducement for the defendant to take preventative steps to try to avoid liability in the future.106 Whether such measures would be optimal or efficient or make any difference at all is, however, another question. We may conclude, therefore, that enterprise risk reasoning places the corporation at the forefront of the imposition of vicarious liability. It provides both a justification for, and explanation of, why the corporation should pay the victim compensation and seeks to calm any fears of an unfair burden being placed on the corporation by relying on arguments of loss distribution, risk internalisation and deterrence. However, as we have seen, such reasoning can only take the courts so far. Other justifications persist and the current law of vicarious liability does not solely reflect enterprise risk reasoning. The recent attempt of the UK Supreme Court to confine reference to economic risk reasoning to difficult cases indicates that a simple alignment between the corporation and vicarious liability is far too reductionist. Corporations

Armes v. Nottinghamshire CC [2017] UKSC 60, [2018] AC 355 ¶¶ 59–63. Barclays Bank plc v. Various Claimants [2020] UKSC 13, [2020] AC 973 ¶ 16. 101 See Simon Deakin, Organisational Torts: Vicarious Liability Versus Non-delegable Duty, 77 Camb. L.J. 15 (2018). 102 Christian Witting, Modelling Organisational Vicarious Liability, 39 Legal Stud. 694, 708–709 (2019). 103 Id. at 710. 104 P.S. Atiyah, Vicarious Liability in the Law of Torts 17 (1967); Gary T. Schwartz, The Hidden and Fundamental Issue of Employer Vicarious Liability, 69 S. Cal. L. Rev. 1739, 1761 (1996). 105 Merkin & Steele, supra note 3, at 322–23. 106 Lord Reed JSC commented in Armes v. Nottinghamshire CC [2017] UKSC 60, [2018] AC 355 ¶ 67 that a number of justifications for the imposition of vicarious liability have been advanced in UK case law, ‘but deterrence has not been prominent among them’. 99

100

290  Research handbook on corporate liability may be held vicariously liable but only if the test for vicarious liability is met; a test that is not solely based on enterprise risk reasoning.

VI. CONCLUSIONS In the UK case of Mohamud,107 Lord Toulson JSC opined that it was right that the employer (here a large supermarket chain) which had selected and entrusted an employee with the position he had misused should be held responsible for his misconduct even though it was not personally at fault. Lord Nicholls in Dubai Aluminium agreed that: … it is a fact of life, and therefore to be expected by those who carry on businesses, that sometimes their agents may exceed the bounds of their authority or even defy express instructions. It is fair to allocate risk of losses thus arising to the businesses rather than leave those wronged with the sole remedy, of doubtful value, against the individual employee who committed the wrong.108

As we have seen, enterprise risk reasoning has been adopted across many common law jurisdictions (Australia being a notable exception)109 and this has permitted a broader application of the doctrine of vicarious liability, extending the liability of corporations to the misconduct of members of their workforce who are ‘akin to employees’ and to intentional (and criminal) misconduct. While the courts’ desire to help victims of sexual abuse, who would realistically have been unable to obtain compensation without vicarious liability,110 has encouraged them to rely on enterprise risk reasoning as a means to extend this doctrine, this approach has been applied to all tort law claims. Therefore, case-law dealing with horrific allegations of sexual abuse, such as Bazley, Lister and CCWS, has been applied to racist attacks (Mohamud), commercial fraud (Dubai Aluminium), negligence (Cox) and misuse of personal data (Various Claimants). This chapter has identified why the courts are drawn to enterprise risk reasoning as a means of holding corporations liable. It responds to an instinctive idea of benefit and burden: enterprises, being well-resourced (or at least insured) and profiting from the labour of their workers, should also take the burden of their capacity to injure others.111 This logic has been embraced by other common law jurisdictions, notably Singapore.112 It rests, as we have seen, on the economic principle that enterprises (including, perhaps more questionably, non-profit organisations) should internalise the full costs of their operation, which will include the commission of torts by workers engaged in the activities of the enterprise. Even if, it is argued, enterprises cannot, in reality, control the actions of their employees, vicarious liability will

Mohamud v. Wm Morrison Supermarkets Plc [2016] UKSC 11, [2016] AC 677 ¶ 45. Dubai Aluminium Co Ltd v. Salaam [2002] UKHL 48, [2003] 2 AC 366 ¶ 22. 109 See New South Wales v. Lepore [2003] HCA 4; (2013) 212 CLR 511; Prince Alfred College v. ADC [2016] HCA 37, (2016) 258 CLR 134. 110 In cases of historic sexual abuse, the perpetrator has often disappeared or is deceased or of limited means. 111 See Gregory C. Keating, The Theory of Enterprise Liability and Common Law Strict Liability, 54 Vand. L. Rev. 1285, 1286 (2001): ‘Fairness requires a just distribution of burdens and benefits’. 112 Skandinaviska Enskilda Banken AB v. Asia Pacific Breweries (Singapore) Pte Ltd [2011] SGCA 22, [2011] 3 SLR 540 ¶ 70. 107 108

Vicarious liability and corporations  291 ensure that enterprises at least face the full expected costs of accidents or wrongdoing, and thus are deterred from undertaking too much risky activity.113 However, we have also seen in the UK Supreme Court a backlash against the dominance of enterprise risk reasoning and a desire in Barclays Bank and Various Claimants to limit the application of vicarious liability. This may be regarded as good news for corporations, although it remains to be seen whether this new approach will be followed by other common law jurisdictions. We might further question to what extent reliance on enterprise risk reasoning as an explanation and justification for the imposition of vicarious liability masks other explanations of why courts feel it appropriate to impose vicarious liability on enterprises, not least the deeper pockets and control arguments that refuse to go away. Can we even ignore arguments based more broadly on social justice, relied upon, for example, in Mohamud, to state simply that faced with two innocent parties – the victim and the corporate employer – if someone must bear the costs of the tort, justice favours imposing liability on the party that employs the tortfeasor rather than the innocent victim?114 Despite, therefore, the appeal of enterprise risk as a means to engage corporate responsibility, the courts remain unwilling to fully embrace this form of reasoning. For corporations, this gives rise to two conclusions. First, it indicates that the doctrine of vicarious liability can only to a certain extent be regarded as imposing a form of corporate social responsibility. As seen above, at best it represents a flawed form of enterprise liability. Second, the law of torts can only go so far and, if litigants are seeking to identify wider notions of corporate social responsibility, attention is better directed to legislation and other regulatory mechanisms.

Reinier H. Kraakman, Vicarious and Corporate Civil Liability, in 2 Encyclopedia of Law and Economics 669, 671 (B. Bouckaert & G. De Geest eds., 2000). 114 Mohamud v. Wm Morrison Supermarkets Plc [2016] UKSC 11, [2016] AC 677 ¶ 45, referring to Holt CJ (one of the founding fathers of vicarious liability) in Hern v. Nichols (1700) 1 Salk 289, 91 ER 256 (KB). 113

16. Toward corporate group accountability Virginia Harper Ho, Gerlinde Berger-Walliser and Rachel Chambers

I. INTRODUCTION Most economic activity worldwide is conducted by corporate groups, and yet the central question of this chapter – how to hold corporate groups legally responsible for the negative impacts of their operations – has long been recognized as an intractable problem.1 This is because the root and scale of the challenge stem from the very features that make corporate groups so ubiquitous. Corporate groups operate as economic enterprises capable of internal control and coordination of capital, information and other means of production, but they are composed of multiple related companies, each of which has a separate legal identity and enjoys limited liability. Attributing liability for the conduct of any one entity within the group to its parent, to another affiliate or to the group as a whole is therefore in tension with the basic attributes of legal personhood that define each constituent company within the group. It may also conflict with the rights and expectations of minority shareholders or creditors of group affiliates. Beyond these challenges, corporate group activity typically spans multiple jurisdictions, while each jurisdiction’s regulatory and judicial power is generally limited to its own territory. As a result, the structure and power of corporate groups has confounded courts and regulators worldwide.2 This regulatory challenge has only grown more apparent as the globalization of business activity, the speed of technological advance and business mobility have all accelerated over the past half century, further strengthening the sheer economic power of modern corporate groups. Indeed, many of the barriers to corporate liability discussed elsewhere in this volume are only amplified for these large, global firms.3 The persistence of these challenges calls for continued efforts to strengthen corporate accountability and responsibility in ways that include but extend beyond legal liability. This chapter discusses from a comparative perspective the challenges of imposing liability on and within corporate groups that are composed of separate legal entities but that them See generally Peter T. Muchlinski, Multinational Enterprises and the Law 300–335 (3d ed. 2020); Christian Witting, Liability of Corporate Groups and Networks (2018); Martin Petrin & Barnali Choudhury, Group Company Liability, 20 Eur. Bus. Org. L. Rev. 771 (2018); Jukka T. Mähönen, The Pervasive Issue of Liability in Corporate Groups, 13 Eur. Co. L. 146 (2016); Klaus J. Hopt, Groups of Companies – A Comparative Study on the Economics, Law and Regulation of Corporate Groups, in Handbook of Corporate Law and Governance 603 (Jeffrey Gordon & Georg Ringe eds., 2015). 2 For an overview, see generally Rachel Chambers & Gerlinde Berger-Walliser, The Future of International Human Rights Litigation: A Transatlantic Comparison, 58 Am. Bus. L.J. 579 (2021). 3 See infra Sections II and III (discussing many of the corporate doctrines explored in Part III of this volume, as well as some of the procedural barriers Part V of this volume addresses). 1

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Toward corporate group accountability  293 selves generally lack an independent legal status. In response to these challenges, it proposes a number of legal reforms to strengthen parent companies’ incentives to internalize the operational risks of their subsidiaries and business partners and also explores alternative paths to corporate group accountability beyond legal remedies.

II.

DEFINING FEATURES OF THE CORPORATE GROUP AND THE REGULATORY CHALLENGE

In general, a corporate group is a firm composed of legally separate entities (both corporate and non-corporate) that are connected through common ownership, contract, or other forms of control and coordination. This coordination of economic activity across the entire enterprise is typically made possible through each parent or holding company’s ownership of all or part of the equity of lower-tier subsidiaries, but it may also be achieved through contractual or relational arrangements that blur the boundaries of the corporate groups, such as joint venture arrangements, certain supply chain networks, or familial ties. However, with some exceptions, most notably in Germany,4 state, national or regional company law does not treat or regulate the corporate group as a separate business vehicle, nor does the term ‘corporate group’ have a uniform definition.5 Like the corporate form itself, corporate group structures are attractive precisely because they facilitate risk-taking by limiting the liability exposure of the group parent and affiliates internally, as well as that of the group’s ultimate shareholders.6 The two key features that make the corporate group possible and give it its risk-shifting power are (i) the ability of corporations to own shares of other legal entities; and (ii) the recognition of limited liability for each legal entity within the corporate group. The first feature facilitates the formation of multi-tier holding company and subsidiary structures with concentrated or complete own4 Germany is known for the most elaborate codified law of the corporate group. See generally René Reich-Graefe, Changing Paradigms: The Liability of Corporate Groups in Germany, 37 Conn. L. Rev. 785 (2005). German law provides that ‘where a controlling enterprise and one or several controlled enterprises are combined under the common management of the controlling enterprise, they form a group; the individual enterprises are group member companies. Where a control agreement is in place between enterprises (Aktiengesetz [Corporation Law] § 291 (Ger.), https://​www​.gesetze​-im​-internet​.de/​ englisch​_aktg/​englisch​_aktg​.html​#p0070), or where one enterprise has been integrated into another (Id. at § 319), the enterprises are to be regarded as enterprises combined under common management. The assumption is that a controlled enterprise forms a group with the controlling enterprise.’ (Id. at § 18). Codifications of the law of corporate groups also exist in Portugal, Italy, Slovenia, the Czech Republic, and partially in Brazil and Taiwan. See Gerhard Manz & Barbara Mayer, Gesellschaftsrechtliche Herausforderungen im Internationalen Konzern [Corporation Law Challenges in International Corporations], 14 Internationale Wirtschafts-Briefe [IWB] 529 (Ger.), https://​www​.keglerbrown​ .com/​content/​uploads/​2015/​09/​NWB​_Manz​_Mayer​_Gesrecht​_Herausforderungen​_04​_lw​.pdf). 5 See David Sugarman, Corporate Groups in Europe: Governance, Industrial Organization, and Efficiency in a Post-Modern World, in Regulating Corporate Groups in Europe 25 (David Sugarman & Gunther Teubner eds., 1990). See also Mähönen, supra note 1, at 146 (noting that EU law does not facilitate the formation of corporate groups or establish a body of law to govern them); see Petrin & Choudhury, supra note 1, at 773 (observing that corporate groups are only obliquely mentioned in UK company law and the UK Corporate Governance Code). 6 Phillip I. Blumberg, Limited Liability and Corporate Groups, 11 J. Corp. L. 573, 611–15 (1986) (discussing the traditional justifications for limited liability).

294  Research handbook on corporate liability ership or even cross-shareholding within the group,7 while the second amplifies the ability of the firm, like shareholders of a single corporation, to coordinate capital investments and information flows within the corporate group, while simultaneously shielding the group as a whole from risks associated with the investments and operations of each subsidiary.8 These features have enabled firms to develop greater operational diversification, as well as greater scale and geographic reach. At the same time, the ability of a firm to amplify and leverage the wealth-generating contributions of shareholders and other constituents so effectively also increases its power to cause harm.9 As further discussed below, the nature of group decision-making and control structures are also central to understanding the rules governing group liability in different jurisdictions. As a starting point, the complexity of corporate groups requires greater coordination of resources and information, necessitating the centralization of certain functions at higher levels of the organizational structure, as well as full integration of subsidiaries into the group.10 Coordination and information-sharing are commonly facilitated through ‘board interlock’ where there is overlap between parent and subsidiary board members and through the use of ‘common officers’, that is, where the directors who serve on lower-tier subsidiary corporate boards are also officers of the parent company.11 At the same time, both coordination challenges and the need to encourage subsidiary innovation and local responsiveness and to leverage subsidiary specialization and information have also motivated greater decentralization and delegation of decision-making authority within corporate groups.12 This is particularly true for corporate groups that have expanded internationally.

As Hopt observes, wholly owned subsidiaries are common in the United States, while much smaller controlling ownership stakes are common in European corporate groups. See Hopt, supra note 1, at 603–604. On cross-shareholding patterns in different jurisdictions, see Jodie A. Kirshner, Group Companies: Supply Chain Management, Theory and Regulation, in Research Handbook on Transnational Corporations 169, 184 (Alice de Jonge & Roman Tomasic eds., 2017). 8 This feature of the corporate group is known as ‘asset partitioning’ and is an extension of how the corporate form isolates the assets of shareholders from the reach of corporate creditors and vice versa. See generally Henry Hansmann & Reinier Kraakman, The Essential Role of Organizational Law, 110 Yale L.J. 387 (2000); George G. Triantis, Organizations as Internal Capital Markets: The Legal Boundaries of Firms, Collateral, and Trusts in Commercial and Charitable Enterprises, 117 Harv. L. Rev. 1102 (2004). 9 The core problem is widely recognized and is particularly salient with respect to human rights. See, e.g., Radu Mares, Liability Within Corporate Groups: Parent Company’s Accountability for Subsidiary Human Rights Abuses, in Research Handbook on Human Rights and Business 446 (Surya Deva & David Birchall eds., 2020). 10 See, e.g., Sumantra Ghoshal & Christopher A. Bartlett, Creation, Adoption, and Diffusion of Innovations by Subsidiaries of Multinational Corporations, 19 J. Int’l Bus. Stud. 365, 365–68, 384–86 (1988) (observing the importance of both subsidiary integration and autonomy for innovation sharing across the group). 11 Colin Mackie, Corporate Groups, Common Officers and the Relevance of ‘Capacity’ in Questions of Knowledge Attribution, 20 J. Corp. L. Stud. 1 (2020) (arguing for broader attribution of common officer knowledge). See also Witting, supra note 1, at 67–68. 12 Virginia Harper Ho, Team Production & the Multinational Enterprise, 38 Seattle U. L. Rev. 499, 521, 521 nn. 103 & 105 (2014). See also John Armour et al., Agency Problems and Legal Strategies, in The Anatomy of Corporate Law 37 (3d ed. 2017); Alan Rugman et al., Reconceptualizing Bartlett & Ghoshal’s Classification of National Subsidiary Roles in the Multinational Enterprise, 48 J. Mgmt. Stud. 253 (2011). 7

Toward corporate group accountability  295 As a result, corporate group governance, control and authority cannot be assumed to follow the conventional understanding of the firm as a hierarchical pyramid operating under the dictates of the ultimate parent or headquarters.13 In fact, many corporate groups exhibit ‘multiplex’ governance structures that give significant authority and autonomy to lower-tier subsidiaries,14 have multiple centers of coordination and control, including multiple headquarters or even ‘co-parent’ holding companies, and have embraced ‘heterarchical’, matrix, and cooperative decision-making structures across the corporate group.15 Corporate group structures also include informal or contractual networks, such as joint ventures, informal alliances, and supply chain relationships, as companies partner with others or outsource certain functions.16 This diversity calls into question legal frameworks for corporate group accountability that presume simplistic top-down or unitary decision-making and control structures, which do not fully account for these modern business forms. In fact, common features of decision-making patterns within complex organizations often make it difficult to attribute responsibility to specific individuals or entities within the corporate group, even when they are acting in concert. Integrated decision-making and authority structures mean that no one actor or entity, other than the group as a whole, may have the necessary knowledge or intent to support liability for harm that may result.17 Moreover, this role partitioning may at times be intentional, and these internal roles and responsibilities are not transparent to regulators, victims of wrongdoing or other third parties, or even at times within the organization itself.18 As if this were not enough, the legal structure, risk profile and formal boundaries of the corporate group are also constantly changing, as firms engage in mergers and acquisitions, divestitures and restructurings, or shift operations to new jurisdictions.19 These difficulties complicate what are already challenging questions surrounding the attribution of knowledge and intent from human actors to organizations within the corporate group. Finally, the regulatory challenge of corporate groups is compounded by their ability to control the legal risk and responsibility they assume by determining their own structure. By 13 On the conventional view, see, e.g., Oliver E. Williamson, Markets and Hierarchies: Analysis & Antitrust Implications (1975); Raghuram Rajan & Luigi Zingales, The Firm as a Dedicated Hierarchy: A Theory of the Origins and Growth of Firms, 116 Q. J. Economics 805 (2001). 14 See Virginia Harper Ho, Team Production & the Multinational Enterprise, 38 Seattle L. Rev. 499, 513–29 (2014) (citing authorities on the range of responsibilities and authority of corporate subsidiaries and their boards). 15 Id. at 511–13 (surveying the literature). 16 Gunther Teubner, Unitas Multiplex: Corporate Governance in Group Enterprises, in Regulating Corporate Groups in Europe 67, 82–85 (1990). Sumantra Ghoshal & Christopher A. Bartlett, The Multinational Corporation as an Interorganizational Network, 15(4) Acad. Mgmt. Rev. 603 (1990); Sharon Watson O’Donnell, Managing Foreign Subsidiaries: Agents of Headquarters or an Interdependent Network?, 21 Strat. Mgmt. J. 525 (2000). 17 See Mackie, supra note 11 (arguing for broader attribution of knowledge among group constituents). See also Browning Jeffries, The Implications of Janus on Issuer Liability in Jurisdictions Rejecting Collective Scienter, 43 Seton Hall L. Rev. 491, 509–28, 543–46 (2013) (discussing the problem of imputing collective scienter in the context of securities fraud litigation under US law). 18 See generally J.S. Nelson, Paper Dragon Thieves, 105 Geo. L.J. 871 (2017) (considering the implications for corporate criminal liability). 19 Forms of shareholding that separate voting and economic control, the evolution of derivatives, and the rise of other forms of financial engineering have also made it more difficult to identify the boundaries of the corporate group. See generally Linn Anker-Sørensen, Financial Engineering as an Alternative Veil for the Corporate Group, 13 Eur. Co. L. 158 (2016).

296  Research handbook on corporate liability choosing their contracting parties and terms, and determining where constituent subsidiaries will be acquired, formed and operate, corporate groups also choose the laws to which they will be subject. They can therefore shift their operations to take advantage of weak regulatory environments or lax judicial enforcement.20 Within jurisdictions, as well as internationally, corporate groups also often have the power to evade or shape the laws to which they are subject.21 In sum, the structure of corporate groups is directly responsible for both their efficiencies and their pathologies.

III.

GROUNDING CORPORATE GROUP LIABILITY

Concerns about corporate group liability typically arise in circumstances where a direct or indirect subsidiary causes harm to tort claimants or other involuntary creditors, but has insufficient capital to offer a remedy or is located in a jurisdiction where plaintiffs are simply unable to seek or obtain redress. Undercapitalization may also impair the claims of minority shareholders and subsidiary creditors in the event of insolvency.22 Corporate law in most jurisdictions does not offer a clear doctrinal answer to these shortcomings, which again derive from the limited liability and separate legal status of corporate group affiliates. To overcome corporate separateness and hold related entities vicariously liable, various approaches have been identified in case law and in the academic literature. A comprehensive solution, however, is still missing. In addition, legal actions against corporate groups pose underlying jurisdictional challenges that any workable proposition needs to acknowledge, especially in a multi-jurisdictional context. The following section outlines these obstacles before discussing various approaches that have been adopted to ground potential liability of the corporate group and its constituents for harms perpetrated by a related entity. Some of these approaches attempt to respond to the further challenge of assigning legal liability in global value chains. A.

Jurisdictional Challenges

While legal theory and practice traditionally have been most concerned with parent companies’ liability for their subsidiaries’ financial shortcomings, the potential for direct or vicarious parent liability for torts such as environmental pollution, product liability, hazardous labor

See, e.g., Jordi Surroca et al., Stakeholder Pressure on MNEs and the Transfer of Socially Irresponsible Practices to Subsidiaries, 56(2) Acad. Mgmt. J. 549 (2013) (studying risk-shifting as a response to pressure from consumers and other stakeholders in a study of 269 subsidiaries in 27 countries affiliated with 110 multinational enterprises); Larry Cata Backer, The Autonomous Global Corporation: On the Role of Organizational Law Beyond Asset Partitioning and Legal Personality, 41 Tulsa L. Rev. 541 (2006) (observing that global firms are largely self-defining and institutionally autonomous of their shareholders, other stakeholders, jurisdictionally bounded domestic regulation and international law). 21 Regarding corporate influence on international law, see generally Stephen Tully, Corporations and International Lawmaking (2007). 22 Voluntary creditors are, however, often protected by intragroup guarantees. See generally Richard Squire, Strategic Liability in the Corporate Group, 78 U. Chic. L. Rev. 605 (2011) (arguing that guarantees are overused). 20

Toward corporate group accountability  297 conditions, or complicity in other human rights violations committed by subsidiaries or suppliers in faraway countries, has become the center of attention more recently. 23 Unable to bring suit, or out of fear of unfavorable treatment in their respective home jurisdictions, tort victims or surviving families often attempt to sue the Western parent, subsidiary or the final buyer abroad, even in cases where the local subsidiary may have sufficient funds to satisfy a claim. Infamous examples of human tragedies that have given rise to such lawsuits include the toxic gas leak at a Union Carbide subsidiary that killed more than 10,000 people in Bhopal, India; Shell’s alleged complicity in the extrajudicial killing of environmental activists in Nigeria at issue in Kiobel v. Royal Dutch Petroleum;24 the large-scale sterilization of banana farm workers in Central America due to pesticides distributed by Dow Chemical; and the Rana Plaza factory collapse that killed 1,134 workers in Bangladesh garment factories that supplied famous Western brands – to cite just a few.25 Under international human rights law, obligations are increasingly being placed on home states to provide access to remedies in cases of extraterritorial human rights violations where local remedies are unavailable.26 States parties to the International Covenant on Economic, Social and Cultural Rights (ICESCR) have the duty to address these challenges in order to prevent a denial of justice and ensure the right to effective remedy.27 To this end, the General Comment to the ICESCR indicates that states parties must establish parent company or group liability regimes to enable human-rights-related litigation to proceed.28 The conundrum that many of these cases face and that explains why they are often unsuccessful is the following. On the one hand, the tort may be committed in a country where legal protection is precarious. This is for reasons such as a corrupt justice system, financial or other practical or procedural hurdles against victims bringing suit, or low prospects of the local court granting sufficient compensation for the victims’ suffering.29 On the other hand, legal remedies in the country that could provide effective legal protection are often difficult to obtain. This is because the parent company is shielded from legal liability based on the concept of limited liability under applicable corporate law, or possibly because the case raises extra-territoriality concerns, since the individual corporate entity sued, such as a US subsidiary of a foreign

Traditionally, international human rights law protected individuals only from government abuse, but courts are increasingly acknowledging corporate responsibility for grave human rights violations. See Chambers & Berger-Walliser, supra note 2, at 581. 24 Kiobel v. Royal Dutch Petroleum, 569 U.S. 108 (2013). 25 For further examples see the Bus. & Hum. Rts. Resource Ctr., https://​www​.business​-humanrights​ .org/​en/​(last visited Jul. 2022). 26 See, e.g., Cmttee. Econ. Soc. & Cult. Rights, General Comment No. 24 on State Obligations under the International Covenant on Economic, Social and Cultural Rights in the Context of Business Activities, U.N. Doc. E/C.12/GC/24 (Aug. 10, 2017) (recognizing that victims of transnational corporate abuses face many obstacles in having access to remedies, including those stemming from group organizational structures, and proposing concrete solutions). 27 International Covenant on Economic, Social and Cultural Rights, Dec. 16, 1996, 993 U.N.T.S. 3 (opened for signature Dec. 16, 1966, entered into force Jan. 3, 1976). 28 General Comment No. 24, supra note 26, at ¶ 44. 29 Few jurisdictions know contingency fees, litigation funding arrangements, or class action lawsuits to the same extent as the United States justice system. Some jurisdictions have what is called a ‘loser pays’ principle that makes any lawsuit risky and may discourage the most vulnerable from bringing suit. For a more detailed presentation of the attributes that make US courts an attractive forum for international human rights claims see Chambers & Berger-Walliser, supra note 2, at 630–35. 23

298  Research handbook on corporate liability parent company, may not have played an active role in the corporate actions that ultimately caused harm to the plaintiffs.30 This has led many courts, especially in the United States, a country that historically has been a preferred forum for many international tort claims due to its long-standing tradition of litigation under the Alien Tort Statute and plaintiff-friendly procedural rules, fee structures and litigation culture, to dismiss cases out of mounting concerns over international comity and extra-territoriality.31 The most recent example in a long line of such cases is the 2021 US Supreme Court decision in Nestlé v. Doe.32 In this case, six individuals from Mali alleged that they were trafficked into Ivory Coast, where they worked as child slaves on farms that supplied cocoa to Nestlé USA and another US-based company that purchases, processes and sells cocoa. The plaintiffs argued that, while the cocoa farms were independently owned, they exclusively supplied the defendant corporations. The US corporations allegedly also provided the farms with technical and financial resources, and the corporations’ major operational decisions originated in the United States. The US Supreme Court found these ties to the United States territory insufficient and held that the respondents improperly sought extraterritorial application of the Alien Tort Statute. The United States is not alone in limiting access to its courts for foreign plaintiffs.33 In most jurisdictions, such lawsuits have been largely unsuccessful. If not already dismissed on procedural grounds, for example for lack of jurisdiction or forum non conveniens,34 plaintiffs and courts have struggled to find appropriate causes of action to hold a parent or final buyer responsible for the torts committed by subsidiaries or suppliers abroad. In isolated cases, mainly in the United Kingdom and Canada, plaintiffs have been successful grounding their claim against the parent company before courts in the parent company’s home state based on direct tort liability.35 Emerging legislation in individual EU countries and at the EU level

30 See, e.g., Daimler A.G. v. Bauman, 134 S. Ct. 746, 763 (2014). In this case, Argentinian victims sued German Daimler AG via its US subsidiary in California for Daimler’s Argentinian subsidiary’s involvement with human rights violations committed by the Argentinian government. The US Supreme Court found the case lacked sufficient connection to California to ground personal jurisdiction over Daimler AG, especially when comparing the amount of corporate activity that took place in California to the corporate group overall. 31 See Gerlinde Berger-Walliser, Reforming International Human Rights Litigation Against Corporate Defendants After Jesner v. Arab Bank, 21 U. Pa. Bus. L.J. 757, 780–92 (2019) (tracing the development of US Supreme Court’s decisions under the Alien Tort Statute and its cases on personal jurisdiction in regard to civil human rights litigation). 32 Nestlé USA, Inc. v. Doe, 141 S. Ct. 1931 (2021). 33 For a detailed comparison of US and European personal jurisdiction rules see Gerlinde Berger-Walliser, Reconciling Transnational Jurisdiction: A Comparative Approach to Personal Jurisdiction over Foreign Corporate Defendants in US Courts, 51 Vand. J. Transn’l. L. 1243 (2018). 34 For a discussion of how forum non conveniens is an impediment to access to remedy, see Gwynne Skinner, Robert McCorquodale & Olivier De Schutter, The Third Pillar: Access to Judicial Remedies for Human Rights Violations by Transnational Business (2013). One example of such procedural barriers is a recent German case, Jabir v. KiK Textilien und Non-Food GmbH, which was dismissed because the statute of limitations under Pakistani law, which applied to the case under German conflict of laws rules, had expired. Jabir v. KiK Textilien und Non-Food GmbH, Case No. 7 O 95/15, Landgericht Dortmund [LG] [District Court Dortmund] Jan. 10, 2019 (Ger.), reported in Bus. & Hum. Rts. Resource Ctr., https://​www​.business​-humanrights​.org/​en/​latest​-news/​kik​-lawsuit​-re​-pakistan. 35 See, e.g., Vedanta Resources Plc v. Lungowe [2019] UKSC 20; Choc v. Hudbay Minerals Inc. (2013), ONSC 1414 (Ont. Super. Ct.) and related discussion infra.

Toward corporate group accountability  299 attaches liability to the parent company’s controlling, supervising and advising actions, or lack thereof.36 Claims grounded on direct liability are therefore less likely to overcome the jurisdictional challenges that often impede efforts to impose vicarious liability on the parent for the conduct of a subsidiary. B.

Theories of Liability within the Corporate Separateness Paradigm

Imputing liability to a parent company for tortious harm that has occurred through the operations of one or more subsidiaries, while nonetheless recognizing the legal separation of the entities, can be achieved in several different ways, including piercing the corporate veil, under a direct liability theory or under an agency theory.37 The first of these, piercing the corporate veil, is the only one of the three that makes an exception to the legal separation between parent and subsidiary, essentially disregarding that separation in certain cases where it is appropriate to pierce the veil. Under a direct liability theory or an agency theory, in contrast, the strictures of the corporate veil are maintained. Under agency theory, the wrongs of the subsidiary are visited upon the parent company as principal. Direct liability, on the other hand, attributes liability to the parent company for its own role in the subsidiary’s wrongdoing. This latter theory has received judicial endorsement outside the United States in recent years. The following sub-sections describe these legal methods for imputing liability to a parent company in certain key jurisdictions, and the challenges plaintiffs face in each case. 1. Veil-piercing ‘Piercing the corporate veil’ under company law refers to a situation in which courts put aside separate personality and limited liability and hold a corporation's shareholders liable for the corporation’s actions or debts. Veil-piercing allows plaintiffs to hold the parent company liable for a subsidiary’s wrongdoing, thus acknowledging but protecting against abuse of the legal separation between companies in a corporate group. Veil-piercing tests vary from jurisdiction to jurisdiction, but as a general rule, veil-piercing is reserved for exceptional cases only.38 In England, veil-piercing has been restricted by the courts, first in the case of Adams v. Cape

36 See infra notes 63–69 and accompanying text. For an overview of current approaches to international human rights litigation in the United States, Canada and Europe, see generally Chambers & Berger-Walliser, supra note 2. The only example of a successful case to date of which the authors are aware is the Hof’s-Haag 29 januari 2021, JOR 2021, 138 m.nt. van Oostrum, C.H.A. van (Oruma et al./Shell Petroleum N.V.) (Neth.) litigation in the Netherlands. See Bus. & Hum. Rts. Resource Ctr., https://​www​.business​-humanrights​.org/​en/​latest​-news/​shell​-lawsuit​-re​-oil​-pollution​-in​-nigeria 37 The focus of this chapter is on civil liability, and so corporate criminal liability is outside its scope. On the attribution of criminal liability in corporate groups, see, e.g., Brandon L. Garrett, Globalized Corporate Prosecutions, 97 Va. L. Rev. 1775 (2011) (noting the unique US approach to corporate criminal liability); Ian Lee, Corporate Criminal Responsibility as Team-Member Responsibility, 31 Oxford J. Leg. Stud. 755 (2011) (advocating collective corporate or group responsibility under UK law). See also Nelson, supra note 18, at 908–21 (detailing how the legal fiction of ‘corporate unity’ among corporate affiliates and among corporate actors and their agents effectively bars liability for conspiracy within corporate groups under US law). 38 Robert B. Thompson, Piercing the Corporate Veil: An Empirical Study, 76 Corn. L. Rev. 1036, 1044–45 (1991); Tan Cheng-Han, Jiangyu Wang & Christian Hofmann, Piercing the Corporate Veil: Historical, Theoretical, and Comparative Perspectives, 16 Berk. Bus. L.J. 140 (2019) (reviewing veil-piercing law in England, Singapore, the United States, Germany and China).

300  Research handbook on corporate liability Industries, which limited the instances in which piercing may be justified to three situations only.39 These limitations were reaffirmed in Prest v. Petrodel Resources Ltd.40 Canadian41 and Australian42 case law, like English case law, has taken a restrictive approach to veil-piercing. Even in the United States, viewed as the most developed jurisdiction on veil-piercing,43 it is an uphill task for plaintiffs to successfully pierce the corporate veil. Different tests are applied in different states, but, generally speaking, the veil can only be pierced when the parent ‘misuses the separate corporate form for wrongful purposes and controls the subsidiary to the extent that the subsidiary is a mere instrument of the parent’.44 Veil-piercing is thus largely reserved to reach the individual shareholders of closely held corporations.45 Even with respect to closely held corporations, research shows that corporate shareholders will not be liable if they act like a passive shareholder – for example by exercising a ‘normal or ordinary shareholder role’ or ‘mere oversight’ or by utilizing director interlocks – but that they will be liable if they exercise ‘too much’ control and thereby become a ‘mere instrumentality’.46 Despite the fact that the most compelling normative justifications for veil-piercing arise in tort cases and in cases involving statutory regimes that are undermined by rigid adherence to the separate legal identity of group affiliates, empirical studies in the United States continue to find that courts are particularly unwilling to pierce the corporate veil in these contexts.47 Scholars have also documented that veil-piercing tests are vague and inconsistently applied by the courts.48 2. Agency theory In US case law and scholarship, attributing liability to the parent company for actions by a subsidiary or supplier without the formalities of veil piercing has typically been achieved under agency theory. In this way the principal or employer is held strictly liable for the acts or omissions of its agents that were within the course and scope of the agency relationship. The test for agency requires the plaintiff to show that (i) the principal had control over both the results and the conduct of the agent, and (ii) the agent was acting within the scope of its 39 Adams v. Cape Industries Plc [1989] AC 433 (a landmark veil-piercing case reaffirming the separate legal identity of parent and subsidiary under Salomon v. A Salomon & Co Ltd [1897] AC 22). See also Martin Petrin, Assumption of Responsibility in Corporate Groups: Chandler v. Cape Plc, 76 Mod. L. Rev. 603, 604 (2013) (reviewing veil-piercing law and noting that, following Adams and related cases, veil piercing is possible in three situations only: (1) based on statute or contract; (2) where a corporate structure is merely a ‘facade’ or ‘sham’; or (3) where the subsidiary acts as the parent’s agent’). 40 Prest v. Petrodel Resources Ltd. [2013] 3 WLR 1 (UKSC). See also Petrin & Choudhury, supra note 1, at 775 (observing the court’s reluctance to pierce the corporate veil in Prest). 41 Transamerica Life Insurance Co. of Canada v. Canada Life Assurance Co. et al. (1996) 2 O.T.C. 146 (Ont. Ct. of J. Gen. Div.). 42 CSR Ltd. v. Wren (1997) 44 NSWLR 463 (NSW Court of Appeal); James Hardie v Hall (1998) 43 NSWLR 554 (NSW Court of Appeal). 43 Mares, supra note 9, at 452. 44 Gwynne Skinner, Rethinking Limited Liability of Parent Corporations for Foreign Subsidiaries’ Violations of International Human Rights Law, 72 Wash. & Lee L. Rev. 1769, 1797 (2015); Thompson, supra note 38, at 1038. 45 Stephen M. Bainbridge, Abolishing Veil Piercing, 26 J. Corp. L. 479, 523 (2000). 46 Robert B. Thompson, Piercing the Corporate Veil Within Corporate Groups: Corporate Shareholders as Mere Investors, 13 Conn. J. Int’ L. 379, 390 (1999). 47 Id. at 385–90 (1999) (updating findings from an early study conducted in 1991, cited supra note 38). 48 Skinner, supra note 44, at 1798.

Toward corporate group accountability  301 authority when the tortious act was committed. In practice, showing this degree of control might be challenging for plaintiffs. For example, in one typical case, the judge held there must be ‘a close relationship or domination between parent and subsidiary’;49 in a similar case, ‘significant control’ over the subsidiary’s operations was required.50 In contrast to the United States, in the UK and most continental European jurisdictions independent legal entities normally do not qualify as agents, and therefore cannot be held vicariously liable for the actions of group affiliates.51 Accordingly, in other common law jurisdictions, as noted above, plaintiffs have had greater success using direct liability to establish parent company liability. 3. Direct liability Direct liability theory has come to the fore in English and other common law courts as veil-piercing has fallen out of favor.52 Under this theory, a parent company can be held directly liable in tort for its involvement in the tortious acts of its subsidiary.53 In a seminal case from 2012, Chandler v. Cape Plc,54 the English Court of Appeal upheld a decision to hold a parent company directly liable for harm suffered by an employee of a subsidiary company. This was the first time the direct liability argument was used successfully at trial. Two significant judgments from the UK Supreme Court in 2019 and 2021 have confirmed the decision in Chandler and expanded the circumstances in which a parent company may be held directly liable for breaching its own duty of care due to the operations of its subsidiary.55 In the first case, Vedanta Resources Plc v. Lungowe,56 the court was confronted with a jurisdictional challenge from the defendant corporations that required it to determine whether the Larry Bowoto et al. v. Chevron Texaco Corp. et al., 312 F. Supp. 2d 1229 (N.D. Cal. 2004), at 1239. See Rachel Chambers, Parent Company Direct Liability for Overseas Human Rights Violations: Lessons from the U.K. Supreme Court, 42 U. Penn. J. Int’l L. 519 (2021), at 548–49 (discussing the factors that led to a finding of control in Bowoto, including the subsidiary’s importance to the parent and the parent holding the subsidiary out to be a department of its own business). 50 Doe I v. Exxon Mobil Corp., 573 F. Supp. 2d 16, 31–32 (D.D.C. 2008). For an analysis of Doe v. Nestlé, see Desirée LeClercq, Nestlé United States, Inc. v. Doe. 141 S. Ct. 1931, 115 Am. J. Int’l L. 694 (2020). 51 Chambers & Berger-Walliser, supra note 2, at 599–600; Muchlinski, supra note 1, at 305 (regarding the UK approach). See also Alexander Schall, Die Mutter-Verantwortlichkeit für Menschenrechtsverletzungen ihrere Auslandstöchter, Zeitschrift für Gesellschaftsrecht 479, 503–506 (2018) (Ger.) (noting that there are exceptions to this rule that could be expanded to justify vicarious liability within groups under German law). 52 Petrin & Choudhury, supra note 1, at 772 (observing that ‘veil-piercing has fallen out of favour with many courts and commentators’ and its application has become increasingly narrow, giving way to consideration of direct liability theories). Direct corporate liability is discussed in Part II of this volume. Outside England/other common law jurisdictions there is new case law on climate change that examines the responsibility of parent companies. See Rechtbank’s-Haag 26 mei 2021, JOR 2021, 208 m.nt. van Biesmans, S.J.M (Milieudefensie et al./Royal Dutch Shell PLC) (Neth.). 53 Some US courts have applied a similar analysis. In the case of Amoco Cadiz, the District Court imposed liability on the parent in light of its control over the subsidiary, its negligent oversight of the subsidiary, and its own negligence with respect to relevant aspects of the subsidiary’s operations in which it was involved. In re Oil Spill by Amoco Cadiz off the Coast of France on March 16, 1978, 954 F.2d 1279 (7th Cir. 1992). 54 Chandler v. Cape Plc [2012] EWCA (Civ) 525 (Eng.). 55 See Chambers, supra note 49. 56 Vedanta Res., Plc. and Konkola Copper Mines, Plc. v. Lungowe [2019] UKSC 20 (Eng.). 49

302  Research handbook on corporate liability plaintiffs, members of a community local to a mine site in Zambia, had an arguable case that the London-based parent company owed them a direct duty of care in respect of harm incurred through severe environmental degradation at the mine. Taking a pragmatic approach to the management of corporate groups, the Supreme Court held that there are various levels of intervention in the relevant operations of the subsidiary that might cause the parent company to incur a duty of care to the plaintiffs.57 Regarding group-wide policies, such as policies on environmental protection, the Court concluded that, if the parent company fails to intervene in the relevant operations of the subsidiary in circumstances where even though – through such policies – it holds itself out as so intervening, this may be sufficient to incur the relevant responsibility.58 The decision was unanimously reaffirmed by the UK Supreme Court in the second case, Okpabi v. Royal Dutch Shell Plc.59 The legal argument for direct parent company liability used in Vedanta and Okpabi has been applied in other common law jurisdictions, notably in Canada.60 Commentators have questioned whether the direct liability approach creates perverse incentives for parent companies, since direct parent company liability in these cases has turned on whether the parent had ‘voluntarily’ assumed responsibility for the operations of the subsidiary, which may encourage parent companies to take a hands-off approach.61 Resting liability on circumstances demonstrating parent control as these cases do may also be out of step with the common patterns of subsidiary integration in corporate groups discussed above because information flows and centers of knowledge and responsibility are integrated across legal boundaries within the corporate group and are neither transparent nor fixed.62 However, some of these concerns may now be less significant in practice, since a hands-off approach may be impractical for many parent companies, both from a group-wide management standpoint and because it runs counter to a growing international expectation of group-wide oversight of human rights and environmental impacts. Such oversight is evolving in some states from a moral expectation into a legal requirement. This legal requirement comes from human rights due diligence laws, which were enacted first in France,63 then in Germany64 and

Id. at ¶¶ 49 and 51. Id. at ¶ 53. The duty of care might also arise from inadequate group-wide policy guidance giving rise to harm, and from adequate group-wide policy guidance that is poorly implemented or supervised. Id. at ¶ 52–53. 59 Okpabi v. Royal Dutch Shell Plc. [2021] UKSC 3 (Eng.). 60 Choc v. Hudbay Minerals Inc [2013] ONSC 1414 (Can. Ont. Super. Ct.). 61 See, e.g., Carrie Bradshaw, Corporate Liability for Toxic Torts Abroad: Vedanta v. Lungowe in the Supreme Court, 32 J. Env’t. L. 139 (2020). 62 See supra Part II. 63 Loi n° 2017-399 du 27 mars 2017 relative au devoir de vigilance des sociétés mères et des entreprises donneuses d’ordre [Law No. 2017-399 of March 27, 2017 Relating to the Duty of Vigilance of Parent Companies and Ordering Companies], Journal Officiel République Française [J.O.] [Official Gazette of France], Mar. 28, 2017 [hereinafter Loi 2017-399]. 64 Gesetz über die unternehmerischen Sorgfaltspflichten in Lieferketten [LkSG] [Act on Corporate Due Diligence Obligations in Supply Chains], Bundesgesetzblatt I 2021, 2959 [hereinafter Act on Corporate Due Diligence Obligations in Supply Chains]. For an official translation, see https://​www​ .bmas​.de/​SharedDocs/​Downloads/​DE/​Internationales/​act​-corporate​-due​-diligence​-obligations​-supply​ -chains​.pdf​?​_​_blob​=​publicationFile​&​v​=​3. See also Markus Krajewski et al., Mandatory Human Rights Due Diligence in Germany and Norway: Stepping, or Striding, in the Same Direction?, 6 Bus. & Hum. Rights J. 550 (2021) (discussing the Act). 57 58

Toward corporate group accountability  303 Norway,65 and have been proposed for the European Union.66 Under the French law, called the Law on the Corporate Duty of Vigilance, companies must undertake risk-mapping that identifies, analyses and ranks risks of serious violations of human rights and fundamental freedoms.67 They must also put in place evaluation procedures that regularly assess, in accordance with the risk-mapping, subsidiaries, subcontractors or suppliers with which the company maintains an established commercial relationship. The German Supply Chain Act requires companies to conduct human rights due diligence with respect to their own business operations and their direct suppliers’ operations.68 The Norwegian law requires companies to conduct human rights due diligence through the supply chain.69 Thus, although there is variance among these laws as to how far down the supply chain companies must conduct due diligence, compliance requires a ‘hands-on’ approach to human rights and environmental risks within the corporate group. As we discuss in Part IV, for jurisdictions that recognize a direct duty of care by the parent company when it assumes such obligations, compliance with a due diligence mandate could create the basis for a robust and enforceable duty of care. 4. Group liability Group principles or ‘enterprise law’ has been described as an entire range of legal principles and applications that disregard the separate legal identity of affiliates in order to better reflect the economic reality of group activity, further the regulatory goals of particular statutory regimes, or allocate responsibility within the corporate group for the full costs and risks associated with the activities of group affiliates.70 In contrast to tort law conceptions of enterprise

65 Act Relating to Enterprises’ Transparency and Work on Fundamental Human Rights and Decent Working Conditions, LOV-2021-06-18-99 (Nor.). For an unofficial English translation, see https://​lovdata​.no/​dokument/​NLE/​lov/​2021​-06​-18​-99​#:​~:​text​=​The​%20Act​%20shall​%20promote​ %20enterprises​,fundamental​%20human​%20rights​%20and​%20decent 66 The European Commission has proposed a directive on sustainable corporate governance that includes mandatory human rights and environmental due diligence with respect to impacts in company supply chains. Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937, COM (2022) 71 final (Feb. 23, 2022), https://​ec​.europa​.eu/​info/​sites/​default/​files/​1​_1​_183885​_prop​_dir​_susta​_en​.pdf 67 Loi 2017-399, supra note 63. 68 Act on Corporate Due Diligence Obligations in Supply Chains, supra note 64, at §§ 5–7. The Act’s obligations apply to a company’s own business area and that of direct suppliers. Id. (imposing an obligation to conduct human rights risk analysis, to adopt preventative measures to tackle identified risks, and to take remedial action). For indirect suppliers, which frequently play a large role in global supply chains, companies are not required to conduct a risk analysis proactively and systematically, but only on an ad hoc basis, when they gain ‘substantiated knowledge’ of a potential human rights violation. Id. at § 9. 69 Act Relating to Enterprises’ Transparency and Work on Fundamental Human Rights and Decent Working Conditions, supra note 65. Due diligence obligations apply throughout the supply chain, which is defined as ‘any party in the chain of suppliers and sub-contractors that supplies or produces goods, services or other input factors included in an enterprise’s delivery of services or production of goods from the raw material stage to a finished product.’ Id. at § 3(d). 70 Phillip I. Blumberg, The Multinational Challenge to Corporation Law: The Search for a New Corporate Personality 236–38, 240 (1993) (distinguishing enterprise principles from veil piercing doctrine and from agency law); Virginia Harper Ho, Theories of Corporate Groups: Corporate Identity Reconceived, 42 Seton Hall L. Rev. 879, 918–19 (2012).

304  Research handbook on corporate liability liability explored later in this volume,71 the term ‘group liability’ generally refers to the attribution of liability jointly and severally among group affiliates or to a single company within the group, such as headquarters or the ‘ultimate parent’ company, that represents the corporate group as an economic enterprise. Group liability has been most widely adopted in certain statutory regimes, such as antitrust and bankruptcy, as a response to the threat corporate groups pose to the underlying purposes of those areas of regulation.72 In these areas, enterprise principles are generally based on varying definitions of control by one member of the group.73 For example, competition law has recognized the economic unity of corporate groups and parent companies’ power to control their subsidiaries when imposing criminal liability on parent companies for acts of their subsidiaries.74 In addition, some aspects of corporate law, namely the duty of oversight and other director and officer fiduciary duties, apply on an enterprise-wide basis, and shareholder proposals and other forms of engagement also extend to all of the group’s operations.75 Mandatory corporate reporting for listed companies and other large firms also generally applies on a consolidated basis in order to provide a group-wide view of financial performance that includes controlled subsidiaries.76 However, even in the United States, Germany and other jurisdictions where it has been more widely embraced,77 enterprise law remains the exception, not the rule.78 Enterprise principles have at times been advocated to ground human rights litigation against parent companies of multinational corporate groups whose subsidiaries have engaged in human rights abuses,79 but

Gregory Keating’s chapter in this volume uses the term ‘enterprise liability’ to refer to a form of strict liability in tort that applies to corporate actors on the basis of an agency relationship with their employees. The term is not used, as we do here, in opposition to entity-based theories of liability. 72 Blumberg, supra note 70, at 60–61 (tracing group conceptions in regulatory regimes back to the New Deal era). On the doctrine of substantive consolidation in bankruptcy, for example, see generally William H. Widen, Corporate Form and Substantive Consolidation, 75 Geo. Wash. L. Rev. 237 (2007). 73 Phillip I. Blumberg, The Increasing Recognition of Entity Principles in Determining Parent and Subsidiary Corporation Liabilities, 28 Conn. L. Rev. 295, 300–301 (1996) (noting that US courts have tended to adopt a group-wide approach ‘only when “control” is accompanied by evidence of financial, operational, or administrative integration’). 74 See generally Carsten Koenig, The Boundaries of the Firm and the Reach of Competition Law: Corporate Group Liability and Sanctioning in the EU and the US, in The Intersections Between Competition Law and Corporate Law and Finance 1 (Marco Corradi & Julian Nowag eds., 2021); Stefan Thomas, Guilty of a Fault that One Has Not Committed: The Limits of the Group-Based Sanction Policy Carried Out by the Commission and the European Courts in EU-Antitrust Law, 3 J. Eur. Comp. L. & Prac. 11 (2012) (discussing case law interpreting an ‘undertaking’ in EU competition law as referring to an economic entity). 75 Virginia Harper Ho, Of Enterprise Principles and Corporate Groups: Does Corporate Law Reach Human Rights?, 52 Colum. J. Tranat’l L. 113, 166–68 (2013) (discussing the group-wide reach of corporate director and officer fiduciary duties and the obligation to comply with applicable law). 76 On consolidated corporate reporting, see infra note 92 and sources cited therein. 77 See Kirshner, supra note 7, at 190–93 (discussing recognition of group principles in Australia, Germany and New Zealand, as well as the United States). 78 See generally Reich-Graefe, supra note 4, at 801 (observing that entity law prevails outside of the statutory forms unless there is undue interference by the parent in subsidiary operations); Blumberg, supra note 73. 79 See generally Mares, supra note 9. 71

Toward corporate group accountability  305 group liability has generally not been accepted in practice.80 A difficulty with group liability is that it ignores, sometimes unpredictably, the separate legal status of corporate group affiliates and the interests of minority shareholders and creditors of the entity to which group liability is attached.81 It is also at odds with the fact that in nearly all jurisdictions, the corporate group lacks an independent legal identity.82 In sum, holding all members (or any member) of the corporate group liable, jointly and severally, for harms caused by an affiliate, or allowing the attribution of liability to a parent company for the acts of its subsidiary, has a number of normative advantages: it assigns responsibility to those ultimately benefiting from the subsidiary’s activities, it can encourage better monitoring and risk management, it can provide victims access to a favorable forum, and it better comports with the economic reality and managerial structures of corporate groups. However, courts across nearly all jurisdictions, including those favorable to direct parent liability, have thus far been hesitant to disregard the separate identity of corporate subsidiaries in order to attach liability to a corporate parent, or to attribute liability on an enterprise-wide or ‘group’ basis. 5. Private regulation and self-regulation Given the recognized limits of home or host state law to impose liability on multinational enterprises on a group-wide basis, various forms of private regulation and self-regulation have emerged to fill the gap.83 These include voluntary codes of conduct, international guidelines and self-regulatory regimes, such as the Organisation for Economic Co-operation (OECD) Guidelines for Multinational Enterprises, the United Nations’ Global Compact and its Guiding Principles for Business and Human Rights (UNGPs).84 In general, these regimes do apply across the corporate group and in some cases to supply chains and other business partners.85 They typically require companies to self-report their adherence to specific principles or guidelines and rely on voluntary actions by companies to in fact comply with them. The UNGPs and the OECD Guidelines go further by requiring companies to conduct human rights due diligence across the corporate group and throughout global value chains. Although such programs have proven useful in shifting industry norms over time, they are typically enforceable

80 See, e.g., Larry Bowoto et al. v. Chevron Texaco Corp. et al., 312 F. Supp. 2d 1229, 1237 (N.D. Cal. 2004) (summarily dismissing this argument). 81 Blumberg, supra note 70, at 142–44, 236–38 (discussing minority shareholder interests within the group structure and the potential disruption of risk assessment and contractual expectations if group liability were to be applied, particularly in the context of conglomerates and other diversified corporate groups that are nonetheless economically interdependent). 82 Id. at 236–38. 83 See generally Stephen K. Park & Gerlinde Berger-Walliser, A Firm-Driven Approach to Global Governance and Sustainability, 52 Am. Bus. L. J. 255 (2015) (discussing multinational enterprises’ influence on international soft law and private regulation); see also Alice de Jonge, The Evolving Nature of the Transnational Corporation in the 21st Century, in Research Handbook on Transnational Corporations 22–30 (Alice de Jonge & Roman Tomasic eds., 2017) (discussing examples). 84 For a discussion of these mechanisms as a form of regulation, see Gerlinde Berger-Walliser, Reforming International Human Rights Litigation Against Corporate Defendants After Jesner v. Arab Bank, 21 U. Penn. J. Bus. L. 757, 769–70 (2019). 85 Note that under many voluntary regimes, companies themselves determine which affiliates will be subject to the regime, thus defining the relevant boundaries of the group and the scope of their commitments.

306  Research handbook on corporate liability only through the reputational pressure of investors, consumers and other external stakeholders, and so their ability to transform corporate practice is often constrained by economic pressures.86 Solutions to strengthen private regulation are emerging. These include proposals to harmonize or ‘harden’ voluntary codes, for example, through the establishment of regulatory standards for such codes (i.e. a ‘code for the codes’), or by rewarding companies which adopt codes of conduct by offering relief from civil or even criminal liability.87 The enactment of human rights due diligence laws – the French Duty of Vigilance Law and the German Supply Chain Due Diligence Act and EU proposals discussed above – can also be viewed as examples of a ‘hardening’ of soft law norms contained within the UNGPs and the OECD Guidelines.88 These developments are important since adherence to voluntary regimes alone cannot compel corporate actors to assume responsibility for the costs of corporate torts and environmental harms, much less on a group-wide basis.

IV.

PATHS FORWARD

Multiple solutions to the challenges of corporate group liability have developed over time, but more far-reaching approaches are needed to address the many limitations of the current practices identified in this chapter. In general, reforms should recognize the dual entity and enterprise nature of corporate groups, as appropriate for a given area of the law. In addition, liability regimes that apply to corporate groups must incentivize the ultimate parent(s) and group affiliates at all levels to fully internalize the costs associated with their operations, and to engage in greater, not less, monitoring of affiliates under their authority. As discussed below, these proposals should focus on the protection of involuntary tort claimants, whether through direct or group liability, and must extend to network or contract-based groups that are similarly integrated.89 Though beyond the scope of this chapter, jurisdiction and conflict of laws rules must follow suit, so as to provide plaintiffs with appropriate fora in multi-jurisdictional cases and to preserve states’ interests in adjudicating disputes against corporate entities doing business in relevant states.90 In the following discussion, we consider a number of reforms that could introduce more predictable and equitable approaches to group liability.

On the limits of voluntary disclosure-based regimes, see Adam S. Chilton & Galit Sarfaty, The Limitations of Supply Chain Disclosure Regimes, 53 Stan. J. Int’l L. 1 (2017) (finding that consumer-oriented human rights due diligence disclosures are ineffective); Charlotte Villiers, Collective Responsibility and the Limits of Disclosure in Regulating Global Supply Chains, 23 Deakin L. Rev. 143 (2018). The limits of the ‘business case’ for corporate responsibility are widely observed. See, e.g., Park & Berger-Walliser, supra note 83 (advocating greater engagement between corporations and regulators in private sustainability rulemaking). 87 See generally Sean D. Murphy, Taking Multinational Corporate Codes of Conduct to the Next Level, 43 Colum. J. Transnat’l L. 389 (2005). On ‘meta-regulation’ as the regulation of private regulation, see Christine Parker, The Open Corporation: Effective Self-Regulation and Democracy 245–91 (2002). 88 See supra Part III.B.3. 89 Witting discusses this principle as the preservation of ‘business form neutrality’ between formal groups and network forms, which is necessary to prevent evasion of liability through creative structuring. Witting, supra note 1, at 5, 17–19. 90 See Chambers & Berger-Walliser, supra note 2, at 609–23 (discussing jurisdiction and conflict of laws issues in international corporate human rights cases). See also Daimler AG v. Bauman, 571 U.S. 86

Toward corporate group accountability  307 A.

Extending Direct Liability

At present, most of the common law doctrines that impose liability on a corporate parent (or shareholder) for harms caused by a subsidiary are more likely to shield parent companies that are less vigilant in monitoring subsidiary risk or less active in taking steps to prevent harm, since the parent is more likely to face liability the more it exercises operational control or direct oversight of the subsidiary.91 This is true of common law doctrines like veil-piercing, as well as the recent case law in the UK and elsewhere extending direct liability to parent companies which exercise the requisite degree of control over a subsidiary. As discussed above, not only can legal rules that depend on evidence of the parent’s knowledge or control be easily evaded by the parent, but this result is in direct tension with the emerging statutory due diligence obligations in many jurisdictions to engage in enterprise-wide risk oversight and ongoing due diligence, as well as with companies’ own voluntary due diligence commitments. It also stands in contrast to reporting requirements that apply to the ultimate parent on behalf of the entire group, which in some jurisdictions include human rights risks and reporting on group-wide due diligence measures to mitigate those risks.92 One possibility advanced in a proposed treaty on business and human rights being drafted by a United Nations working group would require that states parties impose liability on companies (and individuals) for failure to prevent another legal or natural person with whom they have had a business relationship, from causing or contributing to human rights abuses, when the former controls, manages or supervises such person or the relevant activity that caused or contributed to the human rights abuse, or should have foreseen risks of human rights abuses in the conduct of their business activities … or in their business relationships, but failed to take adequate measures to prevent the abuse.93

117, 157 (2014) (Sotomayor, J., concurring) (stating that in a world where it is ‘increasingly common [that] a corporation divides its command and coordinating functions among officers who work at several different locations’, the majority’s approach to personal jurisdiction over foreign parent corporations will limit a ‘State[’s] sovereign authority to adjudicate disputes against corporate defendants who have engaged in continuous and substantial business operations within their boundaries’, and that the majority’s approach will result in ‘the State . . . los[ing] that power’). 91 For this reason, Witting has urged a shift away from control-based group liability regimes. See Witting, supra note 1, at 282–87. 92 Under the EU’s 2014 Non-Financial Reporting Directive, for example, parent companies must report on human rights issues on a consolidated basis, which obliges the parent to disclose, inter alia, the impacts of its subsidiaries, the group policy pursued on these issues and group-level due diligence measures undertaken to prevent, mitigate and remedy adverse impacts. Council Directive 2014/95, of the European Parliament and of the Council of 22 October 2014 Amending Directive 2013/34/EU as Regards Disclosure of Non-Financial and Diversity Information By Certain Large Undertakings and Groups, 2014 O.J. (L 330) 1, at art. 29a. See Rachel Chambers & Anil Yilmaz-Vastardis, The New EU Rules on Non-financial Reporting: Potential Impacts on Access to Remedy?, 10 Hum. Rts. & Int’l Legal Discourse 18 (2016) (discussing the group-wide due diligence requirement). The Directive has been superseded by the Corporate Sustainability Reporting Directive (CSRD). Proposal for a Directive of the European Parliament and of the Council amending Directive 2013/34/EU, Directive 2004/109/ EC, Directive 2006/43/EC and Regulation (EU) No. 537/2014 as Regards Corporate Sustainability Reporting, COM (2021) 189 final (Apr. 21, 2021), https://​eur​-lex​.europa​.eu/​legal​-content/​EN/​TXT/​ HTML/​?uri​=​CELEX:​52021PC0189​&​from​=​EN. 93 In 2014, the United Nations Human Rights Council adopted a resolution to establish an open-ended intergovernmental working group (OEIGWG) to develop a treaty. UNGA Res. 26/9, Elaboration of an

308  Research handbook on corporate liability While this provision might appear to introduce a form of vicarious liability on the part of all companies (not only parent or affiliate companies) for acts of their business partners, it is perhaps more properly viewed as establishing a duty of care that can be breached by a failure of oversight. Critically, this obligation is not limited to control relationships and would offer a defense where the defendant company took ‘adequate measures to prevent the abuse’. In order to establish such a defense, a parent company would therefore generally need to exercise some degree of oversight over business partner operations in order to prevent human rights violations. In contrast to the direct liability theories advanced by the English and Canadian courts, then, this proposal would incentivize greater, not less, monitoring by companies at all levels within a corporate group or network. We also believe that to reach both traditional corporate group structures as well as network groups where control is more attenuated it is necessary to build on the many measures that have already been adopted that mandate or encourage human rights and environmental due diligence throughout supply chains and for all business partners. Sources of such obligations include domestic due diligence laws discussed above and the proposed business and human rights treaty. Due diligence obligations under statutes such as the German Supply Chain Act or the French Duty of Vigilance Law could be linked to statutory or common law tort doctrines.94 Though not yet tested before the courts, it is conceivable that victims of human rights violations could then ground their tort claims on the parent company (or buyer’s) failure to comply with the statutory obligation.95 As such, due diligence laws could help clarify the contours of a duty of care of parent companies within the corporate group in a negligence lawsuit. In some jurisdictions, due diligence laws could also ground a tort claim based on strict liability. For example, German tort law provides for compensation in cases where a person or company commits a breach of a statute that is intended to protect another person.96 The new German Supply Chain Act may well qualify as such a ‘protective’ law and hence give human

International Legally Binding Instrument on Transnational Corporations and Other Business Enterprises with Respect to Human Rights, A/HRC/RES/26/9 (14 July 2014), https://​ap​.ohchr​.org/​documents/​ dpage​_e​.aspx​?si​=​A/​HRC/​RES/​26/​9. At the time of writing, the current version of the draft treaty was the Third Revised Draft. OEIWG Chairmanship, Third Revised Draft, Legally Binding Instrument to Regulate, in International Human Rights Law, the Activities of Transnational Corporations and Other Business Enterprises (17 August 2021), https://​www​.ohchr​.org/​Documents/​HRBodies/​HRCouncil/​ WGTransCorp/​Session6/​LBI3rdDRAFT​.pdf, art. 8.6. This ‘failure to prevent’ model is also advocated by a number of organizations in the United Kingdom. See, e.g., Proposed UK Corporate Duty to Prevent Adverse Human Rights and Environmental Impacts: Principal Legal Elements, Corporate Justice Coalition (Mar. 2020) https://​corpo​ratejustic​ecoalition​.org/​wp​-content/​uploads/​2021/​06/​Duty​ -to​-prevent​_principal​-elements​_FINAL​.pdf. 94 Doug Cassel, Outlining the Case for a Common Law Duty of Care of Business to Exercise Human Rights Due Diligence, 1 BUS. & HUM. Rts. J. 179 (2016) (arguing for an overarching duty of care upon businesses to exercise human rights due diligence). 95 Loi 2017-399, supra note 63, at art. 2 provides for this cause of action, expressly linking the specific duty of vigilance to the general tort provisions in arts. 1240 and 1241 in the French civil code. 96 Bürgerliches Gesetzbuch [BGB] [Civil Code] [hereinafter German Civil Code] § 823 provides: ‘(1) A person who, intentionally or negligently, unlawfully injures the life, body, health, freedom, property or another right of another person is liable to make compensation to the other party for the damage arising from this. (2) The same duty is held by a person who commits a breach of a statute that is intended to protect another person. If, according to the contents of the statute, it may also be breached without fault, then liability to compensation only exists in the case of fault’, https://​www​.gesetze​-im​-internet​.de/​ englisch​_bgb/​englisch​_bgb​.html​#p3489.

Toward corporate group accountability  309 rights victims a cause of action in cases where a company’s non-compliance with the Act’s due diligence requirements leads to death, bodily injury, injury of health, freedom, property or another right.97 At present, this statutory cause of action still requires fault,98 and the plaintiff has the difficult burden of proving that the company’s actions or inactions were the cause of their injuries. However, a more effective approach would be for courts to recognize causes of action for a statutory due diligence violation based on strict liability with a reversal of the burden of proof resting on the defendant.99 This proposal to ground tort liability in duty of diligence laws has several limitations. First is the fact that the obligations set up in these regulations often do not reach deep enough into the supply chain.100 Second, this construct does not create vicarious or joint liability among other affiliates within the corporate group, as the liability issue is reduced to whether or not the parent or buyer subject to the relevant legislation fulfills its obligation to exercise oversight and manage risk. Hence, this approach does not take into account the disaggregated information and control structures prevalent in contemporary corporate groups. Common law jurisdictions have not yet adopted due diligence obligations, and courts would need to establish the link between common law tort principles and per se liability through case law.101 To better reflect the reality of corporate group management, approaches that overcome corporate separateness or create some form of joint liability in the corporate group may be warranted in certain cases and are discussed in the following sections. B.

Expanding Group Liability

Expanding group liability is an alternative to the direct liability theories advanced above. It is widely recognized that the justifications for limited liability for shareholders of a single corporation do not hold in the parent-subsidiary context, particularly when the shareholders of the

See German Civil Code, § 823. Id. at § 823(2); Loi 2017-399, supra note 63 (also requiring fault). See Stephane Brabant & Elsa Savourey, France’s Duty of Vigilance Law: A Closer Look at Penalties (2017), https://​media​.business​ -humanrights​.org/​media/​documents/​d32b6e38d5​c199f89123​67a5a0a613​7f49d21d91​.pdf. 99 Chambers & Berger-Walliser, supra note 2, at 606. A proposed Swiss due diligence law, rejected in a national referendum, would have reversed the burden of proof. Id. at 607–608. The ‘failure to prevent’ model from the proposed business and human rights treaty, supra note 93 and accompanying text, would reverse the burden of proof in this way. 100 As noted above, supra note 64, the German Act on Corporate Due Diligence Obligations in Supply Chains only applies to large German companies and their direct suppliers, although risk assessments further down the chain are required on an ad hoc basis, when the German company gains ‘substantiated knowledge’ of a potential human rights violation. See Not There Yet, but Finally at the Start: What the New Supply Chain Act Delivers – and What it Doesn’t, Initiative Lieferkettengesetz (Jun. 11, 2021) https://​corporatejustice​.org/​wp​-content/​uploads/​2021/​06/​Initiative​-Lieferkettengesetz​_Analysis​_What​ -the​-new​-supply​-chain​-act​-delivers​.pdf (describing from a civil society perspective the pros and the cons of the new law). Loi 2017-399, supra note 63, only applies to suppliers with whom the company maintains an established commercial relationship. 101 Proposals for such laws have been circulated by civil society organizations, see Corporate Justice Coalition, supra note 93 and The Corporate Respect for Human Rights and the Environment Abroad Act, Canadian Network on Corp. Accountability (May 31, 2021), https://​cnca​-rcrce​.ca/​site/​ wp​-content/​uploads/​2021/​05/​The​-Corporate​-Respect​-for​-Human​-Rights​-and​-the​-Environment​-Abroad​ -Act​-May​-31​-2021​.pdf 97 98

310  Research handbook on corporate liability ultimate group parent would remain shielded by limited liability.102 These rationales include encouraging diversified, passive investment by reducing risk, as well as related monitoring, agency and bonding (i.e. insurance) costs that would otherwise be borne by shareholders.103 In the corporate group, however, parent companies typically have concentrated, not dispersed ownership, and monitoring and agency costs are reduced in light of the parent’s ability to efficiently oversee group subsidiaries and appoint their management.104 They also have the ability to internally coordinate the allocation of risk and resources among affiliates. In this context, the presence of multiple layers of limited liability protection within the group allows parent companies which are coordinating economic activity, capital deployment and risk management across related legal entities to externalize risks associated with their coordinated operations.105 1. Reaching traditional corporate groups For these reasons, a number of commentators have argued for the full abolition of limited liability within the corporate group, though most would preserve it at the level of the ultimate parent and its shareholders.106 Other, less radical proposals advocate for its abandonment in tort cases or in certain categories of cases involving wholly owned or controlled subsidiaries and harms to the environment or human rights violations.107 The core argument is that in contrast to other creditors, involuntary creditors such as tort claimants cannot protect themselves ex ante against limited liability through due diligence, contract or insurance.108 One such proposal by Christian Witting would impose liability by statute on all shareholders of insolvent subsidiaries, including the parent company and individual shareholders, on a pro rata basis to the extent that there are personal injury claims left unsatisfied.109 Witting’s ‘modified limited liability’ proposal would also require amending bankruptcy law to give such claims priority over even secured creditors’ claims.110 This proposal achieves the goal of

Blumberg, Limited Liability and Corporate Groups, supra note 6, at 577–96, 623–26. Id. at 612–16. 104 Id. at 623–26. 105 Bainbridge, supra note 45, at 529. See also Blumberg, supra note 6, at 577–96. 106 See, e.g., Frank H. Easterbrook & Daniel R. Fischel, Limited Liability and the Corporation, 52 U. Chi. L. Rev. 89, 110–11 (1985). 107 See Petrin & Choudhury, supra note 1, at 788 (surveying these proposals); Skinner, supra note 44; Gwynne Skinner, Parent Company Accountability: Ensuring Justice for Human Rights Violations 24 (2015) (proposing a statute-based model that would allow courts to disregard the limited liability of parent corporations for claims of customary international human rights violations and serious environmental torts where a parent corporation holds a majority interest in or creates a subsidiary as part of a unified economic enterprise that operates in a ‘high-risk host country’); Anil Yilmaz Vastardis & Rachel Chambers, Overcoming the Corporate Veil Challenge: Could Investment Law Inspire the Proposed Business and Human Rights Treaty?, 67 Int’l & Comp. L.Q. 389 (2018) (proposing a model for veil-piercing for civil liability claims by victims of human rights harm inflicted by businesses that allows victims to claim against the parent company in a corporate group where the parent exerts ‘legal control’ over the subsidiary). 108 See, e.g., Henry Hansmann & Reinier Kraakman, Toward Unlimited Shareholder Liability for Corporate Torts, 100 Yale L.J. 1879, 1881, 1931–32 (1991); Nina A. Mendelson, A Control-Based Approach to Shareholder Liability for Corporate Torts, 102 Colum. L. Rev. 1203 (2002). 109 Witting, supra note 1, at 287–305. Witting’s proposal is expressly limited to personal injury claims. 110 Id. at 295–99. 102 103

Toward corporate group accountability  311 spreading the cost of such claims across the shareholders who benefitted from the corporate activity rather than concentrating it on innocent victims. However, it would impose significant risks on individual shareholders who are not the agents of the corporation. Due to information asymmetries, many shareholders may also be imperfectly informed of the nature and extent of the strict liability risk.111 A similar strict liability rule adopted by the Indian courts in the wake of the Bhopal disaster creates a presumption of parent liability for harms arising out of hazardous activities, the costs of which would indirectly be borne by the parent’s shareholders.112 An alternative proposed by Meredith Dearborn would extend joint and several liability for group affiliates of defendants in mass tort cases, in essence imposing strict ‘horizontal liability’, but would not abolish limited liability for parent shareholders.113 A more nuanced strict liability proposal by Petrin and Choudhury would extend group liability to traditional corporate groups in all tort cases so that claimants could reach any member of the group, but it would be triggered only once remedies against the direct defendant entity have been exhausted.114 As they point out, a key advantage of this proposal is that the prospect of vicarious liability would compel parent or controlling entities within the group to internalize costs and manage risk as part of the full cost of the group’s operations. Another advantage is that litigants and courts would not need to artificially attempt to link the harm to a particular affiliate of the entity responsible for the tort; the vicarious liability of the affiliate would be justified on the basis of its connection to the group and the policy rationale of internalizing to the group the costs associated with the benefits of group activity.115 Recognizing that this proposal would require clarity about the boundaries of the group itself, they suggest relying on statutory definitions of the holding company.116 Like Dearborn’s proposal, Petrin and Choudhury would preserve limited liability for individual shareholders in the group because of the concerns that liability exposure would unduly discourage investment. In addition to encouraging internalization of the costs of risks subsidiary operations within the group as a whole, creating exceptions to internal limited liability would encourage greater monitoring within the corporate group, discourage under-capitalization, and provide a remedy for claimants harmed by group members. However, these approaches do not adequately address network group structures, which would require different responses, as discussed below. Reaching network groups 2. Despite their many advantages, a key challenge to any expansion of group liability under the above proposals is that informal network structures are already ubiquitous and that expanding group liability may compel companies to restructure their operations to avoid the thresholds for ‘control’ or group identity, to transform subsidiaries into independent contractors, or oth111 Witting acknowledges these challenges but anticipates that the proposed rules would motivate risk-averse individuals to shift their investments to companies which engage in high-externality activities. Witting, supra note 1, at 294, 301–303. 112 Muchlinski, supra note 1, at 320–21 (citations omitted). 113 See generally Meredith Dearborn, Enterprise Liability: Reviewing and Revitalizing Liability for Corporate Groups, 97 Cal. L. Rev. 195 (2009). 114 Petrin & Choudhury, supra note 1, at 789–90. 115 Id. at 790. 116 Id. at 789. Petrin and Choudhury also urge the simultaneous adoption of a modified rule of vicarious liability for group networks, discussed below, that would not be based on equity ties.

312  Research handbook on corporate liability erwise avoid group identification. Group liability will be ineffective if it fails to take account of contractual or network relationships, supply chain relationships, and other arrangements involving independent contractors. One approach is to supplement one of the above proposals with specific solutions for network groups. For example, a proposal by Witting calls for the common law to recognize a new tort called ‘multiple entity recklessness’ that would provide a remedy for tort plaintiffs in personal injury cases when an insolvent tortfeasor is part of a corporate network or is an affiliate other than the parent of the insolvent entity. This tort would apply generally whenever a company ‘acts in a way which is objectively reckless in undertaking physical processes which give rise to significant risks of injury’.117 Liability would then extend beyond the tortfeasor on a joint and several basis on the basis of a coordinated relationship, that is, to companies that had ‘significant commercial relationships’ with the company that directly caused harm.118 These business partners or affiliates would also have a defense if they could show that they took preventative measures. Another proposal by Ulfbeck and Ehlers that would reach network groups would impose vicarious liability on upper-tier buyers for harm to employees of lower-tier suppliers on a strict liability basis analogous to traditional respondeat superior liability; this rule would be similarly justified on the basis of the buyer’s indirect control of the lower-tier employees’ responsibilities.119 Ulfbeck and Ehlers note that Poland and the Netherlands already extend this kind of ‘quasi-employer’ liability to independent contractors not under the direct control of an employer.120 Other commentators have argued in a similar vein that employer liability under the German Civil Code should extend to independent entities in the corporate group.121 The advantage of such proposals is that they hold the ultimate parent liable for suppliers’ wrongdoings without abolishing limited liability within the corporate group or attributing third party fault to the parent. Liability is instead based on the parent’s own duties of management and control that are already inherent in the legal group structure. Unlike the imposition of direct tort liability on group affiliates discussed above, this ‘quasi-employer’ liability is also not conditioned upon the parent’s ability to exercise, or actual exercise of, control over the subsidiary or supplier. Liability is instead assumed unless the parent can show that it fulfilled the legally required obligation of oversight and control, or the damage would have occurred even if this care had been exercised, in which cases it will be exculpated.122 Hence, this proposal Witting, supra note 1, at 389–94, 422. Id. at 392, 422. 119 See Vibe Ulfbeck & Andreas Ehlers, Tort Law, Corporate Groups and Supply Chain Liability for Workers’ Injuries: The Concept of Vicarious Liability, 13 Eur. Co. L. 167, 170–73 (2016). 120 Id. at 170. 121 See Schall, supra note 51, at 479, 489–500 (2018) (arguing that such vicarious liability would eliminate the need for specific due diligence regulation). § 831 German Civil Code provides: ‘(1) A person who uses another person to perform a task is liable to make compensation for the damage that the other unlawfully inflicts on a third party when carrying out the task. Liability in damages does not apply if the principal exercises reasonable care when selecting the person deployed and, to the extent that he is to procure devices or equipment or to manage the business activity, in the procurement or management, or if the damage would have occurred even if this care had been exercised. (2) The same responsibility is borne by a person who assumes the performance of one of the transactions specified in subsection (1) sentence 2 for the principal by contract’, https://​www​.gesetze​-im​-internet​.de/​englisch​_bgb/​englisch​_bgb​ .html​#p3510 122 Schall, supra note 51, at 498. 117 118

Toward corporate group accountability  313 not only encourages a hands-on approach, it also leads to a reversal of the burden of proof that will make it easier for involuntary plaintiffs to bring their claims, thereby addressing two of the major shortcomings of the group liability theories previously proposed. However, this approach still does not cover highly disaggregated corporate group structures, or situations where a plaintiff may want to hold an entity other than the ultimate parent responsible for the harm caused by another entity in the corporate group. A broader and more workable approach has also been proposed by Petrin and Choudhury, who recommend defining the extent of the group network based on the degree of economic, legal and operational integration among participants in the network.123 While permitting tort victims to hold any member of the network liable may not be justifiable, they argue such liability could attach if sufficient factors indicated a high degree of integration, as well as evidence that the conduct occurred within the scope of the coordinated activity. For example, they suggest that defining factors of the corporate group could include those proposed by Dearborn,124 namely ‘whether a company furthers the economic goals or business of another company/group, is functionally part of another company/group’s business, or serves the purpose of externalizing another company/group’s liability’.125 This solution would address the question of corporate network boundaries and provide for remedies from a broader range of defendants, perhaps in tandem with expanded direct liability as outlined above.

V.

CONCLUSION: TOWARD ACCOUNTABILITY FOR CORPORATE GROUPS

When we think of corporate power or corporate accountability, or indeed of ‘corporations’ or ‘firms’, we are really thinking of the largely transnational corporate groups that are the dominant contributors to economies worldwide. At the same time, the human costs of environmental degradation, climate change and human rights impacts that are not borne by corporate actors themselves point to the persistent inability of current legal regimes to reach corporate groups. Calibrating the rules that determine legal liability and creating incentives for greater corporate group accountability remain challenging, yet it is important to remember that the legal environment in which global corporate groups operate has also evolved in recent decades to meet these challenges. Business regulation itself is now to no small extent global in reach, encompassing ‘webs’ of public and private actors, rules and enforcement mechanisms that parallel to a significant extent the network nature of corporate groups.126 Despite the jurisdictional, procedural, structural and doctrinal limits this chapter has explored, corporate liability rules are only part of this broader regulatory landscape. Petrin & Choudhury, supra note 1, at 792. Dearborn, supra note 113, at 252–53. 125 They suggest, for example, the defining factors of the corporate group suggested by Dearborn, supra note 113, at 252–53; these include ‘whether a company furthers the economic goals or business of another company/group, is functionally part of another company/group’s business, or serves the purpose of externalizing another company/group’s liability’. Petrin & Choudhury, supra note 1, at 792–93. 126 See John Braithwaite & Peter Drahos, Global Business Regulation 24–26 (2000) (identifying the constellations of actors, principles and mechanisms that have emerged in response to globalization to better regulate transnational business). 123 124

314  Research handbook on corporate liability This chapter has identified a number of possible legislative solutions to the puzzle of corporate group liability, as well as new potential directions for the common law, that would offer remedies to involuntary tort claimants of corporate group affiliates. Most promising of these approaches are those that would respect the separate legal identity of the entities within the corporate group and would attempt to align the treatment of traditional corporate groups and more informal network or supply chain relationships. In particular, creating a legal obligation of due diligence could support direct liability by corporate group parent companies for the conduct of their subsidiaries and potentially for business partners within network groups. Extending existing theories of liability from internal tort claimants, namely employees, to other involuntary claimants would also preserve traditional entity-based liability rules in most cases, while offering necessary recourse for tort victims. Regardless of the path different jurisdictions take, emerging doctrines, private regulatory regimes and developments in international law are raising expectations of corporate accountability for large firms and promising new paths to reach that goal.

17. Liability in the shipping industry Martin Davies

I. INTRODUCTION Unravelling how liability works in the shipping industry is a complicated process with an unavoidably international dimension. Shipowners and ship operators have made an art out of organizing their businesses in such a way as to make it difficult to hold them personally liable for torts or breaches of contract. Some, but by no means all, of the sting of this artfulness is removed by the surprisingly comprehensive nature of the liability insurance coverage provided to ship operators.1 However, the fact remains that it can often be very difficult to determine which of the various entities involved in operating a commercial trading ship is liable for the many different types of damage or loss that can be caused by that ship, from damage to or loss of the cargo that it is carrying, to personal injury to passengers or crew, to damage to other ships or property in collisions, to pollution of the environment from oil spills and gas emissions into the air, and many other possibilities in between. The unique admiralty procedure of ship arrest seems, at first sight, to be a means by which claimants2 can cut through the dizzyingly complex corporate structures erected by potential defendants to get redress from the ship itself. As a result, the procedural requirements for ship arrest are integral to answering the question of how to allocate liability in the shipping industry. In the (many) countries of the common law world that derive their admiralty law from English law, it is still necessary for a claimant to identify the defendant who would be personally liable3 before a ship can be arrested and used as a source of compensation for the claimant’s loss. As a result, the corporate structures established by those associated with the operation of a trading ship assume considerable importance in determining whether a ship can be arrested to obtain security for, and ultimately satisfaction of, a claim in those countries. In contrast, the United States is unique in treating the ship as a legal person with an identity separate from that of its owners, which makes arrest far easier than it is in countries the admiralty law of which derives from that of England and Wales.4 The related but separate American procedure of admiralty attachment raises questions of personal liability similar to those raised in relation to arrest in English-heritage admiralty jurisdictions, but American courts are far

1 The relevant insurers (Protection and Indemnity Associations, or P&I Clubs) would no doubt protest that they are indemnity insurers, not liability insurers: the difference is explained in Section IV below. 2 This chapter will use the English term ‘claimant’ except when referring to procedures in the USA, Singapore, Australia or South Africa, where the term ‘plaintiff’ was used at time of writing. 3 ‘The person who would be liable in personam’ or ‘relevant person’, to use the technical terminology that will be explained below in Section III. 4 The parts of the Senior Courts Act 1981, c. 54 (UK) that deal with admiralty jurisdiction do not apply to Scotland. Admiralty actions in Scotland are governed by Court of Session Rules, Chapter 46, ‘Admiralty Actions’. The Scottish rules are not considered in this chapter.

315

316  Research handbook on corporate liability more willing to look behind the corporate veil to determine in personam liability than are their counterparts in English-heritage jurisdictions. In order to explain how liability works in the shipping industry, it is necessary first to give a thumbnail sketch of the legal and commercial arrangements that are used in the operation of trading ships. That is done in Section II. Then, it is necessary to explain the legal questions that must be answered in order for a claimant to seek redress from the ship itself, rather than trying to chase down any other assets of a distant, and often shadowy, defendant. That is done in Section III, which also explains the remarkable effectiveness in English-heritage jurisdictions of the legal structures established by shipping operators in an effort to avoid liability, thanks in large part to the stubborn unwillingness of admiralty courts in those jurisdictions to look behind the corporate veil. Section IV gives a brief description of insurance arrangements in relation to trading ships, which operate rather differently in the shipping industry than they do on land.

II.

THE CONTRACTS BEHIND A TRADING SHIP

The shipping industry is a prime example of the concept of division of labour. For each of the many different functions needed to operate a trading ship, there is usually a separate corporate entity created just to perform that particular function. To take an example that will presumably be familiar to non-specialist readers and which will remain topical for quite some time, the ship Ever Given, which blocked the Suez Canal for six days in 2021, causing considerable disruption to global supply chains, was not owned by the company whose name was prominently painted on its side. Evergreen, the Taiwanese operator of Ever Given, was a time charterer, an entity that does not have possession of the ship in the legal sense but is merely entitled to its ‘commercial disposition’. The ship was owned by a Japanese company, Shoei Kisen Kaisha, and was managed by a German-based ship manager, Bernhard Schulte Shipmanagement GmbH, which has ship management centres in nine different countries. The usual division of labour for a trading ship works in something like the following way, although there are an almost infinite number of permutations of the various contractual relationships. The principal and often only function of the shipowner (registered as such on the ship registry in the country where the ship is flagged) is ownership of the (often very valuable) capital asset of the ship itself. Because the actual profit-making operation of that capital asset is a very different thing from its ownership, with different requirements, operation is frequently devolved to others, who do not own the ship. The actual operation of the ship has two distinct aspects, also very different from one another: navigational operation, meaning the physical processes involved in arranging for the ship to be sailed around the world; and commercial operation, meaning the process of marketing the ship’s carrying capacity in order to find cargo for it to carry and, thus, to earn money. Those two very different functions are also usually performed by different entities. Navigational operation of a trading ship is often devolved to an entity called a demise (or bareboat) charterer, which arranges for provision of the master5 and crew and other naviga Although ‘master’ is a gendered term, it is an unavoidable term of art in maritime law, and so it will be used throughout this chapter. ‘Captain’ cannot be used as a gender-neutral synonym. ‘Captain’ denotes a qualification; ‘master’ denotes a role, a position of principal authority. For example, several 5

Liability in the shipping industry  317 tional essentials.6 A demise charterer has possession of the ship in the legal sense, much like a lessee of real property, and is responsible for matters such as its seaworthiness and navigational operation. (As can be seen from the arrangements in relation to Ever Given, some or all of the actual tasks of arranging for the physical operation of the ship are often delegated further to a ship manager.) Commercial operation of the ship is usually devolved to a time charterer – like Evergreen in relation to Ever Given – which finds work for the ship to do, dictating what cargoes it will carry and what ports it will visit. A time charterer does not have possession of the ship in the legal sense, but it does have the ‘commercial disposition’ of the ship, which means that it is given the right to earn income from customers who want to pay for the use of the ship’s cargo-carrying function. Thus, there is usually a chain of contracts in relation to the operation of a trading ship: the shipowner charters the ship for a period of time to the demise charterer in return for a daily hire fee; the demise charterer then charters the ship for a (perhaps different) period of time to the time charterer, also in return for a daily hire fee. The time charterer is given the contractual right to give orders to the ship’s master about where the ship should go, and what cargoes it should carry to what destinations, but the time charterer is not responsible for the physical execution of those orders. Thus, to focus for a moment on potential liability in tort, it is the demise charterer (or the shipowner if there is no demise charterer) which is the employer of the people navigating the vessel, not the time charterer, and so it is the demise charterer which is vicariously liable for any negligence of the crew in handling the ship or its cargo. The ship may look as though it belongs to and is operated by the time charterer, but that is simply a way of helping the time charterer to market the ship’s services. Evergreen, the time charterer, was given the contractual right to name Ever Given and to paint the ship in its colours, with its own name prominently on the ship’s side, so as to let any prospective cargo-owning customer know with whom it should deal when arranging for carriage of its goods on that ship, but it was not Evergreen’s employees who sailed the ship through the Suez Canal. In return for its payment of daily time charter hire, the time charterer is given the contractual right to keep the freight7 paid by cargo owners for carriage of their goods. In commercial terms, then, if the time charterer is to make a profit, it must find a sufficient number of cargo contracts to enable it to earn more by way of freight than it has to pay in charter hire. The demise charterer pays hire to the shipowner for the right to use the owner’s capital asset, but in return for arranging the navigational operation of the ship, it receives hire payments from the time charterer, preferably larger than those it has to pay to the shipowner. As already noted, there are many possible permutations of these arrangements. Not every ship is demise-chartered; the shipowner may operate the ship itself, providing the master and deck officers on a large ship may be qualified to call themselves ‘Captain’ but the ship can have only one master. 6 The ship is ‘demised’ to the charterer in the sense that possession is given to the charterer, which becomes ‘disponent owner’. Because the demise charterer must provide its own master and crew, such charters are sometimes called ‘bareboat’ charters, because the charterer charters the ‘bare boat’ without a master and crew. (Please note that in contexts other than this, it is regarded as heretical to call a ship a ‘boat’.) 7 Although the word ‘freight’ is often used in ordinary parlance to describe the cargo itself, it is technically the sum of money paid by the cargo-owner to the carrier for carriage of the cargo. Cargo-owners pay freight; time charterers pay hire.

318  Research handbook on corporate liability crew and other navigational requirements, and chartering the ship directly to a time charterer. For example, Ever Given appears to have been time-chartered directly from Shoei Kisen Kaisha to Evergreen, but it is difficult for an outside observer to be sure, because not all details of the operational charters on a ship are publicly available in the records on the ship’s register. Demise charters are often used for tax minimization purposes, as they serve to separate ownership of the capital asset from the flow of income earned by it, and they have also historically been used as a means of financing, with the lender retaining ownership of the capital asset and the borrower becoming demise charterer with the right to operate the ship without owning it.8 Depending on the shipowner’s tax and financing needs, it may not need to have a demise charterer interposed between it and the commercial operator, the time charterer. Equally, there may be (and frequently are) several time charters in relation to a single ship. Time charters are, in effect, a fairly crude form of futures contract. The time charterer pays a fixed daily rate of hire for the ‘commercial disposition’ of the ship for a period of time – a year, two years, five years (12 years in the case of Ever Given) – thereby guaranteeing the owner or demise charterer a fixed rate of return for that period, but depriving them of the ability to take advantage of any increases in the market hire rate. If the market hire rate goes up during the charter period, the time charterer can lock in a profit for the remainder of the charter period by sub-chartering the ship to another time charterer, which will then have the commercial disposition of the ship for the remainder of the period. The intermediate charterer receives hire from the sub-charterer but pays a lesser amount of hire to the owner or demise charterer, at the original rate agreed between them. The end result in a rising market is that a ship may have several intermediate charterers between those operating the ship and the eventual sub-charterer (or sub-sub-charterer) that has the right to give voyage orders to the ship’s master.9 This thumbnail sketch should suffice to make the point that ships are, in essence, joint venture vehicles.10 In other areas of commercial enterprise, firms with complementary capabilities often combine those capabilities to form cooperative joint ventures. When they do so, they often create a separate corporate entity to operate as the joint venture vehicle, which acts as the focus of the rights and obligations of the venture, and distributes profits among the venturers. That is exactly what a trading ship does, but without the existence of a separate corporate entity because the ship itself is the joint venture vehicle. The various charterers and managers make profits out of the ship’s operation, each contributing different but complementary functions. This all makes sense in the economic terms of the division of labour, but it raises obvious questions about the location of legal liability. To take an everyday example, what should

8 It should be noted that this financing structure is becoming much less common than it used to be, but the details of ship finance lie beyond the scope of this chapter. 9 For example, in Cactus Pipe & Supply Co Inc v. M/V Montmartre, 756 F.2d 1103, 1985 AMC 2150 (5th Cir. 1985), the ship was the subject of a demise charter, a time charter, a time sub-charter, and two other charters of a different kind, a voyage charter and a voyage sub-charter. Voyage charterers do not participate in the operation of the ship, but simply charter the ship’s capacity to carry cargo on a single voyage, so they are consumers of the ship’s services, not providers. In Cactus Pipe, 756 F.2d the voyage sub-charterer was four contractual steps removed from the demise charterer who employed the master and crew, and five steps removed from the shipowner, but the right to give voyage orders was delegated to it down the chain of charters. 10 This analogy is considered at some length in Martin Davies, In Defense of Unpopular Virtues: Personification and Ratification, 75 Tul. L. Rev. 337, 347–50 (2000).

Liability in the shipping industry  319 happen if cargo is damaged by mishandling during carriage? The contract of carriage may well have been made between the time charterer and its customer, the cargo-owner, but the damage was caused by employees or agents of the shipowner or demise charterer. To complicate matters further, the contract is often made by the time charterer merely as agent on behalf of the demise charterer or shipowner, a fact that is often not apparent to the cargo owner, which may believe that it contracted with the time charterer as the carrier in its own name because it is usually the time charterer’s name and logo that appear prominently on the contract document, the bill of lading or sea waybill, and the cargo owner makes payment to the time charterer, not to the shipowner or demise charterer.11 Nevertheless, the contracting carrier may be held to be the shipowner or demise charterer, despite initial appearances.12 Identifying the right defendant may be difficult to determine from the position of the cargo-owner claimant, which does not have ready access to the details of the web of contractual relationships involved in the operation of the ship on which its cargo is to be carried. To make matters worse from the claimant’s point of view, it must choose the right defendant before it brings proceedings, with only limited access to discovery at that point, and usually within a short, unforgiving, limitation period of one year.13 As noted above, the often difficult task of identifying the right person to sue seems to be made much easier by the possibility of suing the ship itself in rem. The procedural requirements for doing that are the focus of the next section of this chapter.

III.

PROCEEDING AGAINST THE SHIP ITSELF

Even if the legal person that would be personally liable for a claimant’s claim can be identified among the plethora of charterers and sub-charterers involved in operating a trading ship, it may be difficult to establish personal jurisdiction over that person if they are located in a country far away,14 and even if personal jurisdiction can be established, a victory for the claimant may prove Pyrrhic if the defendant has no assets that can be reached easily to satisfy 11 See, e.g., Homburg Houtimport BV v. Agrosin Pte Ltd (The Starsin) [2003] UKHL 12, [2004] 1 AC 715 [hereinafter The Starsin]. 12 See, e.g., The Berkshire [1974] 1 Lloyd’s Rep. 185; W & R Fletcher (New Zealand) Ltd v. Sigurd Haavik Aksjeseskap (The Vikfrost) [1980] 1 Lloyd’s Rep. 560; Ngo Chew Hong Edible Oil Pte Ltd v. Scindia Steam Navigation Co Ltd (The Jalamohan) [1988] 1 Lloyd’s Rep. 443; Fetim v. Oceanspeed Shipping BV (The Flecha) [1999] 1 Lloyd’s Rep. 612. Note, however, that it was held in The Starsin, [2003] UKHL 12 that there must be some indication on the face of the bill of lading or sea waybill that the time charterer is not issuing the contract in its own name. 13 The limitation period for cargo claims is one year under national enactments of the International Convention for the Unification of Certain Rules of Law relating to Bills of Lading (the Hague-Visby Rules), Feb. 23, 1968. See, e.g., Carriage of Goods by Sea Act 1971, c. 19, Sch., Art III ¶ 6 (UK); Carriage of Goods by Sea Act Statutory Note, § 3(6), 46 U.S.C. § 30701. Other claims may, of course, have different limitation periods. 14 In the UK and Commonwealth countries, ‘long arm’ personal jurisdiction over foreign defendants is established by service of originating process outside the country, but in the US it is subject to constitutional restrictions based on the guarantee of due process, which have been interpreted with increasing conservatism in recent years, shrinking the scope of personal jurisdiction in the USA. See Goodyear Dunlop Tires Operations SA v. Brown, 564 U.S. 915, 131 S. Ct. 2846 (2011); Daimler AG v. Bauman, 517 U.S. 117, 134 S. Ct. 746 (2014); Bristol-Myers Squibb Co v. Superior Court of California, San Francisco County, 137 S. Ct. 1773 (2017).

320  Research handbook on corporate liability the judgment. For centuries, maritime countries around the world have solved those twin problems by allowing claimants to ask the court to seize a ship owned by the legal person who would be personally liable. Unless the defendant chooses simply to abandon the ship that has been seized within the jurisdiction,15 the defendant must appear before the court and give security for the claim in order for the ship to be released to go on trading, which is usually a commercial imperative. The ability to proceed in rem against a ship and to have it arrested to obtain the defendant’s appearance and security for the claim is a very powerful weapon in the claimant’s arsenal, particularly because in most countries the claimant does not have to provide counter-security for any losses suffered by the defendant as a result of the arrest if the claim turns out to be unsuccessful.16 Thus, a claimant with a claim for $100,000 may arrest a ship worth $10 million, and so keep it from trading until an appearance is made and security is given, without fear of being held responsible for any of the ship operator’s losses if the claim proves to be unsuccessful.17 A very important feature of liability in the shipping industry is that in most countries courts can exercise admiralty jurisdiction over any maritime claim, no matter where in the world it arises, and whether or not the claim has any connection with the country in which the court is situated. Thus, for example, the Senior Courts Act 1981 (UK) provides that the High Court of England and Wales has jurisdiction over maritime claims ‘in relation to all ships … whether British or not … and wherever the residence or domicile of their owners may be, in relation to all claims, wherever arising’.18 There are similar provisions in the admiralty legislation in many other common law countries,19 with the practical result that a claimant may pursue an in rem claim against a ship wherever in the world that ship can be found. Obviously, this makes an internationally comparative analysis of admiralty procedures a matter of immediate practical concern, rather than merely one of solely academic interest. It is in in rem actions of this kind that the structures of liability in the shipping industry are seen in the starkest relief. There is a fundamental difference between how ship arrest is conceived in countries the admiralty law of which is based on that of England and Wales, and how it is conceived in the United States. Both views will be outlined next, to be followed by This does occasionally occur in practice when the total of claims against a ship exceeds its value. See NatWest Markets plc (formerly known as The Royal Bank of Scotland plc) v. Stallion Eight Shipping Co SA (The Alkyon) [2018] EWCA (Civ 2760), [2019] QB 969. A few countries, notably China, do require a claimant to give counter-security, but they are the exception rather than the rule. See Haishi Susong Tebiechengxu Fa (海事诉讼特别程序法) [Special Maritime Procedure Law of the People’s Republic of China] (promulgated by Standing Comm. of the Nat’l People’s Cong., Dec. 25, 1999, effective Jul. 1, 2000) art. 76, https://​flk​.npc​.gov​.cn/​detail2​.html​?MmM​5MDlmZGQ2N​ zhiZjE3OTA​xNjc4YmY2M​GExYjAyM2Y​%3D; Zuigao Renmin Fayuan Guanyu Kouya Yu Paimai Chuanbo Shiyong Falu Ruogan Wenti De Guiding, Fashi [2015] 6 号 (最高人民法院关于扣押与拍卖 船舶适用法律若干问题的规定, 法释【2015】6 号) [Supreme People’s Court Judicial Interpretation No 6 on Ship Arrest and Judicial Sale of Ships] (2015), arts. 4, 5. 17 Sir Bernard Eder, Wrongful Arrest of Ships: A Time for Change, 38 Tul. Maritime L.J. 115, 123 (2013). The claimant is only responsible for damages for wrongful arrest if the in rem claim was brought in bad faith (mala fides) or as the result of gross negligence (crassa negligentia). See id. at 117–18, citing The Evangelismos (1858) 12 Moo PC 352, 359; 14 ER 945 (PC). 18 Senior Courts Act 1981, c. 54, § 20(7)(a), (b) (UK). 19 See, e.g., High Court (Admiralty Jurisdiction) Act 1961, c. 123 § 3(4) (Sing.); High Court Ordinance, c. 4 § 12A(7) (H.K.); Admiralty Act 1988 (Cth) § 5 (Austl.); Admiralty Act 1973 § 4(4) (NZ); Admiralty Jurisdiction Regulation Act 105 of 1983 § 2(1) (S. Afr.); Federal Courts Act, R.S.C. 1985, c F-7 § 22(3) (Can.). 15 16

Liability in the shipping industry  321 a consideration of the law in South Africa, which has a unique approach to holding ships liable for the damage that they cause. A.

The English-heritage Procedure

In countries with admiralty legislation derived from that in England and Wales, two questions of very different kinds arise when the court’s in rem jurisdiction is invoked in a claim arising in connection with the ship that the claimant seeks to arrest. First, it is necessary to identify what the legislation calls ‘the relevant person’, which is the person who would be liable on the claim in personam. In relation to that question, it suffices that the claimant merely alleges a claim of a kind that would fall within a statutory list of admiralty claims20 if all the facts were as alleged by the claimant. That is because the relevant legislation in English-heritage systems defines the ‘relevant person’ as the person who would be liable in personam, not the person who is liable in personam.21 Thus, the plaintiff need not prove that it has a prima facie case for its alleged claim, but merely that it has alleged a claim of the right kind.22 In contrast, the legislation states that an action in rem is permitted only if the ‘relevant person’ was the owner, charterer, or in possession or control of the ship when the cause of action arose, and is the beneficial owner (or demise charterer) when the action is commenced.23 That requires the claimant to prove the ‘jurisdictional fact’ of the requisite ownership connection on the balance of probabilities.24 The inquiry raised by the definition of ‘relevant person’ is a conditional one, based on hypothetical liability, whereas the inquiry raised by the question of the ownership connection is an unconditional one, concerned with facts that need to be established.25 The second, unconditional, question is one of jurisdictional fact, and must be established like any other fact.

The types of claim that give access to the special procedure of ship arrest are listed in: Senior Courts Act 1981 § 20(2) (UK); High Court (Admiralty Jurisdiction) Act 1961 § 3(1) (Sing.); High Court Ordinance § 12A(2) (HK); Admiralty Act 1988 (Cth) §§ 4(2), (3) (Austl.); Admiralty Act 1973 § 4(1) (NZ); Admiralty Jurisdiction Regulation Act 1983 § 1(1)(ii) (S. Afr.); Federal Courts Act § 22(2) (Can.). 21 Senior Courts Act 1971 § 21(4)(b) (U.K.); High Court (Admiralty Jurisdiction) Act § 4(4)(b) (Sing.); High Court Ordinance § 12B(4)(b) (HK); Admiralty Act 1988 (Cth) § 3 (Austl.) (definition of ‘relevant person’); Admiralty Act 1973 § 5(2)(b) (NZ). The Canadian legislation does not use the language of ‘relevant person’ and it provides that in rem action is possible only if the beneficial owner of the ship at the time the cause of action was commenced was also beneficial owner at the time the cause of action arose. Federal Courts Act § 43(3) (Can.). 22 Schwarz & Co (Grain) Ltd v. St Elefterio ex Arion (Owners) (The St Elefterio) [1957] P 179 (EWHC); The Moschanthy [1971] 1 Lloyd’s Rep. 37 (QB (Admlty)); Owners of the Motor Vessel Iran Amanat v. KMP Coastal Oil Pte Ltd (The Iran Amanat) [1999] HCA 11, (1999) 196 CLR 130, 161 ALR 434 (Austl.); Kingstar Shipping Ltd v. Owners of the ship Rolita (The Rolita), [1989] 1 HKLR 394 (C.A.); Equatorial Marine Fuel Management Services Pte Ltd v. The Bunga Melati 5 [2012] SGCA 46, [2012] 4 SLR 546; The Vinalines Pioneer [2016] SGHC 278, [2016] 1 SLR 448 ¶¶ 74–75 (Belinda Ang Saw Ean J). 23 Senior Courts Act 1981, § 21(4)(b)(i) (UK); High Court (Admiralty Jurisdiction) Act § 4(4)(b) (i) (Sing.); High Court Ordinance § 12B(4)(b)(i) (H.K.); Admiralty Act 1988 (Cth) § 17(a), (b) (Austl.); Admiralty Act 1973 § 5(2)(b)(i) (N.Z.); Federal Courts Act § 43(3) (S. Afr.). 24 Owners of Shin Kobe Maru v. Empire Shipping Inc [1994] HCA 54, (1994) 181 CLR 404, 426 (Mason CJ, Brennan, Deane, Dawson, Toohey, Gaudron and McHugh JJ). 25 The Iran Amanat, [1999] HCA 11 ¶ 18 (Gleeson CJ, McHugh, Gummow, Kirby and Hayne JJ). 20

322  Research handbook on corporate liability As well as arresting the ship in relation to which the claim arose, it is possible for the claimant to arrest another ship in the same ownership, as surrogate for the wrongdoing ship.26 This possibility was first created by the international Arrest Convention of 1952,27 which has been adopted in many countries. An action in rem against a surrogate ship is permitted if the ‘relevant person’ was the owner, charterer, or in possession or control of the wrongdoing ship when the cause of action arose, and is the beneficial owner of the surrogate ship when the action is commenced.28 One consequence of these procedural requirements should be clear immediately: if the ‘relevant person’ for the claim in question (the person who would be liable for that claim in personam) is the time charterer of the ship (like Evergreen in relation to Ever Given), the ship cannot be arrested for that claim. In such cases, the first procedural requirement is satisfied, but the second is not, as the time charterer is not the beneficial owner. There is ample authority for the proposition that, for the purpose of the second question of jurisdictional fact, the ‘beneficial owner’ of a ship is the person who has the right to sell, dispose of or alienate all the shares in that ship,29 also described as the person who has the power to have and dispose of dominion, possession and enjoyment of the ship.30 The legal person registered as owner on the relevant registry of ships is not necessarily the beneficial owner.31 In deciding questions of beneficial ownership in this context, admiralty courts in English-heritage systems have displayed a remarkable devotion to the concept of separate corporate personality and an unwillingness to look behind the corporate veil except in cases of fraud. One of many possible examples should suffice to make the point. It also illustrates the kind of difficult international paper trail that claimants must often follow in maritime cases. In The Skaw Prince,32 two ships, Skaw Prince and Skaw Princess, were each owned by a Liberian company: Skaw Prince by Corsair and Skaw Princess by Filey.33 Corsair and Filey each issued

This is often referred to as ‘sister ship arrest’, terminology that is actually inaccurate, as well as being anachronistically gendered. Technically, a ‘sister ship’ is a ship of the same design and build as the wrongdoing ship. A surrogate ship is any ship, of whatever kind, that is owned by the same shipowner. The Australian legislation uses the term ‘surrogate ship’. Admiralty Act 1988 (Cth) § 19. 27 International Convention Relating to the Arrest of Sea-Going Ships art. 3, May. 10, 1952, 439 U.N.T.S. 193. 28 Senior Courts Act 1981 § 21(4)(b)(ii) (UK); High Court (Admiralty Jurisdiction) Act § 4(4)(b)(ii) (Sing.); High Court Ordinance § 12B(4)(b)(ii) (H.K.); Admiralty Act 1988 (Cth) § 19(a), (b) (Austl.); Admiralty Act 1973 § 5(2)(b)(ii) (NZ); Federal Courts Act § 43(8) (Can.). Note that only in New Zealand is it sufficient to be demise charterer of the surrogate when the action is commenced; all other jurisdictions cited require the relevant person to be beneficial owner of the surrogate. 29 The Pangkalan Susu/Permina 3001 [1977] SGCA 5, [1977–78] SLR(R) 105 ¶ 9 (Sing.); The Ohm Mariana, ex Peony [1993] SGCA 43, [1993] 2 SLR(R) 698 ¶ 35 (Sing.); The Min Rui [2016] SGHC 183 ¶ 52 (Belinda Ang Saw Ean J) (Sing.); Kent v. Vessel SS Maria Luisa (No 2) [2003] FCAFC 93, (2003) 130 FCR 12 ¶ 61 (Tamberlin and Hely JJ) (Austl.); Ship Gem of Safaga v Euroceanica (UK) Ltd [2010] FCAFC 14, (2010) 182 FCR 27 ¶ 15 (Besanko J) (Austl.); Shagang Shipping Co Ltd v. Ship Bulk Peace [2014] FCAFC 48, (2014) 314 ALR 230 [20] (Allsop CJ) (Austl.). 30 Tisand Pty Ltd v. Owners of the Ship MV Cape Moreton (ex Freya) [2005] FCAFC 68, (2005) 143 FCR 43 ¶ 147 (Ryan and Allsop JJ) (Austl.). 31 Id. at ¶ 92. 32 The Skaw Prince [1994] 3 SLR(R) 146 (Sing.). 33 The description of the shipowning arrangements in this and subsequent sentences is taken from id. at ¶¶ 7, 9. 26

Liability in the shipping industry  323 only one bearer share; both shares (and, thus, both companies) were owned by a Norwegian company named Pontina. Pontina was in turn wholly owned by a Swedish company named Skaw Shipping A/B. The two ships were mortgaged to a Norwegian bank under a mortgage agreement under which Skaw Shipping A/B was the borrower. The loan agreement between Skaw Shipping A/B and the mortgagee bank was signed on behalf of Skaw Shipping A/B, Corsair and Filey by one Per Olav Karlsen, who was a director of all three companies. Karlsen ‘was involved in every level of control in Corsair, Filey, Pontina, Skaw Shipping A/B and [the ships’ manager]’.34 There was no evidence that Corsair, Filey or Pontina participated in any financial or operational decisions in relation to Skaw Prince and Skaw Princess. Nevertheless, in the High Court of Singapore, Amarjeet Singh, JC held that Skaw Prince could not be arrested as a surrogate for the alleged liability of Skaw Princess on the basis that Skaw Shipping A/B was the beneficial owner of both ships. Amarjeet Singh, JC refused to lift (or pierce) the corporate veil, largely because there was no evidence that the corporate structure was being used as a vehicle for fraud:35 [T]he legal structure of the Skaw group of companies was all already in place long before the charterparty was entered into by the [plaintiffs] with Corsair. Any argument by the [plaintiffs] of the fact of the Skaw Princess and Skaw Prince being in the registered ownership of Corsair and Filey as not precluding the court from applying the principles of equity and trust on the evidence in this case and coming to the conclusion that Corsair and Filey were in reality the trustees of the two ships for the benefit of Skaw Shipping A/B of necessity meant nothing more than an invitation that I should lift the corporate veil, [and] embark on a wide ranging inquiry by examining the structure and arrangements of the various existing companies under the Skaw group.

To paraphrase this conclusion in rather brutal terms, the legal structure of the Skaw group of companies had not been set up to defraud this particular claimant, as it had been set up to defraud (or at the very least, mislead or befuddle) all possible claimants. As is obvious from this example, the widespread practice of setting up ‘one-ship companies’, each wholly owned by some form of holding company, is usually completely effective to insulate ships from the possibility of surrogate ship arrest in systems that derive their admiralty law from England and Wales. B.

The United States

The American doctrine of personification treats the ship itself as a legal person, capable of acquiring legal obligations separately from its owner, even when the owner would not be personally liable.36 That aspect of the doctrine is often criticized, even within the United States, as taking the fiction of the separate legal personality of the ship too far.37 Nevertheless, there is much to be said for the doctrine, which effectively treats the ship as the joint venture vehicle to which liability is attached, leaving it to the joint venturers to determine how the resultant Id. at ¶ 9(e) (per Amarjeet Singh JC). Id. at ¶ 17. 36 Davies, supra note 10. 37 See, e.g., Grant Gilmore & Charles L Black Jr, The Law of Admiralty § 9-18, 615–16 n.75 (2d ed. 1975); David M. Collins, Comments on the American Rule of In Rem Liability, 10 Maritime. Law. 71, 90 (1985); George K. Walker, The Personification of the Vessel in United States Civil In Rem Actions and the International Law Context, 15 Tul. Maritime. L.J. 177, 243 (1991). 34 35

324  Research handbook on corporate liability loss should be allocated among them.38 It is no more absurd to regard a ship, which can itself cause great physical and economic harm, as a legal person separate from its owner (even a sole owner) than it is to regard the mental abstraction that is a corporation as a legal person separate from the person or people (corporate or natural) who own it.39 Personification of a ship and corporate personality are equally fictitious but equally useful in legal terms. Thus, for purposes of ship arrest in the United States, it is not necessary to identify the entity (the legal person) that would be liable in personam, provided that the ship itself can be found and seized within the jurisdiction. That obviously has profound significance for claimants seeking redress. For example, where a time charterer of the ship is the person who would be liable for a claim in personam, the ship can nevertheless still be arrested in the United States if it is the ship on which the claim arose because the ship itself is regarded as the legal person responsible for the claim in question.40 In contrast, as we have seen above, the ship could not be arrested in English-heritage jurisdictions in such a case, because the person that would be liable in personam would not be the beneficial owner of the ship. The doctrine of personification frees American admiralty law (and claimants in admiralty) from the need to unravel the web of contracts associated with a trading ship to identify the appropriate in personam defendant. Another consequence of the doctrine of personification is that there is no surrogate ship arrest in the United States. Only the wrongdoing ship itself can be sued in rem and arrested as the personified defendant; no other ship can be held responsible for the wrongdoing ship’s liabilities. However, it may be possible to obtain judicial seizure of other assets owned by the person who would be liable in personam using the related procedure of admiralty attachment. The procedure for ship arrest is set out in Rule C of the Supplemental Admiralty Rules of the Federal Rules of Civil Procedure; the procedure for attachment is set out in Supplemental Admiralty Rule B. For that reason, American maritime lawyers usually use the shorthand terms ‘Rule C arrest’ and ‘Rule B attachment’. Rule B attachment is available in an in personam action against the shipowner in the admiralty jurisdiction. Obviously, therefore, it is necessary under Rule B to identify the legal person who would be liable in personam. If a defendant is sued in personam in an admiralty claim, then any of its property, ‘tangible or intangible’, that is found within the federal judicial district where the claim is brought can be attached under Rule B if the defendant itself cannot be found within that district. Thus, it is possible to attach (rather than arrest) another ship in the same ownership as the wrongdoing ship, but it is also possible to attach any other property of the defendant, ‘tangible or intangible’, and to garnish debts owed to the defendant, including bank accounts. Although ship arrest and attachment look identical on the waterfront – both involve a court officer immobilizing a ship by service of court process – there are crucial conceptual differences between them. As we have already seen, identification of the person who would be liable in personam (the ‘relevant person’ in the terminology used in English-heritage jurisdictions) is essential in Rule B attachment but not Rule C arrest. There is a rich jurisprudence about alter egos and corporate personality in the case of Rule B attachment. Property of one kind or another that is situated in the United States is often attached Davies, supra note 10, at 340–41. Id. 40 See, e.g., Cactus Pipe & Supply Co Inc v. M/V Montmartre, 756 F.2d 1103, 1985 AMC 2150 (5th Cir. 1985). 38 39

Liability in the shipping industry  325 under Rule B on the basis that it is really owned by someone other than its apparent owner.41 This question is essentially similar to the ‘beneficial owner’ inquiry in English-heritage jurisdictions, but it is subjected to a much more searching examination than is evident in those jurisdictions, with their stubborn resistance to looking behind the corporate veil. To use a fairly recent example, in D’Amico Dry d.a.c. v Nikka Finance Inc,42 the plaintiff attached the ship Sea Glass II, owned by the defendant, Nikka Finance, which the plaintiff claimed was an alter ego of a judgment debtor (Primera) that owed the plaintiff millions of dollars as a result of a judgment of the High Court of England and Wales. The US District Court for the Southern District of Alabama concluded that the attachment was appropriate because Nikka Finance was an alter ego of Primera. The Court applied the Eleventh Circuit’s multi-factor alter ego test,43 which considers whether: (a) the parent and the subsidiary have common stock ownership; (b) the parent and the subsidiary have common directors or officers; (c) the parent and the subsidiary have common business departments; (d) the parent and the subsidiary file consolidated financial statements and tax returns; (e) the parent finances the subsidiary; (f) the parent caused the incorporation of the subsidiary; (g) the subsidiary operates with grossly inadequate capital; (h) the parent pays the salaries and other expenses of the subsidiary; (i) the subsidiary receives no business except that given to it by the parent; (j) the parent uses the subsidiary’s property as its own; (k) the daily operations of the two corporations are not kept separate; and (l) the subsidiary does not observe the basic corporate formalities, such as keeping separate books and records and holding shareholder and board meetings.44 The court concluded that the identities of the two entities, Nikka and Primera, were so blurred that they should be treated as one.45

41 Recall that Rule B attachment is only permissible if the in personam defendant is not found within the jurisdiction. If the defendant is not present, but some of its property is, someone within the jurisdiction must necessarily be in possession of the property. Rule B refers to that person as the ‘garnishee’ and it is the garnishee who is served with the court’s order to attach (i.e., seize or freeze) the asset. This may be a bank, in the case of attachment of a bank account, the master of a ship, in the case of ship attachment, or whoever else has possession of the attached property. The key point to understand is that the garnishee is not party to the proceedings. In alter ego cases, the garnishee has possession of property belonging to one entity; the plaintiff seeking to attach that property argues that the entity that apparently owns the attached property is really the alter ego of the true defendant (not found within the district). 42 D’Amico Dry d.a.c. v. Nikka Finance Inc, 429 F. Supp. 3d 1290, 2019 AMC 1268 (S.D. Ala. 2019). 43 Other US federal circuits use different tests emphasizing different factors. For a description of some of the tests in other circuits, see Martin Davies, The Future of Ship Arrest, in The Arrest Conventions: International Enforcement of Maritime Claims 307, 313–4 (Paul Myburgh ed., 2019). 44 The US Court of Appeals for the Eleventh Circuit adopted what it called this ‘laundry list’ of criteria in a non-maritime case, United Steelworkers of America, AFL-CIO-CLC v. Connors Steel Co, 855 F.2d 1499, 1505 (11th Cir. 1988), but they were applied by the court in D’Amico Dry, 429 F. Supp. 3d as part of federal maritime law. 45 Nikka Finance eventually abandoned an appeal from this decision, thus bringing an end to a saga of litigation in various US courts that began in 2014, in which the plaintiff tried to attach the property of various alleged alter egos of Primera: see Robert Force & Martin Davies, US Maritime Law 2020, in 2021 International Maritime and Commercial Law Yearbook 177, § 320 (Francis D. Rose ed., 2021).

326  Research handbook on corporate liability The willingness of US courts in Rule B cases to focus ‘on reality and not form, on how the corporation operated and the individual defendant’s relationship to that operation’46 is markedly different from the position in the English-heritage jurisdictions. It is very likely that a court engaging in the kind of analysis conducted in D’Amico Dry would have allowed attachment of Skaw Prince47 on the basis that the ostensible owner of Skaw Princess, Filey, was the alter ego of Corsair, the owner of Skaw Prince, because both were alter egos of Skaw Shipping A/B. An even more sceptical view of corporate personality and ownership structures can be found in the unique provisions of South African law, which are considered next. C.

South Africa

As well as allowing arrest of ships in the same ownership as the wrongdoing ship,48 South African law allows arrest of what the admiralty legislation calls ‘associated ships’. The Admiralty Jurisdiction Regulation Act 1983 of South Africa allows arrest of another ship that is owned, at the time when the action is commenced, by a person who controlled the company that owned the ship concerned when the maritime claim arose,49 or a ship that is owned by a company that is controlled by a person who owned the ship concerned, or controlled the company which owned the ship concerned, when the maritime claim arose.50 Put more simply (although perhaps only a little more simply), if Ship A is the ship in relation to which the claim arose, Ship B can be arrested as an ‘associated ship’ if: (1) Ship B is owned at the time of arrest by the legal person who controlled the company that owned Ship A at the time the cause of action arose; (2) Ship A was owned at the time the cause of action arose by the person who controls the company that owns Ship B at the time of arrest; or, perhaps most significantly; (3) Ship A and Ship B are owned by companies that are controlled by the same person – Ship A at the time the cause of action arose, and Ship B at the time of the arrest. A person (including a juristic person such as a company) is deemed to control a company if he/she/it has power, directly or indirectly, to control the company.51 Thus, to make a perhaps obvious point, Skaw Prince and Skaw Princess would clearly be regarded as ‘associated ships’ under the South African legislation because each ship was owned by a company controlled by Skaw Shipping A/B and/or Karlsen. South Africa adopted the ‘associated ship’ procedure in 1983 because of the ease with which the surrogate ship procedure envisaged by the international Arrest Convention of 1952 could be circumvented by the device of the one-ship company,52 and it amended the legislation in 1992 to plug gaps in order to make the procedure work even more effectively.53 As Hilton

46 Flame SA v. Freight Bulk Pte Ltd, 807 F.3d 572, 587, 2015 AMC 2705 (4th Cir. 2015), quoting Vitol v. Primerose Shipping Co Ltd, 708 F.3d 527, 2013 AMC 648 (4th Cir 2013) (internal quotation marks omitted). 47 See supra notes 32–35 and accompanying text. 48 Admiralty Jurisdiction Regulation Act 1983 § 3(7)(a)(i) (S. Afr.). 49 See id. at § 3(7)(a)(ii). 50 See id. at § 3(7)(a)(iii). 51 Id. at § 3(7)(b)(ii). 52 John Hare, Shipping Law and Admiralty Jurisdiction in South Africa §§ 2.0–2.6 (2d ed. 2009). 53 The 1992 reforms are considered in Hilton Staniland, Ex Africa Semper Aliquid Novi: Associated Ship Arrest in South Africa, Lloyd’s Maritime & Com. L.Q. 561 (1995).

Liability in the shipping industry  327 Staniland pointed out after the 1992 amendments, the South African notion of surrogate ship arrest does not merely look behind the corporate veil if that veil is being used as ‘a device, stratagem or a sham to mask the effective carrying on of a business’, but rather it ‘shred[s] the veil in all cases’,54 because it is not concerned with the detailed questions about control, capitalization and operations that typify the American Rule B alter ego inquiry but merely assumes that where there is smoke there is fire.

IV.

INSURANCE ARRANGEMENTS

Establishing liability against any defendant in any walk of life is often illusory if the defendant has no insurance to cover the liability in question. Insurance cover against liability in the shipping industry is remarkably generous and far-reaching, with the result that liability is generally only uninsured if the defendant shipowner or operator is insolvent. Shipowners buy first-party insurance from commercial insurers to cover the risk of loss of or damage to the ship itself. That kind of insurance, generally known as ‘hull and machinery’ insurance, is often placed with syndicates at Lloyd’s of London. In contrast, insurance against liabilities incurred while operating a ship is obtained, on a very different basis, from mutual self-insurance associations that are formally known as Protection and Indemnity Associations, but which are generally referred to as P&I Clubs. In P&I Clubs, shipowners pool their funds to insure themselves on a mutual basis against a very wide range of liabilities. P&I Clubs are not-for-profit insurers owned by the shipowner members which contribute to the insurance pool. Technically, the Clubs provide indemnity insurance rather than liability insurance, because each Club has a ‘pay to be paid’ rule, requiring the member (the shipowner) to discharge any liability itself before seeking indemnity from the Club.55 In practice, however, the Club often takes over control of the handling of a claim and may settle directly with the claimant.56 Most Clubs also offer specific charterers’ liability cover, designed to cover those aspects of liability for which the charterer’s exposure may be different from that of the shipowner.57 The 13 major P&I Clubs have formed the International Group of P&I Clubs, which asserts that it provides insurance cover for liabilities for about 90 per cent of the world’s ocean-going tonnage.58 The International Group pools among all of its member Clubs any liabilities that exceed the amount of the agreed retention of any individual Club (presently $10 million) and arranges commercial reinsurance for the pooled liabilities.59 In essence, any shipowner who has a ship entered in one of the P&I Clubs is both an insured and a co-insurer, which leads to the result, perhaps not surprisingly, that the range of liabili-

Id. at 570. See, e.g., UK P&I Club, Rulebook 2023, Rule 5(A), https://​www​.ukpandi​.com/​media/​files/​uk​-p​ -i​-club/​rules/​2023/​rulebook​-2023​.pdf [hereinafter Rules 2023]. See generally Steven J. Hazelwood & David Semark, The ‘Pay to be Paid’ Rule, in P&I Clubs: Law and Practice 335 (4th ed. 2010). 56 Hazelwood & Semark, supra note 55, at § 20.7. 57 See, e.g., UK P&I Club, Charterers’ Terms and Conditions 2021, https://​www​.ukpandi​.com/​ -/​media/​files/​uk​-p​-and​-i​-club/​charterers​-and​-traders/​charterers​-terms​-and​-conditions​-2021​.pdf. See generally Hazelwood & Semark, Charterers’ P&I Cover, in P&I Clubs: Law and Practice, supra note 55, at 373. 58 About the International Group, Internat’l Group of P&I Clubs, https://​www​.igpandi​.org/​about. 59 Id. 54 55

328  Research handbook on corporate liability ties covered in most Club Rules is very broad, and the exceptions to coverage are few.60 For example, Clubs in the International Group typically provide insurance against fines imposed on shipowner members for pollution of the environment or breach of customs or immigration laws,61 despite the fact that insurance against fines is traditionally regarded as being contrary to public policy. As well as the long list of covered liabilities, the Club rules typically also include an ‘omnibus rule’, which provides that the Members’ Committee may, at its discretion, agree to indemnify a member for any liability not otherwise covered by the Club rules.62 The breadth and depth of P&I insurance cover – the maximum cover available from the International Group pool and collective reinsurance arrangements is presently US$3.1 billion per single incident63 – are an important part of the overall picture of liability in the shipping industry. In combination, that breadth and depth mean that very few liabilities that could possibly be incurred as a result of operating a trading ship are not covered in full by insurance. The principal exception to complete insurance cover occurs when the shipowner has become insolvent – or, indeed, is even approaching or contemplating insolvency. Because of the mutuality concept that is such a fundamental part of the nature of P&I insurance, Club rules typically provide that cover shall cease in the event of the insolvency (or threatened or contemplated insolvency) of a member,64 the underlying reason being that, if the member can no longer contribute financially to the mutual pool, it should no longer be able to ask for protection from the pool. If a shipowner’s P&I Club cover is lost because of actual or impending insolvency, a claimant’s principal (and perhaps only) possible source of security for its claim is the ship in relation to which the claim arose. When in rem proceedings are brought or threatened against a ship operated by a solvent shipowner, the shipowner usually obtains release of the ship from arrest or averts actual arrest by giving security for the claim in the form of a letter of undertaking from the P&I Club in which the ship is entered.65 If the shipowner is (or may become) insolvent, the Club will not provide security on the shipowner’s behalf so as to prevent or terminate arrest, with the result that the claimant’s in rem proceedings may lead to an actual and con-

60 For example, Rule 2 of the UK P&I Club, Rules 2023, supra note 55, contains sections covering 26 different kinds of liability, but Rule 5 contains only five true exclusions, most of which are concerned with excluding risks covered by other insurers, such as hull and machinery or war risk cover. 61 See, e.g., id. at Rule 2, Section 22. 62 See, e.g., Assuranceforeningen Gard, Gard Rules 2021, Rule 2.5, https://​www​.gard​.no/​web/​ publications/​document/​chapter​?p​_subdoc​_id​=​781874​&​p​_document​_id​=​78187. See also Hazelwood & Semark, supra note 55, at §§ 10.277–10.284. 63 The International Group Pooling and GXL Reinsurance contract structure for 2022 has now been finalised, International Group of P&I Clubs (Dec. 21, 2021), https://​www​.igpandi​.org/​article/​ international​-group​-pooling​-and​-gxl​-reinsurance​-contract​-structure​-2022​-has​-now​-been​-finalised. Maximum coverage for oil pollution incidents is ‘only’ US$1 billion. Id. 64 See, e.g., UK P&I Club, Rules 2023, supra note 55, at Rule 29, which terminates cover for a corporate member upon the passing of any resolution for voluntary winding up (id. at Rule 29(A)(ii)(a)), any order being made for compulsory winding up (id. at Rule 29(A)(ii)(b)), dissolution (id. at Rule 29(A)(ii) (c)), appointment of a receiver or manager (id. at Rule 29(A)(ii)(d)), or commencement of proceedings by the member to seek bankruptcy or insolvency protection (id. at Rule 29(A)(ii)(e)). 65 See, e.g., Kairos Shipping Ltd v. Enka & Co LLC (The Atlantik Confidence) [2014] EWCA Civ 217, [2014] 1 Lloyd’s Rep. 586, in which the English Court of Appeal held that a limitation fund (providing security for all claims arising out of a single incident) could properly be constituted by the production of a P&I Club guarantee.

Liability in the shipping industry  329 tinued arrest. The final resolution of such proceedings is a judicial sale of the arrested ship to satisfy any claimants’ claims from the proceeds of sale.66

V. CONCLUSION The role of the shipping industry as the circulatory system through which the lifeblood of international commerce passes has generally been under-appreciated, although the stranding of Ever Given and the supply chain problems of late 2021 have done something to raise public awareness of the extent to which everyday life, for everyone, depends upon ships and what they do.67 Because ships and the cargo they carry can be worth tens or hundreds of millions of dollars, liability issues about any aspect of a trading ship’s work are often large enough for parties to choose to fight about those issues, whether in litigation or arbitration. To return to the point made at the beginning of this chapter, unravelling how liability works in such contested proceedings is a complicated process with an unavoidably international dimension. Courts considering liability in admiralty in English-derived jurisdictions remain besotted with the doctrine of corporate personality while eschewing the doctrine of personification of ships, which seems on its face no less plausible or more fantastic. The doctrine of personification stands out as a uniquely sensible solution to determining liability in the shipping industry, given the way that ships are actually operated in commercial practice, but it has never attracted any support outside of the United States.

66 The procedure for judicial sale in England and Wales is set out in CPR 61.10. CPR 61.10(5) specifically provides that payments out of the proceeds of judicial sale of an arrested ship ‘will be made only to judgment creditors’. 67 The very title of a recent popular book goes some way towards making this point. See Rose George, Ninety Percent of Everything: Inside Shipping, the Invisible Industry that Puts Clothes on Your Back, Gas in Your Car, and Food on Your Plate (2013).

18. Enterprise liability Gregory C. Keating1

I. INTRODUCTION The ‘notion that losses should be borne by the doer, the enterprise, rather than distributed on the basis of fault’2 is often believed to have dominated American tort law in the middle third of the twentieth century.3 This idea, commonly called enterprise liability, is also often thought of as peculiarly American. Outside the United States – and even within it – doubts abound as to whether enterprise liability is a form of common law tort liability, or is alien to it. These doubts originate in the fact that strict enterprise liability burst full-grown upon the law with the enactment of the Workmen’s Compensation Acts at the turn of the twentieth century. Those Acts displaced the common law of torts from one of its most important domains of application and repudiated the conceptions of responsibility that the law of torts had instituted. The existing tort liability regime was individual and fault-based; the liability imposed by the Workmen’s Compensation Acts was collective and strict.4 From this stronghold outside the law of torts proper, enterprise liability ideas proceeded to march on terrain beyond the borders of the Acts, reshaping responsibility in tort in ways that made tort liability both more collective and more strict.5 Enterprise liability’s impact is sometimes subtle, but it tends to be pervasive and powerful. Whenever enterprise liability takes hold of some corner of tort law, it tends to reshape settled doctrine by locating that doctrine in a distinctively new justifying framework. When, for example, enterprise liability takes hold of the tort law of vicarious liability, it loosens that body of law’s roots in traditional agency

I am grateful to Ken Simons and participants in workshops at the UCI and USC law schools for comments on an earlier version of this paper. I am indebted to Shauli Bar-On for excellent research assistance. 2 Guido Calabresi, Some Thoughts on Risk Distribution and the Law of Torts, 70 Yale L.J. 499, 500 (1961). Calabresi is here recounting the idea of enterprise liability; he is also one of its most intellectually powerful and influential proponents. 3 See, e.g., George L. Priest, The Invention of Enterprise Liability: A Critical History of the Intellectual Foundations of Modern Tort Law, 14 J. Legal Stud. 461 (1985). Priest presents an apocalyptic vision of enterprise liability taking over the law of torts, particularly the law of product liability. For criticism, see Gary T. Schwartz, The Beginning and the Possible End of the Rise of Modern American Tort Law, 26 Ga. L. Rev. 601, 602 (1992). 4 See Jeremiah Smith, Sequel to Workmen’s Compensation Acts, 27 Harv. L. Rev. 235, 344 (1914). To this day, theorists of torts as a law of private wrongs see individual fault liability as the heart of the field. See, e.g., John C.P. Goldberg & Benjamin C. Zipursky, Recognizing Wrongs (2020); Arthur Ripstein, Private Wrongs (2016); Ernest J. Weinrib, The Idea of Private Law (rev. ed. 2012). 5 See Gregory C. Keating, The Theory of Enterprise Liability and Common Law Strict Liability, 54 Vand. L. Rev. 1285, 1292–302 (2003). 1

330

Enterprise liability  331 conceptions of responsibility and expands the scope of legal responsibility to cover wrongs whose commission is ‘characteristic’ of the firm’s activity.6 When enterprise liability arose, it was, no doubt, a radical legal innovation. Yet it also went on to become the most important common law innovation of the twentieth century. And it was undeniably important. The significance of enterprise liability for American private law has been justifiably compared to the significance of the Warren Court for American public law.7 Enterprise liability did not remain an idea ensconced in administrative alternatives to the law of torts. It seeped into the law of torts proper, connecting with hitherto unnoticed and latent collective conceptions of responsibility. Vicarious liability in the law of torts became both one of enterprise liability’s two principal fonts8 and one of its principal sites. The common law of products liability in its formative period (roughly 1963–1985) was one of its principal incarnations;9 and enterprise liability represents the fullest development of the idea of responsibility found in common law strict liability. My aim in this chapter is to offer an account of the enterprise liability idea, suggest that enterprise liability is in part an oak sprung from the acorn of more traditional common law strict liabilities, and indicate why enterprise liability is a permanent contribution to the responsibility of firms – public and private – for wrongs committed by those who labor on their behalf. Enterprise liability is enduringly significant because it is tort law’s response to a fundamental clash between its roots and modern social reality. ‘Our law of torts comes from the old days of isolated, ungeneralized wrongs, assaults, slanders, and the like’,10 but the world that modern tort law addresses is a world of organized risk. In our social world, most harms are the predictable byproducts of ongoing activities. Enterprise liability is tort law’s attempt to align the structure of responsibility in tort with the reality of modern risk imposition.

II.

WHAT IS ‘ENTERPRISE LIABILITY’?

Enterprise liability is usually explained in short slogans – ‘activities should bear the costs of those accidents that result from their characteristic risk impositions’; ‘it is only fair that an industry should pay for the injuries it causes’; ‘losses should be borne by the doer, the enterprise, rather than distributed on the basis of fault’. These slogans are commonplace mid-twentieth-century summaries of the enterprise liability idea.11 They capture the idea well enough, but they are so aphoristic that they have a Delphic quality. We need, therefore, to 6 See, e.g., Paula Giliker, Vicarious Liability ‘On the Move’: The English Supreme Court and Enterprise Liability, 4 J. Eur. Tort L. 306 (2013); Paula Giliker, A Revolution in Vicarious Liability: Lister, the Catholic Child Welfare Society Case and Beyond, in Revolution and Evolution in Private Law (Sarah Worthington, Andrew Robertson & Graham Virgo eds., 2018); Jason W. Neyers & Jerred Kiss, Vicarious Liability in the Common Law World: The Revolution in Canada, in Vicarious liability in the Common Law World (Paula Giliker, ed., 2022); Daniel Harris, The Rival Rationales of Vicarious Liability, 20 Fa. State U. Bus. Rev. 49 (2021). 7 G. Edward White, Tort Law in America, 208, 197–207, 168–73 (expanded ed. 2003). 8 See Young B. Smith, Frolic and Detour, 23 Colum. L. Rev. 444, 716 (1923); Gregory C. Keating, The Theory of Enterprise Liability and Common Law Strict Liability, 54 Vand. L. Rev. 1285 (2001). 9 See Priest, supra note 3, at 520–21. 10 Oliver Wendell Holmes, The Path of the Law, in Collected Legal Papers 167, 183 (1920). The paper itself was originally delivered in 1897. 11 See Calabresi, supra note 2, at 500 and the sources cited therein.

332  Research handbook on corporate liability begin our examination of enterprise liability by elaborating a bit on these terse characterizations. Enterprise liability is constituted as a distinctive regime of tort liability, I think, by two prescriptive theses. The first thesis is that the costs of the wrongful harms that are characteristic of an enterprise should be absorbed by the enterprise as an operating expense, not left on those whose bad luck it is to get in the enterprise’s way. The second thesis is that the costs of enterprise-related accidents should not be concentrated either on the victim who originally suffered the injury, or on the particular agent who inflicted the injury.12 The costs of such accidents should instead be distributed among those who benefit from the imposition of the enterprise’s risks. In the case of private firms, the costs of enterprise-related harms should be distributed among customers, employees, suppliers, and shareholders, rather than concentrated either on the victim or on the particular agent responsible for the harm at issue. Enterprise liability is most fully realized as a form of strict liability. As a form of strict liability it imposes liability on the ‘characteristic risks’ of activities.13 In the law of vicarious liability, for example, an enterprise liability approach holds firms accountable for ‘accidents which may fairly be said to be characteristic of [their activities]’.14 ‘Characteristic’ accidents are those ‘that flow from [an enterprise’s] long-run activity in spite of all reasonable precautions on [its] part’.15 The characteristic risks of harm imposed by the structured, systematic activities that enterprise liability subjects to liability are thus assumed to be reasonable, not unreasonable. The burden of avoiding these risks presumably exceeds the benefits of doing so. In a nutshell, enterprise liability supposes that it is reasonable to impose the risks that it governs, but unreasonable not to pay for the harms that issue from those risks. An ‘enterprise’ conception of vicarious liability therefore has a distinctive thrust. It asserts that in imposing strict liability on firms for the torts of their employees committed within the scope of employment the doctrine of respondeat superior expresses ‘the desire to include in the costs of [a firm’s] operation inevitable losses to third persons incident to carrying on an enterprise, and thus distribute the burden among those benefitted by the enterprise’.16 From an enterprise liability perspective, the scope of vicarious liability should turn not upon the motives or intentions of the servant whose tort is at issue, but upon whether the conduct of the firm involved tends to expose third parties to the kind of risk that materialized in injury in the case at hand. There is general significance in this example. Enterprise liability fully realized is a form of strict liability which imposes liability on activities for their ‘characteristic risks’ in order to distribute the costs of an activity across those who benefit from the harm it causes. Thus, enterprise liability’s two prescriptive theses – (1) that characteristic accident costs should be internalized; and (2) that they should be spread across the beneficiaries of the enterprise – are thus linked by a factual assumption. Enterprise liability assumes that, when an enterprise is made liable for its characteristic toll in life, limb, and property damage, it will usually insure against that liability (or self-insure as the largest firms do) and will factor the cost of such In this respect, modern vicarious liability is an ambiguous embodiment of enterprise liability. In practice, firms generally do absorb the costs of the wrongs for which their employees are liable. In theory, they are often entitled to shift those costs back onto the employee. 13 See Restatement (Third) of Torts: General Principles § 18 (Am. L. Inst. 2010) (describing strict liability as liability for ‘characteristic risk’). 14 Ira S. Bushey & Sons v. United States, 398 F.2d 167, 171 (2d Cir. 1968); see also Restatement (Third) of Agency § 7.07 (Am. L. Inst. 2006). 15 Bushey, 398 F.2d at 171. 16 Smith, supra note 8, at 718. 12

Enterprise liability  333 insurance into the cost of its products, the prices that it pays to its suppliers, the wages of its employees, and so on. And the theory of enterprise liability also assumes, as strict liability generally does, that the activity it addresses is worthwhile and ought to continue, provided it pays its way. Enterprises should be held accountable for their characteristic risks because imposing liability for harm issuing from both reasonable and unreasonable risk impositions implements the principle that it is only fair for those who benefit from the imposition of an enterprise’s risks to take the bitter with the sweet and bear the accident costs that flow from those risks. If enterprise liability is defined by two theses, it is supported by three distinct justifications. The first is that cost-internalization will induce an appropriate level of accident prevention. The second is that the dispersion of accident costs is desirable because it is easier for each of many people to bear a small fraction of some total cost than it is for any one of them to shoulder it alone. The third is that it is fairer to distribute the costs of enterprise-related accidents across those who benefit from the enterprise than it is to leave those costs concentrated on the random victims of the enterprise’s activity. Although these three rationales converge in support of enterprise liability, they have different implications and divergent origins. The first rationale – accident prevention – has much in common with familiar (in America, anyway) economic rationales for negligence liability. Inducing appropriate precautions is, for legal economists, the fundamental point of negligence liability.17 Enterprise liability, however, rests on a different idea from negligence liability of how accident prevention is to be effected. Where negligence law asks: ‘What precaution should have been taken to guard against this risk?’, enterprise liability asks: ‘Who is in the best position to take precautions against this kind of risk?’ Where negligence seeks to induce appropriate accident prevention by determining whether some untaken precaution should have been taken, enterprise liability seeks to induce appropriate accident prevention by determining who should make the choice between preventing an accident and letting it happen, and then holding the party that is in the best position to make that choice liable for all the accidents that it chooses not to prevent.18 The second rationale – loss-spreading – has no real counterpart in negligence rhetoric. Negligence cases rarely speak about loss-spreading. Negligence theorists generally suppose that, if loss-spreading is appropriate, it can be effected by the purchase of first-party loss insurance by prospective victims. Enterprise liability theory supposes, on the contrary, that the dispersion of accident costs is plainly desirable and should be effected by the liability system. Loss-spreading is desirable for the same reason that insurance is desirable. Most people prefer bearing a small, certain cost to a large but uncertain one. This is especially true when the cost in question is potentially so large that its occurrence would be devastating. Insurance should be supplied by the liability system because enterprises are generally the best insurers of the risks that characterize their activities. These first two rationales have their origins in conceptions of utility or efficiency. The third rationale – that the burdens and benefits of enterprise-related accidents should be proportionally distributed – expresses an idea of justice or fairness. When an enterprise harms a random victim in the course of pursuing its own benefit, unless the enterprise repairs the harm it has done, it exploits the victim for its own gain. The enterprise enriches itself by impairing the physical integrity, or the psychological integrity, or the property, of the victim. By requiring See, e.g., Richard Posner, A Theory of Negligence, 1 J. Legal Stud. 29, 33 (1985). This idea is famously developed in Guido Calabresi & A. Douglas Melamed, Toward a Test for Strict Liability in Tort, 81 Yale L.J. 1055, 1060 (1972). 17

18

334  Research handbook on corporate liability reparation, enterprise liability rights the wrong that would otherwise occur, namely, the wrong of making the victim the involuntary instrument of the enterprise’s self-enrichment. In so doing, it also distributes fairly the burdens and benefits of risky activities. Those who reap the benefits also bear the burdens. This principle of fairness is the generalization of a principle found in all harm-based strict liability, and it is the fundamental link between enterprise liability and more familiar forms of strict liability in tort – or so the next section shall argue.

III.

STRICT LIABILITIES IN AMERICAN TORT LAW

Enterprise liability sometimes finds expression in a negligence guise,19 but it finds its fullest expression in strict liability because negligence liability stops short of imposing liability on characteristic risk. Understanding enterprise liability thus requires understanding harm-based strict liability in general. In American tort law, strict liability comes in two primary forms. One form of strict liability is harm-based. The other form is based on an impermissible interference with an autonomy right. The first, harm-based, form is found in corners of accident law and in nuisance law. The second, autonomy rights-based, form is found mostly in intentional wrongs to the person or to property. Different meanings of the slippery terms ‘fault’ and ‘strict’ are relevant in these two contexts. Harm-based strict liabilities are strict in that they are imposed on justified conduct. The injury-inflicting conduct to which liability attaches is not wrong in the sense that the party responsible for it should have exercised more care and thereby avoided inflicting the harm. Rights-based strict liabilities are strict in that they are imposed on innocent conduct, conduct which – from a moral point of view – we would be inclined to excuse. Excuses negate blame. It is legally wrong to enter someone else’s property without their permission but, from a moral point of view, if the party entering did so under an innocent misapprehension of the boundaries of the property, their conduct is, morally speaking, blameless. Enterprise liability is a form of harm-based strict liability and the fullest expression of an idea of fairness found in all harm-based strict liabilities. A.

Harm-Based Strict Liability

In modern American tort law, harm-based strict liability is illustrated most clearly by the law of intentional nuisance when it distinguishes between unreasonable conduct and harm that it is unreasonable for the party inflicting it not to repair, and imposes liability for unreasonably unrepaired harm. Unreasonable conduct is conduct which inflicts injury unjustifiably. Negligent conduct, or faulty conduct, is unreasonable conduct: it exposes others to a risk of harm that ought not to have been imposed. By contrast, unreasonably unrepaired harm is harm which should not go unrepaired by the party responsible for its infliction, even though that harm issued from conduct which was beyond reproach. Unreasonable harm is harm for which an actor is strictly liable – liable even though the actor was not at fault in inflicting the harm at issue.

19 See Robert Rabin, Some Thoughts on the Ideology of Enterprise Liability, 55 Md. L. Rev. 1190, 1193 (1996).

Enterprise liability  335 Modern American nuisance law imposes liability for the infliction of unreasonably unrepaired harm when, as in the famous case of Boomer v. Atlantic Cement,20 it holds that damages should be paid for an unreasonable interference with plaintiffs’ rights to the reasonable use of their property, even though the conduct responsible for that interference is justified and ought to be continued. By revising the normal remedy for the wrong of nuisance in New York – from an injunction as a matter of right to damages as a matter of right and injunctive relief only on a showing of unreasonable conduct – Boomer revises the underlying rights. Reasonable conduct resulting in interference with another’s use and enjoyment of land is wrong only if the party inflicting the interference fails to make reparation for the harm that they do. The harm is serious enough to require repair, even though the conduct responsible for its infliction is justified. Reparation fairly reconciles competing, equal rights to the use and enjoyment of land. Boomer, and the distinctive modern American form of liability for intentional nuisance that it embodies, is thus a canonical instance of strict liability for unreasonably failing to repair harm that it was not unreasonable to inflict. Other entrenched instantiations include private necessity cases such as Vincent v. Lake Erie;21 liability for abnormally dangerous activities; liability for manufacturing defects in product liability law; and respondeat superior – the liability of masters for the torts committed by their servants within the scope of their employment. In that case, it is not wrong for the employer to have failed to prevent the employee’s wrong, but it is wrong – it is unreasonable– for the employer not to repair the harm done by the employee’s wrong. The obligation imposed by all of these doctrines is an obligation to undertake an action (e.g., saving your ship from destruction at the hands of a hurricane by bashing the dock to which it is moored), or conduct an activity (e.g., operating a business firm) only on the condition that you will repair any physical harm for which your action or activity is responsible, even though there is no fault in your infliction of the harm itself. The reciprocal right is a right to have any physical harm done to you repaired (so far as possible) by the party responsible for its infliction. All of these harm-based liabilities are strict in that they impose liability on conduct which is not wrong. Stated affirmatively, these strict liabilities impose liability on conduct that is justified, on inflictions of harm that are reasonable. Negligence liability, of course, predicates liability on conduct which is unjustified, on conduct which is unreasonable because it does not show due regard for the property and physical integrity of those that it harms. B.

Rights-Based Strict Liability

Rights-based strict liabilities do not form an important domain of enterprise liability. Their importance, rather, lies in helping us to isolate – by contrast – the particular form of strict liability that enterprise liability embodies. Rights-based strict liabilities are based on autonomy rights. These strict liabilities impose liability not on justified inflictions of harm, but on boundary crossings which may both do no harm and be innocent in their intent.22 This form of strict liability is epitomized by the torts of conversion, trespass, and some batteries. Here,

Boomer v. Atlantic Cement, 26 N.Y.2d 219 (N.Y. 1970). Vincent v. Lake Erie, 124 N.W 221 (Minn. 1910). 22 Two useful terms for these torts are ‘sovereignty-based’ and ‘trespassory’. The former calls attention to the connection between these torts and autonomy. The latter calls attention to the fact that these torts involve the impermissible crossing of boundaries, not the infliction of injury. 20 21

336  Research handbook on corporate liability the wrong is the violation of a right that assigns a power of control over some physical object, or in the case of battery, control over some subject. The law’s specification of a power of control over some domain gives rise to a form of strict liability predicated on the voluntary, but impermissible, violation of that right. If you enter my land or appropriate my pen without my permission, you have violated my right of exclusive control over these objects, even if your entry is entirely reasonable and justified. The wrong consists in the failure to respect the right. Whether or not the tortfeasor was at fault for crossing the boundary fixed by the right is simply irrelevant. Trespass at common law is a case in point. If you enter my property under an entirely reasonable and innocent misapprehension of where the boundary between my property and yours lies, you trespass. You need not even know that you have entered my property without my permission, much less intend the wrong of entering my property without permission. You need intend no wrong and you need do no harm. Indeed, you may benefit me – say, by trimming, topping, and cleaning my trees of bagworms.23 So, too, you may trespass if you are innocently and reasonably mistaken about which building you have permission to use as a set for your movie,24 or if you are simply mistaken about the scope of the permission that I have given you.25 Similarly, you may convert my chattel simply by exercising dominion over it in a way which is ‘in denial of or inconsistent with [my] rights therein’. You do not need to intend to deny my rights, or even know that you are doing so.26 Liability for battery may likewise be predicated on innocent intentional touchings,27 and even on touchings that benefit those who are touched without their consent.28 C.

The Internal Morality of Harm-Based Strict Liability

At least in American tort theory, harm-based strict liabilities are a species of tort liability that now struggles for recognition. They do not fit comfortably within the conception of torts as ‘conduct-based wrongs’, which has come to dominate American tort theory. Harm-based strict liabilities have the structure of modern intentional nuisance liability of the Boomer v. Atlantic Cement variety. They occupy a space which both negligence liability and contemporary tort theory tend to eclipse. In negligence, the obligation to repair arises from the infliction of harm which should have been avoided. In harm-based strict liability, the obligation to repair arises from the infliction of harm which should not have been avoided but which should be borne by the party responsible for its infliction. In the circumstances where they govern, harm-based strict liabilities assert that it is wrong for an actor to do harm without stepping forward and making good the harm done. The primary duty that harm-based strict liability institutes is not a duty not to harm; it is a duty to repair harm, even if the infliction of the harm is reasonable in the sense that it should not have been avoided. The duty attaches no matter how much care has been exercised. Failing to make reparation evinces insufficient regard for the rights of Longenecker v. Zimmerman, 267 P.2d 543 (Kan. 1954). Bigelow v. RKO Radio Pictures, 66 S.Ct. 574 (1946). 25 Cleveland Park Club v. Perry, 165 A.2d 485, 488 (Mun. App. D.C.1960). 26 Zaslow v. Kroenert, 176 P.2d 1 (Cal. 1946). 27 E.g., Vosburg v. Putney, 80 Wis. 523 (1891); White v. University of Idaho, 797 P.2d 108 (Idaho 1990). 28 E.g., Mohr v. Williams, 104 N.W. 12 (Minn. 1905) (the touching exceeded the scope of the consent given). 23 24

Enterprise liability  337 the person harmed, even though the conduct responsible for inflicting that harm is beyond reproach. The thesis that torts is a law of ‘conduct-based wrongs’ appears to be inhospitable to harm-based strict liabilities primarily because it takes negligence to be the template example of a tort. Abstractly stated, a conduct-based wrong is one with respect to which a right is violated when an agent fails to conform her conduct to the standard required by the law. Fault liability is a canonical illustration; it predicates responsibility for physical injury on the judgment that the defendant failed to conform her conduct to the standard of reasonable care.29 Negligence criticizes primary risk imposing conduct.30 The law criticizes the infliction of harm in the first instance on the ground that the conduct responsible for inflicting injury was insufficiently careful. The defendant should have avoided inflicting the injury. Strict liability, by contrast, predicates responsibility on the judgment that the defendant should have repaired the harm that they inflicted – even if they exercised all possible care to avoid inflicting the harm. The conduct that the law criticizes is secondary conduct. Formally, harm-based strict liabilities do not inquire into how much care defendants exercise. Formally, they are indifferent to the reasonableness of the defendant’s primary conduct. Although I cannot argue the point in detail here, I think it is nonetheless correct to say that harm-based strict liabilities generally presume that the conduct they govern is reasonable. Negligence liability is, after all, available in cases where the primary risk-imposing conduct is, in fact, unreasonable. Avoidable harm is negligence law’s domain whereas unavoidable harm is strict liability’s domain. We should therefore understand harm-based strict liabilities to target the wrong of harming-justifiably-but-unjustifiably-failing-to-repair. This kind of strict liability identifies a conditional wrong. It circumscribes a domain within which the infliction of harm is justifiable, but only on two conditions: (1) that the conduct inflicting injury is justified or reasonable; and (2) that reparation is made by the actor who inflicts physical harm for the harm that they have inflicted. Conditional privilege in the law of private necessity – the doctrine of Vincent v. Lake Erie31 – illustrates the distinction between criticizing primary and secondary conduct. The defendant ship owner’s conduct in lashing its ship to, and damaging, the plaintiff’s dock was reasonable not unreasonable, right not wrong. The defendant had the right to use the dock to save its ship from destruction at the hands of the storm, even if using the dock involved damaging the dock. The defendant’s privilege32 to trespass was not conditioned on doing no harm to the The fundamental question in negligence law is whether conduct falls below ‘a standard established by the law for the protection of others against unreasonable harm’. Negligence law fixes that standard by the conduct of a ‘reasonable person in the circumstances’. Restatement (Second) of Torts § 283 (Am. L. Inst. 1977). See, e.g., Ladd v. County of San Mateo, 12 Cal.4th 913, 917 (1996). 30 I owe this term to Lewis Sargentich. Robert Keeton’s contrast between ‘fault’ and ‘conditional fault’ also describes the distinction drawn in the text. See Robert E. Keeton, Conditional Fault in the Law of Torts, 72 Harv. L. Rev. 401 (1959). See also Kenneth W. Simons, Jules Coleman and Corrective Justice in Tort Law: A Critique and Reformulation, 15 Harv. J. L. & Pub. Pol’y 849, 880–81 (1992). 31 Vincent v. Lake Erie, 124 N.W. 221 (Minn. 1910). 32 Taxonomically, this is a complicated matter. In Hohfeldian terms, the ship’s privilege to enter is a right: the ship is entitled to enter, and the dock owner is under a duty not to resist. See Francis H. Bohlen, Incomplete Privilege to Inflict Intentional Invasions of Interests in Property and Personality, 39 Harv. L. Rev. 307 (1926). This privilege is also a power in Hohfeld’s terms, because it enables the ship owner to alter its relations with the dock owner without the dock owner’s permission, as long as the ship enters the dock owner’s property for certain purposes (to save its own property), and conducts itself 29

338  Research handbook on corporate liability dock, a requirement which would have been impossible to meet in the circumstances. The defendant’s privilege was conditioned on making reparation for any harm done to the dock, even though that harm was done rightly and not wrongly. The wrong in Vincent lay not in the defendant’s doing damage to the dock, but in the defendant’s wrongful (or unreasonable) failure to step forward and volunteer in the aftermath of the storm to make good the damage done to the dock. Put differently, Vincent’s strict liability is liability for unreasonable harm, not liability for unreasonable conduct. In Vincent, making reparation for the harm done by docking prevents the injustice of shifting the cost of the ship’s salvation from the ship owner who profits from it onto the dock owner who does not. The imposition of liability on the ship owner for failing to make such reparation rights the wrong of shifting the cost of the ship’s salvation onto the dock owner whose property is the instrument of that salvation. The wrong in strict liability is thus ‘harming justifiably but unjustifiably failing to repair the harm justifiably done’.33 Generalizing, we can say that the wrong involved in harm-based strict liabilities is akin to the wrong in restitution. In restitution cases, the basic wrong consists of retaining a benefit the retention of which unjustly enriches its recipient at the expense of the party conferring the benefit. In harm-based strict liabilities, the basic wrong consists of benefitting from the reasonable infliction of harm on another who merely suffers from its infliction. The role of reparation is to undo that wrong by erasing the harm. When reparation is made, the injurer continues to benefit but no longer benefits by harming the victim. Structurally, harm-based strict liability in tort resembles eminent domain in public law. Eminent domain law holds that it is permissible for the government to take property for public use only if the government pays just compensation to those whose property it takes. This is a two-part criterion. First, the taking must be justified; that is, it must be for a public use. Second, compensation must be paid for the property taken. Strict liability in tort has a parallel structure.34 In negligence, the defendant’s primary conduct determines liability, and it does so only when that conduct is wrongful. In strict liability, the defendant’s conduct triggers liability when the defendant’s failure to step forward and repair the harm faultlessly inflicted is wrongful. Strict liability asserts that the costs of necessary or justified harms should be borne by those who benefit from their infliction, and not by those whose misfortune it is to find themselves in the path of someone else’s pursuit of their own benefit, however reasonable that pursuit may be.

in certain ways (only does what is necessary to save its own property). Along with Robert E. Keeton, Conditional Fault in the Law of Torts, 72 Harv. L. Rev. 401 (1959), Bohlen’s article is a classic statement of the idea of strict liability I am developing in this chapter. 33 Vincent is thus a clear counter-example to the claims of some prominent tort scholars that strict liability involves a duty not to do harm, full stop. Jules Coleman and John Gardner hold views of this kind. See, e.g., John Gardner, Obligations and Outcomes in the Law of Torts, in Relating to Responsibility: Essays for Tony Honoré 111 (P. Cane & J. Gardner eds., 2001). 34 This ‘private eminent domain’ conception of strict liability may make its first appearance in American tort theory in the writings (some famous and some obscure) of Oliver Wendell Holmes. These writings are cited and discussed in Thomas C. Grey, Accidental Torts, Vand. L. Rev. 1225, 1275–81 (2001) and at greater length in his unpublished manuscript Holmes on Torts (on file with author). Two other classic statements are Francis Bohlen, Incomplete Privilege to Inflict Intentional Invasions of Interests of Property and Personality, 39 Harv. L. Rev. 307 (1926) and Robert E. Keeton, Conditional Fault in the Law of Torts, 72 Harv. L. Rev. 401 (1959).

Enterprise liability  339 Harm-based strict liability thus involves both fairness or justice, and wrong or rights violation. To say that it is unfair for an injurer to thrust the cost of its activities onto a victim is not the same as saying that the victim’s right is violated by so doing. It may, for example, be unfair for me to rebuild my house and block the passage of air through your chimney. The loss to you may be great, and the gain to me may be trivial. Unless you have a right to the passage of the air in question, however, what I have done is not a legal wrong.35 Strict liability is thus justified both by the principle of fairness that those who benefit from inflicting harm on others should also shoulder the cost of that harm and by the further claim that the harm done is the invasion of a right so that failure to make reparation for harm done would be a wrong. The judgment of right asserts that the interest violated is urgent enough to justify imposing a legal duty on others. Strict liability asserts that an injurer subject to a regime of strict liability does wrong when the injurer fails to step forward and repair harm rightly inflicted, and it makes this assertion because leaving the cost of the harm on the victim who suffers it shows insufficient respect for the victim’s rights – rights of property in the case of both nuisance and the conditional privilege of private necessity. Vincent is once again illustrative. It would not only be unfair for the ship owner to shift the cost of saving its ship to the dock owner, it would also violate the dock owner’s property rights. The dock owner’s right to exclude the ship must yield to the dire emergency – the ‘necessity’ – in which the ship found itself.36 But there is no reason why the dock owner’s right to the integrity of its property should give way. Saving the ship requires damaging the dock, but it does not require that the cost of saving the ship be shifted onto the owner of the dock instead of being borne by the ship owner who profits from doing that damage. Harm-based strict liabilities thus define a particular class of conditional wrongs where the law lodges its criticism against the defendant’s secondary failure to repair, not against the defendant’s primary, injury-inflicting conduct.37 D.

Enterprise Liability as a Harm-Based Strict Liability

Harm-based strict liabilities have a complex and delicate structure. They involve justified harmful conduct whereas negligent torts do not. But they also involve wrongs – that is the violation of a right – and unfairness. The wrong, in brief, lies in failing to repair harm in circumstances where it is fair for the actor to inflict the injury but unfair for the actor to leave the ensuing loss on the victim. The wrong involved in harm-based strict liabilities lies in benefitting from the reasonable infliction of harm on another at the expense of that other –

Bryant v. Lefever, 4 C.P.D. 172 (1878–79). ‘The situation was one in which the ordinary rules regulating property rights were suspended by forces beyond human control …’. Vincent v. Lake Erie Transp. Co., 124 N.W. 221, 221 (Minn. 1910). 37 It is possible to construe the concept of a conduct-based wrong in a way which obliterates the distinction between primary and secondary criticism of conduct. Asserting, say, that any conduct which violates a right is wrongful conduct obliterates the distinction. Some tort scholars including, perhaps, Ernest Weinrib and Arthur Ripstein, may hew to such a conception. See Ernest Weinrib, The Idea of Private Law (1995). The fundamental reason to reject this understanding of ‘conduct-based wrong’ is that obliterating the distinction between primary and secondary criticism of conduct impairs our ability to understand strict liability in tort. We want categories which enable comprehension instead of frustrating it. Cf. Kenneth W. Simons, Justification in Private Law, 81 Cornell L. Rev. 698, 707–13, 722–27 (1996) (book review of Ernest J. Weinrib, The Idea of Private Law (1996)). 35 36

340  Research handbook on corporate liability that is, without making reparation for the harm from which one has benefitted. Harm-based strict liabilities are corrective in a fundamental way: they undo interactions which involve one actor who benefits herself by reasonably harming another. But they also go beyond corrective justice because they embody a principle of fairness. This principle of fairness is most evident in enterprise liability, and enterprise liability is, in this respect, the most fully realized of the harm-based strict liabilities within the law of torts.38 Enterprise liability applies to activities as opposed to individual actions. In the law of vicarious liability – its most important common law application – enterprise liability applies to firms, through the risks created by their employees in the course of pursuing the firm’s business. In its most important administrative application, worker’s compensation, enterprise liability applies to the activities of firms insofar as those activities occasion harm to their employees. Within tort, strict enterprise liability39 is found primarily in vicarious liability, abnormally dangerous activity liability, and pockets of product liability. Strict liability for wild animals and vicious domestic ones intimates an enterprise liability conception of responsibility though it does not fully incarnate such a conception. The fairness case for enterprise liability is epitomized by saying that it distributes the costs of accidents across those who benefit from the underlying risks. This slogan can be unpacked into three components. The first component is fairness to victims. It is unfair to concentrate the costs of characteristic risk on those who simply happen to suffer injury at the hands of such risk, when those costs might be absorbed by those who impose the characteristic risk. Fairness prescribes proportionality of burden and benefit. Victims who are strangers to the enterprise derive no benefit from it, and it is therefore unfair to ask them to bear a substantial loss when that loss might be dispersed across those who participate in the enterprise and therefore do benefit from it. Victims who are themselves participants in an enterprise share in its benefits, but not in proportion to the detriment they suffer when they are physically harmed by the enterprise. Here, enterprise liability is fairer than negligence. It disperses the costs of enterprise-related accidents and distributes them within the enterprise, so that each bears a proportionate share. The second component is fairness to injurers. Enterprise liability is fair to injurers because it simply asks them to accept the costs of their choices. Those who create characteristic risks do so for their own advantage, fully expecting to reap the benefits that accrue from imposing those risks. If those who impose the risks choose wisely – if they put others at risk only when they stand to gain more than those they put in peril stand to lose – even under enterprise liability, they will normally benefit from the characteristic risks that they impose. If they do not, they have only their poor judgment to blame and society as a whole has reason to penalize their choices. Consider the facts of Ira S. Bushey and Sons v. United States,40 in which a drunken

The fairness case for enterprise liability beyond tort is powerfully made by Jeremy Waldron in Moments of Carelessness and Massive Loss, in Philosophical Foundations of Tort Law, 387 (David G. Owen ed., 1995). 39 The proposition that the vicarious liability of a master for the torts of its servants is strict is a contestable one. See Weinrib, supra note 37. There is little doubt, however, that it is the dominant understanding of the doctrine in American law, even by those who are not proponents of strict liability. See, e.g., Konradi v. United States, 919 F.2d 1207, 1210 (1990) (‘The liability of an employer for torts committed by its employees—without any fault on his part—when they are acting within the scope of their employment, the liability that the law calls “respondeat superior,” is a form of strict liability’). 40 Ira S. Bushey and Sons v. United States, 398 F.2d 167 (2d Cir. 1968); compare Taber v. Maine, 45 F.3d 598 (2d Cir. 1995) (Calabresi, J). 38

Enterprise liability  341 sailor, returning from shore leave, flooded the dry-dock in which his ship was berthed by spinning the wheels that controlled the dock’s valves. In upholding the imposition of liability, Judge Friendly asserted, in a nutshell, that the Coast Guard let its sailors loose on shore leave for its own benefit (as well as for theirs) and it reaped the rewards of their shore leave. It therefore had to take the bitter with the sweet. If the costs of shore leave are greater than the benefits, the Coast Guard has reason to reconsider the practice, and society has reason to discourage it. The conception of responsibility invoked in this rationale is a familiar and widely accepted one. We take it for granted, for example, that: [T]he person to whom the income of property or a business will accrue if it does well has normally also to bear the risk of loss if it does badly. In the law of sales, when the right to income or fruits normally passes to the buyer, the risk of deterioration or destruction normally passes to him as well.41

The same point might be made about the purchase of stocks, or even lottery tickets. It is fair to ask agents who choose to act in pursuit of their own interests and stand to profit if things go well to bear the risk of loss when things go badly. Enterprise liability is fair to injurers. The third component of fairness returns us to the general idea of burden–benefit proportionality: Enterprise liability distributes accident costs among actual and potential injurers more fairly than negligence does. Negligence liability does not require that the costs of accidents – even negligent accidents – be spread among those who create similar risks of harm, whereas enterprise liability does. Enterprise liability asserts: (1) that accident costs should be internalized by the enterprise whose costs they are; and (2) that those costs should be dispersed and distributed among those who constitute the enterprise, and who therefore benefit from its risk impositions. Negligence liability, by contrast, holds that injurers have a duty to make reparation when they injure others through their own carelessness. Negligence liability justifies shifting concentrated losses, whereas enterprise liability justifies dispersing and distributing concentrated losses. To be sure, nothing in negligence liability forbids injurers from insuring against potential liability, but nothing in negligence liability requires it either. Insurance is not integral to negligence liability, even though insuring against negligence liability is standard modern practice. It is, moreover, important in this regard that insuring against negligence liability makes negligence liability fairer precisely because it moves negligence towards enterprise liability. Negligence liability is often harsh, and problematically so.42 In part, negligence law is harsh because it justifies shifting potentially devastating losses from injurers to victims on the basis of relatively modest acts of wrongdoing. A moment’s carelessness behind the wheel of a car can inflict millions of dollars of harm, enough to bankrupt most drivers. The price that negligence liability exacts can thus seem quite disproportionate to the wrongfulness of the conduct the blameworthiness of which justifies the exaction. It may well be fairer to pin responsibility on the negligent wrongdoer than to leave it on the innocent and devastated victim; this neither settles all questions of fairness nor undermines the argument that enterprise liability is fairer Tony Honoré, Responsibility and Fault 79 (1999). ‘Average reasonable person’ doctrine shows this side of negligence liability most clearly. See, e.g., W. Page Keeton et al., Prosser & Keeton on the Law of Torts § 32, at 177 (5th ed. 1984) (noting that the common law traditionally held even people with severe mental disabilities to the standard of ‘a normal, prudent person’). 41 42

342  Research handbook on corporate liability still. The small lapses that sometimes precipitate large injuries are common indeed. Most of us occasionally let our minds wander while behind the wheels of our cars, give some small risk insufficient consideration, or fail to execute some all-too-familiar precaution with the precision that it requires. Most of us also usually escape without injuring anyone else. The luck of the draw is all that distinguishes those of us who get away without injuring anyone from those of us who inflict grievous injury. Fate singles out an unlucky few for liability – often massive liability – and fortune spares the rest. Those unlucky few who inflict injury might justly complain that a system under which they alone bear the costs of the injuries they inflict is less fair than one which pools those losses among all those who create similar negligent risks.43 Negligence mitigated by the institution of liability insurance is fairer than negligence detached from that institution. Liability insurance distributes the costs of negligence among all those who are, over the long run, similarly negligent, and that is fairer than leaving the costs of negligence on those whose misfortune it is to have their negligence issue in injury. Luck and luck alone separates the negligent who cause injury from the negligent who do not. It is fairer to neutralize the arbitrary effects of luck than to let luck wreak havoc with people’s lives. Just as negligence liability with the institution of liability insurance is fairer among actual and potential victims than negligence liability without that institution, so too enterprise liability is fairer than negligence liability with insurance. Once negligence liability operates against the background of liability insurance, all that divides it from enterprise liability is its treatment of those accident costs that flow from reasonable risk impositions. Both negligence liability and enterprise liability pool the accident costs that issue from negligent risk impositions among those who are similarly negligent. Negligence liability, however, leaves the non-negligent accident costs of an activity on the activity’s victims, whereas enterprise liability distributes those costs across the enterprise – across all those who impose the characteristic risks that lead to such accidents. Under negligence liability, victims may disperse the costs of an activity’s non-negligent accidents by purchasing loss insurance, but victim loss insurance will not generally distribute those costs across those who impose similar risks. Loss insurance will disperse accident costs across an actuarially similar pool of insureds, and the premium will be paid out of the insured’s pocket. Absent special circumstances, it will be a matter of mere coincidence if the pool of actuarially similar insureds somehow benefits from the activity responsible for the harm. Demanding that victims insure themselves against accidental losses inflicted upon them by the activities of others and so shoulder the burden of realizing the socially desirable end of loss-dispersion adds ‘institutional insult to personal injury’.44 When reasonable risk imposition results in accidental harm, chance and chance alone separates those who injure and are injured from those who do not injure and are not injured. It is unfair to leave non-negligent losses on those whose misfortune it is to suffer them, when we might readily spread these losses among all those who create similar risks of injury. When the concentrated costs of non-negligent accidents might easily be dispersed and distributed across those who benefit from the creation of the relevant risks, the victims of such accidents might reasonably object to a principle of responsibility that leaves the costs of those non-negligent 43 Jeremy Waldron makes this point forcefully in Moments of Carelessness and Massive Loss, in Philosophical Foundations of Tort Law 387 (David G. Owen ed., 1995). 44 The felicitous expression is Jules Coleman’s. Jules L. Coleman, Adding Institutional Insult to Personal Injury, 8 Yale J. on Regul. 223, 230 (1991).

Enterprise liability  343 accidents concentrated on victims.45 Those who benefit from the imposition of the relevant risks but escape the injury latent within those risks, by contrast, cannot reasonably object to having non-negligent accident costs dispersed and distributed across all those who benefit from the imposition of the relevant risks. It may be rational to seek to appropriate the benefits of recurring risk imposition for oneself and to thrust the burdens of those risk impositions onto others, but it is not reasonable to do so. Dispersing the non-negligent accident costs characteristic of an activity across pools of victims who are bound together only by their actuarial similarity is likewise less reasonable than dispersing them across the injurers who create similar risks and benefit from doing so. People who do not benefit from an activity may reasonably object to bearing its costs when those who do benefit might be made to bear its costs with equal ease. Fairness favors dispersing the costs of blameless accidents among all those who create similar risks of such accidents, just as much as it favors dispersing the costs of accidents precipitated by wrongdoing among lucky and unlucky wrongdoers. Pooling the risks of negligent accidents, but not the risks of non-negligent accidents, is presumptively less fair than pooling both sets of risks.

IV.

ENTERPRISE LIABILITY AS A RESPONSE TO SYSTEMIC RISK

A.

Two Social Worlds

Writing in 1897, Holmes observed that ‘[o]ur law of torts comes from the old days of isolated, ungeneralized wrongs, assaults, slanders, and the like’, whereas ‘the torts with which our courts are kept busy to-day are mainly the incidents of certain well known businesses … railroads, factories, and the like’.46 Implicit in Holmes’s remark is a distinction not just between two kinds of accidents, but between two kinds of social world. Stylizing and simplifying, we can call these two worlds the ‘world of acts’ and the ‘world of activities’, respectively. The ‘world of acts’ is Holmes’s world of ‘isolated, ungeneralized wrongs’. The ‘world of activities’ is the world in which accidents are the ‘incidents’ of organized enterprises. In the ‘world of acts’, risks are discrete. The typical actor is an individual or a small firm which creates risk so infrequently that harm is not likely to materialize from any single actor’s conduct. The typical accident materializes out of the activity of isolated, unrelated actors, acting independently (i.e., natural persons or small firms separately engaging in activities on an occasional basis). Taken as a whole, the activities of these individual actors are diffuse and disorganized, and quite possibly actuarially small. The dogfight that precipitated Brown v. Kendall47 is a representative tort in this world: it arose out of a chance encounter between unrelated parties, neither of whose activities was sustained enough to make such misfortunes commonplace and expected. In the ‘world of acts’, then, risks are isolated, ‘one-shot’ events. Harm, when it materializes, is an accidental misfortune. Because actors are small, and risks independent and uncorrelated, liability rules shift, but do not spread, losses. In this world, the imposition of strict liability on reciprocal risks merely ‘substitute[s] one form of risk for See generally, T.M. Scanlon, What We Owe to Each Other 189–247 (1998). Holmes, supra note 10, at 183 (1920). 47 Brown v. Kendall, 60 Mass. 292 (1850). 45 46

344  Research handbook on corporate liability another – the risk of liability for the risk of personal loss’, as George Fletcher says in his famous piece Fairness and Utility in Tort Theory.48 A fair distribution of the costs of accidents – of harm – may be hard to come by. Fairly distributing the financial costs of accidents across the activities that generate them is possible only if the underlying activity satisfies basic criteria of insurability. Foremost among these criteria is the law of large numbers.49 In the purest form of the ‘world of acts’, however, both actors and activities are small. At the opposite pole from the ‘world of acts’ is the ‘world of activities’. In the ‘world of activities’, risks are generalized and systemic. Systemic risks arise out of a continuously repeated activity (e.g., the manufacturing of Coke bottles, the transportation of gasoline, the supply of water by a utility) that is actuarially large. ‘Accidental’ harm is statistically certain to result from such risks: if you make enough Coke bottles, some are sure to rupture;50 if you transport enough gasoline, some tankers are sure to explode;51 if you leave water mains uninspected in the ground long enough, some are sure to break;52 if you turn loose enough sailors on shore leave, some of them are bound to return to their ships drunk and wreak havoc.53 In the ‘world of activities’, both actors and activities are large. The cost of accidents can therefore be dispersed and distributed. In the ‘world of activities’, the typical injury arises not out of the diffuse and disorganized acts of unrelated individuals or small firms, but out of the organized activities of firms that are either large themselves, or are small parts of relatively well-organized enterprises. The defendant in Lubin v. Iowa City54 (a case where a waterworks left water mains uninspected until they broke) is large in the first sense: a single entity is responsible for the piping of water through underground pipes throughout a city, for laying and maintaining those pipes, for charging consumers for the water so transported, and so on. The transportation of large quantities of gasoline in tanker trucks on highways is large in the second sense: the firms that do the transporting may (or may not) be small and specialized, but they are enmeshed in contractual relationships with those who manufacture and refine the gasoline, those who operate gasoline stations, those who manufacture tractor trailers, and so on.55 In the ‘world of activities’, accidental harms can be spread across the enterprises that cause those harms. When the law of large numbers is satisfied, risks are not only certain to result in harms; they are also very likely to result in harms with predictable regularity. When activities

George P. Fletcher, Fairness and Utility in Tort Theory, 85 Harv. L. Rev. 537, 547 (1972). See Bernard L. Webb et al., Insurance Operations and Regulation 116 (2d ed. 1992). 50 See Escola v. Coca-Cola Bottling Co., 150 P.2d 436 (Cal. 1944). 51 See Siegler v. Kuhlman, 502 P.2d 1181 (Wash. 1972). 52 See Lubin v. Iowa City, 131 N.W.2d 765 (Iowa 1964). The waterworks chose not to replace mains until they broke because it was inefficient to inspect for signs of incipient breakage and replace them before they broke. 53 The suit in the Bushey case, 398 F.2d 167 (2d Cir. 1968), arose out of an incident in which a drunken sailor, returning from shore leave late at night to his Coast Guard ship, which was being overhauled in a floating dry dock, opened the valves and flooded the dry dock causing the dry dock to sink and the ship to partially sink. The court, in an opinion by Judge Friendly, affirmed that the conduct was within the scope of employment, because the risk of drunkenness was a risk increased by the Coast Guard’s ‘long-run activity in spite of all reasonable precautions’ on its part, and hence was fairly attributed to the Coast Guard. Id. at 171. 54 Lubin v. Iowa City, 131 N.W.2d 1181 (Wash. 1972). 55 The perception that the separate actors form a connected enterprise surfaces very explicitly in Siegler, 502 P.2d at 1181. 48 49

Enterprise liability  345 are actuarially large, the accidents that they cause will likewise be predictable and regular, and the costs of those accidents can be factored into the costs of conducting the enterprise. The costs of manufacturing and distributing Coke can include the costs of injuries from exploding Coke bottles; the costs of supplying water to households and businesses can include the costs of the damage caused by broken water mains. B.

From Fairness in the Distribution of Risk to Fairness in the Distribution of Harm

The move from the ‘world of acts’ to the ‘world of activities’ alters the conception of fairness presented by the imposition of strict liability. This can be seen by juxtaposing the enterprise liability principle that the costs of the harm inevitably inflicted by an organized enterprise, the activities of which extend indefinitely across time, ought to be borne by those who benefit from the risk impositions responsible for that harm, with George Fletcher’s famous argument that reciprocity of risk is the principal basis on which the law of torts chooses between negligence and strict liability.56 In brief, the reciprocity of risk criterion plausibly divides the domains of negligence and strict liability in the ‘world of acts’. In that world, harm cannot be fairly distributed. The social conditions necessary for the fair distribution of the harm caused by unavoidable accidents across those who benefit from the risks responsible for those accidents are not satisfied. In the ‘world of acts’, fairness in the distribution of risk is attainable, but fairness in the distribution of harm is not. Enterprise liability exploits the possibility of greater fairness created by the move from the ‘world of acts’ to the ‘world of activities’. For that reason, enterprise liability is distinctively and powerfully modern; it is a form of tort liability tailored to fundamental features of risk in the modern world. The allure of reciprocity of risk as a master criterion of fairness can be explained as follows.57 Risks are reciprocal when they are equal in probability and magnitude and are imposed for equally good reason. The right to impose a risk enhances the freedom of potential injurers, and the exercise of that right endangers the security of potential victims. Reciprocity of risk defines a community of equal freedom and mutual benefit. Reciprocity of risk defines a community of equal freedom because reciprocity exists when risks are equal in probability and gravity. When risks are equal in these respects, people relinquish equal amounts of security and gain equal amounts of liberty. Reciprocity of reasonable risk defines a situation of mutual benefit because risks are reasonable when the benefits of imposing them are greater than the burdens of bearing them. Reciprocity of risk thus defines a fair situation with respect to the distribution of risk. The flip side of this coin is that when risks are not reciprocal, risk is not fairly distributed. By requiring reparation for harm done, strict liability redresses, ex post, the ex ante unfairness of nonreciprocal risk. When risks are reciprocal, strict liability is superfluous. When risks are reciprocal, ‘strict liability does no more than substitute one form of risk for another — the risk of liability for the risk of personal loss’.58 This, in a nutshell, is Fletcher’s argument. Fletcher’s argument is elegant and powerful, but its preoccupation with risk of physical injury – rather than with physical injury itself – should give us pause. With rare exceptions, See Fletcher, supra note 48. This argument is developed at greater length in Gregory C. Keating, Rawlsian Fairness and Regime Choice in the Law of Accidents, 72 Fordham L. Rev. 1857, 1858–59 (2004). 58 Fletcher, supra note 48, at 547. 56 57

346  Research handbook on corporate liability risk of physical injury is a cause for concern only because it occasionally manifests in actual injury. Physical injury is what devastates and destroys lives. Physical injury is what gives the law of accidents its moral urgency. Reciprocity of risk defines a circumstance where the burdens and benefits of risk are proportional and to everyone’s benefit. It is more important, however, to make the burdens and benefits of harm – of accidental, physical injury – proportional. It is more important to distribute the costs of accidents fairly. Harm itself is distributed fairly only when harm – not risk – is reciprocal. Reciprocity of harm, however, is only found in the law of nuisance, and even then only in the case of the mutual, low-level interferences with each other’s use and enjoyment of property that are the subject of the ‘live and let live’ rule of nuisance law.59 Accidental physical injury, however, is rarely reciprocal, and fortunately so. Reasonable risk impositions only occasionally result in accidental physical injury. Harm, therefore, befalls only a few of those exposed to reciprocal risk. In accident law, the alternative to the fair distribution of risk is not the fair distribution of harm, but the fair distribution of the costs of accidents across those who benefit from the imposition of the relevant risks. In accident law, the alternative to the reciprocity of risk criterion is the enterprise liability version of strict liability. Enterprise liability in tort pins the costs of accidents – negligent and non-negligent alike – on the activities responsible for those accidents.60 By doing so, enterprise liability distributes the costs of concentrated, accidental injuries across all those who participate in an enterprise and benefit from its risk impositions. It thus makes a difference whether we think that fairness matters primarily with respect to the distribution of risk or primarily with respect to the distribution of the costs of harm. The two criteria endorse very different versions of the tort system. Identifying fairness with reciprocity of risk leads to the view that fairness ideas in tort find their fullest expression in a common law regime which resembles the common law of accidents at the turn of the twentieth century.61 Identifying fairness with reciprocity of risk leads to an implicit defense of the common law as it was a century ago. Identifying fairness with the fair distribution of the costs of accidents leads to a very different view of the proper shape of the law of accidents. Identifying fairness with the fair distribution of harm leads, presumptively, to favoring enterprise liability, both within and beyond the tort law of accidents. It leads to seeing a wide variety of administrative schemes, including workers’ compensation, no-fault automobile insurance, industry-wide liability for black lung disease, and even the society-wide liability of the New Zealand Accident Compensation scheme, as continuous with the tort law of accidents.62 The ‘live and let live’ rule is usually traced to Baron Bramwell’s opinion in Bamford v. Turnley, 122 Eng. Rep. 27 (Ex. Ch. 1862). The opinion gives the following nineteenth-century list of examples subject to the ‘live and let live’ rule of no liability for low-level nuisances: ‘burning weeds, emptying cess-pools, making noises during repairs’. Id. at 32. 60 See generally Ira S. Bushey & Sons, Inc. v. United States, 398 F.2d 167 (2d Cir. 1968). 61 See Fletcher, supra note 48, at 543–51. 62 Fletcher sees enterprise liability as the expression of loss-spreading ideas entirely independent of fairness, and indeed opposed to fairness. See id. Fletcher describes ‘loss-shifting in products-liability cases’ as ‘a mechanism of insurance’. Id. at 544 n.24. Fletcher describes insurance arguments for the imposition of strict liability as arguments of ‘distributive rather than corrective justice’. Id. at 547 n.40. Imposing liability on insurance or loss-spreading grounds ‘violates the premise of corrective justice, namely that liability should turn on what the defendant has done, rather than on who he is’. Id. Many legal scholars likewise see administrative accident schemes, and even enterprise liability within tort, as animated by ideas which are foreign to the core of tort law. See, e.g., Jules L. Coleman, Risks and Wrongs 395–406 (1992); Weinrib, supra note 37. 59

Enterprise liability  347 In the ‘world of acts’, strict liability merely substitutes ‘the risk of liability for the risk of personal loss’63 – it yields a different, but no fairer, distribution of the financial burdens and benefits of accidental harm. In the ‘world of acts’, negligence is preferable to strict liability because negligence reconciles liberty and security equally, fairly, and less expensively, than strict liability does. In the ‘world of activities’, however, strict enterprise liability is fairer than negligence. Under enterprise liability, those who benefit from the imposition of particular systemic risks – from, say, the risks of selling Coke in pressurized bottles – also bear the financial burdens of the accidents that issue from these risks. In the ‘world of activities’, unlike the ‘world of acts’, the extra burdens that strict liability places on the liberty of injurers are less than the extra burdens that negligence places on the security of victims. Negligence leaves concentrated harms on injurers; enterprise liability disperses concentrated loss and distributes it across all the beneficiaries of an enterprise. In the ‘world of acts’, it is reasonable to impose negligence liability on reciprocal risks. Reasonable injurers may object that the move to strict liability imposes as great a burden on their freedom of action as negligence imposes on the security of victims. Under negligence, the concentrated costs of non-negligent accidents strike victims like lightning; under strict liability, those costs strike injurers like lightning. Because strict liability yields a distribution of accident costs which is no fairer than the distribution under negligence liability, it is reasonable to maximize the size of the pie by preferring the cheaper liability regime. In the ‘world of activities’, by contrast, the burdens are asymmetrical. By pinning an activity’s accident costs on that activity, enterprise liability distributes the costs of non-negligent accidents across those who benefit from the underlying risks. Negligence liability leaves the costs of those accidents concentrated on unlucky victims. Those victims have good reason to object: The burden that strict enterprise liability places on injurers is both less than the burden that negligence liability places on victims and more fairly distributed. The burden of strict enterprise liability on injurers is less than the burden of negligence liability on victims because negligence liability leaves concentrated costs on victims, whereas strict enterprise liability disperses those concentrated costs across the enterprise responsible for them. The burdens of enterprise liability are more fairly distributed because enterprise liability pins the costs of non-negligent accidents on those who benefit from the activity responsible for them. Enterprise liability places the burden on those who benefit.

V. CONCLUSION The above, of course, is little more than a thumbnail sketch of an argument. That argument would require much more than a short book chapter. I hope, though, that this truncated version of the argument is suggestive if not exhaustive, provocative if not conclusive. It has sketched a case for thinking that enterprise liability is an important and defensible addition to the law’s stock of conceptions of responsibility for harm and wrong. Enterprise liability is, moreover, a form of tort liability distinctively addressed to a world of organized activities. Holmes’s observation that ‘[o]ur law of torts comes from the old days of isolated, ungeneralized wrongs, assaults, slanders, and the like’, whereas ‘the torts with which our courts are kept busy to-day

Fletcher, supra note 48, at 547.

63

348  Research handbook on corporate liability are mainly the incidents of certain well known businesses ... railroads, factories, and the like’64 was prophetic when he uttered it in 1897. The observation that we live in a world of organized risk has since become a truism. By itself, however, the truism that we live in a world of organized activities, risks, and wrongs, does not guarantee smooth sailing for enterprise liability. The struggle to shed more individualistic understandings is ongoing and incomplete. At present, the adequacy of enterprise liability is being tested and contested in the context of sexual wrongs committed by agents of institutions.65 In our world, when agents of large organizations, public and private – schools, churches, hospitals, police forces, private corporations – commit sexual wrongs, it feels archaic to ask whether those individual agents are doing the bidding of their individual masters. From the point of view of enterprise liability, that framing misses the point. The question that we must answer is a question of institutional responsibility. Enterprise liability poses the right question. It asks whether the institution at hand – be it church, corporation, government agency or school – stands in such a relation to the agent’s wrong that the wrong may said to be, in Judge Friendly’s felicitous phrase, ‘characteristic’ of the institution’s activity. Wrongs are ‘characteristic’ of an activity when they ‘flow from [an enterprise’s] long-run activity in spite of all reasonable precautions on [its] part’.66 Characteristic risks that some wrong will happen in the course of some employment are greater than normal risks of that wrong happening. ‘Characteristic’ risks are risks the incidence of which is increased by the institution’s presence in the world, even when the institution exercises reasonable care. When intentional wrongs such as rape, sexual assault, and sexual abuse are at issue, the question is whether the nature of the employment – the nature of the institution’s activity – significantly enables the wrong. If so, the institution bears some responsibility for the wrong. Whether this framework is up to the task it sets itself – the task of identifying those circumstances in which institutional responsibility is warranted – remains to be seen. Courts have not found it easy to draw lines distinguishing those sexual wrongs that should be attributed to the personal predilections of the wrongdoers from those that should be attributed to the institutional roles that those wrongdoers occupied. Two California Supreme Court cases from the 1990s make the point. In Mary M. v. City of Los Angeles,67 the plaintiff, who had been drinking, was stopped for erratic driving by a police officer. After performing poorly on a sobriety test, she pleaded with the officer not to take her to jail. He drove her home and raped her. Reversing the intermediate appellate court, the California Supreme Court held that, when ‘a police officer on duty misuses his official authority by raping a woman who[m] he has detained, the public entity that employs him can be held vicariously liable’. Although ‘sexual assaults by police officers are fortunately uncommon’, they are not so ‘unusual or startling’ that they cannot ‘fairly be regarded as typical of or broadly incidental’ to the ‘enterprise of law enforcement’. ‘The danger that an officer will commit a sexual assault while on duty arises from the considerable authority and control inherent in the responsibilities of an officer in enforcing the law.’ The financial costs of wrongs issuing from misuse of that authority ‘should

Holmes, supra note 10, at 183 (1920). See supra note 6 and accompanying text. 66 Ira S. Bushey & Sons v. United States, 398 F.2d 167, 171 (2d Cir. 1968). 67 Mary M. v. City of Los Angeles, 54 Cal.3d 202, 285 Cal.Rptr. 99, 814 P.2d 1341 (1991) (Kennard, 64 65

J).

Enterprise liability  349 be borne by the community, because of the substantial benefits that the community derives from the lawful exercise of police power’. In Lisa M. v. Henry Mayo Newhall Memorial Hospital,68 the 19-year-old plaintiff, who was pregnant, sought treatment in the hospital emergency room for injuries suffered in a fall. An emergency room physician ordered an ultrasound examination to determine whether the fetus had been injured. After completing the prescribed examination, under the pretense of conducting an ultrasound examination designed to determine the fetus’s gender, the ultrasound technician (Tripoli) sexually molested the plaintiff. Reversing the intermediate appellate court once again, the California Supreme Court ruled that the ultrasound technician’s conduct fell outside the scope of his employment as a matter of law. It distinguished Mary M. by explaining that, although the technician had ‘abused his position of trust’, he ‘had no legal or coercive authority over plaintiff’. By ‘employing the technician and providing the ultrasound room, [the hospital] may have set the stage for his misconduct, but the script was entirely of his own, independent invention. For this reason, it would be unfair and inconsistent with the basic rationale of respondeat superior to impose liability’ on the hospital. Justice Kennard, who had authored the majority opinion in Mary M., dissented. The intimate contact inherent in the job, she argued, ‘put [the] plaintiff in a vulnerable position and permitted Tripoli to dupe plaintiff into believing that his sexual assault was actually part of a standard medical procedure’. Consequently, ‘a reasonable trier of fact could conclude that this sexual assault may fairly be attributed to risks arising from, and inherent in, the “peculiar aspects” of Tripoli’s employment’. Enterprise liability’s recasting of the question of vicarious liability as a question of institutional responsibility will not make difficult cases easy. It is often challenging to decide whether an institutional position is an enabling condition of an intentional wrong to an extent sufficient to hold the institution responsible to the victim for the wrong. Even so, the enterprise liability recasting is a step in the right direction. It brings the lens of the law into synchrony with the social reality that the law governs. Institutions dominate our social world.

68 Lisa M. v. Henry Mayo Newhall Memorial Hospital, 12 Cal.4th 291, 48 Cal.Rptr.2d 510, 907 P.2d 358 (1995).

PART V THE CLAIMS PROCESS

19. Overlapping remedies Bert I. Huang

I. INTRODUCTION Where you find one lawsuit against a company, you will likely find more. Often, multiple cases arise from the same underlying event. Numerous claimants may seek remedies for the same alleged fraud, for example, or the same mass tort. The resulting array of parallel litigation and multiple claims calls for coordination. Procedural devices such as class actions, multidistrict litigation (MDL), or other forms of aggregation may enable a large degree of coordination, in addition to serving the needs of efficiency, consistency, and access to justice.1 Due to procedural and jurisdictional limitations, however, as well as practical impediments, achieving an ideal level of global coordination through these devices is often infeasible.2 Among the more acute problems that can occur when such coordination falls short is the possibility of overlapping remedies. Consider, first, the problem of redundant punitive damages. Imagine that Plaintiff 1 is awarded compensatory damages and punitive damages. Plaintiff 2 also wins compensatory damages and punitive damages, perhaps aided by the preclusive effect of findings from the first case or by precedent established there. Likewise for Plaintiffs 3, 4, 5, and so forth. There is no conceptual difficulty with awarding compensatory damages to each claimant. But punitive damages are another matter. If the punitive damages award in each individual case is meant to represent comprehensive punishment (or deterrence) for the defendant’s misconduct, then this penalty should be extracted only once – not repeatedly, case

The literature on these devices is vast, but an insightful and concise starting point would be Professor Lahav’s comparison of three forms of aggregation in the federal courts of the United States – class actions, MDLs, and bankruptcy. Alexandra D. Lahav, The Continuum of Aggregation, 53 Ga. L. Rev. 1393 (2019). Although federal bankruptcy procedure allows for uniquely comprehensive aggregation of claims, it will not be covered in this chapter given its limited application. For an expert introduction, see Troy A. McKenzie, Toward a Bankruptcy Model for Nonclass Aggregate Litigation, 87 N.Y.U. L. Rev. 960 (2012). 2 In light of these limitations, judges in parallel cases can also seek to improve voluntary coordination among themselves. A compilation of such practices (formal and informal) can be found in the classic manual for judges, on handling class actions and MDLs, from the Federal Judicial Center. Fed. Judicial Ctr., Manual for Complex Litigation §§ 20, 22 (4th ed. 2004). 1

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352  Research handbook on corporate liability after case.3 Notice that the over-punishment (or over-deterrence) occurs not just because there are multiple awards of punitive damages in parallel cases, but because these awards overlap.4 Next, consider a second problem of overlapping remedies: imagine again a set of parallel lawsuits, except that here the plaintiffs are seeking injunctive relief. In the first plaintiff’s case, Court 1 issues an injunction. In a case brought by another plaintiff, Court 2 also issues an injunction, but the order requires a somewhat different change in behavior. Likewise for Courts 3, 4, 5, and so forth. Absent coordination among these courts, there is a risk that their orders will be mutually incompatible, and thus the defendant will find itself in an impossible position.5 Notice again that the problem is not just that multiple injunctions have been issued in parallel cases, but that they overlap. A.

The Standard Approach

A standard, intuitive response to these procedural pathologies is to say, ‘just decide it once and for all’. What could be a simpler answer to redundancy or conflict? This approach is not so simple to implement, however, as it requires a way to gather all claimants – present and future – together before a single court at the same time, or a way to bar remedies beyond the first case, or some combination of these methods. Jurisdictions vary in the toolkits available, if any, for serving such an ambitious aim. In the federal courts of the United States, this standard approach could in theory be served by procedural devices that enable preclusion and aggregation, most notably class actions and MDLs. Part II of this chapter will review the utility as well as the limitations of these procedural devices through the lens of how thoroughly they can address each of the two problems of overlapping remedies noted above. While these devices may provide considerable coordi-

3 I refer to these as ‘redundant’ punitive damages, but the problem has been recognized by judges and analyzed by scholars under other names. See, e.g., State Farm Mut. Auto. Ins. v. Campbell, 538 U.S. 408, 423 (2003) (noting ‘the possibility of multiple punitive damages awards for the same conduct’); BMW of N. Am., Inc. v. Gore, 517 U.S. 559, 612 n.4 (1996) (Ginsburg, J, dissenting) (noting that the Court declines ‘to address the question of multiple punitive damages awards stemming from the same alleged misconduct’); Dunn v. HOVIC, 1 F.3d 1371, 1385 (3d Cir. 1993) (en banc) (‘successive punitive damages awards’); Thomas B. Colby, Beyond the Multiple Punishment Problem: Punitive Damages as Punishment for Individual, Private Wrongs, 87 Minn. L. Rev. 583 (2003); Catherine M. Sharkey, Punitive Damages as Societal Damages, 113 Yale L.J. 347, 428 (2003) (‘multiple punishments’). 4 Mere repetition does not imply redundancy, given that multiple awards may be needed to reach the proper degree of comprehensive punishment or deterrence. The US Supreme Court’s guidance in Philip Morris USA v. Williams appears to suggest as much, ruling that, as a matter of constitutional due process, a jury in one plaintiff’s case must not punish the defendant directly for harms done to nonparties (who can presumably sue for punitive damages in their own cases). Philip Morris USA v. Williams, 549 U.S. 346, 353–55 (2007). And yet, in the same breath, the Court also ruled that juries still can consider evidence of such nonparty harms in judging the original act’s reprehensibility when assessing punitive damages. Thus Philip Morris seems to contemplate that a jury may punish the defendant for the inherent reprehensibility of the act (as distinct from punishing directly for others’ harms). This allowable act-focused punishment, if repeated by other juries, may very well involve overlap and redundancy. See also infra note 31. 5 Readers well versed in the Federal Rules of Civil Procedure will recognize that this problem of conflicting injunctions is a principal motivation for rules about involuntary joinder and mandatory class actions – ways to force parties into a single case so as to avoid parallel litigation. Fed. R. Civ. P. 19(a)(1) (B)(ii), 23(b)(1)(A).

Overlapping remedies  353 nation benefits, it turns out that both problems – redundant punitive damages and conflicting injunctions – can still fall through the procedural cracks. B.

A Complementary Approach

Recent work has highlighted an alternative approach based on the concept of concurrent remedies.6 This proposed approach does not aspire to once-and-for-all adjudication, but takes parallel litigation as a given. Its logic relies, instead, on noticing that the repeated adjudication of remedies does not imply the repeated execution of remedies. The idea is to decouple the remedy’s announcement and its implementation. Courts sometimes can and do declare that a certain remedy is appropriate while holding off on executing it, in part or in full. An expansion of such judicial practices, in parallel litigation, can allow multiple remedies to be announced by multiple courts – while also avoiding redundancy or conflict in what is actually required of the defendant. Part III of this chapter will review how this approach would work in the two problems of overlapping remedies noted above. First, as applied to the ‘overkill’ that results from redundant punitive damages:7 in short, each court would give the defendant credit for any part of the intended award that overlaps with the awards levied by parallel courts.8 Next, as applied to conflicting injunctions: in short, each judge would announce her intended injunction, but then partially or wholly stay its effect as needed for the sake of compatibility with the relief she expects parallel courts to impose;9 as multiple courts weigh in, the convergence of their mutual expectations and the updating of their orders can lead to a compatible equilibrium. The costs, complications, and limitations of these proposed solutions will also be reviewed. C. Trade-offs This concurrent-remedies approach differs from the once-and-for-all approach in possibly advantageous ways.10 First, because the concurrent-remedies approach gives no special priority or preclusive effect to the first-in-time result among parallel cases, there should be less incentive for plaintiffs to race to the courthouse, or for defendants to hurry a weaker plaintiff’s case. Second, this approach does not require trying to aggregate all possible claims (including unknown future claims) before a single court, although it is also compatible and indeed complementary with aggregation. Third, and relatedly, it does not require any judge to know the full universe of parallel cases (nor make guesses about future claims) when announcing an

6 See infra Part III. This discussion draws primarily on my prior work on the problems of overlapping remedies. See Bert I. Huang, Coordinating Injunctions, 98 Tex. L. Rev. 1331 (2020); Bert I. Huang, Surprisingly Punitive Damages, 100 Va. L. Rev. 1027 (2014). 7 ‘Overkill’ is what Judge Henry Friendly famously called it. Roginsky v. Richardson-Merrell, Inc., 378 F.2d 832, 839 (2d Cir. 1967) (Friendly, J) (‘We have the gravest difficulty in perceiving how claims for punitive damages in such a multiplicity of actions throughout the nation can be so administered as to avoid overkill. … We know of no principle whereby the first punitive award exhausts all claims for punitive damages and would thus preclude future judgments …’). 8 See infra Section III.A. 9 See infra Section III.B. 10 For illustrations of these qualities in application to the problems of redundant punitive damages and conflicting injunctions, see infra Sections III.A & III.B respectively.

354  Research handbook on corporate liability intended remedy. Fourth, for contexts in which judges can expressly collaborate, this approach supplies them with shared conventions that reflect comity and mutual respect. Fifth, the resulting equilibrium reflects the judgment and reasoning of multiple courts, rather than just one. One salient cost of the concurrent-damages approach is that the path to repose for the defendant may be lengthier and more complex, with multiple cases running their full course, and thus with the end result left unsettled for some time. Given this cost, such an iterative process may be more attractive in settings in which better information is likely to emerge as multiple cases proceed, or in which remedial accuracy (such as the proper amount of punishment, or the ideal tailoring of an injunction) can be improved by gathering the input of multiple courts.11 It should be emphasized that the two approaches can co-exist. The systemic costs of multiple litigation and the value of access to justice remain powerful rationales for large-scale consolidation, even if once-and-for-all resolution remains out of reach. In such contexts, the concurrent-remedies approach may serve as a complement to aggregation and preclusion devices the leaky coverage of which cannot achieve global resolution all at once. More broadly speaking, this approach may be useful to consider whenever some amount of repetitious litigation is unavoidable for any reason, leaving open the risk of overlapping remedies.

II.

PROCEDURES FOR AGGREGATION

In the federal courts of the United States, two well-known aggregation devices are class actions and multidistrict litigation (MDL).12 In concept, these procedures may seem well suited to the standard once-and-for-all approach of trying to bring as many claimants as possible before one single court, and to make the first adjudication as preclusive of further litigation as possible. In practice, while they may serve other aims of aggregate litigation – such as efficiency, consistency, and access to justice – they turn out to be a spotty solution to the potential problems of overlapping remedies. A.

Class Actions

The federal class action is an especially powerful device that combines several procedural mechanisms:13 aggregation of claims, representation of absent claimants, and preclusion of

For an analogous suggestion of advantages gained by not consolidating parallel public-law lawsuits against the government, see Andrew D. Bradt & Zachary D. Clopton, MDL v. Trump: The Puzzle of Public Law in Multidistrict Litigation, 112 Nw. U. L. Rev. 905, 922–23 (2018). For a high-altitude perspective on the potential benefits of courts’ expressing divergent views, see Amanda Frost, Overvaluing Uniformity, 94 Va. L. Rev. 1567 (2008). 12 As will be discussed below, these devices can and often do work in tandem, usually with MDLs transforming into class-action settlements. One of the most publicly salient and practically impactful examples in mass torts is the resolution of a wide range of economic claims arising from the catastrophic BP oil spill after the destruction of the Deepwater Horizon rig in 2010. See Samuel Issacharoff & D. Theodore Rave, The BP Oil Spill Settlement and the Paradox of Public Litigation, 74 La. L. Rev. 397 (2014). 13 Although they are not considered here, many state-court class action devices are modeled on the federal version and follow its doctrinal evolution (to varying degrees). For a survey of class action 11

Overlapping remedies  355 re-litigation. It is not merely the consolidation of many existing cases into one court. Rather, in a class action, a small group of named plaintiffs represent an entire category of potential plaintiffs – including many other claimants who are as yet unnamed, possibly unknown at the time of suit, and, until they receive notice, possibly unaware of the lawsuit’s existence. For these reasons, a proposed class must be approved, or ‘certified’, by the presiding federal judge, who is required to assess the fit and quality of the representation as well as the compelling reasons for proceeding as a class action. There are several formal categories of federal class actions, as specified by Rule 23 of the Federal Rules of Civil Procedure, and a proposed class may be certified under more than one category. A key distinction among the categories (for present purposes) is the reach of their preclusive effect: In ‘mandatory’ classes, anyone who qualifies as a class member will be bound by the results of the litigation or class-wide settlement.14 In ‘opt-out’ classes, potential members are offered the chance to leave the class and thereby avoid being bound by the results or the settlement (which means they can try to bring their own lawsuits).15 The nature of the remedy sought is a primary determinant of the relevant category and thus of whether the class is mandatory or opt-out: a proposed class seeking only injunctive relief will generally be considered a mandatory class under Rule 23(b)(1)(A) or Rule 23(b)(2); were opt-outs and thus separate litigation allowed, that would create the possibility of conflicting injunctions. A proposed class seeking monetary compensation will generally be considered an opt-out class under Rule 23(b)(3). If the defendants’ funds for paying claimants are limited, creating a mandatory class under Rule 23(b)(1)(B) may be possible, so as not to leave out any claimants. B.

Multidistrict Litigation

By contrast, the federal MDL is not a representative device and cannot bind absent or future parties; nor can it, as a formal matter, reach the stage of determining remedies.16 An MDL is assembled by a small panel of judges, who choose a single judge to shepherd and coordinate the pretrial proceedings for similar cases scattered throughout the federal courts system.17 Those cases are transferred to this judge for proceedings including discovery as well as potentially dispositive motions, but they must formally be sent back to the originating courts for trial.18 Thus the MDL device is more limited than class actions as to what can be adjudicated in a coordinated way. The MDL device is also more limited in its preclusive reach: absent

devices outside the United States, see Deborah R. Hensler, From Sea to Shining Sea: How and Why Class Actions Are Spreading Globally, 65 Kan. L. Rev. 965 (2017). 14 Fed. R. Civ. P. 23(b)(1) & (b)(2). 15 Fed. R. Civ. P. 23(b)(3). 16 28 U.S.C. § 1407. See also Manual for Complex Litigation, supra note 2, § 20.13. For an incisive investigation into the origins of this device, see Andrew D. Bradt, ‘A Radical Proposal’: The Multidistrict Litigation Act of 1968, 165 U. Pa. L. Rev. 831 (2017). 17 Only cases in federal court can be transferred to a federal MDL. But state court procedures also allow variations on MDLs. See Zachary D. Clopton & D. Theodore Rave, MDLs in the States, 115 Nw. U. L. Rev. 1649 (2021). 18 In some cases it may be possible for willing judges to effectively undo this transferring-back, through the creative use of other procedures. See Manual for Complex Litigation, supra note 2, § 20.132.

356  Research handbook on corporate liability claimants, such as those who have not yet filed suit, or whose cases have not been transferred to the MDL judge (for example, cases cannot be transferred from state courts), are not part of the coordinated proceedings and thus are not bound by findings or rulings made by that judge. Yet, despite these formal limitations, the MDL device has become a commonly used alternative to class actions as a way of aggregating multiple claimants before one single court.19 A principal reason is that gathering a large number of claimants into one venue can ease the path to large-scale settlement. This often happens with the judge’s help; for example, the judge may create a leadership structure among the claimants’ attorneys, or send bellwether cases to trial to sharpen parties’ estimates of settlement value.20 The result may not be a global settlement, because not all claimants are covered, but it still covers potentially thousands of parallel cases; the process leading to this sort of mass yet non-class settlement is sometimes called a ‘quasi-class action’. The outcome gets closer to a global settlement if an actual class action emerges from the MDL proceedings and a class-wide settlement is approved by the MDL judge, as this would bind many absent claimants. Note, however, that any settlement in an opt-out class action still leaves out claimants who choose not to be bound and who may then proceed with their own lawsuits. C.

Application to Overlapping Remedies

How far can these well-known aggregation devices go in averting the specific overlapping remedies concerns highlighted above – redundant punitive damages and conflicting injunctions? The following discussion will focus on mandatory class actions, which have the power to rule out any further litigation. By contrast, as noted, an opt-out class action allows separate or future litigation by claimants who choose not to be bound by the judgment or the settlement. Similarly, any pretrial rulings that emerge from MDL proceedings (even if dispositive of liability) cannot bind absent or future claimants – although, again, MDLs can readily lead to class-action settlements, including potentially in mandatory classes. This section’s emphasis on mandatory class actions is not meant to downplay the practical impact of the other devices. Settling with the remaining class members (which may be nearly all of them) in an opt-out class action, or settling with the large number of the plaintiffs already present in an MDL, can of course greatly reduce the likelihood of overlapping remedies. The more interesting analytical question, however, is why these problems have not been resolved by the procedural device – mandatory class actions – which in theory would rule them out entirely. Before proceeding, it is also worth acknowledging that class actions may themselves generate, rather than solve, the problems of overlapping remedies. In one sense this may seem obvious: if the availability of the class action device makes suing feasible or enhances incentives to bring suit in the first place, then the likelihood of multiple suits also increases. There is one salient context, however, where even a single class action may grossly aggravate

19 See, e.g., Lahav, supra note 1; Andrew D. Bradt, Something Less and Something More: MDL’s Roots as a Class Action Alternative, 165 U. Pa. L. Rev. 1711 (2017); Charles Silver & Geoffrey P. Miller, The Quasi-Class Action Method of Managing Multi-District Litigations: Problems and a Proposal, 63 Vand. L. Rev. 105 (2010). 20 See, e.g., Alexandra D. Lahav, A Primer on Bellwether Trials, 37 Rev. Litig. 185 (2018). A well-known instance in which such bellwethers informed settlement value was the Vioxx MDL.

Overlapping remedies  357 an overlapping remedies problem: it is where statutory damages or civil penalties stack up linearly, multiplied by the number of violations.21 As a conceptual matter, these linearly stacking awards can begin to overlap, especially at high counts, if some portion of each award is a built-in overcharge intended as punishment or as an extra incentive to bring suit.22 As a practical matter, the resulting problem is vividly illustrated by the eye-popping total amounts (‘trillions’) that can occur when such linearity is turbocharged by a class definition that assembles an enormous number of claimants.23 To be clear, this particular pathology is distinct from (though conceptually related to) the parallel-cases problems which are the focus of this chapter. 1. Redundant punitive damages In theory, a mandatory class action that awarded punitive damages can eliminate the potential for redundancy in that no claimant covered by the class definition could seek overlapping punitive damages in future litigation. As a practical matter, however, in the federal courts of the United States – despite one famous example three decades ago – the current state of legal doctrine has largely foreclosed the possibility of a mandatory punitive damages class. Although most federal class actions seeking monetary awards must be proposed as opt-out classes under Rule 23(b)(3),24 there once was thought to be a narrow path to certification as a mandatory class under Rule 23(b)(1)(B), commonly called the ‘limited fund’ class. The argument would be that, due to constitutional due-process limitations on the size of the total punitive damages for a defendant’s bad act, this maximum amount in effect sets a payment cap across all cases. In turn, this would mean that any claimant left out of the present case may end up missing out on their share of the award – the classic justification for forcing all potential claimants into a limited-fund class. This logic appears to have worked, momentarily. It was applied in one famous case – that of the punitive damages arising from the disastrous Exxon Valdez oil spill off the coast of Alaska in 1989.25 Notably, the federal judge who certified the class under Rule 23(b)(1)(B) not only relied on the limited-fund logic but also expressly acknowledged a need to avoid the redundant punitive damages problem.26 Indeed, certification of this mandatory class was sought by the

21 See generally Bert I. Huang, Concurrent Damages, 100 Va. L. Rev. 711 (2014) (addressing problems arising from linear stacking of statutory damages or of civil penalties). 22 Huang, Surprisingly Punitive Damages, supra note 6, at 1046–59 (analyzing potential redundancy due to repetition of these overlapping components of statutory damages or of civil penalties). 23 Arista Records LLC v. Lime Grp. LLC, 784 F. Supp. 2d 313, 317 (S.D.N.Y. 2011) (noting that ‘if one multiplies the maximum statutory damages award ($150,000) by approximately 10,000 [copyrighted] works, Defendants face a potential award of over a billion dollars in statutory damages alone’, and adding that ‘[i]f Plaintiffs were able to pursue a statutory damage theory predicated on the number of direct infringers per work, Defendants’ damages could reach into the trillions’ [original emphasis]). See also Sheila B. Scheuerman, Due Process Forgotten: The Problem of Statutory Damages and Class Actions, 74 Mo. L. Rev. 103 (2009). 24 Fed. R. Civ. P. 23; see also Wal-Mart v. Dukes, 564 U.S. 338, 360–61 (2011) (holding that claims for monetary relief may not be certified under Rule 23(b)(2) ‘at least where (as here) the monetary relief is not incidental to the injunctive or declaratory relief’). 25 See Linda S. Mullenix, Nine Lives: The Punitive Damages Class, 58 U. Kan. L. Rev. 845, 863–67 (2010); Catherine M. Sharkey, The Exxon Valdez Litigation Marathon: A Window on Punitive Damages, 7 U. St. Thomas L.J. 25, 46–48 (2009). 26 See Mullenix, supra note 25, at 864–65 & n.124.

358  Research handbook on corporate liability defendant Exxon, presumably for the same reason. Moreover, the Alaskan state courts, out of comity, then barred any future punitive damages awards.27 Altogether, this example can be seen as the high point of the once-and-for-all approach. Such a strategy no longer seems viable, however, according to leading scholars.28 They have observed that, in the years since the Exxon Valdez case, the US Supreme Court has further closed down this already narrow path, from both sides: through constitutional doctrine about punitive damages, as well as through doctrine about what counts as a limited fund under Rule 23(b)(1)(B).29 Another well-known case that occurred after these doctrinal developments, arising from tobacco litigation, now seems to serve as a cautionary tale for such attempts.30 Curiously, the Supreme Court case that had altered the relevant constitutional doctrine had come close to eliminating the conceptual (if not practical) possibility of redundant punitive damages – but stopped just short.31 2. Conflicting injunctions In the federal courts of the United States, the possibility of conflicting injunctions can be eliminated by the creation of a mandatory class action for injunctive relief under Rule 23(b)(1)(A) or 23(b)(2). These categories are understood to share that very purpose.32 Thus, formally there would seem to be a ready-made solution based on the once-and-for-all approach. The practical problem, however, is that in many contexts there is not much incentive for claimants seeking an injunction to go through the trouble of trying to certify such a class, unless for some reason they wish to preempt similar relief being sought by another claimant. If anything, there may be strategic reasons for a plaintiff not to try for a mandatory class because Id. at 865 n.126, 866. Punitive damages were barred in parallel state court litigation based on ‘deference to [the] federal court order creating a federal mandatory punitive damages class’. Chenega Corp. v. Exxon Corp., 991 P.2d 769, 775 (Alaska 1999). 28 See, e.g., Mullenix, supra note 25, at 871–80; Catherine M. Sharkey, The Future of Classwide Punitive Damages, 46 U. Mich. J.L. Reform 1127, 1141–43 (2013); Richard A. Nagareda, Embedded Aggregation in Civil Litigation, 95 Cornell L. Rev. 1105, 1132–38 (2010). 29 Professor Sharkey, however, has argued that, under a societal-harm conception of punitive damages (rather than an individual-plaintiff conception), class certification may yet be arguable under Rule 23(b)(2) or 23(b)(3). Sharkey, supra note 28, at 1143–46. Rule 23(b)(2) does create a mandatory class, but only where ‘final injunctive relief or corresponding declaratory relief is appropriate respecting the class as a whole’; this seems an improbable path for awarding punitive damages, even if they are not viewed as individualized. 30 See Mullenix, supra note 25, at 873–75 (detailing the reversal by the US Court of Appeals for the Second Circuit of Judge Jack Weinstein’s innovative attempt to use such a ‘limited fund’ justification for certifying a mandatory punitive damages class in the case known as Simon II). See also In re Simon II Litig., 407 F.3d 125, 134–36 (2d Cir. 2005) (reversing Judge Weinstein’s certification of a mandatory punitive damages class). 31 As previously observed, supra note 4, the Philip Morris decision left open the possibility of redundancy by allowing juries (as a practical matter, and possibly as a conceptual matter) to punish for the full reprehensibility of the defendant’s act, which takes into account the potential risk and harm to others beyond the present plaintiff, in each case. See Philip Morris USA v. Williams, 549 U.S. at 353 (‘While evidence of actual harm to nonparties can help to show that the conduct that harmed the plaintiff also posed a substantial risk to the general public, and so was particularly reprehensible, a jury may not go further and use a punitive damages verdict to punish a defendant directly for harms to those nonparties’). 32 See Nagareda, supra note 28, at 1132 n.116. For further exploration of what it may mean for relief to be ‘indivisible’ in the sense that would justify such a mandatory class, see generally Maureen Carroll, Class Actions, Indivisibility, and Rule 23(b)(2), 99 B.U. L. Rev. 59 (2019). 27

Overlapping remedies  359 certification would mean that the plaintiff’s loss would bind all other potential plaintiffs.33 By contrast, outside a class action a litigation loss for one plaintiff would not bind others who are not party to that case. They would be free to seek similar injunctive relief – and only one victory by any of the plaintiffs is needed for all claimants (including those who had lost in prior attempts) to share in the benefits of the injunction. This asymmetry has been much discussed in debates about so-called ‘nationwide’ or ‘universal’ injunctions,34 where one proffered argument against issuing such relief in non-class litigation has been that a mandatory class action should be the exclusive vehicle for any injunctive relief that necessarily affects nonparties. This argument is a protest against the historical fact that many universal injunctions of high public salience in recent years in the United States (typically seeking to halt certain actions of the executive branch) have been won not through mandatory class actions but in ordinary cases with individual litigants – sometimes with parallel litigation continuing in other courts. The incentives created by this asymmetry are, in principle, as relevant to private lawsuits against corporate defendants as to cases against the government.35 Although a once-and-for-all solution is available, then, one may well expect plaintiffs to neglect it for reasons of strategy or convenience, thus leaving open the possibility of conflicting injunctions.

III.

CONCURRENT REMEDIES

Recent work has highlighted a different and complementary approach for minimizing the problems of overlapping remedies: each judge could announce the remedy in her case, while holding off on requiring the defendant to satisfy it in part or in full. This proposed approach decouples the remedy’s announcement and its implementation. It thereby allows multiple courts to announce remedies ‘concurrently’ – while also not actually requiring the defendant to satisfy redundant or conflicting commands. The informational and procedural demands of this approach are relatively low: it does not require trying to consolidate all possible present and future claimants before a single court,

33 This analysis is premised on the current state of the federal common law of preclusion. See Taylor v. Sturgell, 553 U.S. 880 (2008); Smith v. Bayer Corp., 564 U.S. 299 (2011). 34 See, e.g., Samuel L. Bray, Multiple Chancellors: Reforming the National Injunction, 131 Harv. L. Rev. 417 (2017); Amanda Frost, In Defense of Nationwide Injunctions, 93 N.Y.U. L. Rev. 1065 (2018); Suzette M. Malveaux, Class Actions, Civil Rights, and the National Injunction, 131 Harv. L. Rev. F. 56 (2017); Michael T. Morley, Disaggregating Nationwide Injunctions, 71 Ala. L. Rev. 1, 10 (2019); Mila Sohoni, The Lost History of the ‘Universal’ Injunction, 133 Harv. L. Rev. 920 (2020); Allan M. Trammell, Demystifying Nationwide Injunctions, 98 Tex. L. Rev. 67 (2019); Zayn Siddique, Nationwide Injunctions, 117 Colum. L. Rev. 2095 (2017). 35 If anything, the incentives for plaintiffs not to seek class certification may be even more pronounced in private lawsuits because, under current federal doctrines of preclusion, non-mutual offensive collateral estoppel is essentially unavailable against the federal government as a defendant. United States v. Mendoza, 464 U.S. 154 (1984). Such preclusion is available, by contrast, against private defendants in the right circumstances. Parklane Hosiery Co. v. Shore, 439 U.S. 322 (1979). The availability of non-mutual offensive collateral estoppel suggests to Plaintiff 1 that any findings in her favor against the defendant could potentially be used by Plaintiff 2 (who is not part of a class) in a later attempt to seek the same relief; and, as already noted, Plaintiff 1 also knows that any injunctive relief won by Plaintiff 2 (should Plaintiff 1 have failed at the remedial stage) would then redound to Plaintiff 1’s benefit.

360  Research handbook on corporate liability although it is also quite compatible with aggregation. It does not rely on the halting of parallel cases or the preclusion of future cases; and in its ideal form, no special status or priority is given to the first-in-time ruling. It is robust to changes in the universe of parallel cases, as new cases appear or other cases are dropped. Indeed, when announcing the remedy in the case before her, an individual judge need not know how many such cases exist, much less make guesses about the future. The following discussion illustrates these qualities by showing how the concurrent-remedies approach would play out in the contexts of redundant punitive damages and of conflicting injunctions. It will also identify the costs, complications, and limitations of this approach. The discussion draws primarily from my prior work, though with less detail about variations and extensions, and with more emphasis on what these solutions conceptually have in common. A.

Punitive Damages

This is the proposed guiding principle for judges who are concerned about the possibility of redundant punitive damages: ‘If a judge believes that some portion of the total damages in a case before him reflects an amount that this defendant should not be made to pay repeatedly, then he should designate this portion to run concurrently with the awards in other cases.’36 In effect, a single payment of that amount by the defendant is counted towards satisfying the awards assessed by multiple courts. Such a notion of running penalties concurrently may be most familiar from the analogous practice in criminal law in which a judge orders a defendant’s sentences on related counts to be served concurrently rather than sequentially.37 The notion may also be familiar from the context of concurrent regulatory enforcement, where the penalty assessed by one agency is credited toward that assessed by another for the same underlying misconduct.38 In the punitive damages context, however, such an approach would appear to be novel and thus would need to be enabled by new legislation or new judicial doctrine – similar in spirit to existing state laws that allow offsets for past awards, or allow an award only in the first-in-time case.39 In the simplest version of this approach, each judge would (1) announce all the damages in her own case; and (2) require the defendant to pay the compensatory damages in full; but then (3) explain that the punitive damages will ‘run concurrently’ with those assessed in any paral-

Huang, Surprisingly Punitive Damages, supra note 6, at 1034. For example, if a defendant receives two sentences of ten years each, but these sentences are served concurrently – meaning, at the same time – the result is in effect a total sentence of ten years, not 20. Similarly, if the defendant receives a sentence of five years and another of ten years, to run concurrently, then the effective total is ten years. 38 See, e.g., Press Release, U.S. Dep’t of Justice, Manhattan U.S. Attorney Announces Guilty Plea Agreement with SAC Capital Management Companies (Nov. 4, 2013), http://​www​.justice​.gov/​usao/​ nys/​pressreleases/​November13/​SACPleaPR​.php (‘Because the SAC Companies have already agreed to pay $616 million to the U.S. Securities & Exchange Commission to resolve related civil insider trading charges, that amount will be credited against today’s penalty [of $1.8 billion], and, therefore, the additional payment required under this Agreement will be approximately $1.2 billion’). 39 See Huang, Surprisingly Punitive Damages, supra note 6, at 1042–44 (citing examples of state laws barring punitive damages if already awarded in a prior case; allowing juries to consider offsets for prior awards of punitive damages, or requiring judges to reduce an award in light of past awards; and urging jury consideration of total, including possible future, awards). 36 37

Overlapping remedies  361 lel or future cases.40 Although those parallel cases may be spread out over time, and although future cases may yet be unknown, the logistics should be manageable: for example, the court can require the defendant to deposit the punitive damages into a fund from which no payments are distributed until it is apparent that all parallel cases have emerged and run their course.41 In this scenario, the upshot for the defendant is straightforward: it will end up paying the highest amount of punitive damages awarded by any of the parallel courts – but that is all. It will not pay any overlapping, redundant awards because the amounts assessed by other courts are deemed to be satisfied by the payment of that highest-value award. Note that, mechanically, even if some subset of these concurrent awards are overturned, the defendant will still be liable for the highest amount that survives.42 The upshot for the universe of potential recipients of these funds is more complicated.43 Ideally, the relevant judges would collaborate on how best to equitably distribute that amount, perhaps delegating it to a special master or fund administrator. The coordination required, including overcoming potential discord among judges or pressure from interested parties, may be a notable cost of this approach. A further possible cost is the extra analytical work that may be required of a judge, should she seek to be more conceptually precise about what portion of the announced punitive damages amount in her case should be run concurrently. This is because the commonly stated purposes of punitive damages – retribution and deterrence44 – are distinct and hardly self-defining aims. For example, a judge may think differently about how to treat compensatory damages within a concurrence scheme, depending on whether she is more focused on retribution or on deterrence.45 Similarly, a judge might seek to distinguish conceptually between the portion of the punitive damages award that relates to the general badness of the original conduct and the portion

See id. at 1034–37. For examples of courts using escrows or trusts in this way, including for collecting and distributing punitive damages, see, e.g., Sampson v. Vasey, No. LA28882, 2007 WL 4555839, at *1 (Iowa Dist. Ct. Sept. 4, 2007) (‘[T]he punitive damages shall be deposited into the plaintiff’s attorney’s trust account for distribution after reduction of attorney fees and a proportionate share of the out of pocket costs of recovery with 25% of the gross recovery of punitive damages to the Plaintiff and the remainder paid into the civil reparations trust fund’ (citing Fernandez v. Curley, 463 N.W.2d 5 (Iowa 1990) regarding Iowa’s split-recovery statute)); Payne v. Cmty. Blood Ctr., No. 0210-10211, 2004 WL 5400536, at *3 (Or. Cir. Ct. Oct. 25, 2004) (‘[T]he Court notes that allegations of punitive damages remain pending against Defendant Cryolife, Inc., and that both compensatory and punitive damages may, at some future time, be deposited into the Trust’); In re Carolina Tobacco Co., 360 B.R. 702, 706–707 (D. Or. 2007) (describing the escrow account required by a settlement with states for the payment of future judgment awards). 42 See Huang, Surprisingly Punitive Damages, supra note 6, at 1042–44. 43 It should be noted that punitive damages are not generally understood to be the particular entitlement of any given plaintiff, but rather a windfall; accordingly, it is common for ‘split-recovery’ statutes to divert a share of the award to the state treasury or to charitable uses. See Sharkey, supra note 3, at 370–80. 44 See Exxon Shipping Co. v. Baker, 554 U.S. 471, 492 (2008) (‘Regardless of the alternative rationales over the years, the consensus today is that punitives are aimed not at compensation but principally at retribution and deterring harmful conduct’). 45 Huang, Surprisingly Punitive Damages, supra note 6, at 1035–36. To oversimplify: one might view compensatory damages as not counting toward retribution, while recognizing that those payments do contribute to economic deterrence. 40 41

362  Research handbook on corporate liability that relates to the specific badness directed at this particular plaintiff.46 While the latter may properly be awarded in each of the multiple plaintiffs’ cases, the former should only ever be paid once across all cases. It is the former portion that is redundant if repeated, and hence a judge should designate only this overlapping portion to run concurrently with other courts’ awards. In practice, however, where awards are assessed by a jury without explanation, it may be difficult for a judge to draw such a distinction. B. Injunctions Decoupling the announcement of a remedy from its implementation is also possible with injunctions. A judge who is concerned about the possibility of conflicting injunctions can stay her intended injunction, in full or in part. (A familiar analogue would be the common practice in which a trial judge stays her injunction pending the resolution of an appeal.) In prior work I have explained the judge’s task as follows: ‘She should still express her views on the merits, of course, and specify the exact injunction she would issue (if any), were there no risk of conflicting injunctions. Yet, because she recognizes that the risk is real, she must also make a further issue-or-stay decision.’47 This requires deciding how much (if any) of her intended injunction to stay, based on her expectations of what other judges will do, and then articulating this reasoning as part of her order. As the judges in parallel cases also make their own respective judgment calls, their public explanations – both about intended injunctions and about issue-or-stay decisions – will accumulate.48 Through mutual observation and possibly collaboration, the judges can converge on a compatible set of issue-or-stay decisions by updating their individual orders as needed. What must become compatible in equilibrium is not the set of intended injunctions (though these can be updated too), but the set of issue-or-stay decisions. The path to convergence can be smoothed by the presence of a focal point for the judges’ mutual expectations.49 The most unreflective (but also most likely the default) focal point This conceptualization is consistent with Philip Morris (as discussed supra notes 4 and 31), if one views the portion that relates to the general badness of the original conduct as properly being part of the punishment for the present plaintiff’s harm – and the Court’s opinion can be read as implying as much. See also Nagareda, supra note 28, at 1110 (noting that because the Philip Morris ruling allows juries to consider nonparty harms when evaluating the reprehensibility of the defendant’s conduct, ‘after Williams, an ostensible individual action for punitive damages resulting from market-wide misconduct will continue to have at least some nonparty dimension even though, again, nonparties have not been brought into the suit through class certification’). 47 Huang, Coordinating Injunctions, supra note 6, at 1335. 48 This discussion presupposes that not all judges are willing to completely stay their intended injunctions (such that no relief is implemented at all) while the parallel cases run their course—but in theory, such an ‘all-stay’ starting point is possible and consistent with the spirit of the proposed solution. A variation that seems to be increasing in usage is an ‘all-partial-stay’ approach in which each court allows the intended relief to take effect only within a limited geographic area, while staying its operation elsewhere. See Huang, Coordinating Injunctions, supra note 6, at 1352 & n.65. This practice is also consistent with the spirit of the proposed solution, though of course it is only possible when relevant actions of the defendant can be divided up geographically. 49 The classic exposition of such ‘focal points’ comes from Professor Schelling. Thomas Schelling, The Strategy of Conflict 54 (1960) (‘What is necessary is to coordinate predictions, to read the same message in the common situation, to identify the one course of action that their expectations of each other can converge on. They must ‘mutually recognize’ some unique signal that coordinates their expectations 46

Overlapping remedies  363 would be whatever the first-mover judge chooses to do. Later-moving judges may feel enormous pressure to conform to it by staying any incompatible parts of their own orders. Setting the initial conditions for this sort of path-dependence, however, need not be so haphazard. A more principled focal point is possible: ‘Each district judge should issue or stay her injunction in accordance with the outcome she thinks most district judges would choose.’50 For any judge who thinks she may be the first to move, it is especially important that she announces she is following this convention (even if she does not need to stay any part of her order). Using her first-mover advantage in such a self-restrained way would reinforce the norm, promote comity and mutual regard among the judges, and set a principled focal point from the very start.51 The advantages of this focal point are that it serves to speed up convergence and to shore up the legitimacy of the end result. First, as to convergence: the idea here is not that each judge will guess correctly, on the first try, what most judges would do. Rather, it is that the judges’ guesses about this are likely to start off closer together than their individual views about the ideal remedy. (Think about asking people to guess whether most people are right- or left-handed, as compared to asking them whether they themselves are right- or left-handed.)52 It also provides a principled reason for staying one’s own order, beyond capitulating to another judge’s first-mover advantage.53 Moreover, any later adjustments to a judge’s order would not signify that she is abandoning her own views, but rather that she is updating her estimate of what a majority would do, based on more data.54 Finally, because concurrent orders exist, the convergent outcome can survive the potential appellate overturning of any individual judge’s order.55 Moreover, as to legitimacy: the equilibrium achieved through such convergence can be seen as an approximation of what these judges would have decided together as a group.56 And because of the design of the focal point, they have been continually steering toward a result that, by definition, minimizes the number of judges who would disagree.57 The primary weakness of this solution is that highly individualistic judges can cause it to fail. Adopting the shared convention requires a degree of commitment to comity and mutual regard – after all, it is asking each judge to follow a norm that may deny the plaintiff before her the full extent of the relief she believes appropriate, in order to avoid the risk of incompatible demands on the defendant. The solution can be undone by a judge who is incapable of such self-restraint, does not mind imposing her will on others, or simply is not bothered by a clash of injunctions.

of each other.’); id. at 57 (‘Most situations—perhaps every situation for people who are practiced at this kind of game—provide some clue for coordinating behavior, some focal point for each person’s expectation of what the other expects him to expect to be expected to do.’). 50 Huang, Coordinating Injunctions, supra note 6, at 1335. 51 Id. at 1352–55. 52 Id. at 1347. 53 Id. at 1348. 54 Id. at 1337, 1348. 55 See id. at 1355–57 (describing the potential impact of appellate rulings on the stability of the equilibrium, as well as a proposed role for the appeals courts within the coordination solution). 56 Id. at 1336. 57 Id. at 1349.

364  Research handbook on corporate liability

IV. CONCLUSION This chapter has focused on two acute problems of overlapping remedies that can occur when multiple, parallel lawsuits arise from the same event: first, punitive damages may stack up in a redundant way, creating over-punishment or over-deterrence; and second, multiple courts may issue clashing injunctions. The discussion has reviewed the standard approach to such difficulties, which is to aim at once-and-for-all adjudication. It has also examined why two well-known procedural devices in the federal courts of the United States – class actions and MDLs – can fall short of achieving this aspiration. This chapter has also highlighted an alternative approach, one in which ‘concurrent remedies’ are made possible. The approach takes as a given the fact of multiple adjudication, but recognizes that this need not translate into the multiple imposition of remedies. The idea is to decouple the announcement and the implementation of the remedy. The discussion above has reviewed how this approach might deflate redundant punitive damages and prevent conflicting injunctions in contexts in which parallel litigation is unavoidable. Several limitations of this chapter’s scope are worth addressing. First, its focus on overlapping remedies is not meant to downplay other costs, or even possible benefits, of parallel litigation. Second, although it has addressed two well-known procedural devices in the federal courts of the United States, other existing or proposed devices for coordination in these or other courts (including bankruptcy procedures) may also reduce the likelihood of overlapping remedies.58 Third, and perhaps needless to say, substantive constraints such as damages caps can also mechanically lessen the impact of overlapping remedies – albeit in crude, accuracy-free ways that generally disserve the aims of civil justice. Finally, this discussion has been limited to private civil litigation; beyond this scope, analogous forms of redundancy may include the overlap in penalties assessed by multiple regulatory enforcers, the overlap between tort remedies and regulatory penalties, and possibly the overlap of either with criminal sanctions.59 If coordination among enforcers is unreliable in any such settings, potential analogues to the concurrent-remedies approach may reward further study.

For a small sampling of the literature analyzing a wide variety of such practices, proposals, and conceptual models, see, e.g., Robin J. Effron, Event Jurisdiction and Protective Coordination: Lessons from the September 11 Litigation, 81 S. Cal. L. Rev. 199 (2008); David Freeman Engstrom, Agencies as Litigation Gatekeepers, 123 Yale L.J. 616 (2013); Myriam Gilles, The Politics of Access: Examining Concerted State/Private Enforcement Solutions to Class Action Bans, 86 Fordham L. Rev. 2223 (2018); Margaret H. Lemos, Aggregate Litigation Goes Public: Representative Suits by State Attorneys General, 126 Harv. L. Rev. 486 (2012); McKenzie, supra note 1. 59 See, e.g., Zachary D. Clopton, Redundant Public-Private Enforcement, 69 Vand. L. Rev. 285 (2019); Kyle Logue, Coordinating Sanctions in Torts, 31 Cardozo L. Rev. 2313 (2010). Concerning overlapping settlements across enforcement domains, see Adam S. Zimmerman, Mass Settlement Rivalries, 82 U. Cin. L. Rev. 381 (2018). 58

20. Jurisdiction and corporations: identifying an international standard Richard Garnett

I. INTRODUCTION The question of when a foreign corporation may be subject to the jurisdiction of a national court has been highly significant in international trade and commerce. A particular challenge of applying jurisdictional rules to a corporation is that it is an artificial legal entity and so territorial concepts such as nationality, domicile and residence are less obviously applicable than in the case of an individual. Once however the corporation became the most widely adopted business model in the second half of the nineteenth century and disputes concerning its activities arose, it became critical to devise rules to determine the place(s) in which it could be sued. Today the issue of jurisdiction over corporations remains contentious, with the online landscape having expanded the scope and range of cross-border disputes. The aim of this chapter is to assess whether a common theme or standard may be identified in the various national law approaches to the question. The primary focus will be on common law countries (the United States, England and Wales, and Canada) but examination will also be made of European Union (EU) rules. A historical approach will be taken so that the evolution of the current rules can be understood.

II.

THE PRE-1945 PERIOD

Domestic corporations present few problems jurisdictionally: it has long been accepted in Anglo-American jurisprudence that a corporation could be sued in its place of incorporation. Yet, as corporations grew and business expanded across national boundaries, the question of whether a court in country A could assert jurisdiction over a company incorporated in country B became pressing. The United States, being a federal system, also saw the problem arising as between the states of the union. An obstacle however to establishing jurisdiction over foreign or inter-state corporations was that until the late nineteenth century the power of common law courts in England and the United States to adjudicate was limited to persons and property within the territory of the forum.1 Specifically, in the case of a corporation, such an entity was said to ‘dwell in the place of its creation’.2

1 ‘It was treated as axiomatic at common law that the king’s writ did not run beyond the seas. Accordingly, if the writ could not be served on the defendant within the realm, then the king’s courts could not exercise jurisdiction over the defendant.’ Mr Justice Butcher, 2020 Lords Goff and Hobhouse Memorial Lecture (26 Feb. 2020), https://​www​.judiciary​.uk/​wp​-content/​uploads/​2020/​03/​Judge​-gives​ -the​-2020​-Lords​-Goff​-and​-Hobhouse​-Memorial​-Lecture​.pdf 2 Bank of Augusta v. Earle, 38 U.S. 519, 520 (1839) (Taney CJ).

365

366  Research handbook on corporate liability In a series of decisions, however, American and English courts cast off the territorial shackles and allowed suits to be brought against foreign corporations in certain circumstances. For example, in La Fayette Insurance Co v French,3 the United States Supreme Court upheld the power of state legislatures to authorize service of process on foreign corporations doing business within the forum state of adjudication. In that case the corporation chose to do business in the forum through an agent with the forum legislature requiring as a condition of its doing business there that the agent be required to accept service of process on behalf of the corporation in any disputes. The ‘consent’ of the corporation to be sued in the forum was therefore the basis of jurisdiction. In subsequent United States decisions in the late nineteenth and early twentieth centuries, the trend towards exercising jurisdiction over foreign corporations continued. Courts considered that, at a time of growing inter-state business, it would cause ‘much inconvenience and … manifest injustice’4 to exempt a corporation from suit in another state. Hence, jurisdiction was expanded to include the situation where a corporation was doing business in the state and the litigation arose out of that business,5 and where it was ‘doing business within the state in such a manner and to such an extent as to warrant the inference that it is present there’.6 Jurisdiction was also established where the company had an authorized agent in the forum which engaged in a continuous course of business for the corporation.7 The mere presence of the agent in the forum was however insufficient; the agent must have been doing the business of the corporation.8 A similar trend is noticeable in England where it was held that a foreign corporation could be sued in England where it had a fixed place of business and traded there, despite being incorporated and having its principal place of business abroad.9 An analogy was drawn with an individual defendant who is subject to common law jurisdiction where he or she is ‘present’ in the forum for service. The conclusion that a foreign corporation may be subject to English jurisdiction was said by one court to be of ‘very considerable practical importance’ given the increasing number of Scottish and American companies that had established branches in London, which could incur liabilities to local persons.10 It was therefore possible (and indeed desirable) for a corporation to be found to be present or to ‘reside’ in more than one place. The scope of the ‘carrying on business at a fixed place’ test was broadened in later cases to include the situation where a foreign shipping company rented an office in England to receive applications for freight and passage and paid legal and advertising expenses for the office,11 where a corporation formed a ‘London Committee’, with an English office and staff, to raise

La Fayette Insurance Co. v. French, 59 U.S. 404 (1855). St Clair v. Cox, 106 U.S. 350, 355 (1882). 5 Id. 6 Philadelphia Reading RR v. McKibbin, 243 U.S. 264 (1917); International Harvester v. Kentucky, 234 U.S. 579 (1914). 7 Id. 8 The issue also attracted early academic attention. See, e.g., Edward Quinton Keasbey, Jurisdiction over Foreign Corporations 12 Harv. L. Rev. 1 (1898). 9 Newby v. Von Oppen and the Colt’s Pat. Firearms Mfg. Co. (1872) LR QB 293. 10 Id. at 295. 11 La Bourgogne [1899] AC 431(UKHL). 3 4

Jurisdiction and corporations  367 loan capital for the construction of a railway in the foreign country12 and, most dramatically, where a company rented premises in England for nine days for the exhibition of its products.13 The key thread underlying these decisions is that the business or activities undertaken did not need to be a substantial proportion of the foreign company’s business; it was enough if some business was conducted in the forum. The earlier expressed caution about subjecting foreign corporations to local jurisdiction was receding. Further, and consistent with their American counterparts, English courts accepted from the early twentieth century that a foreign company may be found to be carrying on business at a fixed place in the forum by a representative agent resident there. The leading decision was Okura A Co v Forsbacka Jernverks A/B,14 which involved a Swedish company engaged in the manufacture of steel that appointed a firm to act as its agent in London. The firm acted as sole agent for the company but also acted as agent for other entities. Upon the firm receiving an order from a buyer it would send the order to the foreign company which would approve the order and pass it back to the agent for execution. The English Court of Appeal held that the foreign corporation was not carrying on business by its agent in England for two distinct reasons. The first basis was that the agent had no general authority to enter into contracts on behalf of the corporation with third parties and bind the corporation, and the second was that the agent was not doing the corporation’s business in England. While the first criterion initially had the most impact, in more recent decisions, as discussed later, the second factor has assumed greater significance. Hence it was clear from at least the early twentieth century that both English and United States courts recognised that a corporation could be considered to have multiple ‘presences’ or residences to enable it to be sued in a court other than its country of incorporation or principal place of business. The broad test applied in both countries was whether the company was carrying on business at a place in the forum. A further point of equivalence in the approaches taken in England and the United States to corporate jurisdiction pre-1945 can be seen in the use of service by registration statutes. Such statutes generally required, as a condition of doing business in a state or country, a foreign corporation to register and appoint a person to act as an agent for service of process. Section 35 of the Companies Act 1907 (UK) was typical: (1) Every company incorporated outside the United Kingdom which … establishes a place of business in the UK … shall file with the registrar ... (c) the names and addresses of one or more persons resident in the UK authorized to accept on behalf of the company service of process … (2) Any process … required to be served on the company shall be sufficiently served if addressed to any person whose name has been so filed … and left at or sent by post to the address … so filed.

Almost identical provisions were enacted in later UK legislation.15

AS Dampskib Hercules v. Grand Truck Pacific Railway Co. [1912] 1 KB 222 (EWCA). Dunlop Pneumatic Tyre Co. v. Actien-Gesellschaft für Motor und Motorfahrzeugbau vorm. Cudell & Co [1902] 1 KB 342 (EWCA). 14 Okura A Co. v. Forsbacka Jernverks A/B [1914] 1 KB 715 (EWCA). 15 Companies Act 1929, 19 & 20 Geo. 5 c. 38, §§ 344(1(c), 346(3) and 349; Companies Act 1948, 11 & 12 Geo. 6 c. 38, §§ 407(1)(c), 409(c) and 412. 12 13

368  Research handbook on corporate liability The approach taken by courts in both countries to the interpretation of such legislation was initially consistent. Clearly one purpose of the legislation was to facilitate the process of service by a local party upon a foreign corporation. As was stated by Lord Sumner in Employers Liability Assurance Corp Ltd v Sedgwick, Collins and Company Ltd:16 one plain object of the provision is to protect the foreign company’s British creditors by obtaining for them ab initio the means of serving process in this country, free from the inconvenience of seeking out the foreign company in its country of incorporation.

While the legislation clearly was concerned with the process and mechanics of service on a foreign corporation, it did not appear to create a further rule of jurisdiction over such a corporation based on mere service on a registered agent alone. Arguably, for jurisdiction to exist, the corporation would have to have some further link or connection with the forum. Yet in the same case two judges specifically recognized that jurisdiction over a foreign corporation would be valid where it was based upon service on a registered person nominated under the Act. Interestingly, the basis of the jurisdiction was not presence, as in the common law ‘fixed place of business’ test referred to earlier, but submission: by filing with the registrar the name and address of an agent for service, the corporation voluntarily submitted to the jurisdiction.17 That the act of registration was intended to have jurisdictional effect was also clear from Lord Sumner’s reference to the stricter position at common law, which had been the sole basis for establishing jurisdiction over foreign corporations prior to 1907. The position in the United States was similar, with most states enacting provisions akin to those in the UK Companies Act, referred to earlier. Furthermore, in several decisions, the United States Supreme Court confirmed that such statutes provided not only a means of service on foreign corporations but also a ground of jurisdiction.18 A final important development to note in England was the 1852 Common Law Procedure Act, which, for the first time, allowed a foreign corporation with no presence in England to be sued in the forum.19 The Act allowed service out of the jurisdiction with the permission of the court but in strictly limited circumstances. For example, during the period 1883–1920 the grounds for service out were confined to cases where the defendant was domiciled or ordinarily resident in England, a contract had been breached in England or the person was a necessary or proper party to an action brought against someone who had been served in England.20 From 1920 to 1945 the grounds were slightly expanded to include cases in which a contract was made in England or by an agent within England or was governed by English law or where a tort had been committed in England.21 Further, even if a ground for service out was established, an English court retained a discretion to decline to approve service abroad on the

16 Employers Liability Assurance Corp. Ltd. v. Sedgwick, Collins & Co. Ltd. [1927] AC 95, 108 (UKHL). 17 Id. at 107; see also Lord Parmoor, id. at 115. 18 See, e.g., Pennsylvania Fire Insurance Co of Pennsylvania v. Gold Issue Mining and Milling Co, 243 U.S. 93 (1917) and Robert Mitchell Furniture Co v. Selden Breck Construction Co, 257 U.S. 213 (1921). 19 Common Law Procedure Act 1852. 15 & 16 Vict. c. 76 (UK), § 19. See generally Butcher, supra note 1. 20 Order XI of the Rules of the Supreme Court 1883. 21 Order XI 1920.

Jurisdiction and corporations  369 basis of the likely cost and convenience of the trial.22 Courts also considered it ‘a very serious question whether … to put a foreigner, who owes no allegiance here, to the inconvenience and annoyance of being brought to contest his rights in this country’.23 Extraterritorial jurisdiction over foreign corporations was therefore ‘exorbitant’ and only to be exercised in clear cases. Hence, by 1945, English and United States courts had achieved a remarkable convergence in their approaches to jurisdiction over foreign corporations. This outcome was reached without any conscious borrowing or imitation of the other but rather grounded in a common concern to prevent local creditors being denied redress when dealing with foreign corporations where such entities had engaged in business in the forum. While the common law test of carrying on business at a fixed place in the forum was territorial in focus, the statutory jurisdiction by registration approach focused on the defendant’s consent. After 1945, however, the two countries’ approaches to jurisdiction over corporations diverged substantially. The United States abandoned territoriality in favour of a more fluid and amorphous ‘minimum contacts’ analysis, which has recently led to a scaling back in assertions of jurisdiction. English law has gone in the opposite direction: a gradual expansion of jurisdiction tempered slightly by the United Kingdom’s (former) membership of the European Union and the operation of the forum non conveniens doctrine. Also, while Commonwealth countries largely followed the English model for most of the post-1945 period, in Canada a distinctive model began to emerge. These observations may suggest that the identification of a contemporary international standard for jurisdiction over foreign corporations is a difficult task. Yet, as the Hague Conference on Private International Law now considers whether to pursue a global convention on personal jurisdiction,24 it is important to assess whether an international consensus on rules can be achieved.

III.

THE UNITED STATES SINCE 1945: FROM FLEXIBILITY TO CONTRACTION

The United States’ record on jurisdiction and foreign corporations since 1945 reveals an interesting journey: from the introduction of a flexible, potentially broader ‘minimum contacts’ test in place of the previous territorial approach to a dramatic retreat and contraction of jurisdiction since 2011. The seminal case on jurisdiction in the 1945–2011 period was International Shoe v Washington.25 The Supreme Court there established a test for ‘general’ and ‘specific’ jurisdiction, with general jurisdiction addressing the situation where the dispute itself has no connection with the forum. In such a case a foreign corporation will only be subject to jurisdiction where it engaged in ‘continuous, systematic and substantial activity in the forum state’. The defendant must have certain minimum contacts with the forum state such that maintenance of

Strauss v. Goldschmidt (1892) 8 TLR 239. Société Générale v. Dreyfus (1885) 29 Ch D 239, 242–43. 24 In 2021, following the conclusion of the Hague Convention on the Recognition and Enforcement of Foreign Judgments in Civil or Commercial Matters, Jul. 2, 2019, the Hague Conference requested the establishment of a Working Group on matters related to jurisdiction in transnational civil or commercial litigation (https://​www​.hcch​.net/​en/​projects/​legislative​-projects/​jurisdiction​-project). 25 International Shoe v. Washington, 326 U.S. 310 (1945). 22 23

370  Research handbook on corporate liability the suit does not offend ‘traditional notions of fair play and substantial justice’.26 Alternatively, ‘specific’ jurisdiction may be available over a foreign corporation where a defendant performs ‘single or occasional acts’ or has contacts with the forum and the plaintiff’s cause of action arises out of such acts or contacts. International Shoe was a breakthrough decision whereby the Supreme Court rejected the previous territorial approach to jurisdiction in favour of a broader, policy-oriented test based on assessing the quality of contacts and fairness. The court also introduced the distinction between general and specific jurisdiction which was to be the organizing principle in subsequent cases. A.

General Jurisdiction

The test for general jurisdiction was intended to be difficult to satisfy, requiring ‘continuous and systematic’ business contacts with a state and, in the few Supreme Court decisions on the issue before 2011, jurisdiction was rarely found. For example, in Helicopteros Nacionales de Colombia SA v Hall,27 a Colombian corporation providing helicopter transport services in Peru was not subject to general jurisdiction in Texas in a personal injury action arising out of an accident in Peru. The court found that the company was not authorised to do business in Texas, had no agent there and did not solicit business in that state. There were no continuous and systematic contacts with the forum. From 2011 the Supreme Court, in a series of cases, embarked on a further contraction of the scope of general jurisdiction. Goodyear Tire Dunlop Tire Operations SA v Brown28 concerned a personal injury suit in North Carolina arising from a bus accident in France, with the plaintiffs suing a Turkish company that allegedly manufactured a defective tyre on the bus. After the lower courts upheld jurisdiction, the Supreme Court reversed and redefined the test for general jurisdiction. In a unanimous decision, the court suggested that the contacts required to satisfy the ‘continuous and systematic’ standard must be such as to render the defendant ‘at home’ in the forum state. The two places identified where a defendant corporation will be at home are (a) its state of incorporation and (b) its principal place of business, although, exceptionally, another state may qualify where the contacts with that location are overwhelming. Here the defendant’s contacts with the forum were slight, with only a small percentage of its products sold in the forum compared to the volume of sales elsewhere. The Supreme Court further endorsed the ‘at home’ test in Daimler AG v Bauman29 and BNSF Railway Co v Tyrrell,30 again taking a comparative contacts approach to determining whether a forum other than the place of incorporation or principal place of business may be available for suit. Specifically, where the contacts with the forum are small as a proportion of the national or global whole, general jurisdiction will not exist. Such an outcome was said

28 29 30 26 27

Id. at 316. Helicopteros Nacionales de Colombia SA v. Hall, 466 U.S. 408 (1984). Goodyear Tire Dunlop Tire Operations SA v. Brown, 564 U.S. 915 (2011). Daimler AG v. Bauman, 571 U.S. 117 (2014). BNSF Railway Co v. Tyrrell, 137 S. Ct. 1549 (2017).

Jurisdiction and corporations  371 to be reasonable, since a ‘corporation that operates in many places can scarcely be deemed at home in all of them’.31 Clearly, the policy underlying this approach is to protect corporations with a global presence from suits in multiple fora; such entities should not be jurisdictionally ‘punished’ because of their size. The corollary, however, of such a test is that smaller businesses, with much less geographically dispersed contacts may be more jurisdictionally exposed, as was noted by Sottomayor J in Daimler.32 A further consequence is that a large corporation with business contacts across many states and countries may never be ‘at home’ in any one of them.33 This result would limit access to justice to individual plaintiffs who may lack the resources to litigate against large well-resourced corporations in distant forums.34 The current United States test for general jurisdiction and corporations arguably focuses too heavily on the position of the defendant and is too limited in its allocation of jurisdiction.35 The analysis also provides little scope for courts to tailor the jurisdictional rules to the case presented. While a commercial dispute between two large corporations with ample resources to litigate may be appropriate for application of the ‘at home’ test, confining an individual in a personal injury claim to suit in such fora is too restrictive. The original intended flexibility in the International Shoe ‘minimum contacts’ formulation seems to have been erased. B.

Specific Jurisdiction

The International Shoe case identified an alternative basis for asserting jurisdiction over corporations: ‘specific jurisdiction’. This category focuses on whether the plaintiff’s cause of action arises out of or relates to the defendant’s contacts in the forum, with a consequently smaller number of contacts required than for general jurisdiction. Not surprisingly, plaintiffs have generally had more success in establishing jurisdiction on this ground. Three conditions have been articulated by the Supreme Court for the exercise of specific jurisdiction:36 (i) the defendant must have ‘purposefully availed’ itself of the privilege of conducting activities in the forum state or have purposefully directed its conduct into that state; (ii) the plaintiff’s claim must arise out of or relate to the defendant’s conduct; and (iii) the exercise of jurisdiction must be reasonable in the circumstances.

31 Daimler AG v. Bauman, 571 U.S. 117, 139 n.20 (2014); BNSF Railway Co, 137 S. Ct. 1549, at 1559. 32 Daimler, 571 U.S. 117, at 158. 33 BNSF Railway Co, 137 S. Ct. 1549, at 1560 (Sottomayor J dissenting). 34 Id. at 1561. 35 In Daimler the court suggested that the US approach to personal jurisdiction was excessive compared to other countries: ‘other nations do not share [such an] uninhibited approach to personal jurisdiction’. Daimler, 571 U.S. at 141. Such a view accords with commentators who had argued for ‘heightened due process scrutiny’ in international (as opposed to interstate) cases on the basis that excessive assertions of jurisdiction burden foreign relations and commerce. See Gary Born, Reflections on Judicial Jurisdiction in International Cases, 17 Ga. J. Int’l & Compar. L. 1, 28–32 (1987). More recently, however, the ‘new’ approach of the Supreme Court has been criticised because it ‘discriminates against American companies’ and harms United States commerce by providing disincentives to companies to incorporate or locate their headquarters there. Pamela K Bookman, Litigation Isolationism, 67 Stanford L. Rev. 1081, 1129 (2015). 36 Burger King Corp v. Rudzewicz, 471 U.S. 462, 477 (1985).

372  Research handbook on corporate liability The 1985 decision, Burger King Corp v Rudzewicz, shows that the Supreme Court has taken a liberal view of the ‘purposeful availment’ requirement. In this case, a franchisor with its principal place of business in Florida was permitted to sue Michigan franchisees for breach of contract in Florida where the agreement contemplated ongoing interactions between franchisor and franchisees in Florida. While the presence of a breach of contract in the forum alone would have been insufficient, the ‘continuing and wide-reaching contacts’ between the defendant and the plaintiff in the forum amounted to purposeful availment of the forum by the defendant. Interestingly, unlike the position observed under general jurisdiction, the Supreme Court’s post-2011 decisions do not clearly reflect an intention to wind back the scope of specific jurisdiction. Yet the court has been careful to find jurisdiction only where the defendant’s connections and activities in the forum are substantial. In J McIntyre Machinery Ltd v Nicastro37 the Supreme Court held that a New Jersey court lacked specific jurisdiction over a UK-incorporated manufacturer whose machine injured a New Jersey resident in New Jersey. The court found that the defendant had not purposefully availed itself of the forum: it had no office in the state, nor did it advertise or send employees there. The defendant’s only connection with New Jersey was that the machine entered the state through a distribution network set up by the defendant with a United States company. Specific jurisdiction was also rejected by the court in Bristol Myer Squibbs Co v Superior Court of California38 due to insufficient connection between the plaintiff’s cause of action and the forum. This case involved a products liability suit in California where the plaintiff was not injured in the forum but sued there as part of a general class action that included persons both injured in-state and out of state. Because the plaintiff did not purchase, use or suffer injuries from the product in California, the connection between the cause of action and the forum state was too insubstantial and did not arise out of the defendant’s contacts. The very recent decision of Ford Motor Co. v Montana Eighth Judicial District39 shows however that the court will recognise specific jurisdiction in suits against foreign corporations where the connection with the forum is more than tenuous. Ford Motor involved another products liability suit, in which jurisdiction was found to exist where the defendant advertised, sold and serviced its products in the forum and the plaintiffs suffered injury there. Finally, a comment should be made about jurisdiction in the online context. The Supreme Court is yet to address this issue, but since the late 1990s lower courts have applied two tests to determine whether specific jurisdiction applies in the case of a foreign corporation. The first approach is derived from the Zippo case40 and requires a court to determine whether a defendant’s Internet conduct is passive in that it involves only the provision of information or advertising (and so no jurisdiction exists) or active in that it solicits business from and enters into contracts with forum residents (which establishes jurisdiction). A third category involves interactive websites, which may suffice for jurisdiction depending on the degree of interactivity and material exchanged. Other United States courts have rejected the Zippo test on the basis that (a) it is outdated in the current online environment of social media platforms and (b) general principles of specific

39 40 37 38

J McIntyre Machinery Ltd v. Nicastro, 564 U.S. 873 (2011). Bristol Myer Squibbs Co v. Superior Court of California, 137 S. Ct. 1773 (2017). Ford Motor Co. v. Montana Eighth Judicial District, 141 S. Ct. 1017 (2021). Zippo Manufacturing Co v. Zippo dotcom Inc, 959 F. Supp. 1119 (WD. Pa. 1997).

Jurisdiction and corporations  373 jurisdiction (‘purposeful availment’) can apply more effectively.41 According to this view, a defendant will be subject to specific jurisdiction where it targets or directs specific conduct at forum residents. Such a view arguably sits more comfortably with the Supreme Court’s recent statements on specific jurisdiction in J McIntyre and Ford Motor Co.42 So, specific jurisdiction remains a viable alternative to general jurisdiction, provided that the plaintiff can show a substantial connection between defendant and the forum. Overall, however, the United States approach to jurisdiction over foreign corporations is restrictive, an observation that is further supported in the case of jurisdiction based on ‘registration’ in the forum and jurisdiction arising out of the acts of related companies and subsidiaries. C.

Jurisdiction and Registration

It was noted earlier that in pre-1945 decisions the United States Supreme Court had upheld claims to jurisdiction over foreign corporations based on their registration and appointment of a local agent for service in the forum. While the Supreme Court has not addressed the issue since the Pennsylvania Fire case,43 lower courts have interestingly declared that jurisdiction based on registration is incompatible with the Goodyear/Daimler ‘at home’ test for general jurisdiction.44 This analysis, supported by academic commentary,45 suggests that if general jurisdiction can be created by registration alone then a corporation could be sued in every state where they register to do business, regardless of whether any business was actually conducted. A ‘universal and exorbitant’ jurisdiction would be created over foreign corporations, which is hard to reconcile with the ‘substantial, continuous and systematic’ course of business required for general jurisdiction in a state other than the place of incorporation or principal place of business.46 It is also difficult to argue that registration amounts to a consent or submission by the corporation to jurisdiction in respect of all disputes concerning the corporation in the forum. Since registration is required by the forum state of a corporation as a condition of doing local business, any consent to forum jurisdiction must be limited (at most) to disputes arising out of such business.47 So, registration by a corporation in the forum, while providing an alternative method of service, should not confer general jurisdiction over the entity under United States law. 41 See, e.g., Advanced Tactical Ordnance Systems LLC v. Real Action Paintball Inc, 751 F.3d 796 (7th Cir. 2014); Pervasive Software Inc v. Lexware GmbH & Co KG, 688 F.3d 214 (5th Cir. 2012); AMA Multimedia LLC v. Wanat, 970 F.3d 1201 (9th Cir. 2020). 42 See generally Zoe Niesel, #PersonalJurisdiction: A New Age for Internet Contacts, 94 Ind. L. J. 103 (2019). 43 Pennsylvania Fire Insurance Co of Pennsylvania v. Gold Issue Mining and Milling Co, 243 U.S. 93 (1917). 44 See, e.g., Brown v. Lockheed-Martin Corp, 814 F.3d 619, 639 (2d Cir. 2016); Magwitch LLC v. Pusser’s West Indies Ltd., 200 So. 3d 216, 218 (Fla. Dist. Ct. App. 2016); Magill v. Ford Motor Co., 379 P.3d 1033, 1038–39 (Colo. 2016). 45 See, e.g., Tanya Monestier, Registration Statutes, General Jurisdiction and the Fallacy of Consent, 36 Cardozo L. Rev. 1343 (2015). 46 Daimler AG v. Bauman, 571 U.S. 117, 138 (2014). 47 Leonard v. USA Petroleum Corp., 829 F. Supp 882, 889 (SD. Tex. 1993); Catherine Walsh, General Jurisdiction over Corporate Defendants Under the CJPTA: Consistent with International Standards?, 55 Osgoode Hall L.J. 163, 191 (2018).

374  Research handbook on corporate liability D.

Jurisdiction through Subsidiaries

A further suggested basis by which a foreign corporation may be subject to jurisdiction in United States courts is through the activities of a subsidiary in the forum state. The principal means by which this result is obtained is by application of the ‘alter ego’ theory, whereby the corporate veil of the subsidiary is pierced to attribute its acts and contacts to its foreign parent company for the purposes of determining jurisdiction. Typically, such a situation may arise where the parent has complete control of the subsidiary or there is a complete integration of parent-subsidiary operations. In Daimler the Supreme Court acknowledged that the corporate veil piercing argument may be available to acquire general jurisdiction over a foreign corporation, despite the new ‘at home’ test.48 The veil may be pierced where the subsidiary has no independent role or function but is merely an instrument by which the parent does business in the forum. In such a case the acts of the subsidiary may be attributed to the parent.49 While the doctrine appears to offer a promising extension to the ‘at home’ test from Daimler and Goodyear, its practical scope may be limited. Recall that the effect of the at home test is to confine general jurisdiction to a corporation’s place of incorporation or principal place of business, with suit elsewhere available only in ‘exceptional’ cases. For an exceptional case to exist, the contacts with a forum must be almost overwhelming. At most the corporate veil test can ‘add’ the subsidiary’s contacts to those of the parent to enhance the quantum of connections – yet the threshold will still be hard to satisfy. Two recent lower court decisions confirm the point. In both cases50 the courts imputed the contacts of a subsidiary to its parent, yet still found that the contacts were insufficient, as a proportion of the whole, to satisfy Daimler. The ‘comparative contacts’ analysis may therefore again stand in the way of the alter ego argument meaningfully enhancing the scope of general jurisdiction over foreign corporations.51 In summation, the United States position on jurisdiction over foreign corporations has always been much more restrained than is often assumed. Under the current law it is difficult to sue a foreign corporation in a United States court. General jurisdiction is almost impossible since such companies, by definition, will be incorporated outside the United States and often have their principal place of business abroad as well. Specific jurisdiction seems a better option, but the defendant corporation must have substantial connections with the forum and the plaintiff’s cause of action must arise out of such contacts. Jurisdiction based on registration is largely extinct.52 Daimler AG, 571 U.S. 117, at 134–35. Lower courts have confirmed that the ‘alter ego’ test remains available. Viega GmbH v. Eighth Judicial District Court, 328 P.3d 1152, 1157 (Nev. 2014); NYK Cool AB v. Pacific International Servs Inc., 66 F. Supp. 3d 385, 393 (SDNY 2014). 50 Grupo Mex SAB de CV v. Mt McKinley Ins. Co., 2019 WL 6905228 (Tex. App. 2019); Williams v. Progressive County Mutual Ins. Co., 2019 WL 1434241 (SD Cal. 2019). 51 See generally King Fung Tsang, The Elephant in the Room: An Empirical Study of Piercing the Corporate Veil in the Jurisdictional Context, 12 Hastings Bus. L.J. 185 (2016). 52 This chapter examines the question of personal jurisdiction over corporations. A court must also have ‘subject matter jurisdiction’ over a claim, which may depend upon application of a statute that confers power on a court to adjudicate certain matters. A notable example is the United States Alien Tort Claims Act 1789, which confers original jurisdiction on a United States court to determine a civil action for tort by a foreign claimant. Personal jurisdiction over the defendant, however, must additionally be established in such a case for the matter to proceed. 48 49

Jurisdiction and corporations  375 E.

Forum Non Conveniens

Before leaving the United States material, a final jurisdictional principle should be considered that may impact on the earlier conclusions: the doctrine of forum non conveniens. According to this doctrine a United States court has a discretion to dismiss transnational litigation in favour of a foreign court if the foreign court is available and adequate and the balance of private and public interest factors supports dismissal.53 Private interest factors include the litigant’s relative ease of access to sources of proof, and public interest factors encompass administrative difficulties flowing from court congestion and the desirability of local courts resolving local disputes. In practice however the doctrine has had a limited application in the context of suits against foreign corporations for two reasons. First, the Supreme Court in Piper Aircraft v Reyno54 said that greater deference will be given to a United States plaintiff’s choice of a United States forum in a suit against a foreign corporation than a foreign plaintiff’s choice of a United States court against a United States corporation.55 Empirical studies have shown that lower courts since Piper have generally followed this instruction, with foreign plaintiffs ‘twice as likely to have their suits dismissed’ as US plaintiffs.56 Secondly, the highly restrictive rules of personal jurisdiction over foreign corporations examined earlier mean that cases may often be dismissed without the need for the defendant to rely on a forum non conveniens application.57 The doctrine has therefore played only a limited role in jurisdictional disputes involving foreign corporations. In the next part of the chapter, examination is made of English approaches to jurisdiction over corporations to determine whether some common elements with the earlier material can be identified.

IV.

THE CONTEMPORARY ENGLISH POSITION: ‘WIDER STILL AND WIDER’

A.

England: General Jurisdiction

As noted earlier, the original English approach to jurisdiction over foreign corporations was based on the common law concept of ‘presence’, which required the claimant to show that the defendant was carrying on business in the forum. It was also possible to establish jurisdiction by serving a corporation that had registered in the forum and appointed a local agent to accept

Piper Aircraft v. Reyno, 454 U.S. 235 (1981). Id. 55 Id. at 255–56. 56 Donald Earl Childress III, Forum Conveniens: The Search for a Convenient Forum in Transnational Cases, 53 Va. J. Int’l L. 157, 169 (2012). 57 Some commentators have described the doctrine as ‘redundant’ for this reason: see Maggie Gardiner, Retiring Forum Non Conveniens, 92 N.Y.U. L. Rev. 390, 391, 399, 429 (2017); Peter B Rutledge, With Apologies to Paxton Blair, 45 N.Y.U. J. Int’l L. & Pol. 1063, 1070–71, 1074 (2013); Gerlinde Berger-Walliser, Reconciling Transnational Jurisdiction: A Comparative Approach to Personal Jurisdiction over Foreign Corporate Defendants in US Courts, 51 Vand. J. Transnat’l L. 1243, 1290 (2018). 53 54

376  Research handbook on corporate liability service. Service out of the jurisdiction was available but only in very limited circumstances. It was suggested earlier that pre-1945 English and United States approaches to jurisdiction over foreign corporations were broadly similar and achieved consistent outcomes. If, however, the United States record since 1945 (and particularly in the last ten years) has seen a steady contraction in the scope of jurisdiction over corporations, the experience in England (and most Commonwealth countries) has been the opposite. In England, until 2021, there have been three principal methods for establishing jurisdiction over foreign corporations which cumulatively amount to a wide assertion of jurisdiction. First, the earlier mentioned statutory jurisdiction based on registration of a foreign corporation and appointment of a local person to accept service is preserved in section 1046 of the Companies Act 2006. A foreign company is required to register in the UK when it opens an ‘establishment’, which is defined as a branch or place of business,58 and under section 1139(2) (a) of the Act service of process on the corporation is performed by leaving it at or sending it by post to the registered address of the ‘agent’.59 Once again, no actual carrying on of business on the part of the company in the UK is required; service on the agent will be sufficient to establish jurisdiction. Section 1139(2)(b) further provides that, if service cannot for any reason be effected on such a person, despite the company’s registration, service is valid by leaving the process at or sending it by post to any place of business of the company in the United Kingdom. The width of this rule is demonstrated by the facts that (a) a ‘place of business’ may include an office established for the purposes of transfer and registration of shares and (b) as long as an ‘establishment’ has been opened it does not matter whether any business has yet been conducted.60 Indeed, an earlier decision of the Court of Appeal on the predecessor provision to s 1139(2) (b) shows that the concept of a ‘place of business’ goes well beyond the common law test discussed earlier. In South India Shipping Corporation Ltd v Export-Import Bank of Korea61 a Korean company with its principal place of business in Korea set up a branch office in England. The branch did not enter into any banking transactions in England although it had premises and staff, conducted external relations with other banks and carried out work in relation to the financing of loans, and gave publicity to the foreign company. The court held that the Korean bank had established a ‘place of business’ in England under the earlier version of s 1139(2)(b) referred to above, despite the branch not engaging in banking transactions or the core business of the corporation but only in incidental activities. The second current basis of establishing jurisdiction over a foreign corporation is under Part 6 of the Civil Procedure Rules, which involves leaving the process with a senior person within the company.62 Such method is however unavailable under common law principles when the corporation does not carry on business at a fixed place within the jurisdiction.63 So, where service was effected on a director who was within the jurisdiction, this was held to be insufficient.64 The carrying on of business at a fixed place test must also be satisfied, as this was Overseas Companies Regulations 2009, SI 2009/1801 (UK). Companies Act 2006, c. 46 § 1139(2)(a). 60 Teekay Tankers Ltd v. STX Offshore & Shipping Co [2014] EWHC (Comm) 3612 (Eng.). 61 South India Shipping Corporation Ltd v. Export-Import Bank of Korea [1985] 1 WLR 585 (EWCA). 62 CPR r 6.5(3)(b) (UK). 63 SSL International Plc v. TTK LIG Ltd [2011] EWCA (Civ) 1170. 64 Id.; The Theodohos [1977] 2 Lloyd’s Rep 428. 58 59

Jurisdiction and corporations  377 a ‘fundamental rule of the common law’. The common law rule was preserved to ensure that foreign corporations have a real and substantial presence within the jurisdiction. Alternatively, a foreign corporation may be served at any place of business of the company within the jurisdiction.65 In this context, the common law test is also applied.66 Hence, the common law test of carrying on business at a fixed place in the jurisdiction remains a cornerstone of English law67 and continues to apply both as an independent source of jurisdiction and where service is performed under the Civil Procedure Rules (CPR). Indeed, since 1945, the scope of the common law principle appears to have expanded. Of great significance is the 1989 decision of the Court of Appeal in Adams v Cape Industries Plc.68 The court there approved the Okura line of cases that suggested that a foreign corporation could carry on business at a fixed place in the jurisdiction through an agent where the agent had authority to enter into contracts with third parties that bound the corporation. The court however modified and potentially widened this test, by suggesting that the question of authority is merely one element to consider as part of an overall inquiry in determining whether a representative has been carrying on the principal’s business in the forum. The key question is instead whether the representative is carrying on the foreign corporation’s business almost exclusively or performing its own independent operations. Such an inquiry would be informed by an examination of the functions performed by the representative and all aspects of the relationship between principal and putative agent, in particular the degree of control exercised by the principal over the conduct of the business by the representative. Authority to enter into contracts to bind the corporation is hence now only one factor among many to consider in determining whether an ‘agency’ exists.69 The revised ‘holistic’ analysis has been applied in subsequent decisions70 with Australian courts taking the same approach.71 In Adams, another argument suggested to subject the foreign corporation to jurisdiction was that the corporation and the representative company formed ‘a single economic unit’ such that it was appropriate to attribute all the representative’s contacts and activities of the corporation. Essentially, this contention is a version of the ‘alter ego’ argument considered earlier in the context of the United States material.72 The English Court of Appeal was however less receptive to this argument than American courts, finding that it was ‘a fundamental principle’ of English law that a subsidiary company was a separate legal entity from its parent with separate legal rights and obligations. Hence, the mere existence of a subsidiary in the forum CPR r 6.9(2) row 7. Chopra v. Bank of Singapore Ltd [2015] EWHC (Ch) 1549 ¶ 96 (Eng.). 67 A company selling or advertising goods in the forum by online or offline transactions is also not carrying on business at a fixed place in the forum: Lucasfilm Ltd v. Answorth [2009] EWCA (Civ) 1328 ¶¶ 192–93. 68 Adams v. Cape Industries Plc. [1990] 1 Ch 433 (EWCA). 69 Id. at 531. The distinction between the ‘old’ and ‘new’ tests was not however material on the facts of Adams since the court found the representative to be only a marketing agent of the corporation, performing its own essentially independent business, as well as concluding that the entity had no authority to enter into contracts with third parties to bind the corporation. 70 Chopra [2015] EWHC 1549 ¶ 100; Actavis Group v. Eli Lilly & Company [2013] EWCA Civ 517; Noble Caledonia Ltd v. Air Niugini Ltd [2017] EWHC (QB) 1095 ¶ 51. 71 Anglo-Australian Foods Pty Ltd v. Credit Suisse (1988) 1 ACSR 69 (WASC) (Austl.); Commonwealth Bank v. White [1999] 2 VR 681 (VSC) (Austl.). 72 James Fawcett, Companies in Private International Law, 37 Int’l & Compar. L.Q. 645, 665 (1988). 65 66

378  Research handbook on corporate liability does not subject the foreign parent to jurisdiction unless the subsidiary is an ‘agent’ in the sense earlier mentioned. The only exception to this rule is where the subsidiary is no more than ‘a mere façade concealing the true facts’, that is, a sham company. This approach has also been adopted in Australia.73 A final feature to observe about the English rules on jurisdiction, whether under the CPR or under the Companies Act, is that no connection is required between the business conducted and the claimant’s cause of action. Defendants in some cases74 have sought to limit the jurisdiction in this way but have been repeatedly rebuffed on the basis that such a requirement is not referred to in the relevant instrument. Nor has the common law test of presence ever had such an element. B.

EU: General Jurisdiction

There was however one context in English law in which a connection between the activities of the defendant and the claim was required: where the defendant corporation was domiciled in a European Union (EU) or European Economic Area (EEA) state. The Brussels I Regulation (Recast) and the Lugano Convention provide a set of detailed, codified rules for determining when a court in an EU or EEA country may exercise jurisdiction. The basic principle under the Convention emanates from Roman law – actor sequitur forum rei – which means that the defendant should presumptively be sued in the country of its domicile. Consequently, under article 4 of the Regulation, a corporation that is domiciled in an EU member state must generally be sued in that place. ‘Domicile’ in this context is defined as the place where the corporation has (a) its statutory seat (registered office), (b) central administration or (c) principal place of business. Such a rule is consistent with the general rule applied in common law countries that a corporation may always be sued in its country of incorporation. Significantly also, where jurisdiction was established over a UK-domiciled company under article 4, an English court was not able to stay proceedings in favour of a foreign tribunal on forum non conveniens grounds.75 The Regulation however also provides an alternative basis of jurisdiction over a foreign corporation domiciled in an EU member state. Such a corporation may be sued in another EU member state in relation to a dispute arising out of the operations of a ‘branch, agency or other establishment’ (art 7(5)). Two key questions arise here. First, what is a branch, agency or other establishment? Second, when does a dispute ‘arise out of’ its operations? The Court of Justice of the European Union (CJEU) has suggested that a key element of a branch or agency is whether the entity is subject to the direction and control of the foreign corporation. A distributor or sales agent for a foreign corporation does not satisfy this test.76 Nor does an independent commercial agent whose role is to negotiate business, who has freedom to represent other companies in the same sector and who merely sends orders to the corporation for execution without any authority to bind the corporation.77 There are some parallels with the

Caswell v. Sony/ATV Music Publishing (Aust) Pty Ltd [2012] NSWSC 986. See, e.g., Teekay Tankers Ltd v. STX Offshore & Shipping Co [2014] EWHC (Comm) 3612 (Eng.). 75 Case C-281/02, Owusu v. Jackson, 2005 E.C.R. I-1383. 76 Case 14/76, De Bloos Sprl v. Bouyer SA, 1976 E.C.R. 1497. 77 Case 139/80, Blanckert and Willems PVBA v. Trost, 1981 E.C.R. 819. 73 74

Jurisdiction and corporations  379 Adams test in the requirement that the representative carry on the business of the corporation on an almost exclusive basis. The question whether the dispute ‘arises out of’ the operations of a branch or agency has also been considered in decisions of the CJEU. ‘Operations’ has been broadly defined to include contractual and non-contractual obligations involving the internal management of a branch or agency, contracts entered into by the branch or agency in the name of the corporation and torts arising out of the branch or agency’s activities.78 There must be a close nexus between the operations of the branch and the dispute. Despite the liberal interpretation of the ‘arising out of’ requirement it nevertheless adds an important limitation to establishing jurisdiction over a foreign corporation which is not present in non-EU cases. Since Brexit the United Kingdom has applied to re-join the Lugano Convention as an independent state but the European Commission is not currently supporting its membership. It is possible therefore that the approach to general jurisdiction discussed earlier based on the CPR, Companies Act and the common law will become the test under English law for all foreign corporations. While such a stance mirrors that taken in other Commonwealth countries, such as Australia, it is certainly exorbitant compared to the more restrained approaches to jurisdiction under European Union and United States law. C.

England: Specific Jurisdiction

This observation regarding the breadth of English jurisdiction over foreign corporations is confirmed when the rules for ‘specific jurisdiction’ are considered, which in English law are found in the grounds for service out of the jurisdiction under the English Civil Procedure Rules (CPR). It was noted earlier that since 1852 a claimant has been able to serve process abroad on a foreign corporation with the permission of the English court. Until the 1980s, however, such jurisdiction was only infrequently exercised for two reasons. First, the grounds or gateways for service out were limited in scope, and, secondly, jurisdiction based on service abroad was regarded as ‘exorbitant’ and exceptional. Neither reason applies any longer. First, the range and scope of the gateways for service out have dramatically expanded in the past thirty years. For example, in the case of contracts service may be authorized where the contract was made within the jurisdiction, was made by or through an agent trading in the jurisdiction, is governed by English law or involved a breach of contract within the jurisdiction.79 In the case of torts, service may be permitted where damage was sustained within the jurisdiction or where damage has been sustained from an act committed within the jurisdiction.80 There are also grounds for service out where a foreign defendant is a necessary and proper party to an action brought against another defendant in the forum and where the action concerns property, trusts, restitution or privacy. Many of these gateways did not exist in 1945 and have been broadly interpreted since then. The second major

78 Case 33/78, Somafer SA v. Saar-Ferngas AG, 1978 E.C.R. 2183; Case C-439/93, Lloyds Register of Shipping v. Soc Camperion Bernard, 1995 E.C.R. I-961. 79 CPR Practice Direction 6B r 3.1 (6), (7). 80 Id. at r 3.1(9).

380  Research handbook on corporate liability development since that date is that English courts now routinely exercise their discretion to allow service abroad, such jurisdiction no longer being regarded as extreme or exceptional:81 In his judgment in the Court of Appeal Longmore LJ described the service of the English court’s process out of the jurisdiction as an ‘exorbitant’ jurisdiction … This characterization of the jurisdiction to allow service out is traditional and was originally based on the notion that the service of proceedings abroad was an assertion of sovereign power over the defendant and a corresponding interference with the sovereignty of the state in which the process was served. This is no longer a realistic view of the situation. … In the overwhelming majority of cases [today] where service out is authorized there will have been … a substantial connection between the dispute and the country. Litigation between residents of different states is a routine incident of modern commercial life. … It should no longer be necessary to refer to the muscular presumptions against service out which are implicit in adjectives like ‘exorbitant’. The decision is essentially a pragmatic one in the interest of the efficient conduct of litigation in an appropriate forum.

This statement is a powerful endorsement of the liberal approach to service outside the jurisdiction. The combined effect of this view when coupled with the developments mentioned earlier is to substantially increase the circumstances in which jurisdiction may be exercised over foreign corporations in English law. It is interesting to note that, at the same time these remarks were made, the United States Supreme Court in Daimler was suggesting that there was an international movement towards contraction of jurisdiction over corporations, combined with a greater concern with territoriality, which inspired the ‘at home’ test. The UK Supreme Court however points in the opposite direction: territorial concerns are outdated, with the proper analysis being to examine all relevant interests in a case so as to ensure that litigation is conducted efficiently in the appropriate forum. The earlier consensus between the English and American approaches no longer exists, not only in terms of jurisdictional outcomes but also rationale. The United States and England are now some distance apart on the question of jurisdiction over foreign corporations. D.

Forum Non Conveniens

English courts also retain a discretion to decline jurisdiction in cases involving foreign corporations under the Spiliada principle. According to the principle, a stay will be granted where another available forum exists which would be clearly more appropriate for trial. If the defendant satisfies this condition the burden then shifts to the claimant to show that it would be denied justice if trial proceeded in the foreign court. While English courts have deferred to foreign courts and declined jurisdiction, particularly in commercial cases with slender links to England,82 there have also been decisions in which stays have been refused because of concerns about the quality of justice in the foreign country.83 On balance, the generally wide exercise of jurisdiction over foreign corporations under English law noted earlier has not been significantly limited by the forum non conveniens doctrine.

Abela v. Baadarani [2013] 1 WLR 2043 ¶ 53 (UKSC) (Lord Sumption JSC, with whom Lord Neuberger PSC, Lord Reed JSC and Lord Carnwath JSC agreed). 82 See, e.g., VTB Capital plc v. Nutritek International Corp [2013] 2 AC 337 (UKSC). 83 Cherney v. Deripaska [2009] EWCA (Civ) 849; AK Investment CJSC v. Kyrgyz Mobil Tel Ltd [2012] 1 WLR 1804 (UKPC). 81

Jurisdiction and corporations  381 E.

EU: Specific Jurisdiction

In the discussion earlier on general jurisdiction it was suggested that EU law has forged a middle path between the English and American extremes. The EU rules on specific or ‘special’ jurisdiction, however, provide outcomes closer to the English position, although no permission of the court is required to serve abroad. Under the rules of special jurisdiction under the EU Regulation, alternative forums to the defendant’s domicile are provided in cases that involve a close connection between the action and the forum.84 Such grounds are similar, although not identical, to the English CPR gateways for service out. For example, a defendant may be sued in contract in the place of performance of the obligation (article 7(1)) and in tort in the place where the harmful event giving rise to the damage occurred or the place where the damage occurred (article 7(2)). The focus of the EU rules is on the competence of the forum and the link between the action and the forum. There are also provisions that specifically increase access to courts for certain categories of claimant, with lesser bargaining power, such as consumers and employees. In this respect the EU rules seek to balance the interests of both claimant and defendant (whereas the United States approach focuses only on the defendant corporation’s connections with the forum). A claimant’s need for access to justice is regarded as equally significant to a defendant’s concern for protection from exorbitant jurisdiction.85 Such an approach contrasts with the United States and English views, which do not presumptively allocate jurisdiction to plaintiffs based on their perceived weaker bargaining status. On the face of it, the rules apply equally to all parties. The precise nature of the EU rules also arguably leads to more certain and predictable results than the more abstract United States formulations.86 Also, and similar to the English CPR, it is likely that several of the EU grounds of jurisdiction would not satisfy the United States test of specific jurisdiction. So, for example, in the case of a contractual dispute, a contract may have its place of performance in the forum, but the defendant may not have purposefully directed its activity to that location. Also, in the case of torts, purposeful availment may not occur in every case where damage has been suffered in the forum arising from a harmful event elsewhere.

V.

THE CANADIAN REAPPRAISAL

An interesting jurisdictional experiment has occurred in Canada over the past twenty years. The Supreme Court of Canada has stated, in a series of decisions,87 that a Canadian court would only have jurisdiction over a foreign corporation where the action or the defendant had a real and substantial connection with the forum. While superficially this test sounds like the United States ‘minimum contacts’ principle, the Canadian approach departs from the American model

Regulation (EC) No. 1215/2012 of the European Parliament and of the Council on 12 December 2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters, O.J. (L 351) 1, 3, Recital (16) (EC). 85 L.I. De Winter, Excessive Jurisdiction in Private International Law, 17 Int’l & Compar. L.Q. 706, 717 (1968). 86 Id. at 720. 87 Club Resorts v. Van Breda, [2012] 1 S.C.R. 572 (Can.). 84

382  Research handbook on corporate liability by identifying ‘presumptive connecting factors’ to determine whether a real and substantial connection exists.88 The presumptive connecting factors include the cases where the defendant (a) is domiciled or ordinarily resident in the forum (which corresponds to place of incorporation and principal place of business in the case of a company), (b) carries on business in the forum, (c) commits a tort in the forum, and (d) where a contract connected with the dispute is made in the forum. Importantly, such factors form a type of ‘specific jurisdiction’ and are only examined where the common law test of carrying on business at a fixed place in the forum (‘general jurisdiction’) is not satisfied.89 So, in Chevron v Yaiguaje,90 the Supreme Court confirmed that a foreign corporation would be subject to jurisdiction in a Canadian court under common law principles if it maintained a physical business presence in the forum at which it carried out a degree of sustained business activity. Such business may also be carried out by a representative provided that such person is performing the business of the corporation, analogous to the Adams v Cape Industries test.91 The common law test of carrying on business at a fixed place in the forum differs from the ‘carrying on business’ presumptive connecting factor in the real and substantial connection test since in the latter case the action must arise out of the business activities in the forum.92 In another respect, however, the presumptive connecting factor is easier to satisfy than the common law principle since it will suffice if a corporation maintains an office in the forum or regularly visits the territory of the particular jurisdiction.93 Specifically, there appears to be no requirement to carry on business at a ‘physical’ place in the forum, which may be helpful where jurisdiction is asserted in an online dispute.94 The retention of the common law presence test shows a continued alignment with the English approach to jurisdiction, but in two other key respects Canadian law is more restrictive. First, the presumptive connecting factors, when considered as a whole, represent a substantially more limited claim to jurisdiction than the English gateways for service out of the jurisdiction or the EU rules. Secondly, most Canadian courts and commentators95 reject the view that general jurisdiction may be established based on a corporation’s registration alone in a province, where the suit does not arise out of business transacted in the forum.96 Jurisdiction based on mere registration is incompatible with both the common law presence test and the real and substantial connection principle.97 The Canadian approach is therefore closer to the American view on the jurisdictional spectrum, while eschewing the broad and indeterminate

Id. Chevron v. Yaiguaje, [2015] S.C.C. 42, ¶ 87. 90 Id. 91 Allchem Industries Industrial v. Ship CMA CGM Florida, 2015 F.C. 558 (Can.). 92 Club Resorts, [2012] 1 S.C.R. ¶ 96. 93 Id. at ¶ 87. 94 Stuart Budd & Sons Ltd v. IFS Vehicle Distributors VLC, (2016) 135 O.R. 3d 551 (Can. Ont. C.A.); Equustek Solutions Inc v. Google Inc., [2015] BCCA 265; Vahle Global Work & Travel Co Inc [2019] ONSC 3624 (Can. Ont. Super. Ct.). Active advertising in the forum or maintaining an accessible website there is however not enough: see Club Resorts [2012] 1 S.C.R. 572. 95 Walsh, supra note 47, at 188–9; Monestier, supra note 45. 96 Pearlman v. Great West Life Assurance Co., (1912) 17 B.C.R. 417 (Can. Brit. Colum. C.A.); Procon Mining and Tunnelling Ltd v. Waddy Lake Resources Ltd., 2002 BCSC 129, ¶ 35 (Can. Brit. Colum. Sup. Ct.). 97 Walsh, supra note 47, at 190. 88 89

Jurisdiction and corporations  383 abstractions of United States law. Further, like the EU model, the Canadian courts have made a conscious attempt to balance the interests of claimants and defendants. Finally, the doctrine of forum non conveniens is unlikely to play a significant role in future Canadian cases on jurisdiction. The Supreme Court noted that courts retain a residual discretionary power to decline to exercise jurisdiction ‘in appropriate but limited circumstances in order to assure fairness to the parties and the efficient resolution of the dispute’.98 The power to decline jurisdiction should therefore only be exercised in clear and exceptional cases; not simply where a comparable forum exists elsewhere to adjudicate the matter. In the case of foreign corporations, the real and substantial connection test will likely prevent cases with only a slender link to a Canadian forum being adjudicated, thus making forum non conveniens largely redundant, like in the United States.

VI.

AN INTERNATIONAL STANDARD?

The differences between each of the national approaches means that identification of a clear international standard for jurisdiction over corporations is not easy. Yet it is suggested that a tentative model could be proposed that notes the common elements from each approach while also adopting points of best practice in each system.99 First, the countries of incorporation and principal place of business, being accepted as grounds in all national laws, should be adopted as the primary general jurisdiction factors. Secondly, the common law presence test based on carrying on business at a fixed place in the forum should also be accepted as a general jurisdiction factor. Not only is this principle of great antiquity but there is strong logic in a corporation being subject to the jurisdiction of a country in which it has created a physical presence to trade actively. Such an approach is preferable to the United States ‘at home’ and the EU ‘branch or agency’ tests, which are too restrictive. The ‘at home’ test effectively confines general jurisdiction to the first factor above (incorporation and principal place of business), while the branch or agency test demands a nexus between the branch and the cause of action which seems unnecessary given the already strong link between the corporation and the forum. General jurisdiction should therefore also exist where a corporation carries on business in the forum directly or by an agent acting for the corporation exclusively. Such a conclusion also arguably reflects commercial realities better than the fact of incorporation, particularly where the corporation barely trades in its place of incorporation. Care will need to be taken however to ensure that the rigour of the common law presence test is maintained, and that jurisdiction is not based on only cursory links with the forum. What significance should be given to a company’s registration as a foreign corporation in the forum? The English approach, which recognizes jurisdiction based simply on registration and the appointment of a local agent, should not be adopted given the slender link between the defendant and the forum. The United States and Canadian view, which sees registration as only providing an alternative means of service on the corporation not a separate ground of jurisdiction, is preferable. Club Resorts, [2012] 1 S.C.R. 572, at ¶ 104. For a valuable discussion see Mary Keyes, Jurisdiction in International Litigation 254–65 (2005). 98 99

384  Research handbook on corporate liability The question of piercing the corporate veil was considered earlier. The English approach, as represented in Adams, rejects this doctrine in the context of jurisdiction, in the absence of a sham or fraudulent agent. The United States, by contrast, has been more commercially pragmatic in allowing contacts of a subsidiary with the forum to be attributed to a foreign parent corporation for the purposes of assessing general jurisdiction. The United States’ willingness to pierce the corporate veil and recognise ‘single economic units’ is arguably appropriate in a time when corporations have large and wide transnational group structures and subsidiaries. Such an analysis could be included within the context of common law ‘presence’ jurisdiction. So, in determining whether a foreign company is carrying on business in the forum by a subsidiary it would be appropriate to consider whether the subsidiary is simply a mirror image of its parent. In any event, such an approach may be close to the existing Adams principle. For specific jurisdiction the general and abstract formulations from United States law such as ‘minimum contacts’ and ‘purposeful availment’, while reflecting important policy directions, are not helpful on their own for judges or legal advisers who need guidance in specific cases. The need for certainty and predictability is crucial here. Also, the United States approach to jurisdiction is under-inclusive in focusing almost exclusively on the defendant’s role and activities in the forum. The interest of the claimant in securing access to justice is equally important, particularly where such person is an individual of limited means engaged in a dispute with a well-resourced global corporation. Approaches that rely on narrow, cause of action-specific grounds such as are found in the English service abroad provisions in the CPR, the rules of the EU Regulation or the Canadian presumptive connecting factors are preferable. The grounds of specific jurisdiction should therefore be limited in scope and number, but not at the expense of curtailing claimants’ legitimate rights to sue. Space prevents a detailed examination of the appropriate grounds for specific jurisdiction, but the following are suggested as a tentative guide. Jurisdiction should exist: (1) in contract, where the contract is breached by the defendant in the forum. The defendant’s breach will normally be the trigger for the cause of action and be closely related to the defendant’s performance. It is therefore an important connecting factor with the forum. The place where the contract is made, by contrast, may often be fortuitous, particularly in electronic transactions. (2) in tort, where the tort is committed in the forum or where the injury arising from the tort occurred in the forum. While the Supreme Court of Canada relied only on the place of the tort as its presumptive factor, such an approach may have detrimental effects in products liability cases where a consumer claimant suffers harm in the forum arising from goods manufactured elsewhere. The claimant should not be forced to sue the foreign corporation in the place of manufacture in such a case. Access to justice is therefore supported by including the place of injury as a factor, which is also found in the English CPR and the EU Regulation. (3) where the defendant corporation directs substantial business activity towards the forum and it is reasonably foreseeable that the defendant’s activity would cause loss in the forum.100 This ground will be important to capture those cases in which a defendant, although not having a fixed place of trading in the forum, is nevertheless engaging in Id. at 262–63.

100

Jurisdiction and corporations  385 substantial business activities there, particularly in the online context. While Internet marketing and advertising by itself in the forum is insufficient for jurisdiction, active targeting of forum residents and entering into repeated and numerous transactions with such persons should be taken into account. A similar factor was identified by the Canadian Supreme Court and it is like the American ‘purposeful availment’ principle: if a defendant corporation has reached out to and engaged in business with forum residents, then it cannot complain if it is sued there. (4) where an action is brought against a party who is subject to jurisdiction, jurisdiction should also exist over a foreign corporation which is a necessary or proper party to that action. Where a foreign corporation is closely involved with a local defendant in a dispute with connections to the forum then justice and efficiency demand that both parties be subject to local jurisdiction. Consistent with the approaches taken in the United States and Canada, the doctrine of forum non conveniens should only be available in exceptional cases where, for example, there are multiple proceedings in different countries in respect of the same subject matter. Since the proposed jurisdictional grounds are limited in scope and number and seek to balance the interests of claimants and defendants, the circumstances in which the forum considers itself inappropriate to determine a case should be rare.

VII. CONCLUSION The purpose of this chapter has been to consider whether an international standard for jurisdiction over foreign corporations exists. While considerable harmony existed in the common law world prior to 1945, more recently the positions in the United States and England have diverged substantially, with the United States being very restrictive and defendant-focused and England arguably conferring too wide a jurisdiction on its courts. Common elements in the two views nevertheless exist, and with the European Union and Canada providing examples of more balanced and even-handed approaches, a provisional model of jurisdiction for corporations can be proposed.

PART VI THE FUTURE OF CORPORATE LIABILITY

21. The future of corporate criminal liability in the ESG space J.S. Nelson1

I. INTRODUCTION In March 2022, the United Nations’ Intergovernmental Panel on Climate Change concluded that human-driven climate change may already be on course to cause catastrophes so significant that humanity may not be able to adapt to them.2 This is an explanation for why our social norms around climate change and other important ESG subjects seem to be changing faster, and to be under more pressure, than many of our other social norms. ESG is an acronym for ‘environmental, social, and governmental’ factors that investors are requesting and relying on to evaluate the behavior of companies.3 Although it is true that millennials between the ages of roughly 33 to 40 may be driving much of the most urgent response to climate change, with 76 percent of them saying that climate change represents a serious risk to society,4 concerns about the impact of climate change are broadening and deepening across society. In 2019, 72 percent of investors expressed at least a modest interest in sustainable investing to help prevent climate change, with little distinction among generations.5 This chapter will focus on climate change response as an especially fast-moving set of developments within ESG initiatives.6 Changing norms in society can also manifest in what we determine constitutes criminal behavior.7 In thinking about where the criminalization of corporate behavior seems most likely to occur, changing norms around ESG initiatives, and their connection to other pressures, make ESG initiatives an area around which we should most expect to find such changes in the law. In the white-collar context, there will always be goals and priorities that the government is balancing in choosing its criminal prosecutions. As a recent journal aimed at US Department of Justice (DOJ) personnel explains, the DOJ’s ‘primary goals of all prosecutions of economic

1 The author would like to thank the Leadership and Corporate Accountability team at Harvard Business School for prompting this exploration. Jee Young Kim provided excellent research assistance. The viewpoints expressed in the chapter, and any errors, are my own. 2 See Intergovernmental Panel on Climate Change, Climate Change 2022: Impacts, Adaptation and Vulnerability ¶¶ 1-3–1-4 (March 2022). 3 See, e.g., CFA Institute, ESG Investing and Analysis (2022). 4 See Alicia Adamczyk, Millennials Spurred Growth in Sustainable Investing for Years. Now, All Generations Are Interested in ESG Options, CNBC, May 21, 2021 (citing March 2021 CNBC/Harris Poll). 5 See id. (citing Morningstar numbers). 6 See Stephen Kim Park, Legal Strategy Disrupted: Managing Climate Change and Regulatory Transformation, 58 Am. Bus. L.J. 4, 711, 713 (2021). 7 See generally David Skeel, Shaming in Corporate Law, 149 U. Penn. L. Rev. 1811, 1821–22 (2001).

387

388  Research handbook on corporate liability crimes are accountability and deterrence’.8 Specifically, the government sees the harm of white-collar crime as being that it ‘undermines the rule of law, defrauds victims, and disrupts the marketplace’.9 Academics and others studying patterns in white-collar crime have noted that behavior that may have previously triggered civil liability has been increasingly criminalized.10 There is a saying amongst compliance professionals that what is unethical today is illegal tomorrow.11 Together, these insights suggest that there may be a progression over time to make today’s unethical behavior illegal, and that we solidify our prohibition against it by elevating potential civil liability to criminal liability.12 Shaming and norms – including the changing of norms in society over time – are closely intertwined.13 There has been a historically lively argument about the value of shaming, and the elevated level of shaming that criminal law may carry.14 Many academics, including Professor Samuel Buell, have written about the social value of labeling certain corporate behaviors as criminal, in that it ascribes an important blameworthiness, which is not present to the same extent in the civil law.15 In addition, because we appear to be in a time of re-building social norms, especially in the United States, our criminal law may also be more active.16 In 2021, at least one scholar was calling specifically for the reintroduction and broadening of explicit corporate shaming.17 The line between US civil and criminal liability is also thin, particularly in the area of fraud. The essential difference between federal civil and criminal law in the US is not necessarily in the acts to be proven, but in the degree of fault (‘intent’) necessary for the acts. When intent is not as hard to prove (in areas we will talk about such as fraud), the remaining difference is

8 Thomas L. Kirsch II & David E. Hollar, Prosecution of Individuals in Corporate Criminal Investigations, 66 DOJ Journal of Fed. L. and Prac. (special edition on corporate crime) 3, 4 (2018). 9 Id. (quoting Rod Rosenstein, Deputy Att’y Gen., U.S. Dep’t of Justice, Remarks at the Bloomberg Law and Leadership Forum in New York (May 23, 2018)). 10 See, e.g., V.S. Khanna, Corporate Criminal Liability: What Purpose Does It Serve?, 109 Harv. L. Rev. 1477, 1477–78 (1996). 11 See, e.g., A View of Compliance in U.K. and U.S. Practice, ComplianceNet Conference (Jun. 29, 2021) (comments from Lawrence Deju-Wiseman, Director – Market Abuse and Financial Services Conduct at PwC). 12 See also generally Jennifer Arlen, The Potentially Perverse Effects of Corporate Criminal Liability, 23 J. Legal Stud. 833–67, 833 (1994). 13 See Skeel, supra note 7, at 1820 (‘Shaming sanctions are so integrally connected to social norms that it is not entirely clear where one leaves off and the other begins. A norm cannot survive unless it is enforced and, loosely speaking, norms are enforced in one or more of three different ways: guilt, shunning, and shaming … When we talk about norm enforcement, we therefore are often talking about shaming’). 14 See, e.g., id. 15 See Samuel W. Buell, The Blaming Function of Entity Criminal Liability, 81 Ind. L.J. 473, 491 (2006). 16 Cf. Miranda Forsyth & Valerie Braithwaite, From Reintegrative Shaming to Restorative Institutional Hybridity, 3 Int’l J. Restorative Just. 10–22 (2020). 17 See W. Robert Thomas, The Conventional Problem with Corporate Sentencing (and One Unconventional Solution), 24 New Crim. L. Rev. 391, 424–29 (2021).

The future of corporate criminal liability in the ESG space  389 in the level of proof required, from civil ‘preponderance of the evidence’ to criminal ‘beyond a reasonable doubt’.18 Ultimately, when the factual case for intent against a defendant is strong – many fraud cases may rely, for example, on extensive written documentation – the practical issues determining whether the US government pursues a civil or criminal prosecution are how strongly the government feels that it should signal its condemnation of the behavior and what remedies it seeks.19 The US Supreme Court has explicitly approved of the government’s ability to choose whether it wants to pursue a civil or criminal case based on the same underlying course of conduct.20 These points set the stage for potential changes in corporate criminal liability regarding ESG initiatives. This chapter describes in several parts why we may see movement on ESG initiatives from civil to emerging corporate criminal liability. First, it notes how imprecise ESG is as a term, and how strong economic pressures surround companies that want to announce ESG initiatives. Second, the chapter describes patterns in ESG enforcement outside the United States that have moved from actions against governments to actions against private corporations, especially for not meeting their climate obligations or overpromising their corporate actions through ‘greenwashing’. Third, it considers developments in the United States that may not follow international patterns, but that flash other warning signs for corporate liability. Fourth, the chapter focuses on why fraud prosecutions for ESG are most likely to cross the line from civil to criminal liability in the United States. It concludes with the need to watch the future of corporate criminal liability on ESG issues.

II.

CURRENT STATE OF THE ESG SPACE

There are three main reasons why ESG initiatives may draw prosecutors into expanding criminal corporate liability. First, the current language and standards around ESG are imprecise and make it easy to mislead investors and the market. Accountants and others find ESG to be a wildly frustrating term because it is both ill-defined and overly inclusive.21 Even amongst people who assume that they are committed to the same things, there may, for example, be direct conflicts in the outcome of ‘ESG’ initiatives in the short-term interests of labor and the

See generally, Policy Background; Burdens of Proof, 21B Fed. Prac. & Proc. Evid. (Wright & Miller) § 5122 (2d ed., April 2021 Update). 19 The DOJ’s own Journal makes this point about how the same actions can form the basis of various prosecutions, including civil and overlapping criminal ones. For example, in healthcare fraud, ‘the same conduct—for example, paying kickbacks to secure health care referrals—can form the basis of a variety of government actions: a civil claim under the False Claims Act, a criminal charge of health care fraud, or an administrative action for exclusion from participation in federal health care programs’. Benjamin Greenberg & Susan Torres, Parallel Proceedings in Health Care Fraud, 66 DOJ Journal of Fed. L. and Prac. (special edition on corporate crime) 15, 16 (2018). 20 See, e.g., United States v. Kordel, 397 U.S. 1, 11 (1970). There may still be a double jeopardy issue in the government’s pursuing the same behavior twice, but that is not the same as the government’s freedom to choose how it will pursue behavior that could be either civil or criminal. 21 See, e.g., ESG Ratings and Data: How to Make Sense of Disagreement, Paul Weiss, Jan. 29, 2021; Glenn Fitzpatrick, Jonathan Neilan & Peter Reilly, Time to Rethink the S in ESG, Harv. L. Sch. Forum on Corp. Governance, Jun. 28, 2020. 18

390  Research handbook on corporate liability environment. But, insofar as ESG has become an umbrella term, it tends to be associated with environmental concerns as one of many forms of social-justice initiative. Second, despite how imprecise ESG is as a term, companies are making concrete promises around it. Companies and others have made promises in the environmental context, for example, that have been at times precise and potentially verifiable. Accordingly, in December 2021, it was an attention-grabbing development in the business community for the DOJ to inform Deutsche Bank AG that it may have violated a criminal settlement when it failed to inform prosecutors of its failures to live up to ESG disclosures.22 The problems with ESG disclosures at Deutsche Bank stem from a divergence between its external communication and internal actions. As the Wall Street Journal explained, ‘Deutsche Bank AG’s DB asset management arm, DWS Group, tells investors that environmental, social and governance concerns are at the heart of everything it does and that its ESG standards are above the industry average’.23 In its 2020 annual report, DWS Group promises that more than half of its assets under management – some U.S. $540 billion – are evaluated on ESG criteria.24 But its own April 2021 internal assessment admits that ‘only a small fraction of the investment platform’ applies ESG criteria25 and that the company has ‘no quantifiable or verifiable ESG-integration for key asset classes’.26 Although the potential criminal penalties that Deutsche Bank may face would result most immediately from failure to communicate with prosecutors about its ESG failures, this outcome would still be a step to making failed ESG commitments a ground for criminal liability. As this chapter argues below, we are most likely to see criminal culpability triggered in how we represent a topic. As this author has discussed before, the US enforces white-collar crime largely on the basis of disclosure.27 Fraud, and particularly fraud on investors in the securities context, is already a place in which the line between civil and criminal culpability is very thin. Third, an important reason why the line between civil and criminal culpability for fraud is likely to blur regarding ESG is that there is so much economic pressure on companies to assert their role in this area to investors. There is money to be made from saying what investors want to hear, even if it is not true. In 2021, ESG investing was already estimated, according to Morningstar data, to be worth US $3 billion a day.28

22 See Dave Michaels & Patricia Kowsmann, Justice Department Told Deutsche Bank Lender May Have Violated Criminal Settlement, Wall St. J., Dec. 8, 2021. 23 Patricia Kowsmann & Ken Brown, Fired Executive Says Deutsche Bank’s DWS Overstated Sustainable-Investing Efforts, Wall St. J., Aug. 1, 2021. 24 Id. 25 Id. (quoting the company’s report). 26 Id. (summarizing the report’s findings). 27 See, e.g., J.S. Nelson, Disclosure-Driven Crime, 52 U.C. Davis L. Rev. 1487 (2019); J.S. Nelson, ‘Don’t Ask, Don’t Tell’ Corporate Crime (2017); J.S. Nelson, The Corruption Norm, 26 J. Mgmt. Inquiry 3, 280 (Nov. 2016). 28 See Patricia Kowsmann & Ken Brown, Fired Executive Says Deutsche Bank’s DWS Overstated Sustainable-Investing Efforts, Wall St. J., Aug. 1, 2021 (citing Morningstar numbers).

The future of corporate criminal liability in the ESG space  391

III.

CORPORATE LIABILITY FOR ESG ACTIONS MAY BE MORE SUBSTANTIVE OUTSIDE THE UNITED STATES: THE TREND OF MOVING AGAINST GOVERNMENTS FIRST

Internationally, efforts to impose liability on companies for ESG initiatives may be following two main routes: disclosure and substantive laws targeting specific areas of ESG. More substantive regulation may be emerging primarily in Europe based on corporate duties to address climate change, in addition to disclosure-based regulation, which is emphasized in the US. The nascent movement for ESG liability in Europe and elsewhere seems to have been successful first against governments before being used subsequently against corporations. The most significant corporate precedents, as of this chapter’s time of writing, have been under Dutch law (see the discussion infra in this Part). Plaintiffs also appear to have won final judgments in suits against governments on duty of care and/or related protection of fundamental rights grounds in Pakistan, Colombia, Nepal, Germany, and Belgium.29 They have won more limited cases to have existing promises enforced against governments in New Zealand,30 Ireland,31 and France.32 Plaintiffs had been less successful to date in suits against the European Union,33 India,34 Switzerland,35 the United Kingdom,36 and the United States (see the discussion on the United States infra at Part IV). As of December 2021, additional suits were pending against governments in Australia, Canada, Czechia, Italy, Mexico, Peru, Poland, South Korea (Republic of Korea), and Spain.37 See descriptions of cases and citations infra. Sarah Thomson v. Minister for Climate Change Issues [2017] NZHC 733, 2015-485-919 (NZ). 31 See Friends of the Irish Environment CLG v. The Government of Ireland, Ireland and the Attorney [2020] IEHC 225 (Irish SC). 32 Tribunal Administratif (TA) Paris (4ème section – 1ère chambre), civ., Feb. 3, 2021, N°1904967, 1904968, 1904972 & 1904976/4-1; see also Conseil d’État (CE Sect.) (Le Conseil d’État statuant au contentieux (Section du contentieux, 6 ème et 5ème chambres réunies), Sur le rapport de la 6ème chambre de la Section du contentieux), civ., July 1, 2021, N° 427301. 33 As of March 2021, this case appears to have been dismissed on procedural grounds by the Court of Justice of the European Union. Court of Justice of the European Union Press Release No 51/21, The Court of Justice Confirms That the Action Brought by Families from the European Union, Kenya and Fiji Against the EU ‘Climate Package’ of 2018 is Inadmissible (Mar. 25, 2021). 34 See Order Dismissing Application, Ridhima Pandey v. Union of India & Ors., No. 187/2017, Nat’l Green Trib. Principal Bench, New Delhi, at ¶ 3 (Jan. 15, 2019) (India) (finding ‘no reason to presume that Paris Agreement and other international protocols are not reflected in the policies of the Government of India or are not taken into consideration in granting environment clearances’). 35 In May 2020, Switzerland’s Federal Supreme Court had decided against the plaintiffs. As of March 2021, the case was on appeal before the European Commission on Human Rights. See Bundesgericht [BGer] [Federal Supreme Court] May 5, 2020, 1C_37/2019 (Switz.); Communication of Case to Swiss Federal Government, Application no. 53600/20, Verein KlimaSeniorinnen Schweiz and others v. Switzerland, European Comm’n on Human Rights, Mar. 25, 2021. 36 In January 2019, the English Court of Appeal declined to overturn a High Court ruling against the plaintiffs. In its rejection of the appeal, the Court of Appeal noted that five of the six plaintiffs’ grounds had ‘no real prospect of success’. These included its allegations that the UK government was not understanding or not fulfilling its obligations, as well as that there was a public sector equality duty that had been violated. See Permission to Appeal Refused, Plan B Earth v. Secretary of State for Business and Energy and Industrial Strategy, Court of Appeal, Civil Division, C1/2018/1750, Jan. 25, 2019 (UK). 37 For additional updates, see, e.g., Global Climate Litigation, Urgenda (Undated) (linking to cases and sources). 29 30

392  Research handbook on corporate liability The Expert Group on Global Climate Obligations in their Oslo Principles38 were urging courts to mandate climate action on the part of governments, despite the limitations of existing agreements. These and other efforts have been ‘part of a larger trend of citizens seeking action from the courts on climate issues’.39 The cases concerning established separate rights would seem to pose the most potential for the future civil and criminal liability for corporations in those countries. These cases broadly recognized some form of a duty of care, right to a healthy environment, or human rights in Pakistan,40 Columbia,41 Nepal,42 Germany,43 and Belgium.44 If such a right is being established, and may be protected independently, it is likely that courts will protect it against encroachment by corporations. Although it is true that some rights may remain enforceable against a government when they are not enforceable against private actors, these jurisdictions seem to be the most dynamic places to watch for pending corporate liability such as eventually emerged in the Netherlands. Indeed, the most significant corporate precedents to date are found in Dutch law. Those developments deserve some discussion as a potential roadmap for how international ESG liability for governments may move into liability for corporations in the private sector. In December 2019, the Netherlands Supreme Court ordered the Dutch government to drastically reduce its greenhouse gas emissions.45 According to the Court, it could so rule because ‘the risk of dangerous climate change … can also seriously affect residents of the Netherlands in their right to life and well-being’.46 According to the Court, protection was available ‘pursuant to art. 2 and 8 ECHR [European Convention on Human Rights]’, such that it ‘can and may rule that the State is obliged to achieve this reduction’.47 The Court acknowledged that legislating is typically a political process, but it had to intervene to review the government’s action to protect citizens’ established rights. Generally,

38 See Expert Group on Global Climate Obligations, Oslo Principles on Global Climate Obligations (2015); see also Oslo Principles on Global Climate Change Obligations, Global Social Justice Program (2015) (explaining the origin of the principles and containing updates about their progress). 39 John Schwartz, In ‘Strongest’ Climate Ruling Yet, Dutch Court Orders Leaders to Take Action, N.Y. Times, Dec. 20, 2019. 40 Ashgar Leghari v. Federation of Pakistan, (2015) W.P. No. 25501/2015 (Pak.) at ¶ 6. 41 Corte Suprema de Justicia [C.S.J.] [Supreme Court], Sala. Lab. Apr. 5, 2018, M.P: Louis Armando Tolosa Villabona, Expediente STC4360-2018, Radicacion n.o 11001-22-03-000-2018-00319-01, at 1–2 (Colom.) (original in Spanish). 42 Advocate Padam Bahadur Shrestha v. Prime Minister and Council of Ministers, Singhadurbar, Kathmandu and others, Supreme Court of Nepal, 074-WO-0283, 10th Day of Month of Poush of the Year 2075 BS (Dec. 25, 2018). 43 Bundesverfassungsgericht (BVerfG) (Federal Constitutional Court), 1 BvR 2656/18, 1 BvR 78/20, 1 BvR 96/20 & 1 BvR 288/20 (collectively ‘Climate Change’), dated Mar. 24, 2021, released Apr. 29, 2021, (Ger.) (official English translation). 44 Civ. [Tribunal of First Instance] Brussels, Tribuna I de première instance francophone de Bruxelles, Section Civile -2015/4585/A, June 17, 2021, at 2.3.1 (Conclusions) (official document in French; unofficial computer translation into English provided by the Climate Litigation Network). 45 See HR 20 December 2019, NJ 2020/41 m. nt. Van J. Spier (Neth.) (The State of The Netherlands (Ministry of Economic Affairs and Climate) v. Urgenda Foundation, Supreme Court of The Netherlands, 19/00135) (author using Google translate to quote official document). 46 Id. at Conclusion. 47 Id.

The future of corporate criminal liability in the ESG space  393 ‘[i]n the Dutch constitutional system, the decision-making process about the reduction of greenhouse gas emissions falls to the government and parliament[,] ... [and] [t]hey have a great deal of freedom to make the necessary political considerations’.48 However, the Court wrote that ‘[i]t is up to the judge to assess whether the government and parliament have kept their decision-making within the bounds of the law to which they are bound’.49 Prima facie, the Netherlands had ‘to reduce greenhouse gas emissions by at least 25% by the end of 2020 compared to 1990’.50 The Netherlands Supreme Court’s strong statements seem to have encouraged the country’s lower courts to find climate change liability against corporations. In May 2021, a panel of three judges for the District Court in The Hague ruled under Dutch law that the Royal Dutch Shell (RDS) oil company must reduce its group’s carbon dioxide emissions – including the emissions of its suppliers and customers – by 45 percent from its 2019 levels by 2030.51 The court based its decision on ‘the unwritten standard of care from the applicable Book 6 Section 162 Dutch Civil Code on the basis of the relevant facts and circumstances … and the widespread international consensus that human rights offer protection against the impacts of dangerous climate change and that companies must respect human rights’.52 The ‘standard of care ensures that[,] when determining the Shell group’s corporate policy, RDS must observe the due care exercised in society’.53 The court explained that ‘no inevitable tension needs to exist’ between ‘the different responsibilities for states and businesses’.54 As the court describes: The responsibility of business enterprises to respect human rights, as formulated in the UNGP [United Nations Guiding Principles on Business and Human Rights], is a global standard of expected conduct for all business enterprises wherever they operate. It exists independently of States’ abilities and/ or willingness to fulfil their own human rights obligations, and does not diminish those obligations. And it exists over and above compliance with national laws and regulations protecting human rights. Therefore, it is not enough for companies to monitor developments and follow the measures states take; they have an individual responsibility.55

Finally, the Dutch court included ringing language that could be picked up and echoed elsewhere on the broad obligation at issue. As the court explained: Business enterprises should respect human rights. This means that they should avoid infringing on the human rights of others and should address adverse human rights impacts with which they are involved. Tackling the adverse human rights impacts means that measures must be taken to prevent, limit, and, where necessary, address these impacts. It is a global standard of expected conduct for all businesses wherever they operate. As has been stated above, this responsibility of businesses exists independently of states’ abilities and/or willingness to fulfil their own human rights obligations,

Id. at ‘Judge and political domain’. Id. 50 Id. at Conclusion (upholding the order of the lower court, as well as the judgment of the Court of Appeal). 51 See Rechtbank’s-Haag 26 mei 2021, JOR 2021, 208 m. nt. van Biesmans, S.J.M (Milieudefensie et al./Royal Dutch Shell PLC, C/09/571932 / HA ZA 19-379) (Neth.) (official English translation published by the court). 52 Id. at 4.1.3. 53 Id. at 4.4.1. 54 Id. at 4.4.13. 55 Id. at 4.4.13 (internal citations omitted). 48 49

394  Research handbook on corporate liability and does not diminish those obligations. It is not an optional responsibility for companies. It applies everywhere, regardless of the local legal context, and is not passive.56

The more muscular Dutch legal approach against a company may echo first in the other countries that have found the existence of a fundamental right regarding climate change. In Germany, for example, in September 2021, a group of German activists initiated lawsuits against BMW and Daimler to cut emissions, and, in November 2021, Greenpeace sued Volkswagen to end the production of combustion-engine cars and cut total emissions by 2030.57 Indeed, the lawyer who primarily litigated the case against Shell predicts a coming ‘avalanche of cases against the fossil fuel industry and related industries like the car industry’.58 He argues that ‘[o]ne of the big reasons for the judiciary to exist is to bring balance in society and to protect us from human rights violations from our governments and other large entities that dictate our world and our wellbeing’.59 He believes that ‘[i]t is just a matter of time [before] the same kind of approaches will also be successful in other countries’.60 Interestingly, he anticipates, first, copycat legal action against other oil companies, then against companies in other sectors of the economy, and eventually against ‘individual directors’.61

IV.

DEVELOPMENTS IN THE UNITED STATES

US courts do not seem particularly receptive to the fundamental rights arguments that have prevailed in Europe and elsewhere, but seem reluctant instead to review government action on what they see as political questions. Potential corporate liability for ESG issues is thus more likely to be developed through public nuisance or fraud cases. This chapter argues that the first developments toward corporate criminal liability will come through charges of fraud. A.

US Courts’ Reluctance to Acknowledge New Rights

US courts do not seem likely to follow the international pattern of ESG climate requirements being enforced as fundamental rights. Indeed, US courts seem reluctant to find the development of such new rights in general. For example, in the 2015 climate change case of first impression, Juliana v. United States,62 US Court of Appeals for the Ninth Circuit Judge Andrew Hurwitz objected to lead counsel that he was uncomfortable with the plaintiffs’ arguments because ‘[y]ou’re arguing for us to break new ground’.63

Id. at 4.4.15 (internal citations omitted). See Tom Wilson, Lawyer Who Defeated Shell Predicts ‘Avalanche of Climate Cases’, Fin. Times, Dec 17, 2021, https://​www​.ft​.com/​content/​53dbf079​-9d84​-4088​-926d​-1325d7a2d0ef. 58 Id. (quoting attorney Roger Cox). 59 Id. (same). 60 Id. (same). 61 See id. 62 Juliana v. United States, 217 F. Supp. 3d 1224, 1233 (D. Or. 2016), rev’d and remanded, 947 F.3d 1159 (9th Cir. 2020). 63 Darlene Ricker, Lawyers Are Unleashing a Flurry of Lawsuits to Step Up the Fight Against Climate Change, ABA Journal, Nov. 2019 (quoting Judge Hurwitz on oral argument in 2019). 56 57

The future of corporate criminal liability in the ESG space  395 Juliana had been filed on behalf of a group of young people who sued the US federal government, President Obama, and executive agencies, alleging that the ‘defendants’ actions violate [the plaintiffs’] substantive due process rights to life, liberty, and property, and that defendants have violated their obligation to hold certain natural resources in trust for the people and for future generations’.64 In January 2020, the US Court of Appeals for the Ninth Circuit reversed and remanded Juliana on a standing ground for failing to ‘establish[] that the specific relief [plaintiffs] seek is within the power of an Article III court’.65 Fundamentally, the appellate court objected that ‘it is beyond the power of an Article III court to order, design, supervise, or implement the plaintiffs’ requested remedial plan’.66 In February 2021, the Ninth Circuit rejected a rehearing of the case en banc.67 The Juliana case was brought under the public trust doctrine against the federal government to compel protective action. This set of arguments was similar internationally to the Nepalese Supreme Court case on parens patriae and the Belgian and Dutch cases on breach of governmental duties of care.68 But public trust arguments unavailing in a case against the government in the US would be even more legally tenuous against a private company. More common in the United States has been public nuisance tort suit against companies such as those that marketed tobacco and opiates (see infra at Part IV.B). The Juliana plaintiffs had tried to make a similar case against the federal government in saying that it had ignored the danger of climate change impacts for years, failing either under a duty of care to the public or in the enforcement of international obligations. A fundamental problem, however, in compelling federal government action according to any international obligations, is that the United States has been cagey about putting its environmental commitments into legally enforceable forms. In addition, standing for civil plaintiffs to bring these cases has been a major problem in US courts. According to a district court in a case modeled on Juliana, but filed in the Eastern District of Pennsylvania, despite plaintiffs’ proffering in ‘[a]pproximately half [of their] Amended Complaint … of domestic and international treaty provisions, studies, declarations, and administrative actions effected over the last fifty years addressing air pollution and climate change’,69 plaintiffs lacked an enforceable claim under US law for standing in federal court. Indeed, the court in Clean Air Council v. United States70 seemed incredulous that the plaintiffs would want it to intervene to challenge government action on climate change.71 The court cited only the US Supreme Court as its authority; international commitments and violations of human rights from climate change seemed far from its consideration. As it wrote, ‘[f]ederal courts are courts of limited jurisdiction. They possess only that power authorized by Constitution and statute’.72 Juliana, 217 F. Supp. 3d 1224, at 1233, rev’d and remanded, 947 F.3d 1159 (9th Cir. 2020). Juliana v. United States, 947 F.3d 1159, 1171 (9th Cir. 2020), re’hng denied en banc, 986 F.3d 1295 (Feb. 10, 2021). 66 Id. 67 Juliana v. United States, 986 F.3d 1295 (9th Cir., Feb. 10, 2021) (rejecting rehearing en banc). 68 See discussion supra at Part III. 69 Clean Air Council v. United States, 362 F. Supp. 3d 237, 243–44 (E.D. Pa. 2019). 70 362 F. Supp. 3d 237 (E.D. Pa. 2019). 71 See id. at 242. 72 Id. at 244 (quoting Kokkonen v. Guardian Life Ins. Co. of Am., 511 U.S. 375, 377 (1994)). 64

65

396  Research handbook on corporate liability B.

The Public Nuisance Tort Suit Approach

Perhaps there will be a wave of public nuisance tort suits directly against private industries next, but many of the same standing issues will apply if plaintiffs cannot persuade US courts to accept the basis of their claims, and to recognize that their damages are addressable. An American Bar Association publication has noted that, as of 2019, there were ‘a dozen major public nuisance climate change lawsuits pending in the United States’.73 At the time, ‘[m]ore than 1,300 climate cases have been brought in 29 nations around the world—more than 1,000 of them in the U.S.’.74 Among the most prominent of the public nuisance cases is the one filed in July 2018 by the Mayor and City of Baltimore in Maryland state court against 26 multinational oil and gas companies. This case alleged that the companies are partly responsible for climate change and should have to compensate the City in tort for its costs in responding to it.75 What is interesting about the tort claim as expressed by the City is how much it actually sounds like a claim regarding misinformation or fraud.76 In May 2021, the US Supreme Court overruled the Fourth Circuit’s decision on removal to federal court, but it did not address the underlying allegations against the oil and gas companies.77 Another practical problem with public nuisance suits in torts is that they must show, as in the tobacco, opiate, and other litigation, that the companies involved fully understood how dangerous their actions were at the time and proceeded with impugned conduct anyway. This knowledge may have been fully present in the fossil-fuel industry, for example, but it is harder to argue that most other sectors of the economy fully understood the dangers from climate change internally much before there was a public scientific consensus about it – and at the end of 2021, there still was, arguably, not a political public consensus on the issue in the United States, with the failure of proposed climate change legislation at the federal level.78 In fact, US law has been retreating from substantive regulation of many industries, and now, primarily, in white-collar crime, it polices what parties say instead of what they do. We turn next to show how, in this context, US ESG cases may first cross the line into potential corporate criminal liability in the area of fraud.

Ricker, supra note 63. Id. 75 See Plaintiff’s Compl., Mayor & City Council of Balt. v. BP P.L.C., et al., Circuit Court for Baltimore City, Case No. 24-C-18-004219, July 20, 2018. 76 See, e.g., Mayor & City Council of Balt. v. BP P.L.C., 952 F.3d 452, 457 (4th Cir. 2020), overruled on question of removal by 141 S. Ct. 1532 (2021) (‘Baltimore alleges that, despite knowing about the direct link between fossil fuel use and global warming for nearly fifty years, Defendants have engaged in a “coordinated, multi-front effort” to conceal that knowledge; have tried to discredit the growing body of publicly available scientific evidence by championing sophisticated disinformation campaigns; and have actively attempted to undermine public support for regulation of their business practices, all while promoting the unrestrained and expanded use of their fossil fuel products’). 77 See Mayor & City Council of Balt. v. BP P.L.C., 141 S. Ct. 1532 (2021). 78 See, e.g., Josh Lederman, What the Collapse of Build Back Better Would Mean for Climate Change, NBC News, Dec. 19, 2021; Jeffrey Pierre & Scott Neuman, How Decades of Disinformation About Fossil Fuels Halted U.S. Climate Policy, NPR, Oct. 27, 2021. 73 74

The future of corporate criminal liability in the ESG space  397

V.

CROSSING THE US LINE INTO CRIMINAL PROSECUTION FOR FRAUD

When there is pressure to please the market and investors in order to make money, and companies are not honest about their products and processes in chasing profits, fraud can result. Indeed, we see some potentially serious misrepresentations regarding ESG communications to potential investors. In December 2021, for example, news broke that one of the largest investment firms in the country, BlackRock, was driving investment into so-called ‘ESG’ funds by inserting its primary ESG fund into popular and influential model portfolios offered to investment advisers, who use them with clients across North America. The huge flows from such models mean many investors got into an ESG vehicle without necessarily choosing one as a specific investment strategy, or even knowing that their money has gone into one.79

Most importantly, for investors who think that their money is being channeled into an ESG fund, ‘the ratings BlackRock cites to justify the fund’s sustainable label have almost nothing to do with the environmental and social impact companies in the fund have on the world’.80 In fact, the ratings BlackRock is using were ‘primarily … designed to measure the opposite: the potential harm government regulations and other factors might cause to the companies’ bottom line, especially when it relates to addressing climate change’.81 The ratings firm MSCI, Inc., whose material dominates the world of sustainable investing, makes some 40 cents out of every dollar spent in the market on ESG ratings,82 and counts BlackRock as its largest customer. It has used its ratings to open ‘the door to [ESG-advertised funds] owning companies that have been among those considered the worst offenders by some investors focused on environmental and social responsibility’.83 Companies that the funds have invested in include ‘fossil-fuel giants Chevron and ExxonMobil, along with Facebook (now called Meta Platforms), Amazon, McDonald’s, and JP Morgan Chase, which is the biggest financier of fossil-fuel projects since the 2015 Paris Accords’.84 MSCI’s rating system for ESG investments, according to MSCI – but not according to BlackRock and the other companies that use it – is not supposed to ‘measure a company’s impact on the Earth and society. In fact, [it] gauge[s] the opposite: the potential impact of the world on the company and its shareholders’.85 The rating company ‘doesn’t dispute this characterization’, and it ‘defends its methodology as the most financially relevant for the companies it rates’.86 Financial relevance here seems to mean overall profit, not the financial relevance of the ESG goals for which the ratings are being sold. Cam Simpson & Saijel Kishan, How BlackRock Made ESG the Hottest Ticket on Wall Street, Bloomberg.com, Dec. 31, 2021. 80 Id. 81 Id. 82 Cam Simpson, Akshat Rathi & Saijel Kishan, The ESG Mirage, Bloomberg.com, Dec 10, 2021 (quoting investment bank UBS Group AG’s analysis). 83 Simpson & Kishan, supra note 79. 84 Id. 85 Simpson, Rathi, and Kishan, supra note 82. 86 Id.; Mr. Henry Fernandez, chairman and chief executive of MSCI, fully admits that neither customers nor many portfolio managers using the company’s ratings may understand how MSCI is defining 79

398  Research handbook on corporate liability The misrepresentation of BlackRock’s ESG-advertised fund based on MSCI’s ratings as investing in companies that combat climate change is so significant that, in fact, BlackRock’s ‘ESGU fund holds a heavier weighting in 12 fossil-fuel stocks than the S&P 500 does’.87 BlackRock’s ESGU fund (the formal name of which is iShares ESG Aware MSCI USA) advertises that it provides exposure to ‘U.S. stocks with favorable environmental, social, and governance (ESG) practices’.88 As reporters have noted, BlackRock ‘doesn’t tell anyone what “favorable practices” actually means’.89 On climate change, BlackRock’s posted 2022 guidance does define ‘net zero’ as ‘an economy that emits no more greenhouse gas than it removes from the atmosphere’.90 A motivation for companies pushing ESG-advertised funds is that they typically generate higher fees for investment companies than non-ESG funds.91 However, while customers may be paying these higher fees because they believe that they are helping the planet through their investment choices, their money is, in fact, often funding activities that cause ‘emissions [to] continue to climb and social ills [to] grow’.92 The reality of what is happening with money invested in so-called ESG funds may be a far cry from the language used to promote it. In January 2018, Larry Fink, BlackRock’s CEO, had announced in his letter to investors that BlackRock was taking a higher moral ground.93 As the New York Times summarized it, he ‘inform[ed] business leaders that their companies need to do more than make profits—they need to contribute to society as well if they want to receive the support of BlackRock’.94 The advertising has worked: in late fall 2021, BlackRock was approaching assets under management of US $10 trillion, with a large part of its growth coming from ESG funds.95 As one source explained, ‘[t]o put that number in perspective’, as of 2020, ‘consider that only two countries—the U.S. and China—boast [a] higher GDP than $10 trillion’.96 As BlackRock’s former chief investment officer for sustainable investing describes, inside the company the materials he received to promote ESG funds were simple, ‘even if that meant glossing over how it directly contributed to fighting climate change, which was always hard to explain and [is] at best a bit uncertain’.97 As he describes a basic truth: ‘there’s always

‘ESG’ investments: ‘No, they for sure don’t understand that. … I would even say many portfolio managers don’t totally grasp that. Remember, they get paid . … They’re not as concerned about the risk to the world.’ Id. (quoting Mr. Fernandez). 87 Simpson & Kishan, supra note 79 (citing Bloomberg Intelligence, the research arm of Bloomberg). 88 Simpson, Rathi, & Kishan, supra note 82. 89 Id. 90 Gargi Pal Chaudhuri, iShares 2022 Outlook and ETF Investment Guide, BlackRock, Dec. 13, 2021. 91 See Simpson and Kishan, supra note 79 (citing Tariq Fancy, BlackRock’s former chief investment officer for sustainable investing). 92 See id. (same). 93 See Andrew Ross Sorkin, BlackRock’s Message: Contribute to Society, or Risk Losing Our Support, N.Y. Times, Jan. 16, 2018. 94 See id. 95 See Palash Ghosh, No End in Sight to BlackRock’s Growth as it Approaches $10 Trillion, Pensions & Investments, Nov. 19, 2021. 96 Id. (citing World Bank data). 97 Tariq Fancy, The Secret Diary of a ‘Sustainable Investor’—Part 2, Medium, Nov. 8, 2021.

The future of corporate criminal liability in the ESG space  399 money to be made from telling people what they want to hear’.98 Indeed, as of late 2021, ESG-advertised funds were ‘the fastest-growing segment of the global financial-services industry, thanks to marketing built on dire warnings about the climate crisis, wide-scale social unrest, and the pandemic’.99 The hypocrisy of its misrepresentations to investors has turned BlackRock’s former chief investment officer for sustainable investing into a fierce critic of current ESG investing.100 He explains that his ‘thinking [has] evolved from evangelizing “sustainable investing” for the world’s largest investment firm to decrying it as a dangerous placebo that harms the public interest’.101 The MSCI and BlackRock ESG story may be one of the many examples that draw regulators to consider pursuing fraud charges, and potentially charges for criminal fraud, for the differences between what the companies may be representing that they are doing with investors’ money and what they have actually been doing with those funds.

VI.

WHY IT MIGHT BE THAT FRAUD PROSECUTIONS MOVE FASTEST IN THE US

Especially in comparison with how crucial the law appears to be in the rest of the world in the enforcement of corporate and individual responsibilities regarding climate change, the United States seems to be far behind. Insofar as the US may make progress on asserting criminal liability for climate change, it may be through prosecutions for fraud. This section discusses the nature of federal prosecutions for fraud, how fraud constitutes a doctrinally slippery slope between civil and criminal enforcement, recent political and economic pressures around fraud as it relates to climate change, and finally, signs of movement on fraud prosecutions against US corporations. A.

The Nature of Fraud Prosecutions

Although there are good arguments that the US in particular does not have a credible system of white-collar criminal enforcement,102 what the country does tend to have is built around what entities say instead of what they do. The practical issue is that US legislatures tend not to pass new statutes that contain substantive regulation of business behavior – for example, outlawing the actual use of production

See id. Simpson, Rathi, & Kishan, supra note 82. 100 See, e.g., Tariq Fancy, The Secret Diary of a ‘Sustainable Investor’—Part 1, Medium, Aug. 20, 2021. 101 See, e.g., id. 102 See, e.g., Mihailis Diamantis & W. Robert Thomas, But We Haven’t Got Corporate Criminal Law!, 47 J. Corp. L. 991 (2022) (arguing that ‘[t]he biggest corporate criminals routinely side-step all criminal procedure and any possibility of conviction by cutting deals with prosecutors, trading paltry fines and empty promises of reform for government press releases praising their cooperation’); John Hasnas, The Forlorn Hope: A Final Attempt to Storm the Fortress of Corporate Criminal Liability, 47 J. Corp. L. 1009 (2022) (arguing that corporate criminal liability creates an expensive and wasteful compliance industry that serves no useful purpose). 98 99

400  Research handbook on corporate liability techniques that damage the environment. That would require consensus on banning a practice, which industry and labor may fight, and the hiring of inspectors and other personnel who would have to enforce it. Instead, what legislatures tend to do is either make conduct more expensive, so that the costs imposed in asking businesses to move away from it are hidden, or they set a standard that they ask companies to tell us that they meet. So, for both compliance and profit, companies have an incentive to lie.103 It’s often cheaper to tell the government and other oversight organizations that companies have made changes, than for them to make actual changes. A classic example is the 2015–17 Volkswagen emissions cheating scandal. Even when the company was held liable for lying about its compliance with emissions standards, it never developed so-called ‘clean diesel’ technology, and it escaped liability for the estimated 12,000 additional deaths that its violation of diesel emissions standards may have caused each year.104 In addition, there has been a hollowing out of regulatory resources, and a US government preference since at least the 1990s that companies regulate themselves.105 The way that regulators police compliance is by disciplining companies that do not do what they say they are doing. That approach involves policing what such entities say, rather than spending resources to find out what they are actually doing. A serious problem with this approach is that it overly relies on whistleblowers and the media to reveal corporate misconduct. Data show that local media, certainly across the United States, is disappearing, with thousands of local media companies being bought up.106 Often, among the first services to be de-funded after acquisition of a local media company is investigative reporting, which is vital to holding entities accountable for their actions in a community. Meanwhile, the Securities and Exchange Commission (SEC) and other agencies encourage whistleblowing by employees and others with knowledge of misconduct, but whistleblowers’ careers are often destroyed – a particularly dangerous outcome when they may be among the most ethical people in the company or industry. They face financial hardships with little reasonable possibility of winning an award in a timely way or at all. And terror of such whistleblowers prompts companies to treat employees as potential enemies, and poisons relationships in the workplace.107 In this sense, Professor Miriam Baer is right to say that corporate prosecutions have become ‘unbound’ in that prosecutors, faced with corporate misrepresentations and little substantive 103 See generally, e.g., John C. Coffee, Jr., Crime and the Corporation: Making The Punishment Fit the Corporation, 47 J. Corp. L. 963 (2022). 104 See Nelson, supra note 27, at 1495; Sarah Knapton, Volkswagen Scandal: Nearly 12,000 Deaths Could Be Avoided If Industry Met Emissions Targets, Telegraph, Sept. 22, 2015. 105 See, e.g., Arguments for Various Models, ComplianceNet Conference (June 29, 2021), https://​ www​.compliancenet​.org/​2021. As a former Managing Director of Goldman Sachs, Robert Mass, explained: ‘I remember talking to a regulator, and saying “this looks to me like you’re taking an obligation that was traditionally the government’s obligation and basically saying you now have to do it.” And she said “Absolutely. We’ve written the rules precisely to put it on you.”’ Id. at 23:19. 106 See Penelope Muse Abernathy, News Deserts and Ghost Newspapers: Will Local News Survive? (2020). 107 Consider, for example, that one of the first things that Facebook (now Meta) did in 2021, after whistleblower Frances Haugen disclosed tens of thousands of documents showing that Facebook knew that its products caused harm and had misrepresented itself to the public, was to cut off other employees’ access to similar information inside the company. See Deepa Seetharaman, Facebook Limits Employee Access to Some Internal Discussion Groups, Wall St. J., Oct. 14, 2021.

The future of corporate criminal liability in the ESG space  401 law, try to use what law exists to go after misstatements and other poor behavior.108 Professor John Coffee, Jr. is also correct that US prosecutors have distorted the boundaries of tort and criminal law to prosecute behavior as criminal that may previously have been fraudulent.109 And Professors Mihailis Diamantis and W. Robert Thomas are similarly correct when they say that the mess of this system means that the US does not have a principled corporate criminal law.110 Professor Abraham Goldstein has written about the ‘thinning’ of the line between criminal and civil law in the-white collar context. He noted in 1992 that civil suits were being tagged onto criminal suits in a way that effectively broadened liability for criminal activity. As he explained, ‘[t]he law of presumptions is stretched to make up for expected difficulties of proof in complex cases. And the courts tolerate an extraordinary measure of vagueness in defining crime’.111 One of the features that used to distinguish civil regimes’ focus on disclosure was their delegation of values to the marketplace. As Professor Kevin Davis writes in the context of debates around the passage of the Foreign Corrupt Practices Act, civil ‘[d]isclosure regimes deter by enabling embarrassment, by triggering naming and shaming. They work by exposing wrongdoers to condemnation by customers, suppliers, peers, and the public at large. What disclosure does not entail is explicit denunciation by the state; under a disclosure regime, denunciation is outsourced to society as a whole.’112 Thus, for example, in its focus on disclosure as an implementing agency, the SEC ‘made it clear that it viewed undisclosed questionable foreign payments as bad for business’.113 It is interesting now to pair Professor Davis’s observation about the thrust of civil law’s focus on disclosure with Professor Buell’s analysis of white-collar crime’s de facto dependence on charges of fraud: the ‘lie or concealment of important information that the seller was obligated to disclose’.114 In addition to how regulators extract information from corporations through reporting requirements,115 the emphasis on fraud in practical enforcement is an important reason why corporations and their management interpret the law as focused on statements: what they say, when, to whom, and how.116 As academics criticize the collapse of former distinctions in the law through criminalizing what would otherwise have been civil actions, the criminal law has been taking on the disclo-

108 Miriam Baer, Corporate Criminal Law Unbounded, in The Oxford Handbook of Prosecutors and Prosecution 475, 476 (Wright et al. eds., 2021). 109 See John C. Coffee, Jr., Does ‘Unlawful’ Mean ‘Criminal’? Reflections on the Disappearing Tort/ Crime Distinction in American Law, 71 B. U. L. Rev. 193 (1991). 110 Diamantis & Thomas, supra note 102. 111 Abraham S. Goldstein, White-Collar Crime and Civil Sanctions, 101 Yale L.J. 1895, 1898–99 (1992). 112 Kevin E. Davis, Why Does the United States Regulate Foreign Bribery: Moralism, Self-Interest, or Altruism?, 67 N.Y.U. Ann. Surv. Am. L. 497, 500 (2012). 113 Id. at 501 (emphasis in original). 114 Cf. Samuel W. Buell, Capital Offenses: Business Crime and Punishment in America’s Corporate Age 60 (2016) [hereinafter Capital Offenses]. 115 This issue will be discussed more extensively in a forthcoming article. See J.S. Nelson, Beyond Disclosure Enforcement (forthcoming). 116 See, e.g., Erin Murphy, Manufacturing Crime: Process, Pretext, and Criminal Justice, 97 Geo. L. J. 1435, 1445–46 (2009).

402  Research handbook on corporate liability sure approach of civil law. This is the reverse implication of Professor Coffee’s observation about ‘the disappearance of any clearly definable line between civil and criminal law’.117 B.

Doctrinally Slippery Fraud Prosecutions

As many other parts of white-collar law fail to retain their bite, fraud is a particularly malleable concept in white-collar crime, and an easier basis for prosecutions than many others. As Professor Buell describes, ‘[i]f malfeasance in the business world has a single concept at its core, it is fraud’.118 Fraud, he concludes after a survey of its origins and applications, ‘is deception, with the getting of something from another as the object of the deception’.119 In the ‘intentional and wrongful deception worked upon the fraud victim – either a lie or the concealment of important information that the seller was obligated to disclose’ – the lie or omission is key.120 The DOJ’s own journal provides a nice summary of the dilemmas that prosecutors often find themselves in when prosecuting white-collar cases. It is not an accident that its general discussion of white-collar crime continually refers to standards and strategy for fraud – in some places, four times within a few sentences.121 Professor Ellen Podgor’s research on criminal fraud reveals how imprecise the charge can be. As she writes, although ‘[t]he focus of many white collar criminal offenses is fraud[,] … fraud is not a crime with prescribed elements’.122 Fraud is instead a ‘“concept” at the core of a variety of criminal statutes’.123 The application of fraud charges has been growing as ‘generic statutes such as mail fraud and conspiracy to defraud [are] being applied to an ever-increasing spectrum of fraudulent conduct’.124 Turning to common-law precedent as a source to understand fraud in U.S. federal law, Professor Podgor concludes: ‘The “classic definition” of fraud in English law focuses on “deceit” or “secrecy.” In United States federal criminal law[,] the term is often synonymously used with the term “deceit”. Deception is also the focus of [US] civil fraud.’125 As long as the term has focused on falsehoods – lies and, at times, omissions126 – ‘the law does not define fraud; it needs no definition; it is as old as falsehood and as versable as human ingenuity’.127 There are distinctions to be made between the prosecution of the corporation as against individuals within the corporation. As Professor Buell notes, it ‘is the nature of the corporation … to divide and diminish responsibility’.128 That division and diminution of responsibility includes not only the protection of investors behind limited liability for loss of their assets

Coffee, supra note 109, at 193. Buell, Capital Offenses, supra note 114, at 32. 119 Id. at 44. 120 See id. at 60. 121 Kirsch II & Hollar, supra note 8, at 7–8. 122 Ellen S. Podgor, Criminal Fraud, 48 Am. U. L. Rev. 729, 730 (1999). 123 Id. (citing Anthony Arlidge et al., Arlidge & Parry on Fraud 33 (2d ed. 1996)). 124 Id. at 730–31. 125 Id. at 737 (internal citations omitted). 126 See Buell, Capital Offenses, supra note 114, at 60. 127 Podgor, supra note 122, at 739 (quoting Judge Holmes in Weiss v. United States, 122 F.2d 675, 681 (5th Cir. 1941)). 128 Buell, Capital Offenses, supra note 114, at 24. 117 118

The future of corporate criminal liability in the ESG space  403 in the corporation, but also the division and diminution of responsibility for misconduct by agents of the corporation on the corporation’s behalf.129 Abuse of the corporate form has evolved for large-scale entities.130 Rather than a single person hiding abuse through his control of the entire corporate form, the corporation hides its abuse by delegating to its agents pieces of abusive behavior.131 Even in attempted prosecutions of top executives, the former US Deputy Attorney General describes how ‘[b]lurred lines of authority make it hard to identify who is responsible for individual business decisions and it can be difficult to determine whether high-ranking executives, who appear to be removed from day-to-day operations, were part of a particular scheme’.132 In regard to the corporation itself, Professor Jennifer Arlen notes that ‘a rule of “pure strict vicarious criminal liability” best approximates the existing law governing corporate criminal liability, especially for those crimes which are of particular concern, such as securities fraud, government procurement fraud, and antitrust violations’.133 As Professor Vikramaditya Khanna refines the rule’s impact for management, ‘[u]nder respondeat superior, top management’s involvement does not influence whether the corporation will be liable, but it does influence for how much the corporation will be liable’.134 Moreover, he notes, ‘top management’s involvement in wrongdoing also increases the prospect of liability for regulatory violations’.135 Regarding individuals, although Professor Buell does not believe that ‘individual criminal liability, in its basic structure … fit[s] the problem of bad management that produces corporate crime’,136 to the degree that representatives of the corporation may be individually liable, he returns to the tool of fraud.137 He notes that, ‘[i]n cases of fraud by affirmative misrepresentation, this requirement generally includes that the defendant knew she was uttering falsehood’, although ‘[s]ome federal cases have suggested recklessness as to falsity might be sufficient for criminal liability’.138 Meanwhile, ‘[l]aws that police honesty in dealings with the government usually authorize criminal sanctions only upon proof that an individual knew of the falsity of, for example, a regulatory filing’.139 129 See J.S. Nelson, Paper Dragon Thieves, 105 Geo. L. J. 871, 892–93, 898–99 (2017) [hereinafter Paper Dragon Thieves]; accord Peter J. Henning, Why It is Getting Harder to Prosecute Executives for Corporate Misconduct, 41 Vt. L. Rev. 503 (2017). 130 Nelson, supra note 129, at 884, 901–908 (providing examples) and 909–21 (describing resulting problems with the application of conspiracy law). 131 Id. at 884, 901–902. There is also an interesting note in the DOJ’s Journal that ‘Pinkerton instructions are particularly useful in corporate conspiracy cases, because they allow decision-makers to be held responsible for the reasonably foreseeable actions of their subordinates.’ Kirsch II & Hollar, supra note 8, at 11 (citing United States v. Sullivan, 522 F.3d 967, 977 (9th Cir. 2008) for ‘upholding advertising agency CEO’s fraudulent concealment conviction based on Pinkerton theory’). 132 Sally Q. Yates, Deputy Attorney Gen., Remarks at the N.Y.C. Bar Ass’n White Collar Crime Conference (May 10, 2016). 133 Arlen, supra note 12, at 840. 134 Vikramaditya S. Khanna, Should the Behavior of Top Management Matter?, 91 Geo. L.J. 1215, 1220 (2003). 135 Id. at 1222. 136 Samuel W. Buell, Criminally Bad Management, in Research Handbook on Corporate Crime and Financial Misdealing 59, 85 (Jennifer Arlen ed., 2018). 137 See Buell, Capital Offenses, supra note 114, at 16, 51; Buell, supra note 136, at 71 (citing 18 U.S.C. §§ 201, 666 (2018); United States v. Bonito, 57 F.3d 167 (2d Cir. 1995)). 138 Buell, supra note 136, at 71. 139 Id.

404  Research handbook on corporate liability Finally, there are a growing number of cases being brought by federal prosecutors under 18 U.S.C. § 1348, which is modeled on the bank fraud statute140 but penalizes securities and commodities fraud.141 The importance of Section 1348 being modeled on the bank fraud statute, and not on mail, wire, or traditional securities fraud, is that appellate courts are holding that it reaches securities and commodities fraud schemes in which there is no evidence of direct misrepresentations or material omissions from a duty to disclose.142 This gives prosecutors even more flexibility to charge fraud criminally as a basic concept in corporations’ relations with investors. C.

Political and Economic Pressures Around Fraud

By 2018, government prosecutions against white-collar crimes had fallen to their lowest level in twenty years.143 During the first year of the Trump administration, the DOJ’s fines against corporations fell off 90 percent.144 In addition, Professor Brandon Garrett notes that ‘most of the cases with large penalties in the first twenty months of the Trump Administration were legacy cases that had been initiated and investigated under the Obama Administration’.145 What should make us think that government prosecutions of white-collar crime will pick up, especially in the area of fraud as a low-hanging fruit? First, there is increasing realization that asking corporations to police themselves is not working particularly well. According to Professor Eugene Soltes, the likelihood that a large, publicly traded firm will ‘be criminally sanctioned by the Department of Justice (DOJ) or face a civil enforcement action for accounting matters by the Securities and Exchange Commission (SEC) is 0.5 per cent and 1.1 per cent, in a given year’.146 The likelihood that such a firm will be civilly sued for alleged misconduct is under 5 percent per year.147 Meanwhile, benchmarking data from large firms indicate that they have around 124 substantive reports of legally actionable misconduct per year, or, on average, one every three days.148 Using all available public data sources, this would indicate in the order of one out of nearly 13 (12.8) incidents being reported, or 92 percent of incidents not being reported.149 In 2018, using

See 18 U.S.C. § 1344 (2021). See, e.g., Sandra Moser & Justin Weitz, 18 U.S.C. § 1348—A Workhorse Statute for Prosecutors, 66 DOJ J. Fed. L. & Prac. (special edition on corporate crime) 111, 111–12 (2018). 142 See id. at 113–19 (describing federal court decisions around the country). As the statute’s legislative history records, it was passed to ‘provide needed enforcement flexibility in the context of publicly traded companies to protect shareholders and prospective shareholders against all the types of schemes and frauds which inventive criminals may devise in the future’. 148 Cong. Rec. S7421 (daily ed. July 26, 2002), https://​www​.congress​.gov/​crec/​2002/​07/​26/​CREC​-2002​-07​-26​.pdf. 143 White Collar Prosecutions Fall to Lowest in 20 Years, TRAC Reports (2018). 144 Jamiles Lartey, Corporate Penalties Dropped as Much as 94% Under Trump, Study Says, Guardian, Jul. 25, 2018. 145 Brandon L. Garrett, Declining Corporate Prosecutions, 57 Am. Crim. L. Rev. 47, 115 (2020). 146 Eugene Soltes, The Frequency of Corporate Misconduct: Public Enforcement Versus Private Reality, 26 J. Fin. Crime 923, 924 (2019). 147 See id. 148 See id. 149 See id. (indicating that a ‘back-of-the-envelope’ calculation on all public sources would find a report of an act of substantive misconduct ‘every 1,586 days per company on average’, versus a more accurate rate of once every three days). 140 141

The future of corporate criminal liability in the ESG space  405 another data set of 608 firms, Professors Paul Healy and George Serafeim recorded that only 17 percent of firms (104 in 608) reported internal violations to regulators.150 Similarly, although it is difficult to collect accurate statistics on precisely how much white-collar crime occurs each year, according to victimization studies, people and businesses are far more likely to be victims of white collar crime than of either traditional property crime or violent crime. In a 2018 publication, 35 percent of businesses reported that they had been victims of white collar crime, and 25 percent of households reported that they had been victims of white collar crime.151 Victimization rates for property crime and violent crime, by contrast, are eight percent and a little over one percent.152 Accordingly, nearly 4.5 times as many businesses had been victims of white-collar crime as general property crime, and nearly 25 times as many households had been the victims of white-collar crime as they had been of violent crime. Second, fraud-based damages claims seem to be growing. Fraud may be among the fastest-growing forms of white-collar crime. According to a 2020 report from accounting firm PwC, in a survey of more than 5,000 respondents across 99 territories, nearly half had suffered losses from fraud over the prior 24 months, with an average of six times per company.153 Healthcare fraud is estimated to cost between 3–10 percent of healthcare expenditures, which could total more than $300 billion a year.154 Third, there is new, tough talk on white-collar crime from the US DOJ, and the lowest-hanging fruit may be prosecutions for fraud. In October 2021, as Deputy Attorney General Lisa Monaco explained in her keynote policy address to the American Bar Association, the Biden administration is ‘going to find ways to surge resources to the department’s prosecutors’ combatting white-collar crime.155 Her specific example was the dedication of resources to combat criminal fraud with ‘a new squad of FBI agents … embedded in the Department’s Criminal Fraud Section’.156 She also noted that, as part of the Biden administration’s new aggressiveness on white-collar crime, ‘[w]e also have our prosecutors preparing for more trials right now than at any time in the last decade’.157 In addition, pursuing ESG misrepresentations comports with the advice that federal prosecutors give about what makes the best white-collar cases. As the DOJ’s internal journal

Paul M. Healy & George Serafeim, Agency Costs and Enforcement of Management Controls: Analyzing Punishments for Perpetrators of Economic Crimes Tbl. 6 (2018); see also Paul Healy & George Serafeim, Who Pays for White-Collar Crime?, Harv. Bus. Sch. Working Paper (June 2016). 151 See Gerald Cliff & April Wall-Parker, Statistical Analysis of White-Collar Crime, in Oxford Research Encyclopedia of Criminology 7 (Henry N. Pontell gen. ed. 2018) (citing statistics from a series of sources). 152 See id. 153 PricewaterhouseCoopers, 2020 Fighting Fraud: A Never-ending Battle, PwC’s Global Economic Crime and Fraud Survey 3 (2020). 154 NHCAA, The Challenge of Health Care Fraud, https://​www​.nhcaa​.org/​tools​-insights/​about​ -health​-care​-fraud/​the​-challenge​-of​-health​-care​-fraud/​. 155 Lisa O. Monaco, Dep’ty Attn’y Gen., Keynote Address at ABA’s 36th Nat’l Inst. on White Collar Crime (2021). 156 Id. 157 Sadie Gurman, Deputy Attorney General Lisa Monaco Underscores DOJ’s Tougher Line on Corporate Crime, Wall St. J., Dec. 7, 2021 (see embedded video for Deputy AG Monaco’s original remarks to Wall St. J. CEO Council at 1:23). 150

406  Research handbook on corporate liability advises, in thinking about pursuing cases that ‘will stick’, ‘Look for the Big Lie.’158 As the Appellate Chief of United States Attorney’s Office for the District of Oregon writes, ‘[t]hat seemingly simple advice is a sound guiding principle for any white collar case. These cases are generally complex, and they involve highly paid, often aggressive defense counsel who will leave no stone unturned.’159 In such cases, ‘[t]he common tactic [is to] create a dust storm of confusion, blame underlings, express a lack of business acumen and sophistication, and the like’.160 Meanwhile, a federal prosecutor’s ‘most effective response stays true to that simple theme: there was a big lie, and this defendant cannot explain it, hide from it, or ultimately, defend it’.161 The prosecutor should be able to prove that the defendant ‘wrote it, said it, posted it, or all three’.162 In legal terms, ‘[i]t was false, it was material, and it formed the backbone of his scheme. Everything else is just white noise’.163 As more information emerges about climate change, denial of facts about climate change, and the lack of responsible action from corporations to address it, corporate obfuscations may start to look like a more and more attractive ‘big lie’ for prosecutors to pursue. D.

Signs of Movement on Fraud Prosecutions Against Corporations

Finally, there are signs of movement in the US on ESG fraud prosecutions against corporations for their statements to investors. To date, these have been civil actions, except for the December 2021 action against Deutsche Bank mentioned at the start of this chapter (see supra at Part II). But criminal charges may follow, such as in the example of BlackRock’s advertised ESG fund. In 2018, the Attorney General of the State of New York brought a high-profile case against ExxonMobil Corp. (‘Exxon’), alleging that the company had committed fraud against its investors by misleading them about the risks to the company posed by climate change.164 The reason why the 2018 case failed is because, although Exxon was maintaining two sets of accounting books – one inside the company that accounted for costs from climate change, and an external one that did not – it had not made ‘material misrepresentations that “would have been viewed by a reasonable investor as having significantly altered the ‘total mix’ of information made available”’ because the company was not required to share its internal calculations with outside investors.165 As the court noted, ‘[i]t is undisputed that ExxonMobil does not publish the details or the economic bases upon which ExxonMobil evaluates investment opportunities due to competitive considerations.’166 The court found nothing wrong with 158 Kelly A. Zusman, Making it Stick: Protecting Your White Collar Convictions on Appeal, 66 DOJ J. Fed. L. & Prac. (special edition on corporate crime) 65, 65 (2018) (capitalization in original). 159 Id. at 65. 160 Id. 161 Id. 162 Id. 163 Id. 164 See Summons and Compl., People of the State of N.Y. v. ExxonMobil Corp., No. 452044/2018 (N.Y. Sup. Ct., Oct. 24, 2018). The claims of equitable fraud and common-law fraud were later dropped. See Decision After Trial, People of the State of N.Y. v. ExxonMobil Corp., No. 452044/2018, at 3 (N.Y. Sup. Ct., Dec. 10, 2019). 165 Decision After Trial, supra note 164, at 3 (quoting in part TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976)). 166 Id. at 2.

The future of corporate criminal liability in the ESG space  407 Exxon’s practice in this regard. Again, in a US court, the company was being judged solely on what it said to investors, rather than on the duplicity of its actions in keeping two separate sets of books. But there may be further progress toward liability for fraud, even against the same corporate defendant. In October 2019, the Massachusetts Attorney General filed a similar case against Exxon, which the company quickly sought to remove to federal court, which the Commonwealth contested.167 In May 2020, the federal court permitted the case to be remanded to state court with an interesting decision that went much farther than commenting on the case’s jurisdictional issues.168 In sections headed ‘Greenhouse Gases and Climate Change’, ‘ExxonMobil’s Campaign of Deception’, ‘ExxonMobil’s Misrepresentations to Investors’, and ‘ExxonMobil’s Misrepresentations to Consumers’, the federal Exxon court appeared to find well-pleaded allegations of fraud on the part of the company to multiple external audiences.169 According to the court, ‘Our Earth is plainly getting hotter, and scientists have reached a consensus that this is largely due to rising carbon dioxide concentrations and other greenhouse gas emissions … This fact threatens our planet and all its people, including those in Massachusetts, with intolerable disaster.’170 ExxonMobil may have been in a position to have known about this danger for a long time. As the court writes, ‘[n]early forty years ago, the Commonwealth asserts, ExxonMobil already “knew that climate change presented dramatic risks to human civilization and the environment as well as a major potential constraint on fossil fuel use”’.171 As part of ExxonMobil’s alleged deception, ‘[d]espite this knowledge, “[a]n August 1988 Exxon internal memorandum, captioned ‘The Greenhouse Effect,’ captures Exxon’s intentional decision to misrepresent both its knowledge of climate change and the role of Exxon’s products in causing climate change”’.172 The court noted the coordination of ExxonMobil’s attempts to influence public perception – including, of course, ‘the “total mix” of information made available’ 173 – to push ‘a false narrative that climate science was plagued with doubts’.174 In a reference to another time in which corporate misinformation brought significant liability, the court described ExxonMobil and its allies as ‘in cahoots with a veteran of Philip Morris’ tobacco-misinformation campaign’.175 Specifically in regard to investors, the court notes that ‘the Commonwealth alleges that “ExxonMobil has repeatedly represented to investors … that ExxonMobil used escalating proxy costs” as a way to estimate the financial dangers of climate change to the corporation, yet often “ExxonMobil was not actually using proxy costs in this manner”’.176 Instead, 167 See generally Mem. of Law of the Commonwealth of Massachusetts in Support of its Motion for Remand to the Massachusetts Superior Court for Suffolk County, Commonwealth of Massachusetts v. ExxonMobil Corp., No. 19-12430-WGY (D. Mass., Dec. 26, 2019). 168 See Mem. of Decision, Commonwealth of Massachusetts v. ExxonMobil Corp., No. 19-12430-WGY (D. Mass., May 28, 2020). 169 Id. at 6–11. 170 Id. at 6 (internal citations omitted). 171 Id. at 7 (internal citations omitted). 172 Id. (quoting Commonwealth’s complaint). 173 Cf. Decision After Trial, supra note 164, at 3 (quoting in part TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976)). 174 Mem. of Decision, supra note 168, at 8. 175 Id. at 8. 176 Id. at 9 (quoting Commonwealth’s complaint).

408  Research handbook on corporate liability ‘[d]ocuments disclosed through other litigation revealed that ExxonMobil was internally using a lower proxy carbon cost than what it told investors, or that it failed entirely to use a proxy cost of carbon across many sectors of its business’.177 Ultimately, ‘[b]y not internally applying the proxy cost as it publicly claimed to do, ExxonMobil avoided “project[ing] billions of dollars of additional climate-related costs”’ in its disclosures to investors.178 The Exxon federal court opinion in Massachusetts sounds like the cases making sweeping statements about business liability for climate change coming out of other countries. In addition, although the formal case of fraud against Exxon may still be, as of the time of writing, proceeding in Massachusetts,179 Exxon is already feeling pressure from investors regarding its attempts to deny the impacts of climate change. In September 2020, shareholder suits against the company alleging violations of securities laws were consolidated in Texas.180 In May 2021, a group of activist investors, led by Engine No. 1, was able to elect to the board a slate of directors who promised reform on accounting for climate change.181 By November 2021, Exxon’s formal disclosures to investors had altered course significantly, describing a large percentage of its fossil-fuel assets as potentially ‘impaired’ due to climate change issues.182

VII. CONCLUSION As norms around ESG continue to change, corporations should be on the lookout for what they say and do regarding ESG initiatives. As this chapter has described, international developments around corporate liability for ESG have been accelerating. Although the US is not likely to follow the same path as Europe and other nations to enforce protection against climate change as a fundamental right, social norms around climate change are shifting, and ESG promises are where some of the most potentially egregious misrepresentations may be being made to investors. Building political and economic pressures may push prosecutors over the thin line from civil liability into potential criminal liability, and the DOJ’s announcement about Deutsche Bank may be an indication that a direct criminal case for fraud against a corporation for ESG misstatements may appear in US courts soon. All of these developments could build momentum for further changes to come.

Id. (same). Id. at 9–10 (same). 179 See Jonathan Stempel, Exxon Must Face Massachusetts Lawsuit Alleging Climate Change Deceit, Reuters, Jun. 23, 2021. 180 See Opinion and Order on Transfer to the Northern District of Texas, In re ExxonMobil Corp. Derivative Litigation, 2:19-CV-16380-ES-SCM, at 11 (D. N.J., Sept. 15, 2020). 181 See Svea Herbst-Bayliss, Little Engine No. 1 Beat Exxon with Just $12.5 mln – sources, Reuters, June 29, 2021. 182 See Sabrina Valle, Exxon Warns Some Assets May Be at Risk for Impairment Due to Climate Change, Reuters, Nov. 3, 2021. 177 178

22. Towards corporate digital responsibility Florian Möslein

I. INTRODUCTION Digital transformation is triggering a highly dynamic but also very fundamental process of change that is about to affect the entire corporate world: digitalization means much more than the simple introduction of certain digital processes or tools; rather, it implies significant changes in entrepreneurial business models.1 This transformation process can be exemplified by companies such as Uber, Facebook, Alibaba and Airbnb. Uber, the world’s largest taxi company, does not own any cars; Facebook, the world’s most popular media company, does not generate its own content; Alibaba, the world’s most valuable retailer, does not own inventory; and Airbnb, the world’s largest accommodation provider, does not own its properties.2 These four companies can be considered to be digital companies because their business models are essentially based on innovative use of modern information technologies. All four are now market leaders in their respective segments, in which they have displaced established market players in a comparatively short space of time.3 The technological drivers of this corporate transformation process are manifold and include digital platforms, distributed ledger technologies, and data-driven artificial intelligence. The potential implications for corporate law are increasingly discussed, at least for specific digital technologies,4 but rarely with a focus on corporate liability.5 Yet digital technologies Cf. Nils Urbach & Maximilian Röglinger, Introduction to Digitalization Cases: How Organisations Rethink Their Business for the Digital Age, in Digitalization Cases 1 et seq. (Nils Urbach & Maximilian Röglinger eds., 2018). 2 Henner Gimpel & Maximilian Röglinger, Digital Transformation: Changes and Chances 5 (2015). 3 Cf. also Hamish McRae, Facebook, Airbnb, Uber, and the Unstoppable Rise of the Content Non-generators, Independent, 5 May 2015, http://​www​.independent​.co​.uk/​news/​business/​comment/​ hamish​-mcrae/​facebook​-airbnb​-uber​-and​-the​-unstoppable​-rise​-of​-the​-content​-non​-generators​-10227207​ .html (last visited Aug. 2, 2022). 4 See, e.g., with regard to artificial intelligence, Florian Möslein, Robots in the Boardroom: Corporate Law and Artificial Intelligence, in Research Handbook of Artificial Intelligence 649 (Woodrow Barfield & Ugo Pagallo eds., 2018); Florian Möslein, Artificial Intelligence and Corporate Law, in The Cambridge Handbook of Artificial Intelligence: Global Perspectives on Law and Ethics 74 (Larry di Matteo et al. eds., 2022) (hereinafter Artificial Intelligence and Corporate Law); with regard to distributed ledger technology, see George S. Geis, Traceable Shares and Corporate Law, 113 Nw. U. L. Rev. 227–77 (2018); with regard to digital platforms, see Mark Fenwick, Joseph A. McCahery & Erik P.M. Vermeulen, The End of ‘Corporate’ Governance: Hello ‘Platform’ Governance, 20 Eur. Bus. Org. L. Rev. 171 (2019); see also Christopher M. Bruner, Distributed Ledgers, Artificial Intelligence and the Purpose of the Corporation, 79 Camb. L.J. 431 (2020). 5 With regard to corporate disclosure, on the other hand, see Florian Möslein & Salih Tayfun Ince, Artificial Intelligence and Corporate Disclosure, in Corporate Governance and Artificial Intelligence (Indrajit Dube ed., forthcoming 2023) (hereinafter Artificial Intelligence and Corporate Disclosure). 1

409

410  Research handbook on corporate liability such as distributed ledgers present particularly difficult challenges with regard to liability.6 Corporate liability will itself face new challenges and might become subject to substantial changes as a result of digital transformation. Both in tort law and in company law this change will affect how we perceive corporate responsibility because in both respects corporate liability raises the key question of what behaviour the law expects from corporations and their directors with respect to use of digital technologies. The key challenge in the field of corporate liability will therefore be to develop normative standards with regard to corporate digital responsibility.

II.

THE DIGITAL TRANSFORMATION OF CORPORATE LIABILITY

Before elaborating on the details of corporate digital responsibility (see Sections III–V below), it is necessary to outline the key conceptual characteristics of digital transformation in order to be able to map, assess and evaluate its implications for corporate liability. Companies operate in a multitude of diverse market segments, and their business models differ greatly. Therefore, they are each affected differently by digital transformation. Nevertheless, digitalization is characterized by some specific peculiarities. These peculiarities are not always present to the same extent, and they form a dynamic system in which the various elements play different roles in different circumstances. Taken together, these factors inherently characterize the very process of digital transformation. A. Disintermediation While traditional companies often meet the demands of their customers or at least fulfil intermediary functions in order to balance the interests of different market participants, digital companies like Uber, Facebook, Alibaba and Airbnb limit themselves to acting as mere marketplaces, which enable direct contact between suppliers and customers. Transactions are processed in a peer-to-peer format, with online marketplaces typically not becoming parties to single transaction contracts. Such transformation to the so-called platform economy does not only occur in the financial services industry (banks, insurance and investments), where peer-to-peer crowd-lending platforms supplement traditional bank lending;7 similar developments can be observed in many other industries, like telecommunications, media and transport.8 Disintermediation by digital platforms is mainly enabled by the internet. However, blockchain and distributed ledger technologies also lead to the elimination of intermediaries, at least in their original form: as a decentralized database, a blockchain network does not need 6 Dirk Zetzsche, Ross P. Buckley & Douglas W. Arner, The Distributed Liability of Distributed Ledgers: Legal Risks of Blockchain, 2018 U. Ill. L. Rev. 1361 (2018); see also Till von Poser, Haftungsadressaten in DLT-Netzwerken (2022) (PhD dissertation, University of Marburg). 7 Cf. Christoph Busch & Vanessa Mak, Peer-to-Peer Lending in the European Union, 5 J. Eur. Consumer & Mkt L. 181 (2016) (‘banking without banks’); Madalena Narciso, The Unreliability of Online Review Mechanisms, 15 J. Consumer Pol’y 1–20 (2022); see also Christopher Rennig, Finanztechnologische Innovationen im Bankaufsichtsrecht: Disintermediation als Grundlage eines ‘Banking Without Banks’? (2022). 8 On core concepts and typologies of digital platforms, see Paul Belleflamme & Martin Beitz, The Economics of Platforms 10–40 (2021).

Towards corporate digital responsibility  411 a central unit to mediate between individual players. Still, disintermediation does not occur to the same extent in all cases: depending on the specific design of the blockchain, elements of centralization can also be implemented.9 The legal problems that disintermediation and the platform economy create are manifold. They range from competition law issues to questions about the applicability of provisions for labour or consumer law that are still tailored to traditional business models.10 Not least, platform business models also challenge organizational law and governance because they operate neither as traditional firms nor as conventional market systems: disintermediated platforms are neither purely hierarchical nor totally decentralized.11 Much like other decentralized business models, such as multinational supply chains, they are ‘located at the intersection between exchange and organizational contracts, thus, in the conventional view, between contract and company law’.12 The corporate liability implications of these transformations have rarely been discussed to date, but their relevance is obvious: can platforms, for instance, be held liable for injuries caused by products that have been traded in such marketplaces, and if so, in which circumstances and under which conditions? Much depends on the legal duties of online intermediaries and the increasingly complex legal schemes that regulate their activities.13 For example, the Swiss Federal Court recently ruled that an employment relationship can exist between Uber and its drivers.14 If Uber drivers are considered to be employees of the platform, that implies the possibility of the platform being vicariously liable to its customers and other third parties. While such liability of digital platforms and intermediaries is a topic in its own right, it has obvious implications for corporate liability more specifically, in particular with regard to the responsibility of the board in cases where a company is held liable under these emerging liability regimes. B. Automation Distributed ledger technologies are also one of the main driving forces of a second distinctive feature of digital transformation, namely an enhanced form of automation which some call hyper-automation.15 Of course, automation has deep historical roots. In 1771, for example,

Cf. Ioannis Lianos, Blockchain Competition, in Regulating Blockchain 329, 334–44 (Philipp Hacker et al. eds., 2019). 10 For a broad overview, see, e.g., The Cambridge Handbook of the Law of the Sharing Economy (Nestor M. Davidson et al. eds., 2018); with a more specific focus on competition law challenges, see Jens-Uwe Franck & Martin Peitz, Market Definition and Market Power in the Platform Economy (2019). 11 Cf. the contributions in The Law and Governance of Decentralised Business Models: Between Hierarchies and Markets (Roger M. Barker & Iris H.-Y. Chiu eds., 2020). 12 Fabrizio Cafaggi, Contractual Networks and the Small Business Act: Towards European Principles?, 4 Eur. Rev. Cont. Law 493, 507 (2008). 13 In detail, see The Oxford Handbook of Online Intermediary Liability (Giancarlo Frosio, ed., 2020); Jaani Riordan, The Liability of Internet Intermediaries (2016). 14 Bundesgericht [BGer] [Federal Supreme Court] May 30. 2022, 2C_575/2020 (Switz.); in a similar vein with regard to German law Bundesarbeitsgericht [BAG] [Federal Labor Court] Dec. 1, 2020, 9 AZR 102/20 (Ger.). 15 See, for instance, Abid Haleem et al., Hyperautomation for the enhancement of automation in industries, 2 Sensors Int’l 100124 (2021). 9

412  Research handbook on corporate liability Richard Arkwright invented the first fully automated spinning mill, driven by water power.16 Digital transformation, however, which is mainly about collecting and analysing data, allows for new, highly interconnected automation processes that take advantage of large datasets, for instance in manufacturing – popularly known as ‘Industry 4.0’.17 Beyond this industry automation, distributed ledger technologies also provide the technological infrastructure that enables the automation of many contractual relationships: so-called smart contracts formulate rules and sanctions for bilateral agreements and implement them automatically. Smart contracts are defined as computer protocols, usually based on a decentralized blockchain system, which enable the automatized execution of contracts between two or more parties under pre-encoded conditions.18 While they can also be implemented using traditional mechanical technologies (for example, in vending machines), distributed ledgers allow for the implementation of incomparably more complex rules and enforcement mechanisms. These technologies also offer a decentralized environment with integrated settlement systems.19 In contrast to relational databases, blockchain-based smart contracts can technically be directly executed, and they can change their state over time depending on pre-formulated conditions. The execution can be made dependent on external events (such as stock-market prices, sales data or the receipt of money in an account) by using interfaces known as ‘oracles’.20 Specific arrangements are available as decentralized applications (DApps) and can be combined with one another as in a modular system of contract clauses. The fields of application for smart contracts are diverse. Examples include leased cars that automatically become inoperable in the event of late payment by means of a so-called ‘starter interrupt device’; the organization of processes in distribution chains and more generally in logistics; and autonomous transactions involving autonomous vehicles, for example at petrol stations.21 The so-called internet of things (IoT) is also based on smart contracts, which form the basis for mutual interaction among individual devices.22 Smart contracts promise efficiency gains, especially because they reduce dependence on physical documents, decrease administrative costs and lessen control and data monitoring efforts. They also promise a high Cf. Robert U. Ayres, The History and Future of Technology 177–98 (2021). For an introduction, see Heiner Lasi et al., Industry 4.0, 6 Bus. Info. Sys. Eng’g. 239–242 (2014). 18 While various, partly differing understandings exist, this is the definition used by the Swiss legislature. Bundesrat der Schweizerischen Eidgenossenschaft, Bericht zu den rechtlichen Grundlagen für Distributed-Ledger-Technologie und Blockchain in der Schweiz – Eine Auslegeordnung mit Fokus auf dem Finanzsektor, 14 December 2018, p.  85, https://​www​.newsd​.admin​.ch/​newsd/​message/​ attachments/​55150​.pdf. In a similar sense, Art. 8-ter Abs. 2 S. 1 Legge, 11 February 2019, n. 12 and Gazzetta Ufficiale n. 36 of 12 February 2019, http://​www​.gazzettaufficiale​.it/​eli/​id/​2019/​02/​12/​ 19G00017/​sg (‘un programma per elaboratore che opera su tecnologie basate su registri distribuiti e la cui esecuzione vincola automaticamente due o piu’ parti sulla base di effetti predefiniti dalle stesse’). For an international overview, cf. Riccardo de Caria, The Legal Meaning of Smart Contracts, 6 Eur. Rev. Priv. L. 731 (2019). 19 See Florian Möslein, Rechtliche Grenzen innovativer Finanztechnologien (FinTech): Smart Contracts als Selbsthilfe? Zeitschrift für Bankrecht und Bankwirtschaft (ZBB) 208, 215 (2018). 20 See Florian Möslein, Smart Contracts im Zivil- und Handelsrecht, 183 Zeitschrift für das gesamte Handelsrecht (ZHR) 254–93, 261 et seq. (2019). 21 Don Tapscott & Alex Tapscott, Blockchain Revolution: How the Technology Behind Bitcoin and Other Cryptocurrencies is Changing the World 164–75 (2016). 22 Iria Giuffrida et al., A Legal Perspective on the Trials and Tribulations of AI: How Artificial Intelligence, the Internet of Things, Smart Contracts, and Other Technologies Will Affect the Law, 68 Case W. Rsrv. L. Rev. 747, at 756–60 (2018). 16 17

Towards corporate digital responsibility  413 degree of settlement security by creating a kind of technology-based trust architecture.23 Taken together, these advantages (but also the risks of smart contracts) can be summed up as follows: ‘Potential benefits include low contracting, enforcement and compliance costs, while potential risks include a reliance on the computing system that executes the contract.’24 The legal implications of contract automation and blockchain-based smart contracts are again manifold. These devices challenge contract law in particular because they provide a technology-based enforcement mechanism which concurs with the traditional legal means of enforcement.25 Some already fear the end of contract law.26 In a similar vein, smart contract platforms pride themselves on being ‘digital jurisdictions’ that promise freedom from the bureaucratic hurdles of contract law and allow for truly global contractual relationships, independent of national legal systems, thereby avoiding the complexities of conflicts of laws.27 Insofar as companies can be constructed as a nexus of contracts, these developments also have significance for company law. Smart contracts enable the emergence of technology-based alternatives to traditional legal company forms, in the shape of so-called decentralized autonomous organizations (DAOs). But even if DAOs form ‘nexuses of smart contracts’ and are functional alternatives to legal forms,28 they do not exist outside the sphere of law. Quite the contrary; they raise important questions of corporate liability. In particular, can holders of DAO tokens be held personally liable, like parties in a partnership? Corporate liability is precisely the reason why lawyers recommend using legal wrappers to protect token-holders against personal liability.29 But even in companies that are traditionally legally constituted, possibilities for automation by smart contracts present new challenges for corporate liability. On the one hand, such automation provides more efficient, though more schematic, mechanisms of liability enforcement. Bondholders, for example, are able to facilitate enforcement of their rights by incorporating the borrower’s obligations in a smart contract that is automatically triggered if, for instance, the firm value touches certain pre-defined default barriers.30 On the other hand, companies themselves can also take advantage of these devices in order to facilitate enforcement of their own legal claims against their debtors. Failure to do so may give rise to corporate liability disputes if it can be argued that such automated enforcement would See Kevin Werbach, The Blockchain and the New Architecture of Trust (2018). Sir Mark Walport, Government Office for Science, Distributed Ledger Technology: Beyond Blockchain, A Report by the UK Government Chief Scientific Adviser, 18 (2016) https://​ assets​.publishing​.service​.gov​.uk/​government/​uploads/​system/​uploads/​attachment​_data/​file/​492972/​gs​ -16​-1​-distributed​-ledger​-technology​.pdf); cf. also Stéphane Blémus, Law and Blockchain: A Legal Perspective on Current Regulatory Trends Worldwide, 4 Revue Trimestrielle de Droit Financier (RTDF) 1, 13 (2017). 25 Möslein, supra note 19, at 288 et seq. 26 Alexander Savelyev, Contract Law 2.0: ‘Smart’ Contracts as the Beginning of the End of Classic Contract Law, 26 Info. & Commc’ns Tech. L. 26, 116 (2017). 27 Cf., e.g., https://​aragon​.org/​network (‘The world’s first digital jurisdiction’), with an extensive explanation in their White Paper, https://​wiki​.aragon​.org/​documentation/​whitepaper (both last visited Aug. 2, 2022). 28 Florian Möslein, A Nexus of Smart Contracts? Gesellschaftsrechtspraxis und -theorie im Spiegel der Blockchain, in Festschrift for Christine Windbichler 889 (Gregor Bachmann et al. eds., 2020). 29 See, e.g., Biyan Mienert, How Can a Decentralized Autonomous Organization (DAO) be Legally Structured?, Legal Revolutionary J. (LRZ) 336 (2021), https://​lrz​.legal/​de/​lrz/​how​-can​-a​ -decentralized​-autonomous​-organization​-dao​-be​-legally​-structured. 30 For additional practical applications, cf. Phoebus L. Athanassiou, Digital Innovation in Financial Services: Legal Challenges and Regulatory Policy Issues § 5.01[B] (2016). 23 24

414  Research handbook on corporate liability have been successful, whereas traditional legal enforcement missed the mark. The breach of duty is thereby brought forward from the point in time when a claim is enforceable to the moment when this claim was established. At that earlier point in time, automated enforcement could have been implemented by taking advantage of a smart contract. Automation thereby raises legal questions of corporate liability at a much more abstract level. Moreover, increasing automation is associated with a high degree of complexity in the area of conflict of laws. Since there are no system headquarters, geographical assignment to a specific national legal order is difficult or even impossible in the blockchain. Similarly, the internet, as a connecting link between individual nodes of the blockchain, does not behave congruently with the borders of countries and legal systems.31 C. Autonomy A third, important and distinctive feature of digital transformation concerns autonomous decision-making. Decisions are not made by human beings alone but are increasingly assisted or even adopted by technology. We can currently observe an at least partial shift in decision-making authority to machines, in the form of algorithms and artificial intelligence.32 Accordingly, artificial intelligence devices are increasingly conceptualized as autonomous actants.33 This transformation of decision-making also occurs and is perhaps even foremost within companies. Corporate decisions in particular are based on extensive and complex datasets, which human decision-makers are only able to analyse to a limited extent or with external help.34 Algorithms and artificial intelligence (AI) are therefore already being used to facilitate, accelerate and improve decision-making processes. For instance, it was recently reported that Uniper, a large international energy supplier with 12,000 employees, takes advantage of artificial intelligence for its financial forecasts. While target figures were previously prepared by specific employees, based on historical costs of previous years, internal business forecasts and known strategic initiatives, they are now developed with the assistance of analytical methods, and they are substantially more precise.35 Other fields of application for AI-assisted corporate decision-making include supply chains and staff selection procedures, but there is also the case of a large bakery company that introduced artificial intelligence to predict how many croissants customers would be likely to buy the next day.36

31 For further details, see Florian Möslein, Conflicts of Laws and Codes: Defining the Boundaries of Digital Jurisdictions, in Regulating Blockchain 275 (Philipp Hacker et al. eds., 2019). 32 See, e.g., Robert van den Hoven van Gederen, Do We Need Legal Personhood in the Age of Robots and AI? in Robotics, AI and the Future of Law 15, at 47 et seq. (Marcelo Corrales et al. eds., 2018). 33 Anna Beckers & Gunther Teubner, Three Liability Regimes for Artificial Intelligence: Algorithmic Actants, Hybrids, Crowds 23 (2021); see also Dimitrios Linardatos, Autonome und vernetzte Aktanten im Zivilrecht (2021). 34 Florian Möslein, KI im Gesellschaftsrecht, in Künstliche Intelligenz und Robotik 457, 468 et seq. (Martin Ebers et al. eds., 2020). 35 Alexander Thamm, Der Algorithmus am Vorstandstisch, Handelsblatt (Jul. 20, 2022), https://​ veranstaltungen​.handelsblatt​.com/​kuenstliche​-intelligenz/​der​-algorithmus​-am​-vorstandstisch 36 Pauline Schinkels, Wenn die KI dem Bäcker sagt, wie viele Croissants er backen soll, Handelsblatt (Mar. 22, 2022), https://​www​.handelsblatt​.com/​unternehmen/​mittelstand/​datenstrategie​ -im​-mittelstand​-wenn​-die​-ki​-dem​-baecker​-sagt​-wie​-viele​-croissants​-er​-backen​-soll/​28185046​.html

Towards corporate digital responsibility  415 From a legal perspective, the implications of this third feature for corporate liability are probably most obvious and significant both from a corporate law and a tort law perspective. Challenging legal situations arise in cases in which damages are caused by technological devices that perform tasks without (or with less) human control and supervision, in particular if these devices constantly adjust their own algorithms. Such sophisticated AI-based autonomous systems with self-learning capabilities raise the question of whether unpredictable deviations in the decision-making path can be attributed to any natural or legal person, be it, for instance, the operator or the producer. The complexity and the opacity of such digital technologies complicate chances for victims to discover and prove causation. While these problems are widely discussed with respect to civil liability in general (most notably in the report of the European Expert Group on Liability and New Technologies37), the implications for corporate liability are similar, at least in essence. Whenever harm is caused by decisions that have been delegated to artificial intelligence, the question arises as to who is liable for these delegated decisions.38 The technology itself cannot be considered liable because (and insofar as) artificial intelligence devices do not possess legal capacity: there is no ‘robot liability’.39 In spite of certain legislative proposals, which have been discussed in particular by the Legal Affairs Committee of the European Parliament,40 current law does not confer legal capacity to artificial intelligence devices.41 On the other hand, however, it is difficult to attribute erroneous decisions that have been taken by artificial intelligence to the corporate body that delegated the decision in question. Even if one advocates analogous application of statutory provisions to vicarious agents (in Germany, according to § 278 of the BGB) for use of machines and electronic data processing systems, it does not help to attribute liability to the directors of the company. Because delegates do not act as agents of the directors, but act exclusively within the company’s scope of duties, provisions only allow for attribution to the company, so that shareholders cannot expect any compensation.42 In the case of the latter, it is only a question of liability for the company’s own fault. The required breach of duty can be based on the premise that the fault relates to the act of delegation, for example, because the tasks delegated are what the law qualifies as 37 Expert Group on Liability and New Technologies – New Technologies Formation, Liability for Artificial Intelligence and Other Emerging Digital Technologies (2019), https://​ op​.europa​.eu/​de/​publication​-detail/​-/​publication/​1c5e30be​-1197​-11ea​-8c1f​-01aa75ed71a1; see also Jean-Sebastian Borghetti, Civil Liability for Artificial Intelligence: What Should Its Basis Be?, La Revue des Juristes de Sciences Po 94 (2019); Civil Liability for Artificial Intelligence and Software (Mark A. Geistfeld et al. eds., 2022); David C. Vladeck, Machines without Principals: Liability Rules and Artificial Intelligence, 89 Wash. L. Rev. 117 (2014); Herbert Zech, Liability for Autonomous Systems: Tackling Specific Risks of Modern IT, in Liability for Artificial Intelligence and the Internet of Things 185 (Sebastian Lohsse et al. eds., 2019). 38 See, e.g., Möslein, Artificial Intelligence and Corporate Law, supra note 4. 39 Gerhard Wagner, Robot Liability, in Liability for Artificial Intelligence and the Internet of Things 27 (Sebastian Lohsse et al. eds., 2019). 40 Cf. European Parliament resolution of 16 February 2017 with recommendations to the Commission on Civil Law Rules on Robotics (2015/2103(INL)), Jul. 18, 2018, 2018 O.J. (C 252) 1. 41 However, in some legal systems, particularly in US law, it is possible to embed artificial intelligence in the corporate shell of a legal entity and thus confer legal capacity on it by way of legal structuring; cf. Shawn Bayern, Autonomous Organizations 46 (2021). 42 With regard to German law, see Florian Möslein, Aktienrechtliche Leitungsverantwortung beim Einsatz künstlicher Intelligenz, in Artificial Intelligence und Machine Learning 509, 515 et seq. (Tom Braegelmann & Markus Kaulartz eds., 2020).

416  Research handbook on corporate liability inalienable management tasks – but this is only rarely the case.43 Personal liability both under tort law and under corporate law can also result from directors’ own organizational faults if the selection, instruction or supervision of the delegates – in this case, the artificial intelligence – was negligent.44 Therefore, the core question, at least under German law, concerns the selection, instruction and monitoring duties of directors when they delegate decisions to AI. So, what exactly are these duties to monitor and to ensure proper performance of delegated tasks, and how intensively are directors bound by these duties? The next sections will explore the issues.

III.

INTRODUCING CORPORATE DIGITAL RESPONSIBILITY

A.

Tackling the Responsibility Gap

From the perspective of corporate liability, all three characteristics of digital transformation point in a similar direction: disintermediation, automation and autonomy make the attribution of liability much more difficult as they make it more complicated for victims to engage in discovery and proof of causation. When decisions are taken in a more decentralized manner or are delegated to artificial intelligence, the causal chains tend to become more complex and less transparent. Individual wrongdoing is therefore increasingly difficult to prove, and liability for fault or negligence can no longer be attributed to any specific natural person. In their recent book on liability regimes for artificial intelligence, Anna Beckers and Gunther Teubner aptly call this phenomenon the ‘responsibility gap’.45 In complex entrepreneurial organizations, which are already based on the division of labour, the problem of these responsibility gaps becomes all the more acute. However, corporate law has already developed strategies to tackle this problem. In most jurisdictions, the law increasingly tends to place a duty on the board of directors to implement information and reporting systems in order to monitor the company’s compliance with applicable laws and regulations.46 Failure to make a good faith effort to put in place a board-level system of monitoring and reporting constitutes a breach of directors’ duties. For instance, the jurisprudence of Delaware courts on directors’ and officers’ oversight liability is becoming increasingly strict. According to the landmark Caremark case, directors may be held liable if they knew or should have known that legal violations were occurring in the corporation, and they failed to take steps in good faith to prevent or remedy the situation.47 In 2006, the Delaware Supreme Court held, in

43 With regard to German law, see Meinrad Dreher, Nicht delegierbare Geschäftsleiterpflichten, in Festschrift für Klaus Hopt 517, at 534 et seq. (Stefan Grundmann et al. eds., 2010). 44 Holger Fleischer, Überwachungspflicht der Vorstandsmitglieder, in Handbuch des Vorstandsrechts, § 8, ¶ 28 (Holger Fleischer ed., 2006). 45 Anna Beckers & Gunther Teubner, Three Liability Regimes for Artificial Intelligence 1–22, 73–76 (2021). 46 John Armour et al., The Basic Governance Structure, in The Anatomy of Corporate Law 49, at 71 (Reinier Kraakman et al. eds., 3d ed. 2017); see also Virginia Harper Ho, Board Duties: Monitoring, Risk Management and Compliance, in Comparative Corporate Governance 242 (Afra Afsharipour & Martin Gelter eds., 2021). 47 See In re Caremark Int’l Inc. Derivative Litigation, 698 A.2d. 959 (Del. Ch. 1996), reaffirmed in In re Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106 (Del. Ch. 2009). In more detail, see Marc

Towards corporate digital responsibility  417 Stone v. Ritter, that ‘the necessary conditions predicate for director oversight liability’ include showing either ‘the directors utterly failed to implement any reporting or information system or controls’ or the directors, ‘having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention’.48 More recent decisions made by the Delaware courts stress that in order ‘to satisfy their duty of loyalty, directors must make a good faith effort to implement an oversight system and then monitor it’.49 Other corporate law jurisdictions follow a similar approach by imposing obligations on directors to oversee and monitor the business activities of their companies.50 Failure to ensure that companies have proper control systems in place can constitute a breach of the duty of care. Interestingly, these oversight responsibilities are not limited to compliance with legal provisions but ‘may, in certain circumstances, implicate matters traditionally associated with corporate social responsibility, when those matters expose the company to significant risk, including, for example, risks associated with climate change’.51 In a similar vein, the responsibility gap that results from digital transformation can possibly be tackled by corporate digital responsibility when combined with monitoring and oversight duties. Corporate digital responsibility concerns responsibility for data and data processing through digital technologies.52 While the term itself was first used in politics and consulting practice, it now also appears in legal literature.53 Conceptually, there are overlaps with corporate social responsibility (CSR) because both concepts serve trans- and interdisciplinary bridging functions. In addition, corporate social responsibility and corporate digital responsibility are not primarily legal terms but also include economic, social and ethical considerations. Nonetheless, responsibility concepts can exert considerable influence on both legislation and jurisprudence, as impressively shown by the example of corporate social responsibility.54 In order to assess such potential effects of corporate digital responsibility on (but not exclusively) corporate liability, its specific contours need to be specified. Moore & Martin Petrin, Corporate Governance: Law, Regulation and Theory 218 et seq. (2017). 48 Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006). 49 Marchand v. Barnhill, 212 A.3d 805, 821 (Del. 2019); see also In re Clovis Oncology, Inc. Derivative Litigation, C.A. No. 2017-0222-JRS (Del. Ch. 2019); Charles O’Kelley & Robert B. Thompson, Corporations and Other Business Associations 433 (9th ed. 2022). 50 On ‘the monitoring board’ and its corporate law implications, see Moore & Petrin, supra note 47, at 171. 51 Jennifer Hill, Corporations, Directors’ Duties, and the Public/Private Divide, in Fiduciary Obligations in Business 285, 297 (Arthur B. Laby & Jacob Hale Russell eds., 2021). 52 See Florian Möslein, Corporate Digital Responsibility: Eine aktienrechtliche Skizze, in Festschrift für Klaus Hopt 805 (Stefan Grundmann et al. eds., 2020); Heribert Anzinger, Corporate Digital Responsibility, in Corporate Social Responsibility Compliance 609 (Michael Nietsch ed., 2021). 53 See, e.g., Hans-W. Micklitz & Aurélie Anne Villanueva, Responsibilities of Companies in the Algorithmic Society, in Constitutional Challenges in the Algorithmic Society 263, 277 (Hans-W. Micklitz et al. eds., 2022); cf. also Ulrich Noack, Organisationspflichten und -strukturen kraft Digitalisierung, 183 Zeitschrift für das Gesamte Handelsrecht (ZHR) 105, 112 (2019), and references cited supra note 52. 54 See, inter alia, Andreas Rühmkorf, Corporate Social Responsibility, Private Law and Global Supply Chains (2015); Mia Mahmudur Rahim, Legal Regulation of Corporate Social Responsibility 95 (2013).

418  Research handbook on corporate liability B.

Origins and Spread of the Term

While the roots of the term corporate (social) responsibility go back to the 1970s,55 the term digitalization began to become more common in the 1990s, when Nicholas Negroponte almost prophetically made the initially provocative hypothesis that ‘everything that can be digital will be digital’.56 In contrast, the phrase corporate digital responsibility is of much more recent origin and has only been used for a few years. Early traces of the concept can be found in business ethics debates, where the term was first used in order to achieve an intelligent moderation between informational self-determination (digital autonomy) and real value creation by including the entire repertoire of institutional design, with its wide range of laws, regulations, incentives, nudges, voluntary commitments, trust and integrity.57 In politics, the term and the basic idea were soon taken up by various actors. In Germany, the then Federal Minister of Economics and Technology, Sigmar Gabriel, announced (in a communication from the National Information Technology Summit in 2016, on the occasion of his assumption of the patronage of the Charter of Digital Networking) that an exchange of experience and support for the implementation of corporate digital responsibility would be initiated.58 In 2018, the Corporate Digital Responsibility (CDR) initiative (under the auspices of the Federal Ministry of Justice and Consumer Protection) started to develop guidelines for responsible corporate action in the digital world. In dialogue with major companies, the initiative has explored what CDR encompasses, in which areas CDR activities are necessary, sensible and appropriate, and which concrete measures are to be taken.59 The initial results have been presented as ‘scenario techniques’, on the basis of various case studies.60 The CDR initiative has continued under Germany’s new government, even though the Federal Environment Ministry is now responsible.61 The initiative has recently published a Corporate Digital Responsibility Code, which provides for voluntary commitments, com-

In German literature, Gunther Teubner, ‘Corporate Responsibility’ als Problem der Unternehmensverfassung, 34 Zeitschrift für Unternehmens- und Gesellschaftsrecht (ZGR) (1983); on US law, see David L. Engel, An Approach to Corporate Social Responsibility, 32 Stan. L. Rev. 1 (1979). 56 Nicholas Negroponte, Being Digital (1995). From the more recent discussion of company law, cf., e.g., at the European level: Informal Company Law Expert Group, Report on Digitalization in Company Law (2016), http://​ec​.europa​.eu/​justice/​civil/​files/​company​-law/​icleg​-report​-on​-digitalisation​ -24​-march​-2016​_en​.pdf; and Vanessa Knapp, What are the Issues relating to Digitalization in Company Law? In-Depth Analysis for the JURI Committee, PE 556.961, http://​www​.europarl​.europa​.eu/​RegData/​ etudes/​IDAN/​2016/​556961/​IPOL​_IDA(2016)556961​_EN​.pdf. 57 Frank Esselmann & Alexander Brink, Corporate Digital Responsibility: Den digitalen Wandel von Unternehmen und Gesellschaft erfolgreich gestalten, 12 Spektrum 38, 39 (2016). 58 The press statement is available at Charta digitale Vernetzung, https://​charta​-digitale​ -vernetzung​.de/​pressemitteilung (last visited Aug. 2, 2022). 59 For details of this initiative, see the Federal Ministry of Justice website; cf. CDR-Initiative – Eine gemeinsame Plattform (2019), https://​www​.bmj​.de/​DE/​Themen/​FokusThemen/​CDR​_Initiative/​ _downloads/​cdr​_plattform​.html (in German). 60 More information on this technique is available on the Ministry’s website; cf. Szenarientechnik der CDR-Initiative (2019), https://​www​.bmj​.de/​DE/​Themen/​FokusThemen/​CDR​_Initiative/​ _downloads/​cdr​_szenarientechnik​.html (in German). 61 Cf. the initiative’s website Corporate Digital Responsibility (CDR), https://​cdr​-initiative​.de 55

Towards corporate digital responsibility  419 bined with reporting obligations.62 From a regulatory perspective, the Code is much akin to the well-known Corporate Governance Codes’ self-regulatory technique of ‘comply or explain’.63 In substance, the CDR Code stipulates nine general principles, such as transparency, fairness and human-centredness. Even though these basic principles are exemplified for various fields of action (for example, data handling and climate and resource protection), they nevertheless remain necessarily vague and abstract. On this basis, various large, tech-savvy corporate actors now explicitly commit to digital corporate responsibility and publish their respective policies in some detail on their corporate websites.64 The topic has also gained considerable importance beyond German politics. In France, for instance, the ‘Plateforme RSE’, a national, multi-stakeholder consultation body for global action on corporate social responsibility (reporting to the Prime Minister), has proposed a definition of corporate digital responsibility and addressed more than 30 recommendations to various stakeholders in a statement issued on 6 July 2020.65 A second opinion, adopted on 14 April 2021, places the focus on the environmental and social impact of digital technology.66 The UK government, on the other hand, has focused on specific elements rather than on corporate digital responsibility in general. The Department for Digital, Culture, Media & Sport, for instance, has established a Centre for Data Ethics and Innovation, a government expert body that aims to facilitate trustworthy use of data and AI.67 Moreover, the UK Information Commissioner’s Office has developed an Information Rights Strategic Plan, mainly in order to increase public trust and confidence in how data are used and made available.68 Elsewhere, various private and corporate actors are also addressing this topic. In Switzerland, for instance, a large pension fund has made a strong commitment to CDR. ‘For Ethos, corporate digital responsibility is now an integral part of good corporate governance and the ESG criteria which an investor must take into account when making investment decisions’.69 In

Code of the Corporate Digital Responsibility Initiative (available in German at Corporate Digital Responsibility (CDR), https://​cdr​-initiative​.de/​kodex). 63 For details of regulatory nuances, cf. Florian Möslein, Genuine Self-Regulation in Germany: Drawing the Line, in Self-Regulation in Private Law in Japan and Germany 83 (Harald Baum et al. eds., 2018). 64 See, e.g., artificial intelligence, the Respective Guidelines of Deutsche Telekom, https://​ www​.telekom​.com/​de/​konzern/​digitale​-verantwortung/​details/​ki​-leitlinien​-der​-telekom​-523904. For more examples, see Heribert Anzinger, Corporate Digital Responsibility, in Corporate Social Responsibility Compliance 609–40, 623–26 (Michael Nietsch ed., 2021). 65 Plateforme RSE, Responsabilité numérique des entreprises, 1. L’enjeu des données (July 2020), https://​www​.strategie​.gouv​.fr/​publications/​responsabilite​-numerique​-entreprises​-plateforme​-rse​ -publie​-un​-premier​-avis​-lenjeu. 66 Plateforme RSE, Responsabilité numérique des entreprises, 2. Enjeus Environnementaux et Sociaux (April 2021), https://​www​.strategie​.gouv​.fr/​publications/​responsabilite​-numerique​-entreprises​ -plateforme​-rse​-publie​-un​-deuxieme​-avis​-enjeux 67 More information available at GOV.UK, Centre for Data Ethics and Innovation, https://​ www​.gov​.uk/​government/​organisations/​centre​-for​-data​-ethics​-and​-innovation. 68 Information Commissioner’s Office, Information Rights Strategic Plan 2017–2021, p. 7, https://​ico​.org​.uk/​about​-the​-ico/​our​-information/​our​-strategies​-and​-plans/​ (Strategic Goal #1). 69 Ethos Foundation, Conferences and Panel Discussion (November 2020), https://​www​ .ethosfund​.ch/​en/​event​-corporate​-digital​-responsibility; see also Ethos Foundation, Ethos Engagement Paper: Corporate Digital responsibility (November 2020), https://​www​.ethosfund​.ch/​ sites/​default/​files/​2020​-11/​EngagementPaper​_Res​ponsabilit​eNumerique​_EN​_FINAL​.pdf 62

420  Research handbook on corporate liability addition, the Swiss Digital Initiative has initiated a Digital Trust Label in order ‘to address issues in the growing field of Corporate Digital Responsibility’.70 Last but not least, corporations all around the globe are committing themselves to CDR.71 Such commitments are likely to be motivated by an intention to improve corporate reputations vis-à-vis stakeholders. However, as with CSR, it is difficult to assess whether corporate digital responsibility thus pays off economically and whether there really is a ‘business case’ for CDR.72 In the academic realm, a wealth of English-language publications have appeared recently with the term corporate digital responsibility in their titles.73 While most of these publications are related to business or sustainability research, systems engineering or social sciences, not a single one so far addresses the legal implications.74 The common starting point is the observation that digital technologies and data have become increasingly prevalent and that, consequently, ethical concerns arise.75 The term corporate digital responsibility encompasses the emerging responsibilities of companies associated with digitalization-related impacts, risks, challenges and opportunities,76 and it is broadly defined ‘as the set of shared values and norms guiding an organization’s operations with respect to […] processes related to digital technologies and data’.77 More specifically, the mutual relationship between corporate social responsibility and corporate digital responsibility is discussed, namely whether there is a need for CDR in addition to CSR or whether established concepts of CSR already include CDR.78

70 Cf. Nicolas Zahn, CDR Lab: Standards, Regulations, and Indicators (March 2022), https://​ www​.swiss​-digital​-initiative​.org/​news/​cdr​-lab​-standards​-regulations​-and​-indicators 71 See, e.g., an announcement by the Korean corporation Samsung Electronics Co., Ltd., with a strong focus on digital inclusion, Samsung Newsroom (January 2021), https://​news​.samsung​.com/​ global/​samsungs​-noteworthy​-quest​-to​-advance​-digital​-responsibility 72 With respect to CSR, see Philipp Schreck, The Business Case for Corporate Social Responsibility: Understanding and Measuring Economic Impacts of Corporate Social Performance (2009); for a critique, see Michael L. Barnett, The Business Case for Corporate Social Responsibility, 58 Bus. & Soc’y 167 (2019); cf. also Holger Fleischer, Corporate Social Responsibility, Die Aktiengesellschaft (AG) 509, 518 et seq. (2017) (assessing as a key question of the CSR debate). 73 Saskia Dörr, Corporate Digital Responsibility: Managing Corporate Responsibility and Sustainability in the Digital Age (2021); Laura Maria Edinger-Schons et al., Corporate Digital Responsibility – New Corporate Responsibilities in the Digital Age, 29 NachhaltigkeitsManagementForum 13 (2021); Karen Elliot, Rob Price et al., Towards an Equitable Digital Society: Artificial Intelligence (AI) and Corporate Digital Responsibility (CDR), 58 Soc’y 179 (2021); Lara Lobschat et al., Corporate Digital Responsibility, 122 J. Bus. Rsch 875 (2021); Joanna van der Merwe & Ziad Al Achkar, Data Responsibility, Corporate Social Responsibility, and Corporate Digital Responsibility, 4 Data & Pol’y E1 (2022); Cristina Mihale-Wilson et al., Corporate Digital Responsibility: Relevance and Opportunities for Business and Information Systems Engineering, 64 Bus. & Inf. Sys. Eng’g 127 (2022). 74 With regard to a very specific context, see Giulia Schneider, Framing Accountability in Business-to-Government Data Sharing: The Gap-Filling Role of Businesses’ Corporate Digital Responsibility, 33 Eur. Bus. L. Rev. 957 (2022). 75 Cf. Lobschat et al., supra note 73, at 876 et seq. 76 Edinger-Schons et al., supra note 73, at 14. 77 Lobschat et al., supra note 73, at 876. 78 Cristina Mihale-Wilson et al., Corporate Digital Responsibility: Relevance and Opportunities for Business and Information Systems Engineering, 64 Bus. & Inf. Sys. Eng’g 127 (2022); cf. also Saskia Dörr, Corporate Digital Responsibility: Managing Corporate Responsibility and Sustainability in the Digital Age 53 (2021).

Towards corporate digital responsibility  421

IV.

DIMENSIONS OF CORPORATE DIGITAL RESPONSIBILITY

As numerous and diverse as these initiatives and publications are, the term corporate digital responsibility itself still appears vague. Its use in different circles of business ethics, politics and corporate practice implies that corporate digital responsibility can be interpreted differently, as with other generic phrases like corporate social responsibility, corporate governance and corporate compliance.79 There is also a lack of obvious reference points for lawyers seeking to define the term as there are currently no legal definitions or even mentions of corporate digital responsibility at either national or European level (although existing political initiatives and academic publications may be of some help in providing clues as to a more precise approximation of the concept of corporate digital responsibility). A.

Reference to Extra-Legal Norms

In the first place, CDR refers to voluntary corporate activities that go beyond what is required by current legal provisions in order to actively shape the digital world for the benefit of society.80 As with CSR, corporate responsibility is therefore not limited to the fulfilment of legal obligations; it also has an ethical dimension and includes discretionary efforts to make positive contributions to the social community, in particular as regards corporate reputation but potentially also for purely philanthropic reasons.81 Accordingly, multi-faceted extra-legal norms and, in fact, the entire institutional repertoire of regulatory design need to be taken into account.82 With reference to current legal provisions, evolutionary legal change and a potential juridification of these extra-legal, ethical or social norms of conduct remain possible, and may even be necessary at some point in the future.83 Conversely, critics of these (and similar) responsibility initiatives predict that seemingly voluntary guidelines will ultimately be transformed into hard law.84

79 Cf. Holger Fleischer, Corporate Social Responsibility, Die Aktiengesellschaft (AG) 509, 509 (2017). 80 In a similar direction, Code of the Corporate Digital Responsibility Initiative, supra note 62, at 2. 81 On the four different levels of economic, legal, ethical and discretionary consideration, cf. Edinger-Schons et al., supra note 73, at 17 et seq.; specifically on corporate reputation as an enforcement and disciplinary mechanism, Lars Klöhn & Klaus Ulrich Schmolke, Unternehmensreputation (Corporate Reputation): Ökonomische Erkenntnisse und ihre Bedeutung im Gesellschafts- und Kapitalmarktrecht, Neue Zeitschrift für Gesellschaftsrecht (NZG) 689 (2015). 82 In general, on different regulatory design choices for digital markets, see Damien Geradin & Dimitrios Katsifis, Selecting the Right Regulatory Design for Pro-competitive Digital Regulation: An Analysis of the EU, UK, and US Approaches (24 November 2021), https://​ssrn​ .com/​abstract​=​4025419. 83 Möslein, supra note 52, at 809. 84 E.g., Ulrich Noack, Organisationspflichten und -strukturen kraft Digitalisierung, 183 Zeitschrift für das gesamte Handelsrecht (ZHR) 105, 113 (2019); similarly, on the hardening of CSR rules, see Tamás Szabados, Multilevel Hardening in Progress – Transition from Soft Towards Hard Regulation of CSR in the EU, 28 Maastricht Journal of European and Comparative Law 83 (2021).

422  Research handbook on corporate liability B.

Value Orientation

Secondly, initiatives and publications indicate the substantive ethical considerations that corporate digital responsibility implies by listing values such as justice, participation, trust, autonomy, transparency and sustainability.85 As abstract and vague as these substantive goals may be, they nevertheless express normative evaluations at a collective but not democratically legitimized level, which may well conflict with individual value considerations.86 Of course, it would not make much sense to try to define responsibility without reference to substantive yardsticks. As with the debate about corporate purpose, however, the enumeration of diverse, extremely indeterminate values is likely to conceal societal contradictions and corporate conflicts of interest.87 In this respect, such enumerations may possibly hide more than they actually express. Along with increasing juridification, such enumerations may also give rise to additional fears that corporate law is being used to address a variety of economic and social problems,88 in particular with regard to digital self-sovereignty and the privacy of customers, employees and other stakeholders. C.

Expression of Corporate Responsibility

Thirdly, corporate digital responsibility is primarily a corporate law topic and, accordingly, is understood as a sub-area of comprehensive corporate responsibility.89 Building on the long tradition of economic concepts of the common good,90 the term refers to the fundamental corporate law debate about which purposes or goals public limited companies serve, and about who is competent to define these goals – shareholders, directors, legislators, or even other, hybrid or private regulators.91 The controversial issue, for example, as to whether corporate directors serve shareholder interests alone or whether they must also consider (or actively promote) the

85 In this vein, Plateforme RSE, Responsabilité numérique des entreprises, 1. L’enjeu des données, supra note 65, at 23 (‘sept grands principes’); cf. also Code of the Corporate Digital Responsibility Initiative, supra note 62, p. 3 (enumerating nine guiding principles). 86 In general, on these deliberation processes, see Rob Barlow, Deliberation Without Democracy in Multi-stakeholder Initiatives, J. Bus. Ethics (2021), https://​doi​.org/​10​.1007/​s10551​-021​-04987​-x 87 Holger Fleischer, Corporate Social Responsibility, Die Aktiengesellschaft (AG) 509, 511 (2017). 88 On corporate governance reform in general as a policy response to such problems, cf. Mariana Pargendler, The Corporate Governance Obsession, 42 J. Corp. L. 359 (2016). 89 Code of the Corporate Digital Responsibility Initiative, supra note 62, at 2 (‘Teil einer umfassenden Unternehmensverwantwortung’). 90 See, e.g., Jean Tirole, Economics for the Common Good (2017); with specific regard to financial markets, see Robert J. Shiller, Finance and the Good Society (2012). 91 For an overview, cf. Carole Bonanni, Francois Lépineux & Julia Roloff, Introduction, in Social Responsibility, Entrepreneurship and the Common Good 3 (2012). The idea is particularly deeply rooted in the German corporate law debate; cf. Thilo Kuntz, German Corporate Law in the 20th Century, in Research Handbook on the History of Corporate and Company Law 205, 219 (Harwell Wells ed., 2018); see also, in comparison with French law, Holger Fleischer, Unternehmensinteresse und intérêt social: Schlüsselfiguren aktienrechtlichen Denkens in Deutschland und Frankreich, Zeitschrift für Unternehmens und Gesellschaftsrecht (ZGR) 703 (2018).

Towards corporate digital responsibility  423 interests of other stakeholders92 becomes even more problematic in the context of corporate digital responsibility, especially with regard to the protection of customer data. In German law, for example, the fundamental right to informational self-determination may serve as a point of reference, but it also raises the perpetual question of whether constitutional norms have direct effect or merely constitute a mandate to regulate, directed at the legislator.93 Irrespective of the constitutional embedding, it is remarkable, from a comparative law perspective, that questions of digital transformation (often with a view to corporate purpose, corporate interest and corporate responsibility) play a key role in the fundamental debates on reforming corporate law that are currently being conducted (for instance, in the UK).94 D.

Shaping Digitalization

Beyond all these parallels to conventional concepts of corporate responsibility (and of corporate social responsibility in particular), the truly distinctive feature of corporate digital responsibility is its inherent reference to digitalization, clearly expressed in the second adjective. Due to CSR’s broader orientation towards society, there is still some potential overlap.95 But whereas CSR ‘affords technology only subordinate importance’, CDR, on the other hand, ‘revolves around technology and its implications for corporations and society’.96 Aspects like the exponential growth in technological development, the complexity and malleability of digital technologies, and also their regulatory challenges, justify and even require a distinction between these concepts and separate considerations about digital responsibilities.97 Accordingly, various political initiatives refer to the responsible design of digitalization or digital transformation by corporate managers98 without, however, clearly defining these vague terms. While the European directive on the use of digital tools and processes in company law

92 The idea that the sole duty of directors is to maximize shareholders’ financial value has been increasingly challenged in recent decades; cf. Lynn Stout, The Shareholder Value Myth (2012). For a more recent outline of theoretical foundations and practical application, see Holger Fleischer, Corporate Purpose: A Management Concept and Its Implications for Company Law, 18 Eur. Co. & Fin. L. Rev. 161 (2021). 93 For a similar discussion, with regard to CSR and the social obligation of property laid down in Article 14(2) of the German Constitution, see Holger Fleischer, Corporate Social Responsibility, Die Aktiengesellschaft (AG) 509, 511 (2017); Peter O. Mülbert, Soziale Verantwortung von Unternehmen im Gesellschaftsrecht, Die Aktiengesellschaft (AG) 766, 774, 769 ff. (2009). 94 Cf. the explicit reference to ‘privacy in digital markets’ in The British Academy, Principles for Purposeful Business – How to Deliver the Framework for the Future of the Corporation: An Agenda for Business in the 2020s and Beyond, 12 (2019), https://​www​.thebritishacademy​.ac​.uk/​ sites/​default/​files/​future​-of​-the​-corporation​-principles​-purposeful​-business​.pdf. For similar observations with regard to the reform debates in France and the United States, cf. Möslein, supra note 52, at 811 n.31. 95 Lobschat et al., supra note 73. 96 Cristina Mihale-Wilson et al., Corporate Digital Responsibility: Relevance and Opportunities for Business and Information Systems Engineering, 64 Bus. & Inf. Sys. Eng’g 127, 128 et seq. (2022). 97 Cf. Lobschat et al., supra note 73; similarly, see Cristina Mihale-Wilson et al., Corporate Digital Responsibility: Relevance and Opportunities for Business and Information Systems Engineering, 64 Bus. & Inf. Sys. Eng’g 127, 128 (2022). 98 In this vein, Plateforme RSE, Responsabilité numérique des entreprises, 1. L’enjeu des données, supra note 65, at 83 et seq. (need for an ‘architecture capable de gérer, en bonne gouvernance, la diversité des données et les solutions technologiques adéquates’); cf. also Code of the Corporate Digital Responsibility Initiative supra note 62, at 4 (‘verantwortliche Technikgestaltung’).

424  Research handbook on corporate liability still (and almost anachronistically) limits digitalization to electronic communication,99 one can safely assume a much broader understanding of the term ‘digital(ization)’. Broad recognition has at least evolved among corporate lawyers of the notion that innovative technological developments such as artificial intelligence, blockchain and distributed ledger technologies and the platform economy not only embody key characteristics of digital transformation in general, but also pose new and specific challenges for corporate law.100 Moreover, a technology-specific approach to corporate digital responsibility does not seem appropriate, in spite of the corresponding political strategies in the UK.101 Enabling technologies such as digital platforms, distributed ledger technologies and data-driven artificial intelligence do not work in isolation but often develop their disruptive potential mainly through mutual interaction. From a corporate perspective, the separation of data responsibility and (other) digital responsibilities does not promise any significant advantages either, even if the responsible use of data requires additional and often mandatory legal instruments that reach beyond the corporate context and also encompass contractual market transactions.102 It is accordingly emphasized that CDR concerns the responsible handling of data, as well as responsible use of digital technologies, including in particular data protection, ownership and security but also digital cohesion, empowerment and even robot ethics.103 Some even argue that CDR includes corporate initiatives to mitigate losses of jobs in the course of the automation and digitalization of production processes and supply chains.104 However, the point is that CDR has yet to be acknowledged as a discrete area of study (which is not the case with conventional areas of corporate responsibility).105 Even if the concept of corporate digital responsibility needs to be sharpened at its edges, its core is already taking shape – not least through its data-relatedness – and is therefore rapidly gaining importance in an increasingly data-based, digital society.

Directive (EU) 2019/1151 of the European Parliament and of the Council of 20 June 2019 amending Directive (EU) 2017/1132 as regards the use of digital tools and procedures in company law O.J. EU 2019 L 186/80; see also the Informal Company Law Expert Group (ICLEG), Report on Digitalisation in Company Law 6 (March 2016) http://​ec​.europa​.eu/​justice/​civil/​files/​company​-law/​ icleg​-report​-on​-digitalisation​-24​-march​-2016​_en​.pdf: ‘By digitalisation, we mean the representation of communication in writing or sound by electronic means, and the concept thus concerns electronic communication’. For a critique of this much too narrow understanding, see Florian Möslein, Back to the Digital Future? On the EU Company Law Package’s Approach to Digitalization, 16 Eur. Co. L. 4 (2019). 100 See, e.g., Martin Petrin, Corporate Management in the Age of AI, 3 Colum. Bus. L. Rev. 965 (2019); Christoph van der Elst & Anne Lafarre, Blockchain and Smart Contracting for the Shareholder Community, 20 Eur. Bus. Org. L. Rev. (EBOR) 111 (2019); Gerald Spindler, Digitalization and Corporate Law – A View from Germany, 16 Eur. Co. & Fin. L. Rev. (ECFR) 106 (2019); for references in German literature, see Möslein, supra note 52, at 812 n.33. 101 Cf. references supra at notes 66 and 67. 102 In a similar vein, see Joanna van der Merwe & Ziad Al Achkar, Data Responsibility, Corporate Social Responsibility, and Corporate Digital Responsibility, 4 Data & Pol’y E1 (2022). 103 Cf. Laura Maria Edinger-Schons et al., Corporate Digital Responsibility – New Corporate Responsibilities in the Digital Age, 29 NachhaltigkeitsManagementForum 13, 18 (2021). 104 Frederick Richter, CDR – More Than Just a Hype? Privacy in Germany (PinG) 237, 238 (2018). 105 Christian Thorun, Sara Elisa Kettner & Johannes Merck, Ethik in der Digitalisierung – Der Bedarf für einen Corporate Digital Responsibility 2 (2018), http://​library​.fes​.de/​pdf​-files/​ wiso/​14691​.pdf 99

Towards corporate digital responsibility  425

V.

NORMATIVE FRAMEWORK

A.

Corporate Law

Current corporate law does not explicitly stipulate the taking of corporate digital responsibility. Nevertheless, it is by no means indifferent to the use of digital technologies as it contains a variety of duties from which corresponding responsibilities can be derived.106 1. Duty to obtain information As a restriction to the business judgement rule, the duty of care includes the duty to act on an informed basis.107 Most, if not all, corporate law jurisdictions provide for such an obligation, which has, in turn, important implications for the corporate use of digital technologies. An example is section 93 (1) of the German Stock Corporation Act (AktG), which establishes an obligation to obtain information, stating that members of the board must make business decisions ‘on the basis of appropriate information’. This requirement is clearly incompatible with a complete rejection of the corporate use of digital technologies. Such technologies can process large amounts of data much better than humans, and they are therefore, at least under certain conditions, able to provide better information than exclusively human expertise.108 The board does not have to exhaust all available sources of information, though, but may weigh the costs and benefits of obtaining information against each other. As a US court has noted, ‘[t]he amount of information that is prudent to have before a decision is made is itself a business judgment of the very type that courts are institutionally poorly equipped to make’.109 Contrary to the business judgement itself, this weighing is, however, subject to judicial control. Most corporate law jurisdictions stipulate certain minimum requirements to gather information, even though the precise standards of care differ.110 The more accurate and affordable digital technologies become, and the more widespread their use in business practice, the more difficult it will be for directors to justify not taking advantage of them. The evolution of a corporate law duty to make appropriate use of digital technologies is therefore foreseeable in a time of ‘big data’,111 even if its intensity, scope and reach still require intensive

In more detail on the considerations that follow, with respect to German law, see Florian Möslein, KI im Gesellschaftsrecht, in Künstliche Intelligenz und Robotik 457, 465 et seq. (Martin Ebers et al. eds., 2020); Florian Möslein, Aktienrechtliche Leitungsverantwortung beim Einsatz künstlicher Intelligenz, in Artificial Intelligence und Machine Learning 509, 513 et seq. (Tom Braegelmann & Markus Kaulartz, eds., 2020). 107 See, e.g., Cede & Co v. Technicolor, Inc., 634 A.2d 345, 367 (Del. 1993): ‘The duty of directors to act on an informed basis, as that term has been defined by this Court numerous times, forms the duty of care element of the business judgment rule.’ 108 Similarly, with regard to the use of AI technologies, see Möslein, Robots in the Boardroom, supra note 4, at 661. 109 In re RJR Nabisco, Inc. Shareholders Litigation, 1989 WL 7036, ¶ 19 (Chancellor Allen). 110 In detail and with further references, see Möslein, Robots in the Boardroom, supra note 4, at 661 et seq. 111 Similarly, Andrew McAfee & Erik Brynjolfsson, Big Data: The Management Revolution, 90 Harvard Bus. Rev. 3 (2012); cf. also Roland Müller, Digitalization Decisions at the Board Level, in Governance of Digitalization 43 (Michael Hilb ed., 2017) (‘additional tasks of information governance’). 106

426  Research handbook on corporate liability debate.112 Such a duty can be justified all the more if sector-specific rules explicitly formulate corresponding requirements, for example, for financial institutions.113 2. Duty to monitor The duty to monitor requires directors to engage in basic risk management.114 They have to implement a system to monitor compliance with applicable laws, standards and internal protocols, but they also need to take appropriate measures in order to identify developments that could jeopardize the continued existence of the company. In Marchand v. Barnhill, for example, the Delaware Supreme Court held that the board of an ice cream manufacturer ‘failed to implement any system to monitor [the company’s] food safety performance or compliance’.115 The duty to monitor therefore embodies, at the very least, an obligation to adequately counter risks that are inherent in technology.116 In particular, directors need to familiarize themselves with the functioning and risks of the information technology used and, if necessary, test its validity in a risk-protected area.117 Whenever they delegate decisions to digital technologies, directors must therefore have at least a certain degree of knowledge about relevant digital technology in order to understand the inherent logic of technological processes and thus be able to retain their ultimate decision-making authority.118 In this respect, company directors must define policies and procedures for selecting and monitoring digital technologies in order to maintain their ongoing oversight. As with the use of autonomous vehicles, such oversight is the only way to maintain the possibility of corrective intervention. 3. Duty of obedience The duty of obedience compels ‘corporate fiduciaries to abide by legal norms – both those of the corporation and of external law’.119 Even though both its doctrinal classification and its substantial reach are controversial,120 this duty requires board members to organize and monitor the company in such a way that no violations of norms occur. It therefore has the potential to reflect digitalization-related obligations that are stipulated in legal norms outside corporate law, and to translate these obligations into directors’ duties by attributing the

For references on the controversial debate in Germany, see Möslein, supra note 52, at 813 n.43. See, e.g., section 25a of the German Banking Act (KWG); see also Florian Möslein, KI im Gesellschaftsrecht, in Künstliche Intelligenz und Robotik 457, 476 (Martin Ebers et al. eds., 2020). 114 With regard to US law, see references supra at notes 47 and 48; with regard to German law, see section 91(2) of the Stock Corporation Act (AktG). Cf. in more detail: Möslein, Artificial Intelligence and Corporate Law, supra note 4, at 81. 115 Marchand v. Barnhill, 212 A.3d 805, 809 (Del. 2019); in more detail, see Elizabeth Pollman, Corporate Oversight and Disobedience, 72 Vand. L. Rev. 2013, 2024 et seq. (2019). 116 Möslein, Artificial Intelligence and Corporate Law, supra note 4, at 81. 117 In this sense, see Dirk Zetzsche, Corporate Technologies – Zur Digitalisierung im Aktienrecht, Die Aktiengesellschaft (AG) 1, 7 et seq. (2019). 118 In general, on governance challenges in times of digital change, cf. Governance of Digitalization (Michael Hilb, ed., 2017); Tony Featherstone, Governance in the New Machine Age, Austl. Inst. Co. Dirs., 24 March 2017, https://​aicd​.companydirectors​.com​.au/​advocacy/​governance​-leadership​-centre/​ governance​-driving​-performance/​governance​-in​-the​-new​-machine​-age 119 Alan Palmiter, Duty of Obedience: The Forgotten Duty, 55 N.Y.L. Sch. L. Rev. 457, 458 (2010–2011). 120 For a good survey on the relevant US case law and literature, cf. Pollman, supra note 115, at 718–28. 112 113

Towards corporate digital responsibility  427 ultimate responsibility for their compliance to the board of directors. Such obligations are becoming more and more numerous with the ongoing digital transformation, for example the recently adopted European rules on contracts for digital content and digital services,121 and the provisions of the future European AI Act.122 A prime example in existing law is Article 24 of the EU’s General Data Protection Regulation (GDPR), which requires data controllers to ‘implement appropriate technical and organisational measures’, thereby ‘taking into account the nature, scope, context and purposes of processing as well as the risks of varying likelihood and severity for the rights and freedoms of natural persons’ in order ‘to ensure and to be able to demonstrate that processing is performed in accordance with this Regulation’.123 As a corollary of the duty of obedience, Article 24 of the GDPR can be extended to a wide range of more specific procedural and substantive obligations with regard to data protection and data security within the corporation.124 If corporate law compels directors to organize and monitor the company in such a way that no violations of the law can occur, directors must provide for compliance with this specific provision. With the increase in corresponding data-related legislative requirements, a more general ‘digital oversight liability’ is likely to emerge.125 B.

International (So-Called Ethical) Guidelines

In spite of these specific legal points of reference, more precise contours of corporate digital responsibility have yet to emerge. Whereas digital technologies develop dynamically and sometimes even in a disruptive manner as a result of innovation, the development of established legal principles requires a longer period of time. In order to derive additional normative principles (for example, with regard to the use of algorithms), analogies to existing legal provisions can help, even if these provisions are specifically tailored for other contexts. For example, the rules on algorithmic trading in Article 17 of the European Union’s Markets in Financial Instruments Directive (MiFID II) that apply to investment firms engaging in such trading may serve as a model from which to derive corresponding obligations for the use of algorithms within companies.126 Other (albeit extra-legal) norms promise significantly richer and more comprehensive guidelines, however. In particular, with regard to so-called ethical questions pertaining to the 121 Directive (EU) 2019/770 of the European Parliament and of the Council of 20 May 2019 on certain aspects of contract law relating to the provision of digital content and digital services, 2019 O.J. (L 136) 1. 122 Proposal for a regulation laying down harmonized rules on artificial intelligence (Artificial Intelligence Act) and amending certain Union legislative acts 206 (COM 2021). 123 On the relevance for corporate liability and compliance organization, cf. Gerald Spindler, Haftung der Geschäftsführung für IT-Sachverhalte, Computer und Recht (CR) 715 (2017); see also Chirantan Chatterjee & Daniel Sokol, Data Security, Data Breaches, and Compliance, in Cambridge Handbook on Compliance 936 (D. Daniel Sokol & Benjamin van Rooji eds., 2021). 124 See, e.g., Cécile de Terwagne, Privacy and Data Protection in Europe, in Research Handbook on Privacy and Data Protection Law 10, 29 (Gloria González et al. eds., 2022). 125 Similarly, though with specific regard to cybersecurity, Benjamin P. Edwards, Cybersecurity Oversight Liability, 35 Ga. State U. L. Rev. 663 (2019). 126 In more detail, see Möslein, Artificial Intelligence and Corporate Law, supra note 4, at 82; Florian Möslein, Regulating Robotic Conduct: On ESMA’s New Guidelines and Beyond, in Autonomous Systems and Law 45 (Nikita Aggarwal et al. eds., 2019).

428  Research handbook on corporate liability use of artificial intelligence, an extremely dynamic norm-building process has taken place at very different regulatory levels. The most far-reaching example is the OECD Council Recommendation on Artificial Intelligence of 22 May 2019,127 which has led to standards for the responsible use of this technology being formally recognized by a large number of governments worldwide.128 At the European level, the EU Commission’s communication ‘Building trust in human-centric artificial intelligence’129 supports the core requirements of the ethical guidelines that have been elaborated by a group of experts appointed by the Commission.130 These guidelines were published, after intensive discussion,131 in a finalized version on 8 April 2019.132 On this basis, the high-level expert group has recently presented an assessment list for trustworthy artificial intelligence (ALTAI).133 These and further sets of rules stipulate a number of substantive and also procedural principles which largely overlap.134 They therefore have the potential to refine the applicable standards for corporate digital responsibility. These principles concern, for example, the controllability of technology, and require that the digital systems in question are designed in a stable manner, that they contain precautions against misuse, and that entities using such systems understand and master the respective algorithms. Accordingly, board members who delegate tasks to artificial intelligence can be expected to familiarize themselves with the functionality and risks of the information technology used and, if necessary, test its validity in risk-protected areas.135 Moreover, the principles stipulate that digital processes must be disclosed so that they can be verified and traced in retrospect.136 This accountability requirement is likely to exert an influence on corporate disclosure, for example

OECD, Council Recommendation on Artificial Intelligence, https://​legalinstruments​.oecd​ .org/​en/​instruments/​OECD​-LEGAL​-0449 128 In addition to the 36 member states, six other states have already signed; with the Osaka Final Declaration, the recommendations also received the support of all G20 member states; see G20 Ministerial Statement on Trade and Digital Economy of 9 June 2019, 3 f. and Annex. 129 Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions – Building Trust in Human Centric Artificial Intelligence COM (2019) 168 final (Apr. 8, 2019) (hereinafter Building Trust in Human Centric Artificial Intelligence). 130 See press release Commission Appoints Expert Group on AI and Launches European AI Alliance, 14 June 2018, based on the European Commission Communication, Communication from the Commission to the European Parliament, the European Council, the Council, the European Economic and Social Committee and the Committee of the Regions on Artificial Intelligence for Europe final 237 (COM 2018) (Apr. 25, 2018) (hereinafter Artificial Intelligence for Europe). 131 Over 500 comments were received during the consultation process. The first draft version of the guidelines is available at European Commission, Draft Ethics for Trustworthy AI, https://​digital​-strategy​ .ec​.europa​.eu/​en/​library/​draft​-ethics​-guidelines​-trustworthy​-ai (last visited Aug. 2, 2022). 132 Id. 133 The assessment list is available at European Commission, Assessment List for Trustworthy Artificial Intelligence (ALTAI) for self-assessment, https://​digital​-strategy​.ec​.europa​.eu/​en/​library/​ assessment​-list​-trustworthy​-artificial​-intelligence​-altai​-self​-assessment 134 More extensively on these various principles, Möslein, Artificial Intelligence and Corporate Law, supra note 4, at 83. 135 Id. at 83. 136 See, e.g., Building Trust in Human Centric Artificial Intelligence, supra note 129, at 5 et seq. (key requirement IV); in general, on the requirement for the explainability of algorithms, Joshua A. Kroll et al., Accountable Algorithms, 165 U. Pa. L. Rev. 633 (2017). 127

Towards corporate digital responsibility  429 with regard to the duty of the board to inform shareholders.137 In addition, the guidelines stipulate various requirements that serve to safeguard specific individual rights. By calling for diversity, non-discrimination and fairness, for example, they establish an obligation to avoid (unintentional) data-based biases.138 They thereby have similar objectives to the corporate law principle of equal treatment, which is, however, narrower in its scope.139 Finally, the guidelines postulate public good requirements for AI systems or providers. For example, the OECD principles state that stakeholders should ‘proactively engage in responsible stewardship of trustworthy AI in pursuit of beneficial outcomes for people and the planet ... thus invigorating inclusive growth, sustainable development and well-being’.140 As vague as this wording may sound, its potential impact is far-reaching. When AI devices are used in the corporate realm, for example, must the board of directors ensure that sustainability considerations take precedence over the goal of maximizing corporate profits? If this were the case, these rules would transform corporate law fundamentally, albeit only for corporate decisions that are taken or supported by artificial intelligence devices.141 The specific legal effects that these allegedly ‘ethical’ principles may have, such as in specifying directors’ duties and their standard of care, still remain somewhat unclear. At the very least, these principles create normative standards that enjoy governmental support and increasing practical recognition worldwide. It is therefore reasonable to assume that they will develop into a framework for corporate digital responsibility and also become relevant within company law. C.

Entrepreneurial Self-Regulation

Companies themselves are also becoming increasingly involved in matters of corporate digital responsibility, within and beyond the political initiatives that have been mentioned earlier in this chapter.142 Larger business associations and interest groups also draft relevant guidelines, such as the Global Policy Framework of the International Technology Law Association.143 Legal scholars will have to capture and attempt to structure the content of these various standards in order to maintain an overview of the dynamic process of norm creation at the most diverse levels.144 The OECD principles and the European regulatory initiatives represent an attempt to bundle this entrepreneurial self-regulation and give it a more comprehensive but also more sovereign character. Cf. Möslein et al., Artificial Intelligence and Corporate Disclosure, supra note 5. See, e.g., Building Trust in Human Centric Artificial Intelligence, supra note 129, at 5 et seq. (key requirement V). 139 More extensively on the equal treatment of shareholders, see Federico M. Mucciarelli, Equal treatment of shareholders and European Union Law, Eur. Co. & Fin. L. Rev. (ECFR) 158 (2010); see also Lucian A. Bebchuk, Toward Undistorted Choice and Equal Treatment in Corporate Takeovers, 98 Harvard L. Rev. 1693 (1985). 140 OECD Recommendation, supra note 127, at 1.1. 141 Möslein, Artificial Intelligence and Corporate Law, supra note 4, at 84. 142 See supra Section III.B. 143 The framework is available at ITECHLAW Responsible AI, https://​www​.itechlaw​.org/​ ResponsibleAI 144 For a map that illustrates the variety of different (mainly US-based) AI principles, elaborated by the Berkman Klein Center for Internet and Society at Harvard University, see Berkman Klein Center, Principled Artificial Intelligence, https://​ai​-hr​.cyber​.harvard​.edu 137 138

430  Research handbook on corporate liability As long as corporate law abstains from defining its own standards (for instance, in corporate governance codes), it is likely that these guidelines, though not actually hard law, will serve over time to complete and supplement relevant but vague legal obligations. Due to the variety of such standards, doctrinal differences between their normative foundations become increasingly blurred.145 The boundary between legal requirements (which a board must, due to the duty of legality, strictly comply with) and ethical and moral values (which, in principle, do not limit its organizational discretion) therefore will come under increased scrutiny.

VI.

IMPLICATIONS FOR CORPORATE LAW

The corporate law implications of the developments discussed in this chapter are manifold. They reach far beyond corporate liability and therefore cannot be fully developed herein. Nonetheless, the wider implications need to be sketched as they are likely to interact with one another. A.

Information and Disclosure

Corporate digital responsibility includes various information and disclosure obligations, partly within public limited companies and partly in respect of third parties. Externally, these obligations arise from relevant legal requirements, such as those in the GDPR,146 in the Directive on Contracts for the Supply of Digital Content and Digital Services,147 and also the Regulation on the Promotion of Fairness and Transparency for Commercial Users of Online Intermediary Services (P2B-VO).148 In the internal relationship, on the other hand, shareholders and also the supervisory board or independent directors can only meaningfully exercise their rights and obligations provided for in corporate law if they have sufficient information at their disposal.149 In German law, for instance, shareholders can demand relevant information at the general meeting, pursuant to section 131(1) of the German Stock Corporation Act (AktG) on the use of digital technologies.150 Similar considerations apply with respect to corporate information both in annual reporting and in capital market disclosure. Additional substantive requirements can, in future, be expected in non-financial mandatory disclosures according to the CSR directive, which requires reporting on social, environ-

In more detail, see Möslein, supra note 52. For more details on these transparency obligations, cf. Mario Martini, Regulating Algorithms: How to Demystify the Alchemy of Code?, in Algorithms and Law 100, 113–19 (Martin Ebers & Susana Navas eds., 2020). 147 On the relevant directive, see, e.g., Karin Sein & Gerald Spindler, The New Directive on Contracts for the Supply of Digital Content and Digital Services, 15 Eur. Rev. Con. L. (ERCL) 257 (2019). 148 On this regulation (which, in particular, stipulates corresponding requirements for providers of online intermediary services), see for example Madalena Narciso, The Unreliability of Online Review Mechanisms, 15 J. Consumer Pol’y 1 (2022). 149 In detail, see Möslein et al., Artificial Intelligence and Corporate Disclosure, supra note 5. 150 On technological information as the subject of this right (although primarily in the case of technology-oriented companies and their research expenditures), cf. Klaus Trouet, Die Hauptversammlung – Organ der Aktiengesellschaft oder Forum der Aktionäre? Neue Juristische Wochenschrift (NJW) 1302, 1305 (1986). 145

146

Towards corporate digital responsibility  431 mental and governance-related topics.151 Some companies already include specific chapters on corporate digital responsibility in their CSR reports.152 With regard to the use of digital technologies, there is an obvious need for such information, at least in the case of ‘digitally savvy’ companies. At their core, all these information and disclosure obligations are already laid down in applicable company law; for their more specific contours, reference can be made to the above-mentioned non-legal regulations, which require information on the use of digital technology, despite their non-binding character.153 B.

Board Composition and Structure

Corporate digital responsibility also has a structural dimension, with implications for the composition of the management and supervisory bodies of corporations. These implications do not refer to the much-discussed but somewhat futuristic question of whether artificial intelligence itself can become a member of the board – a question to which the answer is no in the case of most (though not all) corporate laws.154 In the context of corporate digital responsibility the question is instead whether and how to ensure that sufficient digital competence is available at the executive board and supervisory board levels. After all, compliance with all the previously mentioned organizational, monitoring and information duties requires considerable technical knowledge and skills (‘digital fitness’), which, according to numerous studies, board members often still lack.155 The more digitally savvy the company in question, the more important it seems to be to appoint people with the necessary digital skills. However, the current rules do not provide for any mandatory requirements in this regard; even the sector-specific expertise requirements which are widespread, for instance in banking law, do not yet imply any requirement for specific digital expertise.156 Instead, the general requirement is that board members must possess or acquire the minimum level of knowledge and skills that will put them in a position to understand and properly assess all normally occurring business transactions, without external assistance.157 From a legal policy perspective, however, a necessary question arises as to whether more specific qualification or appointment rules should be included in the law or in corporate governance codes (for instance, by mandating chief digital officers or digital committees) or 151 Directive (EU) 2014/95 amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large companies and groups, 2014 O.J. (L 330) 1. 152 Cf., e.g., The United Internet 2020 Sustainability Report, 35–56, https://​report​.united​ -internet​.de/​sustainability/​2020/​annex/​about​-this​-report​.html. 153 See, Möslein et al., Artificial Intelligence and Corporate Disclosure, supra note 5. 154 From a comparative perspective, on this question, see Shawn Bayern et al., Company Law and Autonomous Systems: A Blueprint for Lawyers, Entrepreneurs, and Regulators, 9 Hastings Sci. & Tech. L.J. 135 (2017). 155 See, with further references, Möslein, supra note 52. 156 See also Reinhard Meckl & Jessica Schmidt, Digital Corporate Governance – neue Anforderungen an den Aufsichtsrat? Betriebs-Berater (BB) 131, 133 (2019). 157 For a practical recommendation to ‘appoint a senior executive to be responsible for data privacy and security – a Chief Digital Officer or the dual roles of Chief Privacy Officer and Chief Information Security Officer’, see Alan Friel, Adam Kardash & Sarah Pearce, Data Privacy & Security, in Corporate Legal Compliance Handbook 48, § 48.04 (Theodore L. Banks & Frederick Z. Banks, eds., 2d ed. 2020, 2021–2 suppl.).

432  Research handbook on corporate liability whether it would be better to leave the composition of corporate bodies to the discretion of corporations themselves.158 As is well known in other contexts (e.g., in diversity and gender representation), such structural corporate rules are particularly controversial. As long as it cannot be clearly shown that corporations are unwilling to develop these digital competences, which are in their own interest, there is a case for legislative restraint. C.

Business Judgement and Supervision

Most importantly, corporate digital responsibility gains importance in the context of business judgement and corporate liability. On the one hand, the duty to obtain information limits the discretionary power of the board by requiring, at least under certain conditions, the use of digital technologies; on the other hand, an obligation for directors to adequately counter technology-immanent risks can be derived from their duty to monitor, which requires them to engage in basic risk management.159 At the supervisory board level, if applicable, corporate digital responsibility also plays a role as it affects the methods of supervision. The question arises, for example, whether the supervisory board can or even must make use of digital technologies in order to fulfil its monitoring and advisory duties.160 Conversely, in order to avoid counteracting the supervisory board’s monitoring task, the executive board must ensure that entrepreneurial decisions remain explainable, even if they are based on the use of digital technologies. Artificial intelligence, for example, must not become uncontrollable and thus inexplicable as a consequence of the black box phenomenon.161 At the very least, directors must be able to obtain information on core parameters as defined in Article 13(2)(f) of the GDPR in order to give this information to the supervisory board.162 In so far as so-called explainable AI is available, the executive board is obliged to use it because this increases the level of information that enables the supervisory board to perform its task.163

VII.

CONCLUSION: CORPORATE DIGITAL RESPONSIBILITY IS BRIDGING THE RESPONSIBILITY GAP

Corporate digital responsibility, with its various regulatory layers (and the manifold implications of these), is likely to affect corporate law across almost its entire breadth. Moreover, it will also have implications for tort law. If the digital transformation continues at a rapid pace

158 See also Fabian Lenz, Digitale Kompetenzlücken in der modernen Arbeitswelt als Haftungsrisiko von Arbeitnehmervertretern im Aufsichtsrat, Betriebs-Berater (BB) 2548, 2552 (2018) (arguing that the qualifications of board members must adapt to the changing requirements of digitalization). 159 See supra Section V.A.2. 160 Cf., however, Ulrich Noack, Organisationspflichten und -strukturen kraft Digitalisierung, 183 Zeitschrift für das gesamte Handelsrecht (ZHR) 105, 141 (2019). 161 Cf. Lutz Strohn, Die Rolle des Aufsichtsrats beim Einsatz von Künstlicher Intelligenz, 183 Zeitschrift für das gesamte Handelsrecht (ZHR) 371, 373 et seq. (2019). 162 Möslein, supra note 52, at 820, with further references in n.82. 163 Similarly, with a particular focus on the use of AI in corporate mergers and acquisitions, see Philipp Hacker et al., Explainable AI Under Contract and Tort Law: Legal Incentives and Technical Challenges, 28 Artificial Intel. & L. 415 (2020).

Towards corporate digital responsibility  433 (and there is plenty of evidence that it will continue), corporate digital responsibility will certainly turn out to be more than just a buzzword or hype.164 With regard to corporate liability in particular, corporate digital responsibility has the potential to bridge the responsibility gap that is created by increasing use of digital technologies. The most important transmission mechanism is the duty to implement information and reporting systems in order to monitor companies’ compliance with relevant laws and regulations. In order to satisfy this duty, directors must make efforts to implement oversight systems applicable to digital technologies. Similar to matters associated with corporate social responsibility, these oversight duties are not limited to compliance with legal provisions for the use of digital technology; they could, in certain circumstances, even be extended to compliance with ethical standards, such as with regard to the responsible use of AI. This is particularly true where utilization of technologies exposes the company to significant risk, including risks associated with cybersecurity.165 Finally, under certain circumstances, these duties do not only play a role in the responsibility of directors vis-à-vis the company and its shareholders. They can also become relevant in a tort law context when third parties are affected. All these implications of corporate digital responsibility for corporate liability and their precise scope still need to be specified. In future, digital transformation will give both corporate and tort law plenty of opportunities to do so.

Möslein, supra note 52. Similarly, with respect to corporate social responsibility Hill, supra note 51.

164 165

23. Accountability for AI labor Mihailis E. Diamantis1

I. INTRODUCTION Robots and algorithms will replace almost half of existing jobs in the coming decade.2 Truck drivers, warehouse personnel, assembly line workers, and office staff are among those whose trades face the greatest threat of obsolescence. Algorithms that review documents, trade stocks, and diagnose patients are knocking at the door of legal, investment, and medical services as well. The human toll of this mass labor displacement could be staggering, as tens of millions of workers find themselves with no paycheck and no professional calling. Labor scholars have sounded the alarm, calling for aggressive retraining programs to prepare workers for a new technological landscape.3 Even if, as some economists predict, automation creates one new job for every job lost,4 the fact remains that the workforce is becoming increasingly digital. Humans work alongside algorithms. These corporate algorithms constitute a growing digital workforce, and this workforce is creating another public threat that has received far less attention. As the human element plays a shrinking role in corporate activity, corporations will become increasingly immune from liability for harms they cause. Unshackled from the law’s disciplinary influence, corporations cannot be trustworthy stewards of our economies, lives, and livelihoods. Corporate algorithms can and do hurt people. For proof, one need look no further than current headlines. Algorithms have already discriminated against loan applicants, manipulated stock markets, colluded over prices, and caused traffic deaths. As algorithms become more sophisticated and occupy ever larger economic and social roles, the scope and severity of algorithmic misconduct will only grow. Corporate law is not presently equipped to handle the evolving sources of corporate harm. Civil doctrines of products liability may help for algorithms that are consumer products,5 but most high-profile instances of algorithmic harm – like loan discrimination, stock manipulation, This chapter is an abridged and adapted version of Mihailis E. Diamantis, Employed Algorithms: A Labor Model of Corporate Liability for AI, 72 Duke L.J. 797 (2023). I am grateful to the Duke Law Journal editors for their permission to write it and to my research assistant Kate Conlow for her help in preparing it. 2 Michael Chui, James Manyika & Mehdi Miremadi, Where Machines Could Replace Humans— and Where They Can’t (Yet), McKinsey Q. (July 8, 2016), https://​www​.mckinsey​.com/​business​ -functions/​mckinsey​-digital/​our​-insights/​where​-machines​-could​-replace​-humans​-and​-where​-they​-cant​ -yet. I use ‘robot’ and ‘algorithm’ almost interchangeably. 3 Edward L. Rubin, Beneficial Precaution: A Proposed Approach to Uncertain Technological Dangers, 22 Vand. J. Ent. & Tech. L. 359, 391 (2020); Joshua La Bella, Hey Siri, What Is California Doing to Prepare for the Growth of Artificial Intelligence?, 51 U. Pac. L. Rev. 315, 317 (2020). 4 Insight Report, The Future of Jobs Report 2018, World Economic Forum, http://​www3​ .weforum​.org/​docs/​WEF​_Future​_of​_Jobs​_2018​.pdf. 5 See generally Rebecca Crootof, The Internet of Torts: Expanding Civil Liability Standards to Address Remote Interference, 69 Duke L.J. 583 (2019). 1

434

Accountability for AI labor  435 and anticompetitive pricing – will not qualify. The general law of corporate liability originated in an age when only humans could act on behalf of corporations. Absent any applicable special doctrines, a corporation is only liable for harms that employees cause.6 Algorithms are not employees.7 Nor do algorithms have intentions or scopes of employment. So current law falls short when corporate algorithms, rather than employees, cause harm. Corporations can escape accountability for harmful algorithmic conduct – like traffic accidents and discriminatory lending – for which they would ordinarily be liable. ‘It was the algorithm, not us,’ has become a common corporate refrain when things go awry. There is no easy fix for this growing gap in corporate accountability. Forcing corporations to limit their use of algorithms would unacceptably restrain innovation and technological progress.8 It would also hobble domestic corporations in the fierce race with foreign competitors for dominance over the next stage of economic development.9 Simply using current law more creatively will not close the gap either. Plaintiffs and prosecutors may sometimes be able to find a culpable employee who, for example, negligently designed or purposely misused the algorithm at issue. However, even today, cases of algorithmic harm arise where there is no such employee.10 Smart algorithms can misbehave even if all humans involved acted innocently and responsibly.11 As algorithms become more intelligent and autonomous, the link between algorithmic harm and any identifiable human deficiency will become increasingly tenuous. Simply designing algorithms that are more obedient will not work either. The awesome potential of today’s most advanced algorithms is their unpredictability.12 Machine learning performs so well because it does not follow a fixed sequence of human commands; instead, through training on vast data sets, an intelligent algorithm learns to accomplish the task it is given.13 Machine learning finds better ways to achieve goals than human intelligence could anticipate or even understand. That is the power of AI. A necessary correlate of unpredictable solutions is unpredictable problems. If developers cannot foresee the ways algorithms might injure us, they cannot hardcode preventive measures. The devil’s pact that we make with AI

See 18B Am. Jur. 2d Corporations § 1841; Mihailis E. Diamantis, The Body Corporate, 83 L. & Contemp. Probs. 133, 151–55 (2021). 7 See Joanna J. Bryson, Mihailis E. Diamantis & Thomas D. Grant, Of, for, and by the People: The Legal Lacuna of Synthetic Persons, 25 Artif. Intel. & L. 273, 275 (2017). 8 Jacques Bughin et al., Notes from the AI Frontier: Modeling the Impact of AI on the World Economy, McKinsey Glob. Inst. (Sept. 4, 2018), https://​www​.mckinsey​.com/​featured​-insights/​artificial​ -intelligence/​notes​-from​-the​-ai​-frontier​-modeling​-the​-impact​-of​-ai​-on​-the​-world​-economy. 9 Daniel Castro, Michael McLaughlin & Eline Chivot, Who Is Winning the AI Race: China, The EU, or the United States?, Ctr for Data Innovation (Aug. 19, 2019), https://​www​.datainnovation​.org/​ 2019/​08/​who​-is​-winning​-the​-ai​-race​-china​-the​-eu​-or​-the​-united​-states. 10 Mihailis E. Diamantis, The Extended Corporate Mind: When Corporations Use AI to Break the Law, 91 N.C. L. Rev. 893, 910–11 (2020). 11 Kevin Petrasic et al., Algorithms and Bias: What Lenders Need to Know 1 (2017), https://​www​.whitecase​.com/​sites/​whitecase/​files/​files/​download/​publications/​algorithm​-risk​-thought​ -leadership​.pdf; Solon Barocas & Andrew D. Selbst, Big Data’s Disparate Impact, 104 Calif. L. Rev. 671, 711–12, 729 (2016). 12 Mark A. Lemley & Bryan Casey, Remedies for Robots, 86 U. Chi. L. Rev. 1311, 1335 (2019). 13 See A Beginner’s Guide to Neural Networks and Deep Learning, Pathmind: A.I. Wiki, https://​ skymind​.ai/​wiki/​neural​-network [https://​perma​.cc/​P59K​-RJ45]. 6

436  Research handbook on corporate liability is that, by freeing it from the constraints of low-level programming, it will both help and harm in ways we cannot foresee. The key to holding corporations accountable when their algorithms hurt people is to recognize that the challenge of corporate AI is a modern take on a very old problem the law solved long ago. From a corporate liability perspective, artificial and organic intelligence are not so different. Both are crucial to corporate productivity. Attempting to fully control either, were that possible, would entail unacceptable costs.14 Unpredictability can enhance labor’s value because a workforce that obeys orders mechanically and inflexibly will cause more harm than one that interprets and adapts commands with a dose of common sense. Consequently, both humans and advanced algorithms will end up inflicting unexpected harm some of the time. But the inevitability of harm does not mean that the law should stay its hand – doing so would deny justice to victims and withhold efficient incentives from corporations to exercise due care. Corporate law’s longstanding solution with respect to the human workforce was to recognize that corporations bear a special accountability relationship to some of their workers.15 The hallmarks of that relationship are the control the corporation has over the workers and the benefit the corporation derives from them.16 So long as the workers are acting within the scope of that relationship, a corporation is accountable for the harms they cause.17 The central concept tethering this legal scheme together is ‘employment.’ Over time, courts have doubled down on this general liability framework to overcome abusive corporate efforts to avoid paying for harms they cause.18 Decades before corporations started replacing employees with algorithms, they turned to contract workers.19 Contractors do the same jobs as employees, but, legally speaking, contractors work for themselves (or for agencies).20 Through this formalistic sleight of hand, many corporations immunize themselves from liability when their workers, now contractors rather than employees, commit crimes and torts.21 Many lawmakers have seen through the trick.22 They have responded by emphasizing the functional characteristics of employment – benefit and control – and determined that some contractors are more like employees. Accordingly, corporations could be liable when those contractors-cum-employees break the law. A structurally identical solution could address algorithmic misconduct. As with contract workers, corporations bear a special relationship to some algorithms, characterized by corporate benefit from and control over the algorithm. According to the ‘Labor Model’ advanced 14 Armen A. Alchian & Harold Demsetz, Production, Information Costs, and Economic Organization, 62 Am. Econ. Rev. 777, 780–81 (1972); Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305, 309 n.10 (1976). 15 V.S. Khanna, Is the Notion of Corporate Fault A Faulty Notion? The Case of Corporate Mens Rea, 79 B.U. L. Rev. 355, 369–70 (1999). 16 Mihailis E. Diamantis, Algorithms Acting Badly: A Solution from Corporate Law, 89 Geo. Wash. L. Rev. 801, 832–33, 842–43 (2021). 17 18B Am. Jur. 2d Corporations § 1841. 18 See infra Section III. 19 See generally Keith Cunningham-Parmeter, From Amazon to Uber: Defining Employment in the Modern Economy, 96 B.U. L. Rev. 1673 (2016). 20 Id. at 1682–87. 21 Heather Huston, Beware of Tort Exceptions to Limited Liability, Wolters Kluwer (Jan. 24, 2020), https://​www​.wolterskluwer​.com/​en/​expert​-insights/​beware​-of​-tort​-exceptions​-to​-limited​ -liability. 22 Dynamex Operations West, Inc. v. Superior Court, 416 P.3d 1, 37 (Cal. 2018).

Accountability for AI labor  437 here, the law should treat such algorithms as corporate employees for liability purposes (of course, algorithms should not count as employees for purposes of evaluating benefits like minimum wages and health insurance). Like contractors, these ‘employed algorithms’ may not be paradigmatic employees since the corporation does not pay them directly. But employed algorithms do fit squarely within the broader legal sense of ‘employment’: ‘To make use of’; ‘[t]o use as … a substitute in transacting business’; ‘[t]o ... entrust in the performance of certain acts or functions.’ 23 As the Supreme Court has acknowledged, ‘[t]he definition of “employ” is broad.’24 Abstracting from the legal particularities of labor law, ‘employment’ refers to making use of something.25 Nothing in the broad concept of employment limits the employment relationship to human beings. By recognizing that corporations employ algorithms, the Labor Model could allow the law of corporate liability to keep pace with an evolving and increasingly digital corporate workforce.

II.

REPLACING HUMAN WORKERS

The most straightforward reason for thinking that corporations employ algorithms is the modern history of how corporations use them. Corporations self-consciously replace human employees with algorithms and have many legitimate reasons for using algorithms. Well-designed algorithms often perform tasks more efficiently and accurately than their human counterparts. When corporations use such algorithms, society overall benefits. But not every corporate motivation for using algorithms is so laudatory. Corporations also use algorithms to avoid accountability when things go wrong.26 Under the current general law of corporate liability, corporations are only liable for harms that arise through employment.27 If employment relationships only extend to human beings, corporations can reduce their liability risk by using algorithms instead. This sort of immunity for algorithmic harms benefits corporations, but it reduces net social welfare and harms individuals in and out of the corporation. When corporations limit their liability but not the harmfulness of their conduct, they externalize some of the true costs of their operations. Corporations will use algorithms even when, from a net social welfare standpoint, it would be best if they refrained.28 In real-world terms, corporations will (and do) roll out algorithms prematurely, before risks of harm to others have been responsibly mini-

Employment, Black’s Law Dictionary (11th ed. 2019). Rutherford Food Corp. v. McComb, 331 U.S. 722, 728 (1947). 25 Employment, Black’s Law Dictionary (11th ed. 2019). 26 Microsoft President and Chief Legal Officer Brad Smith has remarked, ‘We don’t want to see a commercial race to the bottom. Law is needed.’ Cade Metz, Is Ethical A.I. Even Possible?, N.Y. Times (Mar. 1, 2019), https://​www​.nytimes​.com/​2019/​03/​01/​business/​ethics​-artificial​-intelligence​.html [https://​perma​.cc/​YMG8​-JPMX (dark archive)]; see also Frank Pasquale, Toward a Fourth Law of Robotics: Preserving Attribution, Responsibility, and Explainability in an Algorithmic Society, 78 Ohio St. L.J. 1243, 1244–45 (2017). 27 Products liability is a common exception to this general rule. Manufacturers are strictly liable when their defective products harm consumers. Restatement (Second) of Torts § 402A (Am. L. Inst. 1965). As I have argued elsewhere, products liability will not apply to most algorithmic harms. Diamantis, supra note 16, at 823–26. 28 A.C. Pigou, The Economics of Welfare 331 (4th ed. 1938). 23 24

438  Research handbook on corporate liability mized.29 They might, for example, use the streets of a busy city as a proving ground for their self-driving cars.30 By swapping to an algorithm, corporations can remove a potential liability – a human employee for whose misconduct the corporation might have to pay. Algorithms either obscure liability or fail, as a matter of law, to transmit liability to corporations when they mess up. Corporations take advantage of this liability loophole and increasingly will as algorithms open new productive opportunities.31 Human employees, victims of corporate harm, and society deserve better. The way to plug the liability loophole is to modernize the law of corporate liability for the coming age of automation. Corporations use human employees and algorithms for the same sorts of productive tasks. This should translate into parity between employees and algorithms when deciding what harm corporations must pay for.

III.

THE PRECEDENT OF CONTRACT WORK

The strategy of shifting functions away from employees to avoid liability is an old page out of a longstanding corporate playbook. ‘Employment laws by their very terms depend on the identification of an employee and an employment relationship.’32 Behind that seeming tautology lies a strategic opportunity that corporations learned to exploit over a century ago. Not all people who work for corporations qualify as their ‘employees.’ Alternative work arrangements have had many forms and have gone by many names over the decades: contract workers, temps, independent contractors, gig workers, etc. They cover every major industry, from transportation, construction, and hospitality, to office work, medicine, and information technology.33 By strategically delegating operations to non-employee workers, corporations can eliminate legal liabilities they would face if employees had undertaken identical tasks.34 This maneuver leaves workers and society materially worse off. Legislative, judicial, and scholarly responses pave a way that could also work in terms of current corporate efforts to replace employees with algorithms.

Christina Pazzanese, Ethical Concerns Mount as AI Takes Bigger Decision-making Role in More Industries, Harv. Gazette (Oct. 26, 2020), https://​news​.harvard​.edu/​gazette/​story/​2020/​10/​ethical​ -concerns​-mount​-as​-ai​-takes​-bigger​-decision​-making​-role/​. 30 Uber Self-driving Cars Are Being Tested in Arizona, Tech. (Oct. 14, 2019), https://​techaz​.org/​uber​ -self​-driving​-cars​-arizona. 31 Tom Barratt, Alex Veen & Caleb Goods, How Algorithms Keep Workers in the Dark, BBC (Aug. 27, 2020), https://​www​.bbc​.com/​worklife/​article/​20200826​-how​-algorithms​-keep​-workers​-in​-the​-dark; Sylvia Lu, Algorithmic Opacity, Private Accountability, and Corporate Social Disclosure in the Age of Artificial Intelligence, 23 Vand. J. Ent. & Tech. L. 99, 102 (2020); Madeleine Clare Elish, Moral Crumple Zones: Cautionary Tales in Human Robot Interaction, 5 Engaging Sci. Tech. & Soc’y 40 (2019). 32 Richard R. Carlson, Why the Law Still Can’t Tell an Employee When It Sees One and How It Ought to Stop Trying, 22 Berkeley J. Emp. & Lab. L. 295, 296 (2001). 33 Katherine Lim, Alicia Miller, Max Risch, & Eleanor Wilking, Independent Contractors in the U.S.: New Trends from 15 years of Administrative Tax Data 38 (2019), https://​www​.irs​.gov/​ pub/​irs​-soi/​1​9rpindcont​ractorinus​.pdf. 34 See generally Carlson, supra note 32. 29

Accountability for AI labor  439 There are several reasons corporations might want non-employee workers. The most economically legitimate reason is that it is easier to expand and contract a non-employee workforce in response to market demand.35 Temp agencies and gig workers are quick to fill any labor shortage, and labor contracts end when corporate need peters out. The less savory reason that some corporations prefer non-employees is to eliminate many of the obligations that employers ordinarily owe. On average, legally mandated employee benefits and protections account for about thirty percent of an employee’s cost.36 These benefits include 401k and retirement plan contributions, unemployment insurance, health insurance, and paid time off for vacation, parental leave, and sick days.37 Employee protections include nondiscrimination, workplace safety, collective bargaining rights, and the like.38 Of particular concern here, one important liability that corporations can also avoid by using non-employees is liability for worker torts39 and crimes.40 Corporations jealously guard this legal immunity for non-employee misconduct.41 The back and forth between corporations trying to avoid responsibility for workers and lawmakers reasserting corporate accountability has lasted nearly a century. When corporations stray too far, courts and lawmakers respond by expanding the definition of ‘employment.’ The most recent and sweeping corporate effort to reclassify workers as non-employees centers on the mushrooming ‘gig economy.’42 Gig workers are independent contractors who perform on-demand services.43 From Uber drivers to Airbnb hosts to Instacart shoppers, the gig economy has exploded since the Great Recession44 to include 55 million independent contractors, or more than one-third of the total workforce.45 Far from considering these

Stanley Nollen & Hellen Axel, Managing Contingent Workers 22 (1996). See Bureau Lab. Stats., U.S. Dep’t Lab., USDL-21-1094, Employer Costs for Employee Compensation – March 2021 (2021); see also Barbara Weltman, How Much Does an Employee Cost You?, SBA (Aug. 22, 2019), https://​www​.sba​.gov/​blog/​how​-much​-does​-employee​-cost​-you. 37 See Weltman, supra note 36. See also Julia Tomassetti, The Contracting/Producing Ambiguity and the Collapse of the Means/Ends Distinction in Employment, 66 S. C. L. Rev. 315, 327–28 (2014). 38 See generally AFL-CIO, Your Rights at Work (2013), https://​aflcio​.org/​sites/​default/​files/​2017​ -03/​RT​%40WK​.pdf. 39 Daryl J. Levinson, Collective Sanctions, 56 Stan. L. Rev. 345, 393 (2003); Alan O. Sykes, The Economics of Vicarious Liability, 93 Yale L.J. 1231, 1261–71 (1984); Sproul v. Hemmingway, 31 Mass. 1, 7 (1833). 40 Stevens v. Spec Inc., 224 A.D.2d 811, 811 (1996); Corporate Criminal Liability: When a Corporation is Liable for Criminal Conduct by an Employee, 2 Corporate Counsel Guidelines § 5:5 (2020). 41 See Anderson v. Marathon Petroleum Co., 801 F.2d 936, 942 (7th Cir. 1986); Huddleston v. Union Rural Elec. Ass’n, 841 P.2d 282, 285–86 (Colo. 1992) (en banc). 42 Noam Scheiber, A Middle Ground Between Contract Worker and Employee, N.Y. Times (Dec. 10, 2015), https://​www​.nytimes​.com/​2015/​12/​11/​business/​a​-middle​-ground​-between​-contract​-worker​-and​ -employee​.html. 43 Sarah A. Donovan, David H. Bradley, & Jon O. Shimabukuro, What Does the Gig Economy Mean for Workers?, Cong. Rsch. Serv., https://​www​.fas​.org/​sgp/​crs/​misc/​R44365​.pdf. 44 Catherine Ruckelshaus et al., Who’s the Boss: Restoring Accountability for Labor Standards in Outsourced Work 3–5 (2014). 45 Nandita Bose, U.S. Labor Secretary Supports Classifying Gig Workers as Employees, Reuters (Apr. 29, 2021, 10:50 AM), https://​www​.reuters​.com/​world/​us/​exclusive​-us​-labor​-secretary​-says​-most​ -gig​-workers​-should​-be​-classified​-2021​-04​-29 (‘As many as 55 million people in the United States were gig workers – or 34% of the workforce – in 2017, according to the International Labor Organization, and the total was projected to rise to 43% in 2020’); T.J. McCue, 57 Million U.S. Workers Are Part of the Gig Economy, Forbes (Aug. 31, 2018, 5:30 PM), https://​www​.forbes​.com/​sites/​tjmccue/​2018/​08/​ 35 36

440  Research handbook on corporate liability workers as employees,46 corporations advance a narrative under which gig workers are entrepreneurs who work only for themselves.47 Uber, for example, recruits hundreds of thousands of ‘driver-partners’ every month48 claiming that it ‘does not employ any drivers or own any vehicles.’49 Corporations who rely on gig workers can exploit the independent contractor classification to save a lot of money.50 The law has largely accepted the independent contractor narrative, which immunizes Uber from having to offer basic employment rights and benefits.51 Uber leverages the ‘independent contractor defense’ to shield it from liability for harm that Uber drivers cause, including physical injury to passengers52 and discrimination against disabled customers.53 Courts’, regulators’, and scholars’ solution to this corporate accountability gap in the gig economy has been to recognize that many corporations actually do employ their gig workers.54 According to one leading scholar, ‘there is a way to correct this growing asymmetry [between corporations and gig workers], and it begins by reassessing what it means to employ workers today.’55 The US Labor Secretary seems to agree; earlier this year, he announced his support for reclassifying gig workers as employees,56 as the United Kingdom has done already.57 Some courts are already pushing in that direction. The Seventh and Ninth Circuits found in 2015 and 2014, respectively, that drivers whom FedEx classified as independent entre-

31/​57​-million​-u​-s​-workers​-are​-part​-of​-the​-gig​-economy/​?sh​=​7129282a7118 (‘More than one third (36 percent) of U.S. workers are in the gig economy, which works out to a very large number of approximately 57 million people.’). 46 Brooke Bahlinger, Overcoming the Surge: How Clark v. City of Seattle Highlights the Conflicts Between Federal, State, and Local Labor Laws, 79 La. L. Rev. 839, 843 (2019). 47 Drive with Uber: An Alternative to Traditional Driving Jobs, Uber, https://​www​.uber​.com/​us/​en/​ drive. 48 Ellen Huet, Uber Is Adding ‘Hundreds of Thousands’ of New Drivers Every Month, Forbes (June 3, 2015, 11:05 PM), https://​www​.forbes​.com/​sites/​ellenhuet/​2015/​06/​03/​uber​-adding​-hundreds​-of​ -thousands​-of​-new​-drivers​-every​-month/​?sh​=​1f7ca71b655e. 49 Goldberg v. Uber Techs., Inc., No. 14-14264-RGS, 2015 WL 1530875, at *1 (D. Mass. Apr. 6, 2015). 50 Cunningham-Parmeter, supra note 19, at 1676. 51 Natasha Singer, In the Sharing Economy, Workers Find Both Freedom and Uncertainty, N.Y. Times (Aug. 16, 2014), https://​www​.nytimes​.com/​2014/​08/​17/​technology/​in​-the​-sharing​-economy​ -workers​-find​-both​-freedom​-and​-uncertainty​.html​?smid​=​tw​-nytimesbits; Orly Lobel, We Are All Gig Workers Now: Online Platforms, Freelancers & the Battles over Employment Status & Rights During the Covid-19 Pandemic, 57 San Diego L. Rev. 919, 934 (2020). 52 Search v. Uber Technologies, 128 F.Supp.3d 222, 229 (D.D.C. 2015); Restatement (Second) of Torts § 409 (Am. L. Inst. 1965). 53 Ramos v. Uber Techs., Inc., No. SA-14-CA-502-XR, 2015 WL 758087, at *5 (W.D. Tex. 2015); Agnieszka A. McPeak, Sharing Tort Liability in the New Sharing Economy, 49 Conn. L. Rev. 171, 174 (2016); Anthony Juzaitis, The Liability Impact of Gig Worker Status, BL (Nov. 14, 2019), https://​news​ .bloomberglaw​.com/​bloomberg​-law​-analysis/​analysis​-the​-liability​-impact​-of​-gig​-worker​-status. 54 Perhaps seeing the writing on the wall, some tech companies are pro-actively reclassifying their gig workers as employees. John Utz, What Is A ‘Gig’? Benefits for Unexpected Employees, Prac. Law. 19, 33 (June 2016). 55 Cunningham-Parmeter, supra note 19, at 1677. 56 Bose, supra note 45. 57 Natasha Lomas, Uber Loses Gig Workers Rights Challenge in UK Supreme Court, TechCrunch https://​techcrunch​.com/​2021/​02/​19/​uber​-loses​-gig​-workers​-rights​-challenge​-in​-uk​-supreme​-court; Uber BV & Ors v. Aslam & Ors [2021] UKSC 5.

Accountability for AI labor  441 preneurs were actually employees.58 ‘If a worker is hired like an employee, dressed like an employee, supervised like an employee, compensated like an employee, and terminated like an employee,’ then he is an employee regardless of corporate machinations.59 More recently, California courts recognized that Uber and Lyft drivers are employees entitled to benefits that the ride-sharing companies had denied them.60 The California courts drew from a landmark 2018 precedent, Dynamex Operations West, Inc. v. Superior Court, which held that the definition of ‘employee’ must be ‘interpreted and applied broadly to include … all individual workers who can reasonably be viewed as working in the [hiring entity’s] business.’61 In light of this standard, Uber’s and Lyft’s classification of their drivers as independent contractors ‘fl[ew] in the face of economic reality and common sense. … To state the obvious, drivers are central, not tangential, to Uber and Lyft’s entire ride-hailing business.’62 The preceding discussion begs the question of what the legal test for employment is. For more than a century, courts evaluating employment relationships have been prepared to look through corporations’ proffered narrative overlay. In 1914, Judge Learned Hand wrote of a coal company that purported to lease mining rights to independent miners from whom it then purchased coal: ‘[i]t is absurd to class such a miner as an independent contractor … [h]e has no capital, no financial responsibility … [b]y him alone is carried on the company’s only business; he is their “hand,” if any one is.’63 Today, courts use several different tests for employment, depending on the legal right being asserted.64 While the tests vary in detail, the control that a corporation exercises over a worker from whom it benefits has emerged as a consistent defining element.65 Even in overcoming the general rule that corporations are only liable for 58 Slayman v. FedEx Ground Package Sys., Inc., 765 F.3d 1033, 1047 (9th Cir. 2014); Craig v. FedEx Ground Package Sys., Inc., 792 F.3d 818, 828 (7th Cir. 2015). 59 Craig v. FedEx Ground Package Sys., Inc. 335 P.3d 66, 81 (Kan. 2014). 60 People v. Uber Tech., Inc., 56 Cal. App.5th 266, 294–96, aff’g No. CGC-20-584402, 2020 WL 5440308, at *18 (Cal. Super. Aug. 10, 2020) (review denied Feb. 20, 2021) (affirming the trial court’s preliminary injunction requiring Uber and Lyft to treat its employees under the FLSA on the grounds that California was likely to succeed on the merits of its statutory claim). 61 Dynamex Operations West, Inc. v. Superior Court, 416 P.3d 1, 32 (2018) (internal quotation marks and italics omitted). 62 People v. Uber Tech., Inc., No. CGC-20-584402, 2020 WL 5440308, at *3 (Cal. Super. Aug. 10, 2020). This decision was not the end of the saga over Uber and Lyft drivers in California. In response to the decision, Uber and Lyft and other tech companies spent a record $205 million on lobbying for a ballot measure in California, Proposition 22, that would have characterized drivers as independent contractors. Michael Hiltzik, With Prop. 22, Uber and Lyft Shaped Labor Law in their Image, Los Angeles Times (Nov. 4, 2020, 12:26 PM), https://​www​.latimes​.com/​business/​story/​2020​-11​-04/​uber​-lyft​-proposition​ -22. Though the measure passed, many voters felt they had been misled. Faiz Siddiqui & Nitasha Tiku, California Voters Say They Regret Passing Prop 22 After Uber Sneaky Tactics to Avoid Making Drivers Employees in California, Voters Say. Now, They’re Going National, Wash. Post (Nov. 17, 2020, 7:00 AM), https://​www​.washingtonpost​.com/​technology/​2020/​11/​17/​uber​-lyft​-prop22​-misinformation. Recently, a California trial court ruled that Proposition 22 violated the California constitution and was unenforceable. Justin Ray, Prop. 22 Is Ruled Unconstitutional: What it Means, How Apps Reacted and What Happens Next, L.A. Times (Aug. 23, 2021, 6:10 AM), https://​www​.latimes​.com/​california/​ newsletter/​2021​-08​-23/​proposition​-22​-lyft​-uber​-decision​-essential​-california. 63 Lehigh Valley Coal Co. v. Yensavage, 218 F. 547, 552–53 (2d Cir. 1914). 64 Grant E. Brown, An Uberdilemma: Employees and Independent Contractors in the Sharing Economy, 75 Md. L. Rev. Endnotes 15, 17 (2016). 65 Lisa J. Brent, Suppressing the Mischief: New Work, Old Problems, 6 Ne. U. L.J. 311, 313–21 (2014).

442  Research handbook on corporate liability the torts and crimes of employees, courts will treat independent contractors as employees where corporations exercise sufficient control.66 In assessing the extent of corporate control over a contractor, courts look through formalities to consider ‘all incidents of the relationship’67 and assess the ‘economic reality’68 of the situation. A similar approach could work for the algorithms that are rapidly supplanting employees in today’s corporate workforce.

IV.

AI AS LABOR FOR WHICH CORPORATIONS ARE ACCOUNTABLE

This then, is the proposal: to assess corporate liability for harms to third parties, the law should treat some corporate algorithms as though they were employees. This ‘Labor Model’ would allow plaintiffs and prosecutors to slot algorithms into corporate law’s existing employee-focused liability rules. The Labor Model maintains that employees and what it calls ‘employed algorithms’ should be legally interchangeable when assessing corporate civil and criminal liability. If a corporation would be liable under existing law for some harm that a human employee caused, the corporation should also be liable if an algorithm caused it instead. Before describing the Labor Model in detail, three caveats are in order. First, the Model applies only in the context of determining corporate liability for harms. Outside of that context, for example, when determining labor rights, the Labor Model assumes that algorithms will be regarded as the inanimate mechanisms that they are. To emphasize this limitation, the Labor Model refers to corporate algorithms that satisfy its criteria as ‘employed algorithms,’ rather than ‘employees.’ The second caveat is that the Labor Model fills a gap in corporate legal accountability but does not replace existing doctrines. If corporations or individuals would be liable for some harm, algorithmic or otherwise, under a legal theory available in current law, they would remain liable under the same theory even after implementing the Labor Model. For example, product liability laws would remain unchanged. Longstanding experience dictates that some legal redundancy is helpful for holding corporations accountable.69 As a third and final caveat, it should be noted that the Labor Model does not purport to be a stand-alone doctrine of corporate liability. It relies on existing liability law. The Labor Model simply states when those liability laws could extend to algorithmic harms, rather than solely to harms that employees cause. Accordingly, the Labor Model needs a background framework to translate some elements of existing liability rules to the algorithmic context. For example,

See e.g., Bowers v. Trinity Groves, No. 3:21-CV-0411-B, 2021 U.S. Dist. LEXIS 157446 (N.D. Tex. Aug. 20, 2021); Beil v. Telesis Constr., Inc., 608 Pa. 273, 289–91 (Pa. 2009). 67 NLRB v. United Ins. Co. of Am., 390 U.S. 254, 258 (1968). 68 Souder v. Brennan, 367 F. Supp. 808, 813 (D.D.C. 1973); Real v. Driscoll Strawberry Assocs., Inc., 603 F.2d 748, 754–55 (9th Cir. 1979); Bruce Goldstein et al., Enforcing Fair Labor Standards in the Modern American Sweatshop: Rediscovering the Statutory Definition of Employment, 46 UCLA L. Rev. 983, 1008 (1999). 69 See generally David M. Uhlmann, The Pendulum Swings: Reconsidering Corporate Criminal Prosecution, 49 U.C. Davis L. Rev. 1235, 1282 (2016); Shayna A. Hutchins, Flip that Prosecution Strategy: An Argument for Using RICO to Prosecute Large-scale Mortgage Fraud, 59 Buff. L. Rev. 293, 304–305 (2011). 66

Accountability for AI labor  443 it is clear what act elements and mental state elements mean when human employees are the source of harm: the law attributes to corporations the acts and mental states of employees.70 But what do they mean for algorithms? I have offered answers in prior work that, because they also draw heavily on a comparison between algorithms and employees, would resonate well with the Labor Model.71 Under the Labor Model, corporations would be liable for the harms of their employed algorithms just as they presently are for the harms of their human employees. The key to the Model is to define what it means for a corporation to employ an algorithm. The general rule for attributing civil and criminal violations of employees to corporations is respondeat superior. That doctrine has two requirements. At the time of the violation, the employee (1) must have intended to benefit the corporation and (2) must have been working within the scope of her employment.72 Each requirement performs a different function, ensuring the fairness and the effectiveness of corporate liability, respectively. Respondeat superior’s first element – intent to benefit – helps ensure fairness. Corporate liability is usually thought of as a type of vicarious liability – holding one person (the corporation) responsible for the violations of another (the employee). Vicarious liability is presumptively unfair, so it requires special limits or justifications. Respondeat superior’s intent-to-benefit requirement fills this role. Vicarious liability is most concerning when the interests of the agent and principal diverge.73 The intent-to-benefit requirement ensures that a corporation will not be liable for a violation if its employee’s only possible motivation was to benefit herself or harm her employer.74 By first checking that the employee was working for the corporation, respondeat superior limits itself to cases where the employee was intuitively acting as the corporation.75 This alignment of purposes generates an overlapping practical identity between the employee and the corporation. Respondeat superior thereby applies only to cases where employees seem less like third parties and more like direct corporate embodiments.76 Respondeat superior’s second element – scope of employment – helps to ensure efficacy. Corporate liability is not always a suitable way to address workplace misconduct. This is because, due to agency costs, corporations cannot guarantee that their employees will always 70 Michael W. Tankersley, The Corporate Attorney-Client Privilege: Culpable Employees, Attorney Ethics, and the Joint Defense Doctrine, 58 Tex. L. Rev. 809, 831 (1980); Ryan Abbott & Alex Sarch, Punishing Artificial Intelligence: Legal Fiction or Science Fiction, 53 U.C. Davis L. Rev. 323, 351 (2019). 71 See Diamantis, supra note 10; Diamantis, supra note 16. 72 See Parker v. Carilion Clinic, 819 S.E.2d 809, 819 (Va. 2018); Lundberg v. State, 255 N.E.2d 177, 179 (N.Y. 1969); Harlow v. Managing Partners, Inc., 755 N.E.2d 1158, 1162 (Ind. Ct. App. 2001). 73 See Osborne v. Lyle, 587 N.E.2d 825, 832 (Ohio 1992) (Homes, J. dissenting); Xue Lu v. Powell, 621 F.3d 944, 951–53 (9th Cir. 2010) (Bybee, J. concurring in part and dissenting in part); Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1584 (9th Cir. 1990) (en banc) (Hall, J. dissenting). See also Barbara Black, Application of Respondeat Superior Principles to Security Fraud Claims Under the Racketeer Influenced and Corrupt Organizations Act (RICO), 28 Santa Clara L. Rev. 825, 833–36 (1984). 74 Restatement (Third) of Agency § 7.07 (Am. Law. Inst. 2006). 75 Earnest J. Weinrib, The Idea of Private Law 186 (2nd ed. 2012) (‘[R]espondeat superior construes (indeed, constructs) the doer as composite: the-employer-acting-through-the-employer. When the conditions that permit this construction of the doer are present, “the enterprise may be regarded as a unit … Employee’s [sic] acts sufficiently connected with the enterprise are in effect considered deeds of the enterprise itself.”’) (quoting Fruit v. Schreiner, 502 P.2d 133, 141 (Alaska 1972)). 76 N.Y. Cen. & Hudson River R.R. Co. v. United States, 212 U.S. 481, 495 (1909); Restatement (Third) of Agency § 7.07 cmt. B (Am. Law. Inst. 2006).

444  Research handbook on corporate liability behave. Nor would it necessarily even be desirable for corporations to exercise maximum oversight over their employees, for example when the employee is at home with her family. Respondeat superior’s scope-of-employment requirement helps limit corporate liability to cases in which corporations could reasonably prevent violations. ‘An employee acts within the scope of employment when performing work assigned by the employer or engaging in a course of conduct subject to the employer’s control.’77 The scope-of-employment requirement is a proxy for assuring that corporations will only be liable for conduct they had the power to prevent. This incentivizes corporations to implement compliance measures – better monitoring, training, discipline, and productivity metrics – to reduce the chance that employees will break the law while on the job.78 At the same time, it mitigates corporate incentives to invest in wasteful or socially undesirable compliance protocols. Respondeat superior may be reasonably well tailored to address employee misconduct, but it does not currently apply to algorithms. The doctrine ‘requires an employment relationship at the time of the injury and with regard to the transaction resulting in it.’79 Algorithms are not employees. Even if the doctrine were to apply, no algorithm would satisfy either of its elements. Algorithms cannot intend to benefit any corporations because, lacking minds, algorithms cannot intend anything. Without an employment relationship, algorithms would never operate within a scope of employment. By limiting respondeat superior to human employees, the law adopts a superficial understanding that overlooks the doctrine’s true flexibility. But deeper principles of fairness and effectiveness are at work in the doctrine. For centuries, these principles manifested themselves in specific doctrinal requirements tailored to the assumption that corporate production occurs only through human effort. That assumption no longer holds in the present era, in which algorithms are rapidly replacing human labor. By recovering the principles behind respondeat superior, more generalized versions of its two elements come into view that could flexibly apply to human and digital labor alike. The Labor Model of corporate liability requires two innovations. The first is to recognize that corporations can employ algorithms. Whatever formal limits there are on who or what can be an employee in other contexts, for the purposes of assessing corporate liability, the legal concept of employment should extend to cover ‘employed algorithms.’ The second innovation is to define what employed algorithms are by generalizing respondeat superior’s two elements. Since the elements address fairness and effectiveness in the context of human labor, they help resolve structurally similar enforcement challenges of algorithmic labor. The generalized version of respondeat superior is what I have elsewhere called the ‘beneficial-control test.’ The intent-to-benefit and scope-of-employment elements of respondeat superior roughly ensure that corporations can expect to benefit from, and can control, employee conduct before holding them liable for employee violations. Where human employees are concerned, the two elements are serviceable proxies for benefit and control. Since the elements are inapplicable to algorithms, courts would need to inquire directly into whether a corporation claims substantial benefits from the algorithm’s operation and exercises substantial control over it. In assessing the benefits a corporation claims from an algorithm, courts

Restatement (Third) § 7.07. See Fleming James, Jr., Vicarious Liability, 28 Tul. L. Rev. 161, 168 (1954). 79 30 C.J.S. Employer—Employee § 221.

77 78

Accountability for AI labor  445 should include indirect benefits.80 Even if an algorithm does not provide an immediate revenue stream, it might boost corporate profitability by making operations more efficient or providing data to help inform business strategies. Measuring corporate control over algorithms requires a multifaceted approach. Relevant powers include the power to design the algorithm, terminate its operation, modify it, monitor it, and override it. None of these powers standing alone are necessarily determinative of corporate control over an algorithm, but the more powers a corporation has, the more control it has. In sum, the Labor Model of corporate liability for algorithmic harms tracks respondeat superior’s approach to employee harms. Corporations should be liable for the harms that their employed algorithms cause. A corporation employs an algorithm if it exercises beneficial control over it.

V. CONCLUSION ‘Liability is one of the big unspoken-about issues here. We want to ensure there’s responsibility at the end of the day and that they are not just passing that along to someone else.’81 Just two years ago, that is how California Assemblywoman Lorena Gonzalez described her motivation for crafting bill AB5, which reclassified much of the gig workforce in California as employees. Large tech companies in California like Uber and Amazon use independent contractors to perform high-risk jobs like driving passengers and delivering packages. In so doing, these corporations avoid millions in liabilities for civil and criminal injuries they would have to pay had they used employees instead.82 Legislators,83 regulators,84 and judges85 are pushing back against this corporate gambit, and its availability as a tool to hide from victims may not last long. But corporations have already uncovered the next frontier of liability management. Independent contractors are not the only available source of non-employee labor. Algorithms are increasingly capable of performing tasks that corporations assigned to employees just a decade ago. Since algorithms are not employees, doctrines for holding corporations liable apply awkwardly, if at all. Corporations are increasingly taking advantage of this liability loophole. Assemblywoman Gonzalez might just as easily have been speaking about corporations’ expanding algorithmic workforce as about contract workers. Similar solutions often work for similar problems. Or so this chapter has argued. The leading proposals for addressing corporate abuses of the gig workforce involve reclassifying certain independent contractors as employees. The Labor Model advanced here would do the same for corporate algorithms. Corporate liability generally requires employee misconduct. George E. Danner, The Executives’ How To Guide to Automation 139–48 (2019). Greg Bensinger, Uber: The Ride-Hailing App that Says it Has ‘Zero’ Drivers: The Silicon Valley Company’s Word Games Help Shelter it from Liability, Wash. Post. (Oct. 14, 2019), https://​www​ .washingtonpost​.com/​technology/​2019/​10/​14/​uber​-ride​-hailing​-app​-that​-says​-it​-has​-zero​-drivers/​. 82 Kevin Alden, Strict Liability for the Information Age, 46 B.Y.U. L. Rev. 1619, 1620 (2021) (‘[Amazon] has been able to avoid liability for the ten deaths and sixty other “serious injuries” caused by their vehicles by placing a legal firewall between itself and the drivers.’). 83 2019 Cal. Legis. Serv. ch. 296 (West) (Assembly Bill No. 5). 84 Bose, supra note 45. 85 Dynamex Operations W. v. Superior Ct., 416 P.3d 1, 39 (2018). 80 81

446  Research handbook on corporate liability For purposes of assessing whether a corporation is liable for a civil or criminal harm caused by an algorithm, the Labor Model recognizes that some algorithms are employed by corporations. Drawing on the principles embedded in the existing doctrines of corporate liability, the Labor Model defines an ‘employed algorithm’ as one from which a corporation derives substantial benefits and over which it exercises substantial control. On this approach, corporations would be liable for algorithmic harms just as they presently are for the harms that employees bring about.

24. The company and blockchain technology Kelvin F.K. Low, Edmund Schuster and Wan Wai Yee

I.

INTRODUCTION

Given the excitement over the blockchain and distributed ledger technology (DLT), it is unsurprising that proponents have suggested that they will revolutionize corporate governance and management and perhaps even disrupt, or render redundant altogether, the corporate form. It is perhaps useful to first distinguish blockchains from distributed ledgers.1 Blockchains, as the name suggests, are a species of distributed ledger technology that record transactions in blocks rather than individually and then chain these blocks together with a cryptographic hash so as to make alterations to transactions contained in earlier blocks easily detectable by checking against the hash of a later block. Non-blockchain DLTs either rely on other cryptographic protocols to secure the ledger or else simply rely on good old-fashioned trust in the ledger’s registrar(s). Blockchains themselves must also be segregated into permissionless and permissioned varieties. In their permissionless form, anybody can participate in the record-keeping process by downloading the relevant code and running it on a compliant computer. As anyone can participate in altering the ledger, permissionless blockchains rely on particular types of consensus algorithms to prevent abuse, the most famous and commonplace being the proof of work (PoW) consensus algorithm underlying the Bitcoin blockchain. Proof of work leverages game theory to disincentivize participants from fraudulently altering the blockchain ledger as it is costly to win the opportunity to amend the ledger (as participants called miners have to compete to solve complex cryptographic puzzles) and the Bitcoin consensus protocol regards the longest blockchain as the most authoritative. Game theory is applied in a simplistic way, contrary to actual game theory scholarship,2 treating each participant as homo economicus, deigning to banish bad behaviour through ‘tokenomics’. PoW is ‘wasteful by design’3 and thus sometimes criticized as proof of waste:4 the Bitcoin blockchain has a carbon footprint equivalent to a medium-sized country5 but processes only 4.6 transactions per second.

Kelvin F.K. Low & Eliza Mik, Pause the Blockchain Legal Revolution, 69 Int’l & Comp. L.Q. 135, 138 (2020). 2 Ariel Rubinstein, Afterword, in John von Neumann & Oskar Morgenstern, Theory of Games and Economic Behavior: 60th Anniversary Commemorative Edition 633 (2007). 3 Edmund Schuster, Cloud Crypto Land, 84 Mod. L. Rev. 974, 980 (2021). 4 Kelvin F.K. Low, Confronting Cryptomania: Can Equity Tame the Blockchain?, 14 J. Equity 240, 247 (2020). 5 At the time of writing, this would be Norway; see Bitcoin Energy Consumption Index, Digiconomist, https://​digiconomist​.net/​bitcoin​-energy​-consumption. For an analysis, see, e.g., Andrew L. Goodkind, Benjamin A. Jones & Robert P. Berrens, Cryptodamages: Monetary Value Estimates of the Air Pollution and Human Health Impacts of Cryptocurrency Mining, 59 Energy Res. & Soc. Sci. 101281 (2020). Mining for cryptocurrencies has also been shown to create negative spill-over effects for local energy markets; see Matteo Benetton, Giovanni Compiani & Adair Morse, When Cryptomining 1

447

448  Research handbook on corporate liability The openly acknowledged 51 per cent attack vulnerability has also since transitioned from ‘theoretical possibility to worrisome reality’6 for significant blockchains such as Ethereum Classic, which has been subjected to at least four known 51 per cent attacks. Whilst the very largest permissionless blockchains such as Bitcoin (and Ethereum while it relied on PoW) have thus far remained unaffected,7 it is notable that Ethereum Classic was ranked among the top 20 cryptoasset blockchains by ‘market capitalization’8 in a field of literally tens of thousands of blockchains at the time it was successfully targeted. Alternative consensus protocols for permissionless blockchains exist. The most notable such alternative is Proof of Stake (PoS), the protocol recently9 adopted by Ethereum (the second biggest10 cryptocurrency) after years of delays.11 While PoS addresses the environmental concerns, it is in principle still subject to similar 51 per cent attacks,12 a vulnerability that is ultimately impossible to eliminate entirely. Mitigating it results in traps for the unwary.13 Much of the interest in blockchains and DLT from the corporate sector lie in permissioned varieties of the same. Unlike their permissionless brethren, most permissioned DLTs do not depend on game theory to keep their registrars honest, relying instead on ‘good old-fashioned trust’.14 This means, however, that such DLTs often do not possess the immutability of their permissionless cousins, which are in any event not truly immutable since ‘blockchain immutability is not an absolute concept but rather more 60 blocks/shades of grey’.15 Absent the check provided by PoW or PoS, there is little point in organizing a permissioned DLT by way of chained blocks since any authorized registrar will be able to change the entire ledger, hashes and all, so many of these will not technically be blockchains except perhaps by misnomer. Some permissioned DLTs such as Hyperledger Fabric and Hyperledger Sawtooth preserve both the blockchain structure and its immutability but leverage other non-PoW consensus protocols, specifically Apache Kafka and proof of elapsed time (PoET) respectively.

Comes to Town: High Electricity-Use Spillovers to the Local Economy (2021), https://​papers​.ssrn​.com/​ sol3/​papers​.cfm​?abstract​_id​=​3779720 6 Low, supra note 4, at 249–50. 7 But see Eric Budish, The Economic Limits of Bitcoin and the Blockchain (NBER Working Paper 24717, 2018), https://​www​.nber​.org/​papers/​w24717, for a discussion of economic limits for reliable PoW security. 8 The term ‘market capitalization’ (current market price times circulating supply) is widely used for cryptoassets, even though it is a particularly fraught metric given the market’s illiquidity and rampant manipulation: Josh Zumbrum, Why Crypto’s Market Cap Never Booms, or Busts, as Much as You Think, Wall St. J., Aug. 5, 2022, https://​www​.wsj​.com/​articles/​why​-cryptos​-market​-cap​-never​-booms​-or​ -busts​-as​-much​-as​-you​-think​-11659691802 9 Joshua Oliver, Ethereum ‘Merge’ Concludes in Key Moment for Crypto Market, Financial Times, Sep.  15, 2022, https://​www​.ft​.com/​content/​4d3c85ee​-c812​-47b2​-a973​-acaf1c141a50 10 Again, by market capitalization. 11 Ethereum had been trying to transition to Proof of Stake since 2014: David Gerard, It’s a $69 Million JPEG, but Is it Art?, Foreign Pol’y, Mar. 19, 2021, https://​foreignpolicy​.com/​2021/​03/​19/​nft​ -beeple​-69​-million​-art​-crypto​-nonfungible​-token/​ 12 Instead of an attacker having to control 51% of the network hash rate, the attacker would have to control 51% of staked cryptoassets, which is not as difficult as it sounds because cryptoasset holdings are often highly concentrated. 13 Liam Frost, How to Stop Your Ethereum 2.0 Validator from Getting Slashed, Decrypt, Dec. 3, 2020, https://​decrypt​.co/​50270/​how​-to​-stop​-your​-ethereum​-2​-0​-validator​-from​-getting​-slashed 14 Low & Mik, supra note 1, at 140. 15 Id. at 144.

The company and blockchain technology  449 However, the former achieves consensus through a backend centralized server whereas the latter, like PoW, has a tendency to fork at least temporarily.16 The mutability of most permissioned DLTs is not necessarily a tragedy since immutability should not be regarded as censorship resistance (as enthusiasts suggest) but rather change resistance. Change is neither inherently bad nor good. When a mistake is corrected, change is rectification (good), not censorship (bad). A blockchain, however, is insensitive to context and hence blockchain immutability is unavoidably indiscriminate, preventing all change.17 Thus DLTs must either accord some user(s) superuser privileges to rectify transfers that are legally void or voidable, in which case they are not immutable or, if immutable, will inevitably diverge from the legal reality.18 In short, a choice must be made as to being either pointless or useless, though some cryptomaniacs ponder the possibility of an absolutely authoritative immutable DLT – mistakes, frauds, hacks and all – or what we consider the heartless option.19 Sans immutability, the point of DLT may legitimately be questioned. Many proponents of permissioned DLTs suggest that distributed ledgers are more secure than centralized ones. A centralized ledger supposedly presents a single point of failure whereas a distributed ledger is more robust. Within the legal literature, it is commonly assumed that in order to compromise a DLT every single copy of the ledger must be compromised,20 but this is wrong.21 Many permissioned DLTs make use of the practical Byzantine Fault Tolerance (pBFT) consensus algorithm. So named because it purports to solve the ‘Byzantine Generals Problem’22 introduced by Lamport, Shostak and Pease in 1982 in which malfunctioning nodes within a distributed system were metaphorically represented by traitorous Byzantine generals, the pBFT algorithm was introduced by Castro and Liskov in 1999,23 almost ten years before Satoshi Nakamoto’s White Paper24 introduced the Bitcoin payment system. pBFT tolerates the compromise of less than one-third of the network’s nodes so that the increased cost to a registrar far outstrips the increased cost to a hacker determined to compromise the records. Any superuser privilege(s) will also necessarily reintroduce a single (or more) point(s) of failure. Furthermore, the much-vaunted improved security ignores the possibility of offline backups, which will permit registrars to reconstruct compromised records.25 It is of course also possible to back up DLTs offline but this will either be extremely costly (entailing the back up of all nodes) or else compromise the egalitarian ideals of decentralisation, since some nodes (those that are chosen

Id. at 144, 163. Id. at 150, Schuster, supra note 3, at 988–90. 18 Id. at 990–92. 19 Kelvin F.K. Low, Bitcoin Users Should Not Overlook Cryptocurrency’s Fundamental Flaw, Nikkei Asia, Jun. 14, 2022, https://​asia​.nikkei​.com/​Opinion/​Bitcoin​-users​-should​-not​-overlook​-cryptocurrency​ -s​-fundamental​-flaw 20 See, e.g., Dirk A. Zetsche, Ross P. Buckley & Douglas W. Arner, The Distributed Liability of Distributed Ledgers: Legal Risks of Blockchain, 2018 U. Ill. L. Rev. 1361, 1371–72 (2018). 21 Low, supra note 4, at 255–57. 22 Leslie Lamport, Robert Shostak & Marshall Pease, The Byzantine Generals Problem, 4 A.C.M. Transactions on Programming Languages & Sys. 382 (1982). 23 Miguel Castro & Barbara Liskov, Practical Byzantine Fault Tolerance and Proactive Recovery, 20 A.C.M. Transactions on Computer Sys. 398 (2002). 24 Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System (Oct. 31, 2008), https://​ bitcoin​.org/​bitcoin​.pdf 25 Robert Scammell, Fujifilm Refuses to Pay Ransomware Demand, Restores Network from Backups, Verdict (Jun. 7, 2021), https://​www​.verdict​.co​.uk/​fujifilm​-ransom​-demand/​(last visited Oct. 19, 2022). 16 17

450  Research handbook on corporate liability for backups) will be more equal than others. A less common consensus algorithm employed in permissioned DLTs is that of crash fault tolerance (CFT) but CFT, as its name suggests, only provides resilience against node crashes (i.e. completely stops working) without providing any tolerance towards malicious or otherwise faulty nodes26 so that it is even less secure than pBFT from malicious actors. A key selling point of many DLT projects is their ability to interface with so-called smart contracts or more accurately, ‘self-executing ledger-modification instructions’.27 These smart contracts either automate the process of contracting or, more commonly, its performance or both. Automation is however not dependent on the use of DLT, with automation in finance predating DLT by a good many decades: the first automated clearing service in the world was created by the Dutch Postcheque- en Girodienst in April 1965.28 The expression smart contract itself was coined by Szabo in 1997,29 more than a decade before Nakamoto envisaged the blockchain. What the blockchain contributed to smart contracts was immutability, but obviously only if the smart contract was embedded into an immutable blockchain. Already not obviously desirable, immutability may be even less so in the smart contracts space given the ubiquity of coding errors.30 Since many proposals for the use of DLT technology in this context are of the permissioned mutable variety, it is not obvious what DLT contributes to automation beyond a trendy catchphrase. Departing cloud crypto land allows us to rationally evaluate the potential impact of DLTs on company law as we know it. Our chapter is, apart from this introduction and a conclusion, divided into two parts. Part II, subdivided into two sub-parts, explores the potential impact of the blockchain on the internal governance of the company. Sub-part A considers proposals to replace centralized share registers with DLT equivalents; and sub-part B considers the use of DLT to manage a company’s data. Part III considers the potential of so-called Decentralized Autonomous Organizations (DAOs), which some have suggested can supplant the supposedly ageing corporate form. Throughout, we seek to identify hyperbole and misunderstanding.

II. A.

BLOCKCHAIN AND INTERNAL GOVERNANCE DLT Shareholding: The Promise and the Hype

Before considering the scope for the application of DLT, it is important to understand how today’s intermediated securities holding structures evolved. As Morton explains,31 the growth of intermediation began in the middle of the twentieth century for a number of reasons: (i) securities markets grew massively in size and volume; (ii) cross-border investment increased; Hyperledger Fabric’s Kafka consensus protocol is also only CFT but not BFT. Low & Mik, supra note 1, at 165. 28 Dirk de Wit, The Shaping of Automation: A Historical Analysis of the Interaction Between Technology and Organisation, 1950–1985, 208 (1994). 29 Nick Szabo, Smart Contracts: Formalizing and Securing Relationships on Public Networks, 2 First Monday (1997), https://​doi​.org/​10​.5210/​fm​.v2i9​.548 30 Low & Mik, supra note 1, at 172–73. 31 Guy Morton, Historical Introduction: The Growth of Intermediation and Development of Legal Analysis of Intermediated Securities, in Intermediation and Beyond 23, 24–27 (Louise Gullifer & Jennifer Payne eds., 2019). 26 27

The company and blockchain technology  451 (iii) the number and range of those investing in securities increased very substantially; (iv) incentives pointed towards collective and packaged investment; (v) the volume and speed of settlement in securities markets increased substantially; (vi) securities finance activity increased substantially; and (vii) securities custody and administration services became increasingly professionalized and widely available. Intermediation tends to take one of two forms: immobilization and dematerialization. Using shares to distinguish the two, in the former, share certificates exist but these are immobilized and held by a central securities depository (CSD), with actual trades taking place only in the books of these CSDs, their intermediaries, or further intermediaries down the chain. In the US, the CSD used for publicly traded shares is the Depository Trust & Clearing Corporation (DTC), which has physical possession of global share certificates and does the clearance of trades through the debit and credit of the accounts opened with the DTC.32 Where shares are dematerialized, there are no share certificates at all, even though there will often be a requirement to keep a share register of the uncertificated shares. The UK’s CREST system, operated by Euroclear (UK and Ireland) (EUI) as CSD, is such a system. Although a CSD will often be the holder of the issued securities, this is not always the case.33 In the UK’s CREST system, for example, EUI is not the holder of the securities. Instead, the holder of the securities or CREST member is normally a financial institution or, more rarely, an individual holding a CREST-sponsored account.34 However, in spite of these market developments, much of our legal infrastructure still assumes the classical pattern of direct holdings of shares, resulting in various problems for the persons identified in the literature as the ultimate account holders (UAHs).35 Especially from a corporate liability perspective, UAHs lack important rights available to direct holders of securities. For instance, indirect shareholders do not have the right to requisition a meeting36 or access shareholder oppression or unfair prejudice rights,37 and indirect bondholders are unable to sue on their bonds.38 Less directly, intermediation also presents obstacles to UAHs exercising their stewardship functions. For instance, an indirect shareholder who wishes to exercise his votes will have to instruct his intermediary, who would also be receiving the instructions from other UAHs.39 Many things can go wrong: for instance, the intermediary might not receive the voting instructions in a timely manner, particularly if there are several further layers through which the shares are held and time is often of the essence in the exercise of 32 Alternatively, investors in the US can also be registered as holders of the shares through DTC’s Direct Registration System (DRS), which is a dematerialized form of holding securities. However, it is not mandatory for issuers or investors to use the DRS. See US Sec. & Exch. Com., Holding Your Securities: Get the Facts (2003), https://​www​.sec​.gov/​reportspubs/​investor​-publications/​in​vestorpubs​ holdsechtm​.html 33 Christopher Twemlow, Why are Securities Held in Intermediated Form?, in Gullifer & Payne, supra note 31, at 85, 90–92. 34 Law Com., Intermediated Securities: Who Owns Your Shares? A Scoping Paper (2020), https://​s3​ -eu​-west​-2​.amazonaws​.com/​lawcom​-prod​-storage​-11jsxou24uy7q/​uploads/​2020/​11/​Law​-Commission​ -Intermediated​-Securities​-Scoping​-Paper​.pdf 35 Cf. Louise Gullifer & Jennifer Payne, Introduction, in Gullifer & Payne, supra note 31, at 1, 7. 36 Eckerle v. Wickeder [2013] EWHC 68 (Ch). 37 See, e.g., Companies Act 2006, c 46 (UK), § 994. 38 See, e.g., Richard Salter, Enforcing Debt Securities, in Gullifer & Payne, supra note 31, at 129–54. 39 Eva Micheler, Custody Chains and Asset Values: Why Crypto-securities are Worth Contemplating, 74 Cambridge L.J. 505 (2015).

452  Research handbook on corporate liability voting rights at contested shareholder meetings. This problem appears to be more pronounced in the US40 than in the UK.41 A further problem, linked to the complexity of the intermediate holdings, is that the direct holder of the securities, often a CSD, may make mistakes as to those voting instructions, resulting in the shares being over-voted or votes being improperly disregarded.42 Where bonds are held in an intermediated fashion, the existence of a single direct bondholder is extremely troublesome for bondholder schemes of arrangement since the majority in number requirements set out in section 899 of the Companies Act 2006 cannot be met.43 Where securities are dematerialized, as opposed to immobilized, it is often possible for an investor to choose to hold the securities directly rather than indirectly through an intermediary. This is certainly possible under the CREST system44 and also under the Direct Registration System established by DTC.45 However, despite this possibility, and despite the increasingly well-known problems with intermediation, direct holding seems to be increasingly unpopular. According to Twemlow,46 the number of individuals directly holding in the CREST system has dropped from over 50,000 in 2003 to approximately 5,400 in 2018. By April 2018, the total value of personal member holdings in the CREST system was a mere £1.3 billion approximately, or roughly 0.025 per cent of the value of corporate holdings of approximately £5.2 trillion. Why is direct holding not more popular? Twemlow highlights a number of practical consequences for an investor who wishes to hold directly: [E]nd investors would need individually to instigate all actions (such as each individual buy, sell and tax payment, as well as monitoring for and reacting to each corporate action process (such as selecting dividend currency or bonus issue uptake)). Access to trading venues (to obtain best price), clearing (to remove counterparty risk) and settlement venues (CSDs) would be significantly constrained due to the restrictions such infrastructure may have on access in order to meet financial stability and risk management considerations, in the interests of society.

In the US, likewise, holding through brokers remains routine.47 Quite simply put, the benefits of intermediation are perceived by most market participants to far outweigh its drawbacks. Contrary to the misconceptions of many DLT enthusiasts, especially those with a purely technical background, intermediaries do not merely offer a parking place for the holding

George S. Geis, Traceable Shares and Corporate Law, 113 Nw. U. L. Rev. 227 (2018). Law Com., Intermediated Securities: Summary of Responses to Call for Evidence (2021), at 57, https://​s3​-eu​-west​-2​.amazonaws​.com/​lawcom​-prod​-storage​-11jsxou24uy7q/​uploads/​2020/​11/​Law​ -Commission​-Intermediated​-Securities​-Summary​.pdf (last visited Jan. 25, 2022). 42 Marcel Kahan & Edward Rock, The Hanging Chads of Corporate Voting, 96 Geo. L.J. 1227, 1243 (2008). 43 Jennifer Payne, Intermediation and Bondholder Schemes of Arrangement, in Gullifer & Payne, supra note 31, at 175–86. 44 Louise Gullifer, Ownership of Securities: The Problem Caused by Intermediation, in Gullifer & Payne, supra note 31, at 1, 3; Morton, supra note 31 and accompanying text. 45 Supra note 32 and accompanying text. 46 Twemlow, supra note 33, at 86–87. 47 Cf. Christopher E. Austin, Paul M. Tiger & Max A. Wade, Additional Lessons from the CBS-NAI Dispute: The Limitations of ‘Street Name’ Ownership in Effectively Exercising Stockholder Rights, Harvard Law School Forum on Corporate Governance (Oct. 17, 2018), https://​corpgov​.law​ .harvard​.edu/​2018/​10/​17/​additional​-lessons​-from​-the​-cbs​-nai​-dispute​-the​-limitations​-of​-street​-name​ -ownership​-in​-effectively​-exercising​-stockholder​-rights 40 41

The company and blockchain technology  453 of securities; they are servicing a demand, offering a suite of services to their clients. For instance, intermediaries may also offer the services of lending securities in the accounts to other borrowers and thus obtain a return for their clients. They also facilitate the cross-border holding of securities, given restrictions on the dealing of securities by foreign investors. Some professional investors deliberately choose to outsource the management of shares such as the exercise of voting rights or other corporate actions to third party intermediaries. Much of the legal literature predicting an impending DLT revolution assumes that DLTs will disintermediate intermediaries leading to the easy identification of UAHs as these will now hold their securities directly on the DLT.48 Much of this literature is thin on technical explanations of how DLTs work. As the London Stock Exchange Group rightly observed in its response to the Law Commission’s call for evidence in its Intermediated Securities project,49 and as we have also striven to show, the term ‘DLT’ is currently used to describe various types of technology, and there are differences between ‘consensus models, functional specifications, performance and implications as regards transparency of data and network governance’.50 These different implementations each have their strengths and drawbacks, which often balance each other. For example, a DLT is either public or private, with the inevitable consequence that a private DLT is less transparent than a public one. It is not obvious that all shareholders would be attracted to direct holding in a public DLT with respect to which anyone ‘would be able to view the arrangement of ownership at any time and identify changes instantly as they occurred’.51 It seems more likely that any DLT implemented will be private, limiting even read-only access to authorized users. This will allow hostile bidders who are building their positions and who hold less than the relevant disclosure threshold to hide their positions except against certain parties such as regulators. Lest this be thought to be some panacea to enforcement of disclosure, it must be recalled that DLTs do not prevent intermediation so that a rogue can still rely on intermediaries to camouflage his holdings if they exceed the disclosure threshold, in which case regulators are left to rely on existing tools of enforcement. In some instances, a balance cannot actually be achieved between competing traits. Thus, a DLT can either be immutable or subject to law but not both:52 an immutable DLT that is rectifiable is an oxymoron. One cannot hypothesize a legal revolution on the basis of a fictional DLT with all of the strengths and none of the weaknesses of all known DLTs. It is simple enough to dismiss the disintermediation fantasy by examining the recent history of endogenous cryptoassets such as Bitcoin. ‘Considering that crypto-assets are native to decentralised blockchains, the proliferation of crypto-asset exchanges suggests that there is

Christoph van der Elst & Anne Lafarre, Blockchain and Smart Contracting for the Shareholder Community, Eur. Bus. Org. L. Rev. 111 (2019); Geis, supra note 40; Federico Panisi, Ross P. Buckley & Douglas W. Arner, Blockchain and Public Companies: A Revolution in Share Ownership Transparency, Proxy-Voting and Corporate Governance? 2 Stan. J. Blockchain L. & Pol’y 189 (2019); Sarah Green & Ferdisha Snagg, Intermediated Securities and Distributed Ledger Technology, in Gullifer & Payne, supra note 31, at 337–58. 49 Law Com., supra note 41. 50 Id. at 57. 51 David Yermack, Corporate Governance and Blockchains 21 Rev. Fin. 7, at 17 (2017). See also Elisabeta Pana & Vikas Gangal, Blockchain Bond Issuance 23 J. Applied Bus. & Econ. 217 (2021). 52 Low & Mik, supra note 1; Schuster, supra note 3; Low, supra note 4. 48

454  Research handbook on corporate liability a commercial demand for intermediation that blockchains will not eliminate.’53 A leading commentator has revealed that ‘market practice highlights that most bitcoin transactions (up to 99 per cent, according to one authoritative source) occur “off-chain” between customers at the same exchange’.54 This is because on-chain transfers are costly in terms of transaction fees and slow, as the general advice is to wait for six blocks of confirmation before treating the transaction as final for Bitcoin, effectively an hour.55 Despite the supposed interest in Bitcoin from institutional investors, few institutional investors invest directly, preferring to gain exposure through Bitcoin exchange traded funds (ETFs).56 This is because direct holdings of cryptoassets require an investor to navigate the treacherous path ‘between the Scylla of fraud and the Charybdis of loss’:57 the latter dictates that multiple copies be kept, as the loss of the only copy of a private key is disastrous whereas the former implores against multiplicity since each additional copy is an additional point of failure. Any DLT that commits to immutability will likely see similar commercial pressures towards intermediation peculiar to the cryptoasset markets arise quite apart from the existing commercial pressures in the securities market that led to intermediation. Glaringly absent in prophecies proclaiming the coming DLT revolution are explanations of how DLTs will in and of themselves replicate the services currently provided by existing intermediaries.58 Any investor who wishes to invest in securities, some of which are centrally recorded and some of which are recorded on DLTs, will likely choose intermediation if only for convenience alone. Likewise, assuming all securities worldwide are recorded on DLTs, intermediation will again likely be preferred for the same reason unless all CSDs choose to use a single DLT, which seems highly unlikely given the phenomenon of blockchain balkanization we see today. Although there is talk of blockchain interoperability,59 this will be extremely challenging, especially if one is ideologically committed to decentralization. If one is not so committed, then we are merely in the realm of software compatibility60 and there is no reason why we should not explore the interoperability of centralized ledgers. Furthermore, arguably the greatest challenge of interoperability is backwards compatibility61 – many end users, including business end users, cling to legacy systems62 – else one sacrifices inclusion

Low & Mik, supra note 1, at 161. Matteo Solinas, Bitcoiners in Wonderland: Lessons from the Cheshire Cat, Lloyd’s Maritime & Comm. L. Q. 433, 434 (2019). 55 Kelvin F.K. Low, Trusts of Cryptoassets, 34 Trust L. Int’l 191, 204 (2020). 56 Rachel McIntosh, Are Institutional Investors Buying Bitcoin? BTC’s Institutional Growth, Coinmotion (July, 27 2021), https://​coinmotion​.com/​are​-institutional​-investors​-buying​-bitcoin​-btcs​ -institutional​-growth 57 Low, supra note 4, at 209. 58 Cf. Twemlow, supra note 33, at 105–106. 59 See, e.g., Rafael Belchior, André Vasconcelos, Sérgio Guerreiro & Miguel Correia, A Survey on Blockchain Interoperability: Past, Present, and Future Trends, 54 A.C.M. Computing Surv. 168 (2022). 60 Cf. Peter Wagner, Interoperability, 28 ACM Computing Surv. 285 (1996). 61 Cf. Polkadot’s interoperable blockchains, dubbed parachains, which offer forward compatibility. See Gavin Wood, XCM Part II: Versioning and Compatibility, Polkadot Blog, Sep. 16, 2021, https://​ polkadot​.network/​blog/​xcm​-part​-two​-versioning​-and​-compatibility 62 Ravi Khadka, Belfrit V. Batlajery, Amir M. Saeidi, Slinger Jansen & Jurriaan Hage, How Do Professionals Perceive Legacy Systems and Software Modernization?, Proceedings 36th Int’l Conf. Software Engineering 36 (2014). 53 54

The company and blockchain technology  455 for interoperability. Bridges between blockchains introduce further points of failure63 and interoperable immutable blockchains pose peculiar risks to end users.64 Even assuming that these services can somehow be replicated by a particular, as yet non-existent DLT, it is not obvious that the cost savings from disintermediation will be passed on to the end investor. As a Bank of England Staff Working Paper warned, on the assumption that such a DLT is technically possible, ‘the economic surplus obtained by technological improvements and by dis-intermediating traditional post-trade processing risks either being offset by deadweight loss or being entirely consumed by the new network provider(s)’.65 In this respect, it should be noted that cryptoasset intermediaries currently enjoy fatter margins than their non-cryptoasset counterparts.66 One of the oft-heralded benefits of DLT is its potential to remove the distinctions between trading, clearing and settlement. It is often assumed that today’s settlement cycles (‘T+2’ for many stock exchanges) are limited by technology when in truth it is a policy choice. In the UK, ‘[i]mmediate same day settlement is available today, while liquid equity trades have a two day period between trading and settlement’.67 The US Depository Trust & Clearing Corporation (DTCC) notes that the National Securities Clearing Corporation (NSCC) and DTC ‘can support T+1 and even same-day (T+0) settlement today, using existing technology’.68 The T+2 settlement cycle is a market convention so that shortening the cycle is an exercise in industry coordination rather than technological upgrade. Cryptomaniac dreams of real time gross settlement, in which counterparty risks are eliminated, are quite simply unrealistic and come with significant downsides. ‘Immediate settlement at the point of trade comes with additional risks and costs (such as additional liquidity costs and loss of netting and other efficiencies) and may make compliance checks difficult.’69 If the DLT is immutable, immediate settlement will leave no time for inevitable mistakes, whether stemming from bugs or fat fingers, to be discovered and rectified. If the DLT is rectifiable, rectification will necessarily impact trades executed by smart contracts that had operated on the unrectified state of the ledger. Some legal scholars have speculated that DLTs will resolve the collective action problem where shareholding is widely diffused. Although large institutional shareholders are well advised and they would have the ability to engage with management, retail shareholders often

63 Andrew Thurman, Blockchain Bridge Wormhole Suffers Possible Exploit Worth over $326M, CoinDesk (Feb. 3, 2022), https://​www​.coindesk​.com/​tech/​2022/​02/​02/​blockchain​-bridge​-wormhole​ -suffers​-possible​-exploit​-worth​-over​-250m 64 Zhiyuan Sun, Vitalik Buterin Gives Thumbs Down to Cross-chain Applications, CoinTelegraph (Jan. 7, 2022), https://​cointelegraph​.com/​news/​vitalik​-buterin​-gives​-thumbs​-down​-to​-cross​-chain​ -applications 65 Evangelos Benos, Rodney Garratt & Pedro Gurrola-Perez, The Economics of Distributed Ledger Technology for Securities Settlement 28 (Bank of England Staff Working Paper No. 670, 2017), https://​ www​.bankofengland​.co​.uk/​working​-paper/​2017/​the​-economics​-of​-distributed​-ledger​-technology​-for​ -securities​-settlement 66 Eva Szalay, Crypto Exchanges Are Booming, for Now, Financial Times (Aug. 24, 2021), https://​ www​.ft​.com/​content/​d09adf75​-9ee9​-4c47​-9595​-69c02113febe 67 Twemlow, supra note 33, at 107. 68 DTCC, Advancing Together: Leading the Industry to Accelerated Settlement 5 (Feb. 2021), https://​www​.dtcc​.com/​-/​media/​Files/​PDFs/​White​-Paper/​DTCC​-Accelerated​-Settle​-WP​-2021​.pdf 69 Twemlow, supra note 33, at 107. See also DTCC, ‘Building the Settlement System of the Future’ at 5 (Sep.  2021), https://​www​.dtcc​.com/​-/​media/​Files/​Downloads/​WhitePapers/​DTCCs​-Project​-ION​ -Platform​-Moves​-to​-Development​-Phase​-Following​-Successful​-Pilot​-with​-Industry​.pdf

456  Research handbook on corporate liability have difficulties engaging management directly due to their individually small stakes. As Daniels observes, ‘retail investors cumulatively represent significant blocks of shares, but an individual retail investor has few incentives to incur the time and effort costs of voting’.70 The unfortunate reality is that retail investors have limited attention and are almost exclusively concerned with achieving high returns.71 Similar traits can be found in the cryptoasset community, which is made up of mostly retail investors. A 2020 survey by CoinGecko of yield farmers, shorthand for a strategy by which cryptoasset owners temporarily place their cryptoassets at the disposal of some startup’s application for profit (i.e. a loan), demonstrated that although 79 per cent of yield farmers claimed to understand the associated risks and rewards of their investments, 40 per cent of them admitted they did not know how to read smart contracts.72 Accordingly, it is difficult to understand how a DLT will magically cure retail investors of their overconfidence and apathy. Van der Elst and Lafarre argue that a permissioned DLT can set rules on voting or be used as a common platform for investors to ask questions at general meetings so that these questions can be transparently communicated to the investors.73 But if the investors do not even show up or are otherwise uninformed and so unaware of what questions to ask, it is hardly obvious how DLT will incentivize them to do so. Andhov74 has argued that DLTs can be used to solve the coordination problem because of its transparency, allowing shareholders to coordinate among themselves in dealings with the board of directors, particularly ahead of major contested shareholder decisions, but this suggestion both ignores the greater problem of shareholder apathy and makes the dubious assumption that any DLT implemented will be fully public. In a private DLT, it is not obvious that the identity of shareholders will necessarily be made available to other shareholders nor is it in the interests of the company to do so. The shambolic track record of DAO voting75 suggests that many of these postulations are more wishful thinking than realistic. Even large institutional investors are reluctant to coordinate among themselves due to regulatory concerns that they may be acting in concert. In the UK, concerns arise over whether shareholders may be held to be acting in concert under the City Code on Takeovers and Mergers so that they will be required to make mandatory bids, though the UK Panel of Takeovers and Mergers has clarified that most kinds of engagement are not likely to be so

70 Alexander Daniels, Blockchain and Shareholder Voting: A Hard Fork for 21st Century Corporate Governance 21 U. Pa. J. Bus. L. 405, 439–40 (2018). 71 Cf. Turan G. Bali, David Hirshleifer, Lin Peng & Yi Tang, Attention, Social Interaction, and Investor Attraction to Lottery Stocks (NBER Working Paper 29543, 2021), https://​www​.nber​.org/​papers/​ w29543 72 See Yield Farming Survey: 25 August 2020 – 4 September 2020, CoinGecko (2020), slide 12, https://​assets​.coingecko​.com/​reports/​Surveys/​2020​-Yield​-Farming​-Survey​.pdf 73 van der Elst & Lafarre, supra note 48. 74 Alexandra Andhov, Corporations on Blockchain: Opportunities & Challenges 53 Cornell Int’l L.J. 1 (2020). 75 See, e.g., the multiple flip-flopping votes by the Tribe DAO on whether or not to compensate victims of the Rari Capital hack. Liam J. Kelly, Tribe DAO Votes to Repay Rari Capital Hack Victims—Again, Decrypt (Sep.  20, 2022), https://​decrypt​.co/​110102/​tribe​-dao​-votes​-repay​-rari​-capital​ -hack​-victims​-again, or the outright oppressive vote by the Juno Network DAO to expropriate a supposed whale. Liam J. Kelly, How the Juno Network DAO Voted to Revoke a Whale’s Tokens, Decrypt (Mar. 20, 2022), https://​decrypt​.co/​95435/​juno​-network​-dao​-proposal​-16​-voted​-to​-revoke​-tokens​-from​-whale

The company and blockchain technology  457 regarded.76 In the US, even after the various regulatory changes and case law, concerns remain over the risks of violating section 13D of the US Securities and Exchange Act of 1934 if shareholders who consult together may be regarded as acting as a group, with public disclosure and economic consequences.77 If the objective is facilitating shareholder stewardship, particularly among retail shareholders, the solution has to lie in removing or simplifying the impediments for them to exercise their votes, such as by regulating the ability of intermediaries to limit their liability in their terms and conditions. Our current structure of intermediated holding of securities did not arise by design but was shaped by the invisible hand of the market. It has given rise to numerous problems, in part because the underlying laws assume direct holding and in part because the participants have favoured particular advantages over others. Latterly, it seems obvious that if an investor deliberately chooses to outsource its voting rights to an intermediary, it should not be able to exercise the said voting rights. One cannot have one’s cake and eat it and no amount of distribution ought to change the outcome. As to the former, some of these can be circumvented by clever interpretation by the courts. Thus, although s 90A of the Financial Services and Markets Act 2000 (FSMA), read with paragraph 8(3) of Schedule 10A, provides that only persons with an ‘interest in securities’ have claims against issuers for misleading statements or dishonest omissions, appearing to suggest that only direct holders could sue, in SL Claimants v Tesco Plc,78 the English High Court refused to strike out the claims of UAHs holding through intermediaries, suggesting that an equitable proprietary right would suffice as an ‘interest in securities’. Such creativity is not always possible so that the rule of privity prevented a UAH who held a bearer bond through intermediaries from having any recourse against its issuer79 and section 90 of the FSMA does not apply to private placements. Some issues are easily resolved, such as the stumbling block posed by section 899 of the Companies Act to bondholder schemes of arrangement: the majority in number requirement can simply be removed.80 Others, such as whether to extend section 90 of the FSMA to private placements, is less obvious. At any rate, it is clear that our legal plumbing requires updating to reflect the market reality of intermediation, whether to address obvious problems or resolve uncertainty. It is less clear that disintermediation is necessary or even desirable. B.

DLT Data Management: When Naïveté Meets Reality

DLTs have also been described as having the potential to revolutionize the way data are used in business organizations. For instance, it has been suggested that blockchain technology could be used by companies in their financial accounting – utilizing blockchain-based ledgers to account for a company’s assets, liabilities and transactions.81 In a 2018 report, the Institute of Chartered Accountants in England and Wales (ICAEW) described blockchain as ‘fundamentally an accounting technology’ and highlighted how 76 UK Panel on Takeovers & Mergers, Practice Statement No. 26: Shareholder Activism (Sep. 9. 2019), https://​www​.thetakeoverpanel​.org​.uk/​wp​-content/​uploads/​2008/​11/​ps26​.pdf 77 17 C.F.R. § 240.13d-5; Joseph A. McCahery, Zacharias Sautner & Laura T Starks, Behind the Scenes: The Corporate Governance Preferences of Institutional Investors, 71 J. Fin. 2905 (2016). 78 [2019] EWHC 2858 (Ch). 79 Secure Capital SA v. Credit Suisse AG, [2017] EWCA Civ. 1486. 80 Payne, supra note 43, at 175. 81 Yermack, supra note 51, at 24–26.

458  Research handbook on corporate liability blockchains ‘allow for a greater degree of transparency than traditional ledgers’.82 At the core of proposals to utilize DLTs in the realm of corporate accounting is the idea of creating an accounting information system that holds data in a secure and ‘self-verifying’ way.83 Similarly, a combination of blockchain ledgers, smart contracts and ‘Internet of Things’ (IoT) devices has been suggested as a way to improve the security and transparency of corporate supply chains,84 which supposedly supports global efforts to improve the sustainability of corporate activities.85 Let us first examine the case for using DLTs in the area of financial accounting. It has been suggested that DLTs could enable ‘real-time accounting’, with firms posting transaction and asset data to a (public or private) DLT. This, it is claimed, would allow investors and others to gain a real-time perspective of a company’s financial position, aggregate the information into real-time income statements and balance sheets and hence remove the need for periodic financial disclosures. Data so recorded and made available would be safe from (clandestine) ex post alterations due to the design of most blockchain protocols.86 There are two reasons to remain very sceptical of the significance of any impact DLTs will – or could ever – have on accounting and financial disclosures. First, it is not clear that companies providing more direct access to their financial records would indeed be beneficial for companies themselves or their investors. The vision of a firm providing reliable, useful (and to some extent ‘immutable’ or tamper-evident) real-time data on its operations seems to largely ignore, for instance, the significant and unavoidable judgement and discretion involved when a company, at least one of meaningful complexity, prepares its financial statements. The extent of this discretion as well as its importance for corporate decision-making and corporate governance more broadly are topics long recognized, and extensively studied, in both accounting and corporate governance research.87 When Apple Inc., for instance, defers some of its revenue to reflect the ‘unspecified software upgrade rights … bundled in the sales price of the respective product’,88 it will presumably determine the appropriate revenue deferral based on its non-public and commercially sensitive ICAEW, Blockchain and the Future of Accountancy (2018), https://​www​.icaew​.com/​-/​media/​ corporate/​files/​technical/​technology/​thought​-leadership/​blockchain​-and​-the​-future​-of​-accountancy​.ashx 83 See, e.g., Jun Dai & Miklos A. Vasarhelyi, Toward Blockchain-Based Accounting and Assurance, 31 J. Info. Sys. 5 (2017). 84 See, e.g., Rita Azzi, Rima Kilany Chamoun & Maria Sokhn, The Power of a Blockchain-based Supply Chain, 135 Computers & Indus. Engineering 582 (2019); Vishal Gaur & Abhinav Gaiha, Building a Transparent Supply Chain, 98 Harv. Bus. R. 94 (2020); Nir Kshetri, Blockchain’s Roles in Meeting Key Supply Chain Management Objectives, 39 Int’l J. Info. Mgmt. 80 (2018). 85 See, e.g., Mahtab Kouhizadeh, Sara Saberi & Joseph Sarkis, Blockchain Technology and the Sustainable Supply Chain: Theoretically Exploring Adoption Barriers, 231 Int’l J. Prod. Econ. 107831 (2021). 86 Yermack, supra note 51, at 24; Dai & Vasarhelyi, supra note 83. 87 See, e.g., Connie L. Becker, Mark L. Defond, James Jiambalvo & K.R. Subramanyam, The Effect of Audit Quality on Earnings Management, 15 Contemp. Acct. Res. 1 (1998); Alex Edmans, Vivian W. Fang & Katharina A. Lewellen, Equity Vesting and Investment, 30 Rev. Fin. Stud. 2229 (2017); Robert M. Bowen, Shivaram Rajgopal & Mohan Venkatachalam, Accounting Discretion, Corporate Governance, and Firm Performance, 25 Contemp. Acct. Res. 351 (2008); Michael Ettredge, Ying Huang & Weining Zhang, Earnings Restatements and Differential Timeliness of Accounting Conservatism, 53 J Acct. & Econ. 489 (2012). 88 See Apple Inc., Annual Report (Form 10-K) (Oct 29, 2021), https://​www​.sec​.gov/​ix​?doc​=/​ Archives/​edgar/​data/​320193/​000032019321000105/​aapl​-20210925​.htm 82

The company and blockchain technology  459 information, the sharing of which would be potentially harmful as it may aid competitors and others. Similar examples can be found on virtually every page of a company’s financial statements – from allocation of costs and revenues to different business segments to decisions about provisions and contingent liabilities or the accounting for restructuring costs. Accounting is both a big industry and an academic discipline precisely because it involves complex decisions and requires experts to assess how rules and principles should best be applied to the specific circumstances of a firm. Modelling it as little more than stubbornly adding and subtracting objectively verifiable numbers demonstrates gross misunderstanding. If, however, the preparation and presentation of financial statements involves a strong human element and requires the exercise of judgement and expertise, the automated real-time disclosure of meaningful financial data appears impossible – at the very least until companies dramatically increase the resources they devote to the disclosure process, which is of course the exact opposite of the technology’s apparent promise. Moreover, even if publishing informative, real-time transaction data were indeed feasible and of value for investors, disclosing such data would necessarily entail obvious indirect costs for the affected firms. The ability of private firms to avoid the costs associated with third-party effects of public disclosures – i.e. the positive effect such disclosures have on competitors – has for instance been identified as one of the reasons for the rise of private markets.89 More granular, real-time data would likely greatly increase these negative effects for issuers. Finally, even a passing consideration of typical accounting scandals will show that the use of openly accessible real-time financial data is highly unlikely to prevent accounting fraud. Accounting fraud tends to be perpetrated by high-level executives90 and hardly ever involves – and likely never requires – a nefarious ex post alteration of database entries. It is hard to see, for instance, how the use of Enron’s infamous special purpose vehicles (SPVs)91 could plausibly have been prevented by making – still fraudulent – data accessible in real time on a blockchain ledger. This is a simple case of the classic ‘garbage in – garbage out’ problem that pervades cryptomaniac logic:92 if the initial data are incorrect, whether inadvertently or due to fraud, securing them cryptographically does little to improve their reliability. We thus conclude that there is little theoretical justification for expecting that moving to a DLT-based system for financial data disclosure in fact offers tangible advantages to investors, creditors or other stakeholders. The second, and potentially stronger, reason for scepticism towards a DLT revolution in accounting is more technical in nature. As we have explained, the key characteristic of permissionless blockchains is their supposed immutability. At their core, therefore, blockchain-based ledgers differ from traditional databases not by the type (or richness) of data they can hold, but simply by the way data is organized, stored and secured. Consequently, when discussing the benefits of blockchain-based ledgers in accounting – real-time or otherwise – we must focus See, e.g., the excellent discussion in Elisabeth de Fontenay, The Deregulation of Private Capital and the Decline of the Public Company, 68 Hastings L.J. 445 (2017). 90 See, e.g., the analysis of cases in Zabihollah Rezaee, Causes, Consequences, and Deterrence of Financial Statement Fraud, 16 Critical Persp. Acct. 277 (2005); Mark S. Beasley, Joseph V. Carcello & Dana R. Hermanson, Fraudulent Financial Reporting: 1987–1997: An Analysis of U.S. Public Companies (1999), https://​egrove​.olemiss​.edu/​cgi/​viewcontent​.cgi​?article​=​1330​&​context​=​aicpa​_assoc 91 For a description, see for example Steven L. Schwarcz, Enron and the Use and Abuse of Special Purpose Entities in Corporate Structures, 70 U. Cin. L. Rev. 1309 (2002). 92 Low and Mik, supra note 1, at 155. 89

460  Research handbook on corporate liability on features and applications that are specifically enabled by, and thus plausibly connected to, the use of the technology in question, rather than on advantages of, for instance, digitalization more generally.93 Upon closer inspection, however, it is evident that blockchain ledgers are neither necessary nor sufficient for enabling the perceived benefits of real-time accounting, to prevent fraudulent alteration of accounting data, or to increase the transparency of company financial data. Virtually all major, publicly traded corporations already use sophisticated business software to record, track and validate their transactions. Companies like SAP and Oracle, and countless vendors of enterprise accounting and inventory software, specialize in creating data solutions for enterprises that enable managers to access and utilize internal data in their decision-making. These systems typically provide different levels of data access to internal users, and – where appropriate – interface with systems of third parties, such as suppliers and customers. Put differently, the very data that one could be tempted to ‘put on the blockchain’ already exists in easily accessible form within firms. If not for the – as we think – overwhelming commercial reasons not to do so, companies could easily make some of these data accessible to outside investors, creditors or others. If, say, Apple wanted to share real-time data on iPhone sales with its shareholders, it could presumably make the relevant data available at negligible (direct) cost. The fact that companies generally choose not to make such data available is unsurprising – the indirect costs of doing so likely far outweigh the benefits. How, if at all, can the use of blockchain technology alter the cost-benefit calculation that has led firms to almost universally reject an ‘open data’ approach to accounting so far? The direct costs of making available data using traditional (non-blockchain) systems are already negligible, and in any event the addition of blockchain-based ledgers to existing internal systems cannot plausibly reduce these direct costs. The indirect, commercial cost of disclosing more granular financial and transaction data in real time, on the other hand, is a consequence of third parties acquiring the knowledge underlying the data,94 and is hence generally independent of the way in which it is stored. It follows that blockchain applications in accounting would need to somehow increase the benefits of making real-time disclosures to justify any expectation of the technology’s transformative potential. However, whereas blockchains are regarded by some to have introduced various technologically novel concepts, the subset of features that could reasonably be used to improve the permanence or immutability of a company’s internal data are in no way unique to blockchains, and often absent from DLTs more broadly. In particular, companies could easily design their traditional systems in a way that ensures data tampering is evident to any of its users. Technologies like cryptographic hash functions95 have been available for decades,96 and they enable companies to digitally commit to the data made available, whether or not they use blockchain ledgers. Similarly, as discussed above, companies are acutely aware of the risk of data losses, and generally ensure that backups of crucial business data are available. It would 93 For a more detailed discussion of the right comparator for benchmarking blockchain solutions, see Schuster, supra note 3, at 997–98. 94 See the discussion in de Fontenay, supra note 89. 95 For an excellent overview, see Arvind Narayanan, Joseph Bonneau, Edward Felten, Andrew Miller & Steven Goldfeder, Bitcoin and Cryptocurrency Technologies: A Comprehensive Introduction 2–10 (2016). 96 Bart Preneel, Cryptographic Hash Functions, 5 Eur. Transactions on Telecommunications 431 (2010).

The company and blockchain technology  461 therefore be incorrect to assume that the use of blockchains, or indeed any other types of DLT, would unlock functionally novel possibilities for companies. Instead, it appears that – as is so often the case in the cryptoverse – the proposed use of DLTs largely aims to solve non-existent (or long-solved) problems, while offering no tangible benefit over the use of traditional systems, often as a result of ignorance of the complexity of commerce and/or the corporation. The same is largely true for the use of DLTs for increasing the transparency of and improving the security of supply chains.97 Perhaps even more so than in the case of financial data, supply chain data suffer from the limitations of the ‘garbage in – garbage out’ problem. The design challenge thus is to create a system that addresses the risk that data held in the blockchain ledger ‘may simply be immutable garbage’98 – no blockchain or DLT system can, in and of itself, ensure the veracity of the data entered.99 This, however, is the obvious main risk for supply chain data: an untrusted third party can just as easily add false data to a blockchain ledger as into any traditional database. One proposed technological solution for this problem is the utilization of IoT devices (i.e. essentially network-connected sensors) to improve the reliability of the data in the ledger.100 While it is undoubtedly true that sensor-based monitoring can in some cases improve the reliability of data compared to manual entries,101 no plausible reason exists for assuming that the use of DLTs meaningfully contributes to this reliability. Even more so than in the case of financial data, the users of supply chain data are unlikely to be particularly worried about data-tampering, as they will often be in a position to ensure direct receipt of the data (and would thus only have to worry about their own tampering). As in the case of financial data, the database-facing technology to replicate the features of blockchains relevant for this application have existed for decades. This seems to imply that the actual problems with creating reliable supply chain data are not rooted in problems with the holding and processing of data, but instead exist, as so often happens, at the interface between our complex and messy world on the one hand, and its simplified representation in the world of machine-readable data on the other hand. Based on our analysis of how companies and their stakeholders use and process data, we thus do not believe that a rational case can be made for DLTs holding the potential to revolutionize how firms account for or trace their assets, liabilities or transactions. Rationality, of course, is not a reliable guide.102 While we remain sceptical, we readily admit that DLTs could of course be used to hold corporate financial or supply chain data, irrespective of whether See, e.g., Azzi et al., supra note 84; Gaur & Gaiha, supra note 84. Warwick Powell et al., Garbage in Garbage Out: The Precarious Link between IoT and Blockchain in Food Supply Chains, 25 J. Ind. Info. Integration 100261 (2022). 99 Low and Mik, supra note 1, at 144–45. 100 See, e.g., Neda Azizi et al., IoT–Blockchain: Harnessing the Power of Internet of Thing and Blockchain for Smart Supply Chain, 21 Sensors 6048 (2021); Abderahman Rejeb, John G. Keogh & Horst Treiblmaier, Leveraging the Internet of Things and Blockchain Technology in Supply Chain Management, 11 Future Internet 161 (2019); Muzammil Hussain et al., Blockchain-Based IoT Devices in Supply Chain Management: A Systematic Literature Review, 13 Sustainability 13646 (2021). 101 But with the caveat that sensors can malfunction and be tampered with. 102 Tommy Koens & Eric Poll, The Drivers Behind Blockchain Adoption: The Rationality of Irrational Choices, in Euro-Par 2018: Parallel Processing Workshops 535 (Gabriele Mencagli et al., eds., 2019). 97

98

462  Research handbook on corporate liability more efficient alternatives exist. As such, we may well see an increase in the use of DLTs by companies; we submit, however, that the results are unlikely to differ significantly from the status quo and are driven more by hype than functionality.

III.

THE WAY OF THE DAO

There have also been attempts to utilize blockchain-based smart contracts to create Decentralized Autonomous Organizations (DAOs). No universally accepted definition of DAOs has yet emerged, but they are usually described as ‘algorithmic’ business organizations103 using blockchain technology and smart contracts for their governance.104 DAOs have been described as alternatives to traditional corporations,105 and a potential solution to the managerial agency problem at the centre of the traditional corporate governance debate.106 While DAOs come in many different varieties, what they tend to have in common is that they use smart contracts enabling investors to directly participate in their decision-making. While this participation has obvious parallels to shareholder voting in a traditional corporation, the protocol-based interactions between the participants in a DAO allow, in principle, for more timely, continuous and far more granular involvement of investors in ‘corporate’ decisions than what we usually observe in traditional firms,107 and the DAO is said to offer a ‘a radically different template for organizational behavior’108 compared to the classic Berle-Means109 model. The first DAO was created in 2016 and raised about US $150 million from investors buying DAO tokens.110 The aim was to operate an organization comparable to a traditional venture capital fund, albeit with investors, that is DAO token holders, voting on the use of funds based on (smart contract) proposals submitted; the DAO would then autonomously implement the decisions of the DAO token holders.111 Shortly after its inception, one of the DAO participants exploited a weakness in the DAO’s smart contract code in what is often described as a See, e.g., Kevin Werbach, Blockchain and the New Architecture of Trust 110 (2018). See, e.g., Primavera De Filippi & Aaron Wright, Blockchain and the Law: The Rule of Code (2018). 105 Wulf A. Kaal, Blockchain-based Corporate Governance, 4 Stan. J. Blockchain L. & Pol’y 1, 5-6 (2021). 106 Id.; see also Anne Lafarre & Christoph Van der Elst, Blockchain Technology for Corporate Governance and Shareholder Activism 6 (ECGI Law Working Paper No. 390, 2018), https://​papers​ .ssrn​.com/​sol3/​papers​.cfm​?abstract​_id​=​3135209 107 In traditional public corporations, only the most significant corporate decisions will usually require a shareholder vote, with day-to-day management delegated, typically, to a board of directors; see generally, e.g., John Armour, Henry Hansmann, Reinier Kraakman & Mariana Pargendler, What Is Corporate Law? in The Anatomy of Corporate Law 1, 11 (Reiner Kraakman et al., eds., 3rd ed. 2017). 108 Chris Brummer & Rodrigo Seira, Legal Wrappers and DAOs (2022), https://​papers​.ssrn​.com/​sol3/​ papers​.cfm​?abstract​_id​=​4123737 109 Adolf A. Berle & Gardiner C. Means, Modern Corporation and Private Property (1932). 110 See Sec. & Exch. Com., Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Release No. 81207 (2017), https://​www​.sec​.gov/​litigation/​investreport/​ 34​-81207​.pdf 111 Id. For a brief description see, e.g., Michele Finck, Blockchain Regulation and Governance in Europe 187–89 (2018). 103 104

The company and blockchain technology  463 ‘hack’.112 The hacker managed to withdraw about a third of the funds raised, a situation that was ultimately remedied by ‘hard forking’ the underlying blockchain protocol, Ethereum,113 in what can be seen as a powerful demonstration of the fact that blockchains are not, ultimately, immutable,114 provided that sufficient consensus towards ex post correction emerges among its users. Despite this rocky start, various DAOs have since been created, with varying levels of autonomy and decentralization.115 A discussion of the precise governance mechanisms of existing and proposed DAOs is beyond the scope of this chapter. Instead, we want to briefly examine the disruptive potential of DAOs as such as an alternative organizational form for business activity. The reader will perhaps not be too surprised at this point that we have strong doubts about the potential of DAOs as viable alternatives to or replacement for traditional corporations – and indeed about the concept’s potential to play any significant role in our economy in the longer term. While the reasons for our scepticism are very much based on the limitations of DLTs described above, we regard the attempt to use the technology to emulate or replace traditional corporations as particularly naïve. There are, it is submitted, at least two fundamental reasons for doubting the usefulness of DAOs. First, DAOs, rather than solving an existing corporate governance problem, reintroduce a challenge that has long been identified, and addressed more efficiently than DAOs can, by all major corporate law jurisdictions. Second, the usefulness of DAOs ultimately depends on a wholesale adoption of blockchain technology in our economies – a development we regard as neither likely nor desirable.116 Virtually all corporate law jurisdictions provide for delegated, centralized management, typically vested in a board of directors or similar corporate body. The reason for this choice is simply that the costs of involving all owners of a firm in decision-making usually far outweigh the benefits.117 There are two components of the costs of direct decision-making by a firm’s shareholders. First, gathering shareholders and holding meetings is obviously costly in itself, and given the myriad decisions a firm of any relevant size has to take on a daily basis, continuous direct decision-making by shareholders on day-to-day matters clearly is not feasible. The second type of cost relates to inefficiencies and the value of private information: high-quality decisions can only be made by informed agents. A lively debate exists, of course, on the optimal delineation of the powers of boards and shareholders, but few if any corporate scholars would doubt that a degree of general centralized authority, vested in a board, will generally bring about better decisions at lower cost.118 Having a smaller group of specialized, 112 Sec. & Exch. Com., supra note 110; see also Finck, supra note 111, at 187–89; Michael Schillig, Decentralized Autonomous Organizations (DAOs) under English Law (2022), https://​papers​.ssrn​.com/​ sol3/​papers​.cfm​?abstract​_id​=​4221221; David Gerard, Attack of the 50 Foot Blockchain: Bitcoin, Blockchain, Ethereum & Smart Contracts 108–10 (2017). 113 See Werbach, supra note 103, at 67. 114 See Finck, supra note 111, at 188. 115 For an overview of existing design choices, see, e.g., Aust. Law Reform Com., New Business Models, Technologies, and Practices (2022), https://​www​.alrc​.gov​.au/​publication/​fsl7/​ 116 See, e.g., Low & Mik, supra note 1, Schuster, supra note 3, Low, supra note 4. 117 For a discussion of centralized management as core feature of corporations generally, see, e.g., Armour et al., supra note 107, at 11–13. 118 For a discussion of the trade-off between shareholder and board power, see, e.g., Stephen M. Bainbridge, Director Primacy and Shareholder Disempowerment, 119 Harv. L. Rev. 1735 (2006); Lucian Arye Bebchuk, The Case for Increasing Shareholder Power 118 Harv. L. Rev. 833 (2005);

464  Research handbook on corporate liability professional managers acquire and evaluate business information and act on this basis is not only more efficient than collective shareholder voting, it also enables companies to hold and take into account proprietary, non-public information without sharing it with all investors, and hence, functionally, the public. Indeed, we suspect that very few businesses could operate successfully without using some confidential information, which naturally requires a degree of centralized decision-making as soon as a firm has more than just a handful of investors. The centralization of authority does of course also introduce agency problems,119 the minimization of which is the central focus of much corporate law and governance. How do DAOs fit into this debate? One view is that DAOs ‘solve’ agency problems and hence remove or mitigate agency costs.120 However, the deep flaw of this thinking is that this is ultimately a proposal to remove the agent (i.e. the manager) to solve the agency cost problem. While it is self-evidently true that agency costs can be avoided by not utilizing agents (in the economic sense), what is missing, of course, is a plausible way of replicating the significant advantages traditional corporation derive from creating the managerial agency relationship in a form that can be utilized by DAOs without rendering them pointless. One could argue that the exercise of voting and other governance rights by participants (token holders) of a truly autonomous DAO does not entail the direct costs of continuous shareholder decision-making described above, which could thus shift the optimal allocation of authority towards investors compared to a traditional firm. Historically, these costs have largely been linked to holding physical meetings – costs DAOs would not incur. This argument ignores, however, that the legal and (non-DLT) technological prerequisites for electronic voting by shareholders and virtual shareholder meetings have long existed,121 with no discernible effect on the typical allocation of powers in the modern corporation. The reason for this is simply, it is submitted, that the direct costs of transmitting and aggregating investor votes pales in comparison to the far greater indirect costs a direct ‘shareholder democracy’122 would necessarily impose on the firm and its investors. From this perspective, the attempt to remove agency costs by putting a diverse and uncoordinated group of investors directly in charge of

William W. Bratton & Michael L. Wachter, The Case Against Shareholder Empowerment, 158 U. Pa. L. Rev. 653 (2010). For a review of the debate and the evidence it relies on, see, e.g., David Kershaw & Edmund Schuster, The Purposive Transformation of Corporate Law, 69 Am. J. Comp. L. 478 (2021). See also Sofie Cools, The Dividing Line Between Shareholder Democracy and Board Autonomy: Inherent Conflicts of Interest as Normative Criterion, 11 Eur. Company & Fin. L. Rev. 258 (2014). 119 For an overview, see, e.g., John Armour, Henry Hansmann & Reinier Kraakman, Agency Problems and Legal Strategies, in Kraakman et al., supra note 107. 120 See, e.g., Kaal, supra note 105, at 6, arguing that blockchain and smart contracts could enable ‘near error free, and zero transaction/agency cost coordination’ between corporate actors; Alex Murray, Scott Kuban, Matt Josefy & Jon Anderson, Contracting in the Smart Era: The Implications of Blockchain and Decentralized Autonomous Organizations for Contracting and Corporate Governance, 35 Acad. Mgmt. Persp. 622 (2021). 121 This has for instance widely been used in the context of the recent pandemic, but virtual shareholder meetings have been possible in many jurisdictions throughout the last decade; see, e.g., Dirk A. Zetzsche, Virtual Shareholder Meetings and the European Shareholder Rights Directive – Challenges and Opportunities, (2007), https://​papers​.ssrn​.com/​sol3/​papers​.cfm​?abstract​_id​=​996434 122 DAO governance is highly concentrated. ‘By analyzing the distribution of ten major DAOs’ governance tokens, we find that, across several major DAOs, less than 1% of all holders have 90% of voting power’: Chainalysis, The Chainalysis State of Web3 Report 47 (Jun. 2022), https://​go​.chainalysis​.com/​ 2022​-web3​-report​.html

The company and blockchain technology  465 corporate decision-making feels more like an attempt to rerun the history of company law, than a serious proposal to improve how businesses are organized.123 Moreover, it is worth highlighting that DAOs are currently used mainly in ‘Decentralised Finance’ (DeFi) applications.124 The reason for this is simple: DAOs can only be truly autonomous as long as they operate exclusively within the blockchain ecosystem. For any interaction with the non-crypto world, a DAO will need to rely on ‘oracles’125 – reintroducing the agency problem, but without the benefit of two centuries’ worth of agency cost mitigation technology (i.e. company law).126 Thus, even ignoring the economic obstacles of DAOs as viable forms of business organization, the technical prerequisite for truly autonomous DAOs replacing traditional corporations is that sufficiently vast parts of our economy reside on the blockchain, and that said blockchains are immune from the immutable garbage problem. As we have argued elsewhere, there are strong reasons to doubt the feasibility, and question the desirability, of such a future.127 Finally, it is worth highlighting that the DAO structure is fraught with significant legal uncertainty. A ‘typical’ unincorporated DAO, for instance, risks being classified as an unincorporated partnership under national partnership laws128 – a problem currently at issue in CFTC v Ooki DAO.129 The reasoning to such a conclusion is not difficult to discern: whatever nomenclature participants may adopt, the characterization of their legal relations is determined by the law, not their labels. Thus, ‘licences’ have been found to be leases,130 ‘sub-leases’ to be assignments,131 and ‘floating charges’ actually fixed in nature.132 ‘The manufacture of a five pronged instrument for manual digging results in a fork even if the manufacturer, unfamiliar with the English language, insists that he intended to make and has made a spade.’133 The legal consequence of such a classification is usually the unlimited personal liability of the ‘partners’ (i.e. the token holders) of the DAO. Without incorporation or registration, eliminating this risk can be difficult, even for legislators, as each jurisdiction will make its own determination of a DAO’s legal status under national law.134 The law applicable to this determination depends

See also Lafarre & Van der Elst, supra note 106, at 8. Schillig, supra note 112. 125 Low and Mik, supra note 1, at 172. 126 See also Brummer & Seira, supra note 108 (highlighting the need for ‘legal personhood’ to interface with the real world). 127 See, e.g., Low and Mik, supra note 1, Schuster, supra note 3; Low, supra note 4. 128 See Carla L. Reyes, Autonomous Corporate Personhood, 96 Wash. L. Rev. 1453 (2021); Carla L. Reyes, If Rockefeller Were a Coder, 87 Geo. Wash. L. Rev. 373 (2019); Carla L. Reyes, Autonomous Business Reality, 21 Nev. L.J. 437 (2021); Stephen D. Palley, How to Sue a Decentralized Autonomous Organization, Coindesk (Mar. 20, 2016), https://​www​.coindesk​.com/​markets/​2016/​03/​20/​how​-to​-sue​-a​ -decentralized​-autonomous​-organization. See also Schillig, supra note 112. 129 Currently pending in the US District Court for the Northern District of California; see, e.g., Brief of LeXpunK as Amicus Curiae, CFTC v. Ooki DAO, NO. 3:22-cv-05416 (N.D. Cal. 2022), https://​www​ .courtlistener​.com/​docket/​65369411/​commodity​-futures​-trading​-commission​-v​-ooki​-dao/​ 130 Street v Mountford [1985] AC 809. 131 Milmo v Carreras [1946] 1 KB 306. 132 Re Brumark Investments Ltd sub nom Agnew v IRC [2001] 2 AC 710; Re Spectrum Plus Ltd [2005] 2 AC 680. 133 Supra note 130, at 819 (Lord Templeman). 134 For a parallel non-blockchain case, see, e.g., European Court of Justice, Case C-208/00, Überseering BV v. Nordic Construction Company and Baumanagement GmbH, E.C.R. I-9919 (2002). 123 124

466  Research handbook on corporate liability on the applicable national conflict rules for business organizations, which differ significantly across jurisdictions.135 Some DAOs thus use so-called ‘legal wrappers’, formally adopting a traditional corporate form or a purpose-made legal structure136 to ensure members benefit from limited liability and the ‘DAO’ benefits from separate legal personality.137 Such incorporated or limited liability company (LLC) DAOs are, in our view, best understood as traditional firms with unconventional – and in our view inefficient – governance arrangements. Since these governance arrangements have long been theoretically available to companies, but rarely if ever used, it seems plausible to assume that they are not ultimately superior to more widely used modes of corporate governance. The fact that governance decisions are implemented using a blockchain protocol does not plausibly alter the costs or benefits in a significant way.

IV. CONCLUSION The blockchain and DLT space is replete with resplendent promises. It is unsurprising, given public dissatisfaction with large corporations, that some of these extend to revolutionizing the corporate form. However, it is pertinent to observe that, some 14 years after the pseudonymous Satoshi Nakamoto introduced the concept of a blockchain and sparked cryptomania, practically all these promises have remained unfulfilled or metamorphosized into an unrecognizable form. To mention but one, the promise of a decentralized non-fiat currency has descended into a speculative investment perhaps better characterized as unlicensed gambling.138 Although the potential is mostly imagined, the hype is real.139 Those who do not invest the time to properly understand the technology, and those unfamiliar with the real challenges of the corporate form, and their historic and economic roots, are at risk of being lulled by the siren call of the cryptoverse, where every misunderstood problem and each under-analysed path dependency has a common solution – the blockchain. We will thus be unsurprised by greater use of DLTs in corporations and the formation of yet more DAOs in the coming years. What we do not expect to see, however, is either ‘innovation’ solving any genuine problem. If anything, some seem doomed to resurrect the dreadful ghosts of past corporate depravities.

135 For a detailed overview from a European perspective, see, e.g., Carsten Gerner-Beuerle et al., The Private International Law of Companies in Europe (2019). 136 See, e.g., Wyoming’s law on DAO LLCs, Wyoming Statute § 17-31-101 et seq. 137 See Brummer & Seira, supra note 108, for an analysis of legal wrappers and possible structures. See also Iris H.-Y. Chiu, Regulating the Crypto Economy: Business Transformations and Financialisation (2021) for an analysis of structuring options. 138 Bob Seeman, The Coinmen 107–43 (2022). 139 Koens & Poll, supra note 102.

Index

absolute liability, and statutory liability 66–7, 68, 78 accessory liability, and joint liability 264–7 accountability digital responsibility, international ethical guidelines 428–9 directors’ business judgments 238, 243, 246, 250–51, 252 group see group accountability securities laws, directors’ and officers’ liability under 175, 183–5 statutory liability 65 accountability for AI labor 434–46 algorithm design 434–6, 437 artificial and organic intelligence similarities 436 corporation’s control over workforce and resulting benefits 436–7 immunity for algorithmic harms 437–8 Labor Model 436–7, 442–3, 444–5 replacing human workers 437–8 see also blockchain technology; digital responsibility accountability for AI labor, contract work (non-employee) 436, 438–42 gig economy classification 439–41 legal immunity for non-employee misconduct 439 legal test for employment 441–2 accountability for AI labor, employed algorithms, respondeat superior doctrine and vicarious liability 443–5 beneficial-control test 444–5 fairness and effectiveness principles 444 intent-to-benefit requirement 443, 444 and scope-of-employment requirement 443–4 affiliates, and group accountability 305, 309, 311 agency issues and attribution 160 blockchain technology, internal governance 464–5 contractual model 15 criminal liability 104–5 director fiduciary and oversight duties and liability under Caremark 196, 197, 209–10 group accountability 300–301 agency liability 136–55

467

agency authority 136–7, 138 apparent authority 138–9, 140 non-authorised agents 137–9 ratification of unauthorised act 137–8 and uncertainty 140, 145, 155 agency liability, directors as agents 138, 140–46 acting as company 141–3 attribution rules 143–4 delegated powers 145–6 liquidator as agent 144 non-executive directors 137, 141 personal liability for procurement of a tortious act 144–5, 151, 152–5 shareholder role in general meeting 142–3, 144 agency liability, vicarious liability 146–55 constructive imposition 151–2 defamatory statements 148–9, 150, 152 identification theory 152–3 motor vehicle drivers 147, 152–3, 154 partnership firms 12, 146–7 wrongful acts 147–51, 152–5 aggregate theory, corporate liability 27, 29, 31 aggregation procedures, overlapping remedies 354–9 Ahern, D. 62–81 AI (artificial intelligence) digital responsibility 414–16, 432 labor accountability see accountability for AI labor tortious liability and risk, information revolution and digitalization of society 127–8 Alchian, A. 28, 240, 436 Alexander, C. 106, 109, 202, 213 algorithms and AI labor see under accountability for AI labor blockchain and Byzantine Fault Tolerance (pBFT) consensus algorithm 449 Allen, W. 7, 8, 15, 55, 197, 198, 208–10, 211, 246, 249 allocated powers rule, and attribution 160–61 Arlen, J. 36, 38, 40, 53, 59, 85, 89, 90, 91, 92, 93, 100, 103, 104, 105, 106, 107, 109, 111, 112, 114, 194–220, 388, 403 Armour, J. 31, 55, 57, 67, 95, 201, 202, 209, 239, 240, 241, 243, 263, 264, 294, 416, 462, 463, 464

468  Research handbook on corporate liability asset partitioning corporate liability, nexus of contracts theory 30–31, 34 group accountability 293, 294, 309–11, 312 ‘at home’ test, international standard identification 370–71, 373, 374, 383 Atiyah, P. 37, 146, 148, 150, 289 attribution 156–72 agency law comparison 160 agency liability, directors as agents 143–4 artificial intelligence (AI), attribution issues, digital responsibility 415–16 attribution as allocated powers rule 160–61 and compensation 163, 164, 166 corporate constituents’ liability 21–2 criminal offences 167–70 derivative benefit (shareholder dividends) 163–4, 166 directors sued for breach of duties 158–9, 162, 163–4, 167–8 and illegality defence 156–7, 158–9, 162, 163, 165–7 joint liability 257–8 joint liability, directors’ liability for corporate wrongdoing 262–4 legal conflicts 167–72 rule-based approaches 157–65, 166 special rules, problems with 158–9 statutory liability see statutory liability, attribution models and third parties 162, 164–6, 167, 170–72 and tortious liability 116–17 two-step test 162–5, 166 uncertainty 158–60 Australia Criminal Code 70 joint venture exception from prohibited cartels 73 serious corporate wrongdoing and criminal law 79–80 Australia, cases Allen Manufacturing Co Pty Ltd v. McCallum & Co Pty Ltd 268 AMI Australia Holdings Pty Ltd v. Bade Medical Institute (Australia) Pty Ltd 268 Ancient Order of Foresters in Victoria Friendly Society Ltd v. Lifeplan Australia Friendly Society Ltd. 260 Anglo-Australian Foods Pty Ltd v. Credit Suisse 377 Armstrong Strategic Management and Marketing Pty Ltd v. Expense Reduction Analysts Group Pty Ltd (No 9) 261

Bird v. DP 279–80 Caswell v. Sony/ATV. Music Publishing (Aust) Pty Ltd 378 Club of the Clubs Pty Limited v. King Network Group Pty Limited (No 2) 260 Colonial Mutual Life Assurance Co of Australia Ltd v. Producers’ and Citizens’ Cooperative Assurance Co of Australia Ltd 147, 148–9, 151–2, 153 Commonwealth Bank of Australia v. Kojic 257, 258 Cooper v. Universal Music Australia Pty 268 CSR Ltd. v. Wren 300 Gambotto v. W.C.P. Limited 142 Grimaldi v. Chameleon Mining NL (No 2) 259, 260 Hallmark Construction Pty Ltd v. Brett Harford 152 Hamilton v. Whitehead 257 Hoath v. Connect Internet Services 268 Hollis v. Vabu Pty Ltd. 277 Inverness Medical Switzerland GmbH v. MDS Diagnostics Pty Limited 268 Johnson Matthey (Aust) Ltd v. Dascorp Pty Ltd 257, 262, 263, 266, 268 JR Consulting & Drafting Pty Ltd v. Cummings 268, 269, 270 Keller v. LED Technologies Pty Ltd 257, 263, 264, 267, 269, 270, 271 Kent v. Vessel SS Maria Luisa 322 King v. Milpurrurru 267 Kuczborski v. Queensland 73 LED Technologies Pty Ltd v. Elecspess Pty Ltd 267 Microsoft Corporation v. Auschina Polaris Pty Ltd 264, 266, 267, 270, 271 New South Wales v. Lepore 290 Northside Developments Pty Ltd v. Registrar-General 20, 21, 140 Oakley Inc v. Oslu Import and Export Pty Ltd 270 O’Brien v. Dawson 264 Owners of the Motor Vessel Iran Amanat v. KMP Coastal Oil Pte Ltd (The Iran Amanat) 321 Owners of Shin Kobe Maru v. Empire Shipping Inc 321 Peter’s American Delicacy Co Ltd v. Heath 142 Pioneer Electronics Australia Pty Ltd v. Lee 264, 268 Pittmore Pty Ltd v. Chan 261, 262

Index  469 Prince Alfred College v. ADC 279, 282, 283, 285, 290 Queensland Mines v. Hudson 260 Realtek Holdings Pty Ltd v. Wetamast Pty Ltd 261 Root Quality Pty Ltd v. Root Control Technologies Pty Ltd 261, 267, 268, 270, 271 Scott v. Davis 147, 149 Shagang Shipping Co Ltd v. Ship Bulk Peace 322 Ship Gem of Safaga v. Euroceanica (UK) Ltd 322 Sporte Leisure Pty Ltd (ACN 008608919) v. Paul’s International Pty Ltd 257, 272, 275 Stevens v. Brodribb Sawmilling Co Pty Ltd 277 Sweeney v. Boylan Nominees Pty Ltd 151, 152, 153, 279 Sydneywide Distributors Pty Ltd v. Red Bull Australia 264, 268, 269 Tisand Pty Ltd v. Owners of the Ship MV. Cape Moreton (ex Freya) 322 Trustees of Roman Catholic Church v. Ellis 279 TS & B Retail Systems Pty Ltd v. 3Fold Resources Pty Ltd 258, 268 Tsaprazis v. Goldcrest Properties Pty Ltd 261 Universal Music Australia Pty Ltd v. Sharman License Holdings Ltd 268 Wah Tat Bank Ltd v. Chan Cheng Kum 257 WEA International Inc v. Hanimex Corporation Ltd 267 authority, and agency liability see under agency liability bad faith standard 56, 198, 206, 210–11, 215, 218–19 Baer, M. 32, 103, 401 Bainbridge, S. 28, 29, 33, 48, 222, 226, 229–30, 234, 237, 238, 239, 249, 300, 310, 463 bank fraud 404 see also fraud Bebchuk, L. 93, 97, 188, 463 Becker, G. 101, 200 beneficial ownership, ship as legal person 322–3, 325 beneficial-control test, accountability for AI labor 444–5 Berger-Walliser, G. 292–314, 375 Berle, A. 127, 462 Bitcoin 447, 449, 453–4 Black, B. 84–5, 181, 182, 186

BlackRock 397–9 Blair, M. 30, 33, 242 blockchain technology 447–66 alternative consensus protocols for permissionless blockchains 448–9 attack vulnerability 448 Bitcoin 447, 449, 453–4 change resistance 449 Ethereum 448, 463 and game theory 447 securities 449–50, 451, 452 shareholders 451, 452, 464–5 and smart contracts 450, 456, 462–3 see also accountability for AI labor; digital responsibility blockchain technology, distributed ledger technology (DLT) 447, 448–50 Byzantine Fault Tolerance (pBFT) consensus algorithm 449 future direction 453 blockchain technology, internal governance, Decentralized Autonomous Organizations (DAOs) 456, 462–6 agency problems 464–5 Decentralised Finance (DeFi) applications 465 electronic voting by shareholders 464–5 legal uncertainty 465–6 origins 462–3 usefulness issues 463–4 blockchain technology, internal governance, distributed ledger technology (DLT) data management 457–62 cost-benefit calculation 460 financial accounting 458–9 internet of things (IoT) devices, use of 458, 461 permissionless blockchains 459–60 risk of data losses 460–61 supply chain data 461 blockchain technology, internal governance, distributed ledger technology (DLT) shareholding 450–57 collective action problem 455–6 disclosure threshold 453 disintermediation cost savings, issues over 455 future direction 453–5 immediate settlement concerns 455 mandatory bids 456–7 trading, clearing and settlement, removing distinctions between 455 blockchain technology, internal governance, intermediation growth 450–6 backwards incompatibility 454–5

470  Research handbook on corporate liability and blockchain interoperability 454–5 broker holdings 452–3 immobilization and dematerialization, distinction between 451 market effects and problems 457 ultimate account holders (UAHs) 451, 453 voting instruction errors 452 Blumberg, P. 293, 303, 304, 305, 310 boards see under directors Borghetti, J.-S. 85, 415 Bowstead, W. 136, 137, 138, 146, 151 Braithwaite, J. 113, 313 Branson, D. 221–2, 228, 230, 235 Bratton, W. 9, 15, 26, 87, 91, 92, 96, 97, 464 breach of contract, and joint liability 261–2 breach of duties, and attribution 158–9, 162, 163–4, 167–8 bribery and statutory liability 75–6 see also fraud Brodie, D. 35, 286, 287, 288 broker holdings, blockchain technology, internal governance 452–3 Buell, S. 40, 100–115, 195, 199, 201, 207, 214, 388, 401, 402, 403 burden of proof business judgment rule and fiduciary liability 229 criminal liability 105, 114 group accountability 309, 313 reverse burdens of proof, statutory liability, attribution models 73 business judgment rule and fiduciary liability 56, 221–36 abuse of power 226 as anomalous 231–4 burden of proof 229 business judgment scope 227 directors and monetary liability for negligence 225 discretion preservation 226–7 and duty of care 229 fiduciary authority 223–5, 226, 227 and good faith 229 judicial review 226, 229, 230–33 as jurisdictional abstention doctrine 230, 232–4 overreach risk 232–3 reformulation issues 228, 229–30, 232 risk preferences of shareholders 233–4 see also directors’ business judgments buy-and-hold investors, issuer liability 87, 88 Calabresi, G. 37, 330, 331, 333 Canada

Allchem Industries Industrial v. Ship CMA CGM Florida 382 Bazley v. Curry 148, 282, 284, 286, 287, 289 Chevron v. Yaiguaje 382 Choc v. Hudbay Minerals 302 Club Resorts v. Van Breda 381, 383 Doe v. Bennett 278 Equustek Solutions Inc v. Google Inc. 382 Hall v. Hebert 163 international standard identification 381–3 KLB v. British Columbia 279 Maple Leaf Foods Inc. v. Schneider Corp. 232 Mentmore Manufacturing Co v. National Merchandise Manufacturing Co 145, 267, 268–70, 271 Pater International Automotive Franchising Inc v. Mr Mechanic 267 Pearlman v. Great West Life Assurance Co. 382 Procon Mining and Tunnelling Ltd v. Waddy Lake Resources Ltd. 382 R v. Wholesale Travel Group 73 Roman Catholic Episcopal Corporation of St George’s v. John Doe 150 Stuart Budd & Sons Ltd v. IFS Vehicle Distributors 382 Transamerica Life Insurance Co. of Canada v. Canada Life Assurance Co. 300 Vahle Global Work & Travel Co 382 Cane, P. 102, 282 Carney, W. 36, 85, 89, 90, 91, 92, 93, 105, 195, 201 Chambers, R. 292–314 charterer, shipping industry 316–18, 319 Chiu, I. 86, 466 Choudhury, B. 24, 31, 33, 192, 241, 242, 245, 254, 292, 293, 300, 301, 310, 311, 313 civil liability corporate liability, justifications, criminal liability 32, 39, 40 and criminal liability 105, 106, 109 joint liability, directors’ liability for corporate wrongdoing 264 statutory liability 67, 69, 79 class actions overlapping remedies see overlapping remedies, class actions securities class actions, issuer liability, and political economy 95–6, 97 tortious liability and risk, risk management 122–4, 125, 126 close connection test, vicarious liability 281–5 Coffee, J. 40, 84, 85, 86, 87, 92, 93, 99, 102, 105, 205, 247, 400, 401, 402

Index  471 collective action 82, 92, 455–6 Collins, D. 119, 323 command and control model, statutory liability 64 common design test, joint liability 265, 266, 267 common law presence test, international standard identification 375–7, 382–3 compensation and attribution 163, 164, 166 and directors’ business judgments 243–4, 251 group accountability 297, 308 issuer liability 85–8, 89–90, 92 statutory liability 66, 69 tortious liability and risk 121, 127, 132–4 vicarious liability 275, 285, 286, 289, 290 see also damages; insurance competence issues 46, 58, 111–12, 114, 247, 248–50 concession theory 25–7, 29, 31, 32 concurrent remedies, overlapping remedies 353, 354, 359–65 consequentialist case, criminal liability 103–4, 105 contract work, and AI see accountability for AI labor, contract work (non-employee) contracting-out and casualisation practices 278–9 see also employment contracts, nexus of contracts theory see corporate liability, nexus of contracts theory corporate constituents’ liability 17–22 attribution rules 21–2 director power 17–18, 19–22 indoor management rule 18–22 corporate liability 24–41 aggregate (participant/contractualist) theory 27, 29, 31 fiction (concession/grant) theory 25–7, 29, 31, 32 modern theories 28–31 real entity (organic) theory 26, 27–8, 29, 31–2 sanctions 39, 40 tort law 32 corporate liability, justifications 34–40 cost-benefit alignment 35, 36–7 efficient risk allocation 37 employees, control over 35 injuries and damages, dealing with 35–6 loss prevention 36–7 traditional 35–6 corporate liability, justifications, criminal liability 32, 37–40 abolitionist view 40 civil liability 32, 39, 40

and corporate moral agency 38 as deterrence mechanism 38–9 societal disapproval and shaming 40 corporate liability, nexus of contracts theory 28–9, 32–3 asset partitioning 30–31, 34 and legal entities 30–31 and limited liability feature 33, 34 non-shareholder interests 29–30, 33–4 and shareholders 29, 30, 33 team production theory 33 corporate separateness paradigm, group accountability 299–306 cost factors blockchain technology, internal governance 455 enterprise liability 332, 333, 342–3 tortious liability and risk 121–2 cost-benefit analysis blockchain technology, internal governance, distributed ledger technology (DLT) data management 460 corporate liability, justifications 35, 36–7 directors’ business judgments, risk-taking 242–3 Cox, J. 47, 48, 57, 88, 89, 92 criminal liability 100–115 agency costs 104–5 agency liability, wrongful acts 147–51, 152–5 and attribution 167–70 burden of proof issues 105, 114 and civil liability 105, 106, 109 and collective reponsibility 102 consequentialist case 103–4, 105 corporate liability justifications see corporate liability, justifications, criminal liability corporations as inanimate 101–2 director fiduciary and oversight duties and liability under Caremark 195–6, 201–2 enforcement 108–13 and ESG see environmental, social, and governmental (ESG) factors and future of criminal liability industry capture concerns 114–15 and institutional responsibility 107–8, 109 legal doctrine 106–8 political economy 113–15 powers of the firm, effects of 103 and public issues 110, 115 reputations 105–6 respondeat superior doctrine 106–7, 108, 111

472  Research handbook on corporate liability retribution effects 102–3 sanctions and punishment 101–2, 103–4, 107, 109, 110, 112 statutory liability 63–4, 65, 68, 79–80 white-collar crime concept 113, 115 criminal liability, official discretion and leniency introduction 108–13, 115 deferred- and non-prosecution agreements (DPAs and NPAs) 109, 110, 112 judicially sentencing cases 112–13 prosecutors and competence issues 111–12, 114 self-reporting and cooperation encouragement 112 Crootof, R. 128, 434 damages corporate liability, justifications, criminal liability 39 environmental, social, and governmental (ESG) factors, fraud cases 405 overlapping remedies 360–62 overlapping remedies, class actions 357–8 tortious liability and risk, risk management 124–5, 126 see also sanctions data management, blockchain technology see blockchain technology, internal governance, distributed ledger technology (DLT) data management Davies, M. 315–29 Davies, P. 18, 141, 143 Davis, K. 95, 227, 230, 231–2 Deakin, S. 28, 287, 289 Decentralized Autonomous Organizations (DAOs) see blockchain technology, internal governance, Decentralized Autonomous Organizations (DAOs) decentralized features, digital responsibility 412, 413 ‘deeper pockets’ argument, vicarious liability 275, 279, 286, 287 defamatory statements, agency liability, vicarious liability 148–9, 150, 152 Deferred Prosecution Agreements (DPAs) 65, 72, 109, 110, 112 Demsetz, H. 240, 436 deterrence issues 38–9 director fiduciary and oversight duties and liability under Caremark 195–6, 197, 198–9, 200–201, 203–4, 213–14 issuer liability 85–6, 89–91, 94 securities laws, directors’ and officers’ liability under 184

systems perspective, feedback mechanisms 53–4 vicarious liability 289 Diamantis, M. 27, 31, 39, 40, 107, 108, 110, 399, 401, 434–46 Dietrich, J. 256–72 digital responsibility 409–33 AI (artificial intelligence) 414–16, 432 AI (artificial intelligence), attribution issues 415–16 blockchain technologies 410–11, 412–13, 424 corporate responsibility expression 422–3 decentralized applications (DApps) 412 decentralized autonomous organizations (DAOs) 413 digitalization design 423–4 director duties 415–16, 431–2 disintermediation by digital platforms 410–11 distributed ledger technologies 410–11, 411–14, 412, 424 enforcement mechanisms 413–14 job losses, corporate initiatives to mitigate 424 monitoring 417, 426–7, 432 responsibility gap, tackling 416–17, 420 self-regulation 429–30 shareholder and stakeholder interests 422–3 smart contracts 412–14 value orientation 422 see also accountability for AI labor; blockchain technology; tortious liability and risk, risks, new, information revolution and digitalization of society digital responsibility, corporate law 425–7, 430–32 artificial intelligence and black box phenomenon 432 board composition and structure 431–2 business judgement and supervision 432 duty to obtain information 425–6 information and disclosure obligations 430–31 obedience duty 426–7 digital responsibility, international ethical guidelines 427–9 accountability requirement 428–9 controllability of technology 428 individual rights, safeguarding 429 public good requirements 429 digital responsibility, origins 418–20 English-language publications 420

Index  473 France, Plateforme RSE consultation body 419 Germany, Corporate Digital Responsibility (CDR) initiative 418–19 Swiss Digital Initiative 420 UK, Centre for Data Ethics and Innovation 419 direct liability group accountability 296–7, 301–3, 307–9, 312 statutory liability, attribution models 69–70, 78 direct and procure test, joint liability, directors’ liability for corporate wrongdoing 266–7 director duties 17–18, 19–22 as agent see agency liability, directors as agents and attribution 158–9, 162, 163–4, 167–8 business judgment rule and fiduciary liability 225 digital responsibility 415–16, 431–2 environmental, social, and governmental (ESG) factors, fraud cases 403 issuer liability 85, 91–2, 93–4, 94, 95 and joint liability see joint liability, directors’ liability for corporate wrongdoing securities laws see securities laws, directors’ and officers’ liability under statutory liability 73–4 systems perspective 47–9, 50, 55, 57–8 see also individual liability director fiduciary and oversight duties and liability under Caremark 55, 105, 194–220, 234–5, 416–17 agency costs 196, 197, 209–10 bad faith standard 198, 206, 210–11, 215, 218–19 Business Judgment Rule protection 204, 209 Caremark 1.0 208–10 Caremark 2.0 212–19 Caremark 2.0, improving director liability 212–14, 219 company liability for employees’ crimes 201–2 criminal liability 195–6, 201–2 deterrence issues 195–6, 197, 198–9, 200–201, 203–4, 213–14 directors’ and officers’ (D&O) insurance 219 enhanced duties, imposition of 195, 198, 199, 212, 213, 214, 215, 216–18 good faith, acting in 197–8, 204, 207–8, 211 individual liability 200–201, 205–6

information on detected material misconduct 199, 201, 202, 204, 207–9, 210–11, 212–14, 217 injunctions 205, 207, 212 management’s ability to undermine investigations 199 optimal deterrence requirements 203–4 personal liability 205–6 plane safety violations 217–18 profit pursuit through misconduct 196–8, 206–7, 210, 211, 213, 214, 218–19 respondeat superior and strict liability 203 sanctions 200, 201, 211 self-reporting 199, 204 social interests 198, 204–8, 216–17 strict liability and negligence, inefficiency of 202–4, 209 tort liability rules 196 violation risks causing serious personal injury or death to multiple people 215–16 see also systems perspective, company liability, Caremark liability directors’ business judgments 237–55 accountability 238, 243, 246, 250–51, 252 and compensation 243–4, 251 individual liability 244–5, 247 limited liability 239–40, 245 sanctions 247, 250 shareholders 239–40, 240–43, 246, 251–2 social interests 249–50 social welfare arguments 239–46 socially optimal risk-taking 239–43 and uncertainty 247, 248, 249 see also business judgment rule and fiduciary liability directors’ business judgments, fairness arguments against Business Judgment Rule (BJR) 246–50 directors’ decision-making and risk-taking 249 disproportionate impact of large awards 247 hindsight bias or lack of competence 247, 248–50 judicial review 238, 248 self-serving behavior consideration 243, 248 social welfare considerations 249–50 directors’ business judgments, fairness arguments for Business Judgment Rule (BJR) review 250–53 accountability 250–51, 252 judicial accountability for business judgment 251, 252 negligence-type liability 250

474  Research handbook on corporate liability ‘vindication of interests’ justification 251, 252 directors’ business judgments, risk-taking 239–46, 249 accountability 243, 246 cost-benefit analysis 242–3 environmental risk 241–2, 245 systemic risks impacting on the public 242, 245–6 value-enhancing activity 243–4, 245–6 disclosure issues blockchain technology, internal governance 453 environmental, social, and governmental (ESG) factors and future of criminal liability 390, 391 issuer liability 86, 90 securities laws 188–90 vicarious liability 275, 276 discretion business judgment rule and fiduciary liability 226–7 criminal liability see criminal liability, official discretion and leniency introduction international standard identification, English position 380 disintermediation 410–11, 455 distributed ledger technology (DLT) blockchain technology see blockchain technology, distributed ledger technology (DLT) digital responsibility 410–11, 411–14, 412, 424 division of labour concept, shipping industry 316, 318 dualism, regulatory, and issuer liability 98 due diligence defence, statutory liability 64, 66–7, 70, 71, 73, 75, 76–7, 78 due diligence laws, group accountability 302–3, 305, 306, 308–9, 310 Easterbrook, F. 28, 86, 89, 239, 310 economic reality test, vicarious liability 277, 278 Eisenberg, M. 229, 247, 248 employment accountability for AI labor 437–8, 441–2 company liability for employees’ crimes 201–2 contracting-out and casualisation practices 278–9 flexible working conditions and vicarious liability 276–8 gig economy 276–7, 439–41

job losses, and digital responsibility 424 enforcement mechanisms criminal liability 108–13 digital responsibility 413–14 Engstrom, D. 196, 364 enterprise liability 330–49 cost factors 332, 333, 342–3 definition 331–4 enterprise-related accidents and proportionality consideration 333–4 negligence 333, 336, 337, 338, 341–3, 347 private law 331 and respondeat superior doctrine 332 systemic risk response 343–7 vicarious liability 330–31, 340 enterprise liability, strict liability 332–3, 334–43 conditional privilege 337–8 conduct-based wrongs 337 and corrective justice 340 fairness principle 339, 340–41, 343–7 harm-based 332, 334–5, 339–43 harm-based, internal morality 336–9 negligence liability, insuring against 341–2 nuisance law 334, 335, 336, 339, 346 power of control 335–6 public law 338 trespass at common law 336, 337–8 unreasonable conduct 334–5, 338 enterprise risk reasoning, vicarious liability 285–90 environmental protection, group accountability 302, 308 environmental risk, directors’ business judgments 241–2, 245 environmental, social and governance (ESG) matters and securities laws see securities laws, directors’ and officers’ liability under, environmental, social and governance (ESG) matters statutory liability 76–7 environmental, social, and governmental (ESG) factors and future of criminal liability 7, 387–408 disclosure issues 390, 391 Expert Group on Global Climate Obligations, Oslo Principles 392 governments first, moving against 391–4 international pattern, US reluctance to follow 394–5 public nuisance tort suit approach 395, 396 public trust doctrine 395 sanctions 403, 404 shaming and norms 388

Index  475 environmental, social, and governmental (ESG) factors and future of criminal liability, fraud cases 388–9, 390, 397–9 bank fraud 404 BlackRock 397–9 companies with incentive to lie 399–400 criminal and civil law, loss of distinction 401–2 damages claims, growth of 405 ExxonMobil case 406–8 incidents not being reported 404–5 political and economic pressures 404–6 prosecution dilemmas 402–4 prosecutions and signs of movement 406–8 resources to combat criminal fraud 405 self-regulation 400, 404 strict vicarious criminal liability 403 top management involvement 403 Volkswagen scandal 400 whistleblowers and the media reliance 400 white-collar crime concept 388, 390, 396, 399, 402, 404, 405–6 Ethereum 448, 463 ethical guidelines, digital responsibility see digital responsibility, international ethical guidelines EU AI Act 427 Collective Redress Directive 98 Contracts for the Supply of Digital Content and Digital Services Directive 430 Corporate Sustainability Directive proposal 76, 77 General Data Protection Regulation (GDPR) 427, 430 Hirmann v. Immofinanz 94 Lugano Convention 378, 379 Markets in Financial Instruments Directive (MiFID II) 427 Überseering BV v. Nordic Construction Company and Baumanagement 465 European Court of Human Rights, Salabiaku v. France 73 Ever Given and Suez Canal 316, 317, 318, 322 ExxonMobil 406–8 failure to prevent model, statutory liability, attribution models 62, 64, 65, 70–72, 75, 76, 78 Fairfax, L. 174–93 fairness principle directors’ business judgments see directors’ business judgments, fairness arguments

enterprise liability, strict liability 339, 340–41, 343–7 feedback mechanisms, systems perspective see systems perspective, feedback mechanisms Ferran, E. 19, 78, 79, 156 fiction theory, corporate liability 25–7, 29, 31, 32 Fisch, J. 84, 85, 188, 191, 192 Fischel, D. 28, 39, 86, 89, 100, 239, 310 fixed place test, international standard identification 366–7, 368, 369, 376–7, 382, 383, 384–5 Fleischer, H. 416, 420, 421, 422, 423 Fletcher, G. 247, 344, 345–6, 347 flexible working conditions, and vicarious liability 276–8 forum non conveniens doctrine 298, 375, 380, 383, 385 Fox, M. 87, 89, 90, 91, 92, 95 France Duty of Vigilance Law 306, 308 Plateforme RSE consultation body 419 fraud bribery and statutory liability 75–6 and ESG see environmental, social, and governmental (ESG) factors and future of criminal liability, fraud cases securities laws, directors’ and officers’ liability under 176–80, 181 Fried, J. 92, 188 Friedman, L. 52, 53, 54, 119, 122, 127 fuduciary liability see business judgment rule and fiduciary liability Gadinis, S. 211, 241, 245 Garnett, R. 365–85 Garrett, B. 109, 110, 111, 207, 208, 299, 404 Geis, G. 409, 452, 453 Gelter, M. 28, 82–99 Germany Corporate Digital Responsibility (CDR) initiative 418–19 Jabir v. KiK Textilien und Non-Food GmbH 298 Stock Corporation Act 425, 430 Supply Chain Act 303, 306, 308–9 Gerner-Beuerle, C. 222, 234, 236, 466 Gevurtz, F. 84, 228, 229, 231 Gierke, O. von 9, 14, 26, 31, 35 gig economy 276–7, 439–41 Giliker, P. 146, 148, 151, 274–91, 331 global warming 131–2 globalization and Alien Tort Statute (ATS) 129–31, 133 good faith standard 197–8, 204, 207–8, 211, 229 Gordon, J. 239, 240, 241, 243

476  Research handbook on corporate liability Grantham, R. 141, 144, 262, 263 Greenfield, K. 196, 242–3 group accountability 292–314 affiliates and minority shareholders, ignoring 305, 309, 311 agency theory 300–301 burden of proof 309, 313 compensation 297, 308 corporate separateness paradigm 299–306 decision-making and control structures 294, 295 direct liability 296–7, 301–3, 307–9, 312 due diligence laws 302–3, 305, 306, 308–9, 310 environmental protection 302, 308 forum non conveniens grounds 298 future challenges 306–13 group liability 303–5 group liability expansion proposal 309–13 human rights issues 297–8, 302–3, 304–5, 308–9 involuntary tort claimants, protection of 306 joint and several liability 304, 305, 309, 311 jurisdictional challenges 296–9 liability concerns 296–306 limited liability for each legal entity (asset partitioning) 293, 294, 309–11, 312 multi-tier shareholding company and subsidiary structures 293–4, 307, 311 ‘multiplex’ governance structures 295 network groups 306, 308, 311–13 piercing the corporate veil 299–300, 307 private regulation and self-regulation 305–6 respondeat superior liability 312 and risk taking 293–5 strict liability 308–9, 311 and supply chains 303, 305, 306, 309 traditional corporate groups 308, 310–11 vicarious liability 296–7, 299, 308, 309, 311, 312 voluntary codes 304, 305, 306 Hansmann, H. 30–31, 34, 239, 241, 288, 294, 310 harm-based enterprise liability 332, 334–43 Harper Ho, V. 191, 192, 292–314, 416 Harris, R. 26, 27, 129 Hasnas, J. 38, 40, 399 Henning, P. 115, 403 hierarchy, management see systems perspective, management hierarchy Hill, J. 70, 84, 417, 433 hindsight bias, directors’ business judgments 247, 248–50 Holmes, O. 331, 338, 343, 347–8

Hong Kong Kingstar Shipping Ltd v. Owners of the ship Rolita (The Rolita) 321 Ming An Insurance Co (HK) Ltd v. Ritz-Carlton Ltd 282 Moulin Global Eyecare Trading Ltd v. Commissioner of Inland Revenue 143, 156, 257 Tai Shing v. Maersk 265 Yakult Honsha v. Yakuda 265 Horwitz, M. 26, 27, 122 Huang, B. 351–64 human rights issues, group accountability 297–8, 302–3, 304–5, 308–9 identification of international standards see international standard identification identification theory agency liability, vicarious liability 152–3 statutory liability, attribution models 68, 69, 79 illegality defence, and attribution 156–7, 158–9, 162, 163, 165–7 incentives companies with incentive to lie, environmental, social, and governmental (ESG) factors, fraud cases 399–400 and ownership structures see issuer liability, ownership structures and incentives India, Ridhima Pandey v. Union of India 391 individual liability agency liability, directors as agents 144–5, 151, 152–5 digital responsibility, international ethical guidelines 429 director fiduciary and oversight duties and liability under Caremark 200–201, 205–6 directors’ business judgments 244–5, 247 issuer liability, ownership structures and incentives 91–2 ‘makes the wrong his or her own’ test, joint liability 268–70 securities laws, directors’ and officers’ liability under 175, 183–5 see also director duties indoor management rule 18–22, 140 information availability digital responsibility, corporate law 425–6 director fiduciary and oversight duties and liability under Caremark 199, 201, 202, 204, 207–9, 210–11, 212–14, 217

Index  477 tortious liability see tortious liability and risk, risks, new, information revolution and digitalization of society see also misstatements injunctions director fiduciary and oversight duties and liability under Caremark 205, 207, 212 overlapping remedies 352, 353, 354, 355, 356, 358–9, 362–3 insider trading, securities laws 174, 177 institutional investors, and issuer liability, and political economy 88, 93, 96, 97 institutional responsibility, and criminal liability 107–8, 109 insurance directors’ and officers’ (D&O) insurance 85, 94, 219, 244–5 enterprise liability, strict liability 341–2 issuer liability 85, 90–91, 94 shipping industry 327–9 tortious liability 116, 121–2 vicarious liability 287, 288, 289 see also compensation intellectual property infringements, joint liability 265–6 intent-to-benefit requirement, accountability for AI labor 443, 444 intermediation growth, blockchain technology see blockchain technology, internal governance, intermediation growth international standard identification 365–85 ‘at home’ test 370–71, 373, 374, 383 Canada position 381–3 ‘carrying on business at a fixed place’ test 366–7 common law presence test 375–7, 382–3 fixed place test 366–7, 368, 369, 376–7, 382, 383, 384–5 forum non conveniens doctrine 375, 380, 383, 385 identification issues and suggestions 383–5 piercing the corporate veil 384 pre-1945 period 365–9 principal place of business 383 service out of the jurisdiction 368–9 international standard identification, English position 375–81 discretion to allow service abroad 380 EU Lugano Convention 378, 379 general jurisdiction 375–8 ‘place of business’ concept 376–7, 378, 383 registration 367, 368, 369, 373, 374, 376, 382–3

representative company and ‘alter ego’ principle 377–8 specific jurisdiction 379–80, 381 international standard identification, US since 1945 369–75 comparative contacts approach 370, 374 general jurisdiction 370–71, 373 online context 372–3 piercing the corporate veil 374 products liability372 384 ‘purposeful availment’ requirement 372, 373, 384 specific jurisdiction 371–3 subsidiaries and alter ego’ theory 374, 384 internet of things (IoT) devices, blockchain technology 458, 461 Ireland, Friends of the Irish Environment CLG v. The Government of Ireland 391 issuer liability 82–99 buy-and-hold investors 87, 88 collective action problems 82, 92 compensation and circulatory problem 86–8 compensation and deterrence 85–6 deterrence rationale 89–91, 94 deterrence rationale, unclear incentives 90–91, 94 director duties 85, 91–2, 93–4, 94, 95 disclosure issues 86, 90 insurance 85, 90–91, 94 misstatements 87, 90, 91 national differences 83–5 pocket-shifting and primary and secondary market comparison 86–7 sanctions 89, 92 securities 89–90, 95–6, 97, 98 social cost of securities fraud 89–90 issuer liability, ownership structures and incentives 91–5 collective action problem 92 creditor protection 94–5 dispersed ownership at firm level 93 individual liability 91–2 monitoring incentives and capabilities 92–4, 95 shareholders 82, 91–2, 93–4, 95 issuer liability, and political economy 95–8 and institutional investors 88, 93, 96, 97 ownership structure 97–8 private enforcement of securities law 98 and regulatory dualism 98 Johnson, L. 222, 223, 226, 229–30, 231, 232, 233 joint liability 256–72 as accessory to another’s primary wrong 259–60

478  Research handbook on corporate liability and attribution 257–8 group accountability 304, 305, 309, 311 piercing the corporate veil 258–9 strict liability wrongs 270–72 and uncertainty 267–8, 270 vicarious liability 257–8 joint liability, directors’ liability for corporate wrongdoing 260–70 accessory liability 264–7 accessory liability, in English law 265–7 breach of contract 261–2 civil liability rules 264 common design test 265, 266, 267 direct and procure test 266–7 intellectual property infringements 265–6 liability tests in other jurisdictions 267–70 limited liability and separate legal identity of shareholders 263–4 ‘makes the wrong his or her own’ test 268–70 primary liability for other wrongs and ‘dis-attribution’ 262–4 Joint Stock Companies 9–10, 11, 19 judicial accountability for directors’ business judgment 251, 252 judicial review business judgment rule and fiduciary liability 226, 229, 230–33 directors’ business judgments 238, 248 jurisdictional abstention doctrine 230, 232–4 Kahan, M. 89, 107, 111, 201, 210, 213, 452 Keating, G. 35, 247, 250, 286–7, 290, 304, 330–49 Keay, A. 238, 240, 246, 249, 250, 251, 252, 254 Kershaw, D. 47, 229, 253, 464 Khanna, V. 39, 93, 98, 100, 105, 107, 114, 388, 403, 436 Knight, F. 122, 132, 240 Kornhauser, L. 36, 37, 101, 195, 196, 200, 201, 202, 203, 204, 211 Kraakman, R. 30–31, 34, 37, 38, 48, 84, 101, 103, 195, 200, 201, 202, 203, 204, 206, 207, 214, 239, 241, 288, 291, 294, 310 Labor Model, accountability for AI labor 436–7, 442–3, 444–5 Lafarre, A. 424, 453, 456, 462, 465 Langevoort, D. 56, 87, 88, 96–7, 99, 207, 209 Laufer, W. 32, 38, 107, 108 Leblanc, R. 47, 48, 49, 50 legal doctrine, criminal liability 106–8 legal fictional perspective 10–14 legal person, ship as see shipping industry, ship as legal person

legal test for employment 441–2 see also employment legal uncertainty, blockchain technology 465–6 leniency, criminal liability see criminal liability, official discretion and leniency introduction Lim, E. 142, 143, 156–72 limited liability 12–13 and corporate liability, nexus of contracts theory 33, 34 directors’ business judgments 239–40, 245 group accountability 293, 294, 309–11, 312 joint liability, directors’ liability for corporate wrongdoing 263–4 tortious liability 117 List, C. 38, 102 Lott, J. 39, 202 Loughrey, J. 237–55 Low, K. 447–66 Macey, J. 95, 207 McKendrick, E. 150, 151, 277–8 ‘makes the wrong his or her own’ test, joint liability 268–70 manslaughter, corporate manslaughter offence 69 material misconduct, director fiduciary and oversight duties and liability under Caremark 199, 201, 202, 204, 207–9, 210–11, 212–14, 217 Means, G. 127, 462 Mendelson, N. 52, 117–18, 133, 310 mergers, tortious liability 118 Miazad, A. 211, 241, 245 Micheler, E. 25, 43, 54, 451 Mik, E. 447, 448, 450, 453, 454, 459, 461, 463, 465 Miller, P. 221–36 Mintzberg, H. 45, 49, 50, 51 misstatements issuer liability 87, 90, 91 securities laws 177–9, 180, 190, 192–3 see also information availability Mitchell, G. 111, 207, 208 monitoring digital responsibility 417, 426–7, 432 director fiduciary see director fiduciary and oversight duties and liability under Caremark issuer liability, ownership structures and incentives 92–4, 95 systems perspective 55 Moore, M. 49, 56, 250, 417 morality, harm-based, internal, enterprise liability 336–9 see also social interests

Index  479 Morgan, P. 150, 151, 277, 283, 287 Möslein, F. 409–33 motor vehicle drivers, agency liability 147, 152–3, 154 multidistrict litigation (MDL), overlapping remedies 355–6 negligence business judgment rule and fiduciary liability 225 director fiduciary and oversight duties and liability under Caremark 202–4, 209 directors’ business judgments 250 enterprise liability 333, 336, 337, 338, 341–3, 347 statutory liability 65 Nelson, J. 295, 299, 387–408 Netherlands climate change liability against corporations 392–4 Ministry of Economic Affairs and Climate v. Urgenda Foundation 392 network groups, group accountability 306, 308, 311–13 New Zealand Banfield v. Johnson 264 Broadlands Finance Ltd v. Gisbourne Aero Club 21 Brooks v. New Zealand Guardian Trust Co Ltd 262 Cook Straight Skyferry Ltd v. Dennis Thompson International Limited 261 Cromwell Corp Ltd v. Sofrana Immobilier (NZ) Ltd 21 Dollars & Sense Finance Ltd v. Nathan 147, 148, 151, 152, 153 Livingston v. Bonifant 264 Ruscoe v. Cryptopia 136 S v. Attorney-General 151, 153 Sarah Thomson v. Minister for Climate Change Issues 391 Trevor Ivory Ltd v. Anderson 262, 267 nexus of contracts theory see corporate liability, nexus of contracts theory Neyers, J. 284, 331 non-authorised agents, agency liability 137–9 non-executive directors, agency liability, directors as agents 137, 141 nuisance law enterprise liability, strict liability 334, 335, 336, 339, 346 environmental, social, and governmental (ESG) factors and future of criminal liability 395, 396

obedience duty, digital responsibility, corporate law 426–7 opt-out, overlapping remedies, class actions 98, 355, 356, 357 organic theory, corporate liability 26, 27–8, 29, 31–2 out-of-pocket losses, securities laws 180, 181, 186, 187 outside directors, securities laws 175, 178, 180–81, 185–7 see also director duties overlapping remedies 351–64 aggregation procedures 354–9 complementary approach and concurrent remedies 353, 354 concurrent remedies 353, 354, 359–65 concurrent remedies, punitive damages 360–62 future research 364 injunctions 352, 353, 354, 355, 356, 358–9, 362–3 multidistrict litigation (MDL) 355–6 parallel cases 353–4, 356, 357, 360, 361, 362 standard approach (once-and-for-all) 352–3, 354 trade-offs 353–4 overlapping remedies, class actions 354–5, 356 linear stacking awards 357 mandatory 356–9 opt-out 98, 355, 356, 357 preclusive effect 355 redundant punitive damages 357–8 ownership structures see issuer liability, ownership structures and incentives Pakistan, Ashgar Leghari v. Federation of Pakistan 392 parallel cases, overlapping remedies 353–4, 356, 357, 360, 361, 362 Pargendler, M. 28, 422 Parker, C. 52, 53, 54, 306 partnership firms, agency liability, vicarious liability 12, 146–7 Payne, J. 257, 451, 452, 457 permissionless blockchains 459–60 personal liability see individual liability Petrin, M. 1–5, 24–41, 48, 49, 50, 57, 116, 254, 292, 293, 300, 301, 310, 311, 313, 417, 424 Pettit, P. 38, 102 piercing the corporate veil group accountability 299–300, 307 international standard identification 384 joint liability 258–9

480  Research handbook on corporate liability shipping industry 316, 322, 323, 325, 327 tortious liability 117 ‘place of business’ concept, international standard identification 376–7, 378, 383 plane safety violations 217–18 pocket-shifting, issuer liability 86–7 Poland, ClientEarth v. Enea 237 political economy criminal liability 113–15 and issuer liability see issuer liability, and political economy political pressures, environmental, social, and governmental (ESG) factors, fraud cases 404–6 politics, role of, tortious liability and risk 133–4 Pollman, E. 47, 196, 224, 426 Posner, R. 86, 89, 91, 119, 333 private regulation enterprise liability 331 group accountability 305–6 issuer liability, and political economy 98 securities laws, directors’ and officers’ liability under 177, 179 see also self-regulation products liability 331, 372, 384 profit pursuit through misconduct, director duties and liability under Caremark 196–8, 206–7, 210, 211, 213, 214, 218–19 property rights, third party, and attribution 170–72 public policy issues and criminal liability 110, 115 digital responsibility, international ethical guidelines 429 directors’ business judgments, risk-taking 242, 245–6 enterprise liability, strict liability 338 environmental, social, and governmental (ESG) factors and future of criminal liability 395, 396 statutory liability 64 see also social interests quasi-employee identification, vicarious liability 278–81, 288 Rabin, R. 128, 334 real entity theory, corporate liability 26, 27–8, 29, 31–2 reformulation issues, business judgment rule and fiduciary liability 228, 229–30, 232 registration international standard identification 367, 368, 369, 373, 374, 376, 382–3

securities laws, directors’ and officers’ liability under 178, 180–81 Reich-Graefe, R. 32, 293, 304 relationship test, vicarious liability 276–81 relevant person identification, shipping industry 321, 322, 324 remedies, overlapping see overlapping remedies reputations corporate liability, justifications, criminal liability 40 criminal liability 105–6 environmental, social, and governmental (ESG) factors and future of criminal liability 388 statutory liability 64 respondeat superior doctrine and AI labor see accountability for AI labor, employed algorithms, respondeat superior doctrine and vicarious liability criminal liability 106–7, 108, 111 director fiduciary and oversight duties and liability under Caremark 203 and enterprise liability 332 group accountability 312 Reynolds, F. 136, 137, 138, 146, 150, 151, 258 Rhee, R. 116–35 Richman, D. 112, 202 Ripken, S. 25, 51 risk management blockchain technology 460–61 business judgment rule and fiduciary liability 233–4 corporate liability, justifications 37 digital responsibility, corporate law 426–7, 432 director fiduciary and oversight duties and liability under Caremark 215–16 directors’ business judgments see directors’ business judgments, risk aversion; directors’ business judgments, risk-taking enterprise liability 343–7 and group accountability 293–5 systems perspective, feedback mechanisms 52 and tortious liability see tortious liability and risk vicarious liability 285–90 see also uncertainty Rock, E. 188, 223, 452 Root Martinez, V. 103, 216 Rose, A. 86, 87, 88, 89, 90, 92, 93 rule-based approaches, attribution 157–65, 166

Index  481 Salmond test, vicarious liability 149, 282, 285 sanctions corporate liability 39, 40 criminal liability 101–2, 103–4, 107, 109, 110, 112 director fiduciary and oversight duties and liability under Caremark 200, 201, 211 directors’ business judgments 247, 250 environmental, social, and governmental (ESG) factors 403, 404 issuer liability 89, 92 securities laws, directors’ and officers’ liability under 187, 193 see also damages Schuster, E. 447–66 Schwarcz, S. 242, 253, 459 Schwartz, G. 289, 330 scope-of-employment requirement, and accountability for AI labor 443–4 securities blockchain technology 449–50, 451, 452 issuer liability 89–90, 95–6, 97, 98 securities laws, directors’ and officers’ liability under 174–93 director and officer liability insurance (D&O insurance) 187 Exchange Act, Section 10(b) and Rule 10b-5 (securities fraud prohibition) 176–80 Exchange Act Section 17(a) (fraudulent conduct) 181 Exchange Act Section 20(a) (control person liability) 181–2 individual liability and accountability 175, 183–5 individual liability and accountability, deterrent impact 184 insider trading 174, 177 loss causation 180 misstatements 177–9, 180, 190, 192, 192–3 out-of-pocket losses 180, 181, 186, 187 outside directors 175, 178, 180–81, 185–7 and private actions 177, 179 sanctions 187, 193 Securities Act Section 11 (registration statement) 178, 180–81 transaction causation 179–80 securities laws, directors’ and officers’ liability under, environmental, social and governance (ESG) matters 187–93 disclosures 188–90 materiality assessment 191–2 Task Force 189–90, 192–3 voluntary documents 190–91, 192 self-regulation

digital responsibility 429–30 environmental, social, and governmental (ESG) factors, fraud cases 400, 404 group accountability 305–6 see also private regulation self-reporting 112, 199, 204 self-serving behavior consideration, directors’ business judgments 243, 248 separateness, corporate, group accountability 299–306 severity levels, tortious liability and risk management 119–22, 125–6, 127, 128, 129, 131, 132, 133, 134 sexual abuse claims, vicarious liability 280, 284–5, 289 Shapira, R. 56, 201, 217 shareholders 8, 9, 10, 11, 12–13, 15, 16, 17, 18, 19 agency liability, directors as agents 142–3, 144 and attribution 163–4, 166 blockchain technology 451, 452, 464–5 blockchain technology and distributed ledger technology (DLT) shareholding see blockchain technology, internal governance, distributed ledger technology (DLT) shareholding business judgment rule and fiduciary liability 233–4 corporate liability, nexus of contracts theory 29, 29–30, 30, 33 digital responsibility 422–3 director fiduciary and oversight duties and liability under Caremark 198, 205 directors’ business judgments 239–40, 240–43, 246, 251–2 group accountability 293–4, 305, 307, 309, 311 issuer liability, ownership structures and incentives 82, 91–2, 93–4, 95 joint liability, directors’ liability for corporate wrongdoing 263–4 systems perspective 49–50 Sharkey, C. 128, 352, 358 Shavell, S. 36, 37, 85, 89, 119, 125 shipping industry 315–29 commercial operation and time charterer 317, 318, 319 division of labour concept 316, 318 Ever Given and Suez Canal 316, 317, 318, 322 insurance arrangements 327–9 insurance arrangements, and insolvency 328–9 legal liability issues 318–19

482  Research handbook on corporate liability navigational operation and demise (bareboat) charterer 316–18, 319 piercing the corporate veil 316, 322, 323, 325, 327 Protection and Indemnity Associations (P&I Clubs) 327–9 ship arrest requirements 315 trading ship contracts 316–19 shipping industry, ship as legal person 315–16, 319–27 admiralty jurisdiction 320–23, 324, 326 beneficial ownership 322–3, 325 English-heritage procedure 321–3 relevant person identification 321, 322, 324 ship seizures 320–21, 324 South Africa 326–7 surrogate for the wrongdoing ship, (associated ship) 322, 326 US and doctrine of personification 323–6 Singapore BNM v. National University of Singapore 150 Bunga Melati 138–9 Chwee Kin Keong and Others v. Digilandmall.com Pte Ltd 136 Equatorial Marine Fuel Management Services Pte Ltd v. The Bunga Melati 321 Gabriel Peter & Partners v. Wee Chong Jin 141, 144, 145 Ho Kang Peng v. Scintronix Corp. Ltd. 156, 157 Ng Huat Seng v. Munib Mohammad Madni 279, 280 Ong Han Ling v. Am. Int’l Assurance 137, 150 Red Star Marine Consultants Pte Ltd. v. Personal Representatives of Satwant Kaur 156, 157, 158, 166 Skandinaviska Enskilda Banken AB (Publ) v. Asia Pacific Breweries(Singapore) Pte Ltd 141, 150, 282, 290 Skaw Prince 322–3, 326 slavery, modern, statutory liability 76 smart contracts and blockchain technology 450, 456, 462–3 digital responsibility 412–14 social interests director fiduciary and oversight duties and liability under Caremark 198, 204–8, 216–17 directors’ business judgments 239–46, 249–50 enterprise liability 336–9 issuer liability 89–90

tortious liability and risk, risk management 121 see also public policy issues social welfare arguments, directors’ business judgments 239–46 socially optimal risk-taking, directors’ business judgments 239–43 Soltes, E. 196, 197, 201–2, 207, 210, 213, 404 South Africa, ship as legal person 326–7 Squire, R. 87, 90, 93, 296 statutory liability 62–81 and absolute liability 66–7, 68, 78 accountability 65 bribery 75–6 civil liability 67, 69, 79 civil penalty provisions 66 command and control model 64 compensation 66, 69 criminal liability 63–4, 65, 68, 79–80 Deferred Prosecution Agreements (DPAs) 65, 72 due diligence defence 64, 66–7, 70, 71, 73, 75, 76–7, 78 environmental, social and governance (ESG) matters 76–7 future direction 78–80 legislative framing and statutory drafting options 66–7 and legislative intervention 65 money laundering 77 officer liability 73–4 penalty design 65 public policy objectives 64 regulatory models 63–6 reputational damage avoidance 64 slavery, modern 76 strict liability 63–4, 66–7 third party right of action 67 tort of negligence 65 statutory liability, attribution models 67–73, 78 corporate manslaughter offence 69 direct liability 69–70, 78 failure to prevent model 62, 64, 65, 70–72, 75, 76, 78 identification doctrine, company’s human ‘directing mind and will’ 68, 69, 79 intended application to companies 69 quality of organisational systems and corporate culture 70, 71 reverse burdens of proof 73 vicarious liability 68 Stout, L. 30, 33, 44, 242, 243, 248, 253, 423 strict liability director fiduciary and oversight duties and liability under Caremark 202–4, 209

Index  483 and enterprise liability see enterprise liability, strict liability environmental, social, and governmental (ESG) factors, fraud cases 403 group accountability 308–9, 311 joint liability 270–72 statutory liability 63–4, 66–7 Strine, L. 57, 196, 202, 205, 206, 240 subsidiaries group accountability 293–4, 307, 311 international standard identification, US since 1945 374, 384 successor liability, tortious liability 10, 12, 65, 118 supply chains 128–9, 303, 305, 306, 309, 461 Switzerland, Swiss Digital Initiative 420 Sykes, A. 36, 37, 39, 100, 101, 286 systemic risk response, enterprise liability 343–7 systems perspective 42–60 and competence 46, 58 director duties 47–9, 50, 55, 57–8 future research 45 shareholders 49–50 vicarious liability 58–9 systems perspective, company liability, Caremark liability 54–8 bad faith standard 56 internal recognition among directors 55 monitoring obligations 55 obligations 55 senior officers 57–8 see also director fiduciary and oversight duties and liability under Caremark systems perspective, feedback mechanisms 52–4 Caremark action against directors and senior officers 53 deterrence effects 53–4 integration mechanisms 53 internal discipline mechanisms 52, 53 risk-management 52 tort norms 53–4 systems perspective, management hierarchy 49–51, 58 allocation of responsibilities 50 integrating mechanisms 51 management interaction and coordination 51 power and authority relations 50 systems-managerial model 49, 58, 59 Tan, C.-H. 136–55, 299 team production theory, corporate liability 33 Teubner, G. 295, 414, 416 third parties, and attribution 162, 164–6, 167, 170–72 Thomas, R. 47, 48, 57, 88, 110, 388, 399, 401

Thompson, R. 117, 186, 287, 299, 300, 417 tort law agency liability, directors as agents 144–5, 151, 152–5 corporate liability 32 director fiduciary and oversight duties and liability under Caremark 196 environmental, social, and governmental (ESG) factors and future of criminal liability 395, 396 group accountability 306 statutory liability 65 systems perspective, feedback mechanisms 53–4 tortious liability and risk 116–35 and attribution 116–17 compensation 121, 127, 132–4 insurance 116, 121–2 limited liability rule 117 mergers 118 piercing the corporate veil 117 risk navigation 132–4 and risk-spreading 116–18 successor liability 10, 12, 65, 118 and uncertainty 119–22, 132 vicarious liability 117 tortious liability and risk, risk management 118–26 and causal commonality 120–21 class actions, restricted use of 122–4, 125, 126 correlated losses 120–21 economic distinction between risk and uncertainty 122 frequency of occurrence 119–22 insurance and capital cost 121–2 legal response to high severity 122–5 novel risks and new social needs and pressures 121 punitive damages 124–5, 126 risk pooling 120 risk-neutral strategies 125–6 severity levels 119–22, 125–6, 127, 128, 129, 131, 132, 133, 134 tortious liability and risk, risks, new 127–33 foreseeability and pure economic loss doctrines 133 global warming 131–2 globalization and Alien Tort Statute (ATS) 129–31, 133, 298 politics, role of 133–4 risk navigation, new conditions and risk of severe liability 132–3 systemically important companies, collapse of 134

484  Research handbook on corporate liability tortious liability and risk, risks, new, information revolution and digitalization of society 127–9 internet companies and potential liability 129, 133 liability risk from AI 127–8 risk and harm, change in the spatial relationship between 128 risk and interests, increased interconnectedness 128–9 supply chains 128–9 see also digital responsibility trade-offs, overlapping remedies 353–4 trespass at common law, enterprise liability 336, 337–8 two-step test, attribution 162–5, 166 Uhlmann, D. 110, 442 UK Bribery Act 64, 65, 71, 75 Centre for Data Ethics and Innovation 419 Common Law Procedure Act 368 Companies Act 13, 19, 63, 66, 140, 141, 159, 160, 251, 252, 367, 376, 452, 457 Competition Act 164 Corporate Manslaughter and Corporate Homicide Act 65, 69, 73–4, 78 CREST system 451, 452 Criminal Finances Act 71 Economic Crime (Transparency and Enforcement) Act 77 English East India Company 9–10, 11 English-heritage procedure, ship as legal person 321–3 Health and Safety at Work Act 74 Human Rights Act 73 Insolvency Act 164–5 international standard identification see international standard identification, English position Interpretation Act 62 Joint Stock Banking Act 19 Modern Slavery Act 76 Partnership Act 146–7 Post-Legislative Scrutiny of the Bribery Act 65 Proceeds of Crime Act 65, 167 Senior Courts Act 320 UK, cases Abela v. Baadarani 380 Actavis Group v. Eli Lilly & Company 377 Adams v. Cape Industries 299–300, 377, 379, 382, 384 Ajou v. Dollar Land Holdings 143

AK Investment CJSC v. Kyrgyz Mobil Tel Ltd 380 Akzo Nobel N.V. v. Competition Commission 64 Allen Manufacturing Co Pty Ltd v. McCallum & Co Pty Ltd 264 Allen v. Bernhard 247 Allen v. Whitehead 68 Angelmist Properties Ltd. v. Leonard 238, 248 ARB International Ltd. v. Baillie 248 Armes v. Nottinghamshire CC 275, 279, 281, 288–9 AS Dampskib Hercules v. Grand Truck Pacific Railway Co. 367 Automatic Self-Cleansing Filter Syndicate Co Ltd v. Cuninghame 17 B. Liggett (Liverpool) Ltd v. Barclays Bank 21, 140 Bamford v. Turnley 346 Bank of India v. Morris 69, 164–5 Barclays Bank plc v. Various Claimants 278, 279–80, 281, 289, 291 Belmont Finance Corpn Ltd v. Williams Furniture Ltd 67 Ben Hashem v. Ali Shayif 258 Bilta (UK) Ltd v. Nazir 156, 157, 158–9, 163–4, 165, 166, 167, 168–9, 172, 251, 256, 257, 258, 260 Birdi v. Specsavers Optical Group Ltd. 237 Bishopsgate Contracting Solutions Ltd. v. O’Sullivan 238 Blackpool Football Club Ltd v. DSN 281 Blanckert and Willems PVBA v. Trost 378 Bolton Partners v. Lambert 137 Bowman v. Fels 171 Re Brian D. Pierson (Contractors) Ltd. 238 British Thomson-Houston Co Ltd v. Sterling Accessories Ltd 262 Re Brumark Investments Ltd sub nom Agnew v. IRC 465 Brumder v. Motornet Service and Repairs Ltd 54 BTI 2014 LLC. v. Sequana 245 C Evans & Son Ltd v. Spritebrand Ltd 145, 263, 266, 270, 271 Caparo Industries plc v. Dickman 145 Chandler v. Cape 77, 300, 301 Cherney v. Deripaska 380 Chopra v. Bank of Singapore Ltd 377 Ciban Mgmt. Corp. v. Citco (BVI) Ltd 136, 138 Citizens’ Life Assurance Company v. Brown 149 ClientEarth v. Shell 237

Index  485 CMS Dolphin Ltd v. Simonet 260 Cook v. Deeks 259, 260 Coppen v. Moore 68 Cox v. Ministry of Justice 279, 286, 287, 288 Credit Lyonnais Bank Nederland N.V. v. Export Credits Guarantee Department 146 Crown Prosecution Service v. Aquila Advisory Ltd 156, 166, 167–70 Customs and Excise Commissioners v. Barclays Bank 145 Cutler v. Wandsworth Stadium Ltd 67 D & F Estates Ltd v. Church Comrs 277 Davies v. Health and Safety Executive 73 De Bloos Sprl v. Bouyer 378 Devlin v. Slough Estates Ltd 237 Re DKG Contractors Ltd. 238 Doe d. Murray v. Bridges 67 Dubai Aluminium Co Ltd v. Salaam 147, 148, 150, 282, 283, 284, 290 Duncan v. Findlater 286 Dunlop Pneumatic Tyre Co. v. Actien-Gesellschaft für Motor und Motorfahrzeugbau vorm.Cudell & Co 367 In re Duomatic Ltd 138, 160 E v. English Province of Our Lady of Charity 278–9 East Asia Co Ltd v. PT Satria Tirtatama Energindo (Bermuda) 140 Ebrahimi v. Westbourne Galleries Ltd 254 Eckerle v. Wickeder 451 Egger v. Viscount Chelmsford 147 Employers Liability Assurance Corp Ltd v. Sedgwick, Collins and Company Ltd 368 Fairline Shipping Corporation v. Adamson 261, 262, 264 Federation Internationale De L’Automobile v. Gator Sports Ltd 266 Ferguson v. Wilson 263 Fetim v. Oceanspeed Shipping BV. (The Flecha) 319 Financial Services Authority v. Martin 265 Flitcroft 13 Foss v. Harbottle 142 Freeman & Lockyer v. Buckhurst Park Properties (Mangal) Ltd. 18, 19, 20, 22, 138, 144 Fyffes Group Ltd v. Templeman 260 Gauntlett v. King 148 Gencor ACP Ltd v. Dalby 260 Gibson v. O’Keeney 152 Gilford Motor Co Ltd v. Horne 259 Haesler v. Lemoyne 148

Handi-Craft Company v. B Free World Ltd 265, 270, 271 Headway Construction Co Ltd v. Downham 155 Hely-Hutchinson v. Brayhead Ltd 21, 141 Hern v. Nichols 291 Hewitt v. Bonvin 147 HL Bolton (Engineering) Co Ltd v. TJ Graham & Co Ltd 68 Holman v. Johnson 157 Homburg Houtimport BV. v. Agrosin Pte Ltd (The Starsin) 319 Houghton & Co v. Nothard, Lowe & Wills Ltd 140 Hounga v. Allen 163 Howard Smith v. Ampol Petroleum 237 Howard v. Patent Ivory Manufacturing Co 20 Hurstwood Properties (A) Ltd v. Rossendale Borough Council 259 Re J Leslie Engineers Co Ltd (In Liq) 67 James Scott Winter v. Hockley Mint Limited 151 Jarmain v. Hopper 148 John v. Dodwell & Co. Ltd. 260 Julien v. Evolving Tecknologies & Enterprise Development 156 Kairos Shipping Ltd v. Enka & Co LLC (The Atlantik Confidence) 328 La Bourgogne 366 Lee Ting Sang v. Chung Chi-Keung 150, 154 Re Lennard’s Carrying Co v. Asiatic Petroleum Co Ltd 68 Lister v. Hesley Hall 35, 148, 150, 155, 282, 284 Lister v. Romford Ice and Cold Storage Co 274 Lloyds Register of Shipping v. Soc Camperion Bernard 379 Lonrho v. Shell Petroleum Co Ltd (No. 2) 67 Mackay v. Commercial Bank of New Brunswick 146 Madoff Securities International Securities Ltd v. Raven 247 Mahonyv. East Holyford Mining Co 19–20 Marex Financial Ltd v. Sevilleja 14, 142 Market Investigations v. Minister of Social Security 150, 277 MCA Records Inc v. Charly Records Ltd 143, 145, 256, 265, 266, 270, 271–2 Meridian Global Funds Management Asia Ltd v. Securities Commission 21, 22, 68, 69, 78, 143, 149, 157–9, 161, 165, 172, 257

486  Research handbook on corporate liability Milmo v. Carreras 465 Mohamud v. Wm Morrison Supermarkets 59, 155, 275–6, 282–3, 284, 290, 291 Morgans v. Launchbury 147, 152 Morison Sports Ltd v. Scottish Power 67 Morris v. Kanssen 20 Moulin Global Eyecare Trading Ltd v. Commissioner of Inland Revenue 143 Mousell Bros Ltd v. London and North-Western Railway 67–8 Multinational Gas and Petrochemical Co v. Multinational Gas and PetrochemicalServices Ltd 142, 143 National Guild of Removers Ltd v. Luckes 266 Nature Resorts Ltd v. First Citizens Bank Ltd 67 NatWest Markets v. Stallion Eight Shipping Co SA (The Alkyon) 320 Navarro v. Moregrand Ltd 152 Newcastle International Airport Ltd v. Eversheds LLP 141 Ngo Chew Hong Edible Oil Pte Ltd v. Scindia Steam Navigation Co Ltd (The Jalamohan) 319 Noble Caledonia Ltd v. Air Niugini Ltd 377 Okpabi v. Royal Dutch Shell Plc. 302 Okura A Co v. Forsbacka Jernverks 367, 377 O’Neill v. Phillips 254 Ormrod v. Crosville Motor Services Ltd 147 Owusu v. Jackson 378 Patel v. Mirza 157, 163, 166 Performing Right Society Limited v. Ciryl Theatrical Syndicate Limited 266 Plan B Earth v. Secretary of State for Business and Energy 391 PLG Research Ltd v. Ardon International Ltd 267 Prest v. Petrodel Resources 258, 259, 300 R v. Andrews-Weatherfoil Ltd 68 R v. British Steel 70 R v. Chargot Ltd (t/a Contract Services) 73, 74 R v. Cornish 69 R v. Gateway Food Markets Ltd 66 R v. Hitchins 74 R v. Skansen Interiors Ltd 72 R v. Wholesale Travel Group 73 R v. Winson 68 Raphael v. Goodman 148 Ready Mixed Concrete (South East) Ltd v. Minister of Pensions and National Insurance 154, 277

Reeves v. Commissioner of Police of the Metropolis 162 Regier v. Campbell-Stuart 155 Ridgeway Maritime Inc v. Beulah Wings Limited (The Leon) 261 Rolled Steel Products (Holdings) Ltd v. British Steel Corp 21 Royal British Bank v. Turquand 18–19, 21, 140 Royal Brunei Airlines Sdn Bhd v. Tan 262 Rubin v. Gunner 248 Safeway Foodstores Ltd v. Twigger 157, 159, 164 Said v. Butt 261 Salmon v. The Hamborough Company 10 Salomon v. Salomon & Co Ltd 14, 16, 27–8, 300 Salsbury v. Woodland 277 Schwarz & Co (Grain) Ltd v. St Elefterio ex Arion (Owners) (The St Elefterio) 321 Sea Shepherd v. Fish & Fish Ltd 266 Secure Capital SA v. Credit Suisse 457 Selangor United Rubber Estates v. Cradock 163 Serious Fraud Office v. Barclays 66, 79 Serious Fraud Office v. Rolls Royce Energy Systems 112 Serious Fraud Office v. Standard Bank 71 Serious Fraud Office v. Sweett Group 72 Sharp v. Blank 238, 247, 249 Sheldrake v. DPP 73 Re Sherborne Associates Ltd. 249 Singla v. Hedman 248 Singularis Holdings Ltd v. Daiwa Capital Markets Europe Ltd 136, 156, 157, 158, 162, 164, 165 Skandinaviska Enskilda Banken AB (Publ) v. Conway 67 SKX v. Manchester CC 281 SL Claimants v. Tesco Plc 457 Sliney v. Havering London Borough Council 73 Smart v. Hutton 148 Smith v. Henniker-Major 20 Societa Esplosivi Industriali SpA v. Ordnance Technologies 266, 270 Somafer SA v. Saar-Ferngas 379 South India Shipping Corporation Ltd v. Export-Import Bank of Korea 376 SSL International Plc v. TTK LIG Ltd 376 Standard Chartered Bank v. Pakistan National Shipping Corp 22, 144, 263, 264 Stevenson Jordan & Harrison Ltd v. MacDonald & Evans 154

Index  487 Stone & Rolls Ltd v. Moore Stephens 157, 158, 162, 163, 167 Street v. Mountford 465 Sutton’s Hospital 9, 10, 14 T Oertli AG v. EJ Bowman 170 Teekay Tankers Ltd v. STX Offshore & Shipping Co 376, 378 Tesco Supermarkets Ltd v. Nattrass 66, 68, 75, 78, 79, 143 ‘Thelma’ (Owners) v. University College School 147 Trustees of the Barry Congregation of Jehovah’s Witnesses v. BXB 283 Uber BV. v. Aslam 277 Various Claimants v. Barclays Bank 58, 59, 137 Various Claimants v. Catholic Child Welfare Society (CCWS) 58, 274, 275, 276, 281, 285–6, 288 Vedanta Resources plc v. Lungowe 77, 298, 301–2 Vertical Leisure Limited v. Poleplus Limited 150–51 Re VGM Holdings 163 Viasystems (Tyneside) Ltd v. Thermal Transfer (Northern) Ltd 279 VTB Capital Plc v. Nutritek International Corp 258, 261, 380 W & R Fletcher (New Zealand) Ltd v. Sigurd Haavik Aksjeseskap (The Vikfrost) 319 Wah Tat Bank Ltd v. Chan Cheng Kum 266 Welfab Engineers Ltd. 238 Welsh Development Agency v. Export Finance Co Ltd 261 Wessely v. White 249 West Mercia Safetywear Ltd (in liq.) v. Dodd 245, 252 White Horse Distillers Ltd v. Gregson Associates Ltd 269 Williams v. Natural Life Health Foods 145, 262, 263 WM Morrison Supermarkets Plc v. Various Claimants 275, 276, 283–4 Zahir Monir v. Steve Wood 147, 150, 153 ultimate account holders (UAHs), blockchain technology 451, 453 uncertainty and agency liability 140, 145, 155 attribution 158–60 and directors’ business judgments 247, 248, 249 and joint liability 267–8, 270 tortious liability and risk 119–22, 132 see also risk management

unreasonable conduct, enterprise liability 334–5, 338 US Alien Tort Statute (ATS) 129–31, 133, 298 Bankruptcy Code 94 Communication Decency Act 129 Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) 66 Delaware General Corporation Act 225 Depository Trust & Clearing Corporation (DTCC) 451, 455 Dodd-Frank Act 182 Environmental Protection Agency (EPA) 66 Exchange Act, Section 10(b) and Rule 10b-5 176–80 international standard identification see international standard identification, US since 1945 Sarbanes-Oxley Act 94, 175, 243–4 Securities Act Section 11 (registration statement) 180–81 Securities and Exchange Act 457 Workmen’s Compensation Acts 330 US, cases In re Adelphia Commc’ns Corp. 94 Advanced Tactical Ordnance Systems LLC v. Real Action Paintball Inc 373 Aldana v. Del Monte Fresh Produce 130 Alfa Mutual Insurance Co. v. Richard Charles Roush 148, 153 Allis-Chalmers Mfg. Co. 197 American Express Co. v. Italian Colors Restaurant 123 Anderson v. Marathon Petroleum Co. 439 Arista Records LLC v. Lime Grp. 357 Aronson v. Lewis 56, 57, 224, 227, 228 Arthur Andersen LLP v. U.S. 134 AT&T Mobility LLC v. Concepcion 123 ATR-Kim Eng Fin. Corp. v. Araneta 211 Bank of Augusta v. Earle 365 Barnes v. Osofsy 180 Basic v. Levinson 123, 179 Beanal v. Freeport-McMoran 130 Beil v. Telesis Constr. 442 Bigelow v. RKO Radio Pictures 336 Blue Chip Stamps v. Manor Drug Stores 180 BMW of North America v. Gore 124, 352 BNSF Railway Co v. Tyrrell 370, 371 In re Boeing Co Deriv. Litig. 48, 56, 105, 214, 217–18, 219 Bondali v. Yum! Brands 190–91 Boomer v. Atlantic Cement 335, 336 Bowers v. Trinity Groves 442 In re. BP plc, Sec Litig. 191

488  Research handbook on corporate liability Bristol Myer Squibbs Co v. Superior Court of California 319, 372 Brown v. Lockheed-Martin Corp 373 Bryant v. Lefever 339 Burger King Corp v. Rudzewicz 371, 372 Burgess v. Premier Corp. 182 Butler v. Bunge Corp 153 Cactus Pipe & Supply Co Inc v. M/V. Montmartre 318, 324 In re Caremark International Derivative Litigation 105, 234-5, 416-17, see also director fiduciary and oversight duties and liability under Caremark; systems perspective, company liability, Caremark liability In re Carolina Tobacco Co. 361 Casey v. Woodruff 227 Cede & Co. v. Technicolor 224, 228, 229, 425 Chenega Corp.v. Exxon Corp. 357–8 Chiarella v. United States 177 In re. China Agritech S’holder Derivative Litig. 211 In re Citigroup Inc Shareholder Derivative Litigation 55, 56, 234 Citizens United v. Federal Election Commission 27 Clean Air Council v. United States 395 Cleveland Park Club v. Perry 336 In re Clovis Oncology Derivative Litig. 214, 216, 417 Comcast Corp. v. Behrend 123 Cortez v. Nacco Material Handling Group 117 Craig v. FedEx Ground Package Sys. 441 Daimler A.G. v. Bauman 298, 306–7, 319, 370–71, 373, 374, 380 D’Amico Dry d.a.c. v. Nikka Finance Inc 325, 326 De Ronde v. Gaytime Shops 147, 152 Dillon v. Sears-Roebuck Co. 148, 153 Dirks v. SEC 177 Dodge v. Ford Motor Co. 127 Doe I v. Exxon Mobil Corp. 301 Doe I v. Nestlé USA 130, 131, 301 Doe VIII v. Exxon Mobile Corp. 130 Dunn v. HOVIC 352 Dura Pharmaceuticals v. Brouda 180 Dynamex Operations West v. Superior Court 436, 441, 445 Epic Systems Corp. v. Lewis 123 Exxon Shipping Co. v. Baker 124, 361 In re. Facebook 215–16, 219 Fernandez v. Curley 361 Filártiga v. Peña-Irala 130

Flame SA v. Freight Bulk Pte Ltd 326 Flomo v. Firestone Nat.Rubber Co. 130 Ford Motor Co. v. Montana Eighth Judicial District 372 Fruit v. Schreiner 37 Gantler v. Stephens 223, 225 Goldberg v. Uber Techs. 440 Gonzalez v. Google LLC 129 Goodyear Dunlop Tires Operations SA v. Brown 319, 370, 374 Graham v. Allis-Chalmers Mfg. Co. 196, 206, 224 Greenman v. Yuba Power Prods. 127 Gross v. Biogen 57 Grupo Mex SAB de CV. v. Mt McKinley Ins. Co. 374 Guttman v. Huang 206 Halliburton Co. v. Erica P. John Fund 179 Harlow v. Managing Partners 443 Helicopteros Nacionales de Colombia SA v. Hall 370 Henningsen v. Bloomfield Motors 127 Hertzberg v. Dignity Partners 180 Hodges v. New England Screw Co. 231 Hoffman v. Silverio-Delrosar 117 Hollinger v. Titan Capital Corp. 443 Huddleston v. Union Rural Elec. Ass’n 439 IBS Financial Corp. v. Seidman & Associates 182 International Harvester v. Kentucky 366 International Shoe v. Washington 369–70, 371 Ira S. Bushey & Sons v. U.S. 35, 117, 332, 340–41, 346, 348 J McIntyre Machinery Ltd v. Nicastro 372, 373 Janus Capital Group v. First Derivative Traders 178 Jesner v. Arab Bank 130–31 Joy v. North 233 Juliana v. United States 394–5 Kahn v. M&F Worldwide Corp. 225 Kiobel v. Royal Dutch Petroleum 130, 131, 297 Kokkonen v. Guardian Life Ins. Co. of Am. 395 La Fayette Insurance Co v. French 366 La. Mun. Police Employees’ Ret. Sys. v. Pyott 206 Ladd v. County of San Mateo 337 Lamps Plus v. Varela 123 Larry Bowoto et al. v. Chevron Texaco Corp. 301, 305 Lebanon Cty. Employees’ Ret. Fund v. AmerisourceBergen Corp. 214, 219

Index  489 Lehigh Valley Coal Co. v. Yensavage 441 Leo Sain v. ARA Manufacturing Company 153 Leonard v. USA Petroleum Corp. 373 Lisa M. v. Henry Mayo Newhall Memorial Hospital 349 Lo Rayne Poutre v. George Sanders 153 Lockton v. Rogers 230 Longenecker v. Zimmerman 336 Lorenzo v. SEC 178 Lundberg v. State 443 McCabe v. Ernst & Young 180 McPhadden v. Sidhu 224 McWhorter v. Sheller 139 Magill v. Ford Motor Co. 373 Magwitch LLC v. Pusser’s West Indies Ltd. 373 Marchand v. Barnhill 48, 55, 56, 214, 215–16, 219, 417, 426 Mary M. v. City of Los Angeles 348 In re Massey Energy Company Derivative and Class Action 205, 206 Mayor & City Council of Balt. v. BP P.L.C. 396 Metro Comm’n Corp. BVI v. Advanced Mobilecomm Techs. 206 Michelson v. Duncan 225 Miller v. Am. Tel. & Tel. Co. 206 Mohr v. Williams 336 Mortimer v. McCool 117 National Convenience Stores v. Fantauzzi 35 Nestlé v. Doe 131, 298 New York Cent. & H.R.R. Co. v. U.S. 40 Newby v. Von Oppen and the Colt’s Pat. Firearms Mfg. Co. 366 Niccum v. Hydra Tool Corp. 118 NLRB v. United Ins. Co. of Am. 442 N.Y. Central & Hudson River R.R. Co. v. United States 106, 443 NYK Cool AB v. Pacific International Servs 374 In re Oil Spill by Amoco Cadiz 301 Omnicare v. Laborers District Council Construction Industry Pension Fund 178 Osborne v. Lyle 443 Palsgraf v. Long Island R.R. Co. 128 Parker v. Carilion Clinic 443 Parklane Hosiery Co. v. Shore 359 Parnes v. Bally 228 Patrick v. Miss New Mexico-USA Universe Pageant 139 Payne v. Cmty. Blood Ctr. 361

Pennsylvania Fire Insurance Co of Pennsylvania v. Gold Issue Mining and Milling Co 368, 373 People v. Uber Tech. 441 Percy v. Millaudon 231 Pervasive Software Inc v. Lexware 373 Petro-Tech v. Western Company of North America 35 Philadelphia Reading RR v. McKibbin 366 Philip Morris USA v. Williams 352, 358, 362 Piper Aircraft v. Reyno 375 Ramos v. Uber Techs. 440 Revlon v. MacAndrews & Forbes Holdings 225 Richter v. Acha 177 In re RJR Nabisco 425 Robert Mitchell Furniture Co v. Selden Breck Construction Co 368 Robins Dry Dock & Repair Co. v. Flint 129 Roginsky v. Richardson-Merrell 353 Roth v. Robertson 206 Rutherford Food Corp. v. McComb 437 St Clair v. Cox 366 Salt Lake City v. Hollister 27 Salzberg v. Sciabacucchi 96 Sampson v. Vasey 361 San Mateo v. Southern Pac. R.R. 27 Sarei v. Rio Tinto 130 Search v. Uber Technologies 440 SEC v. Straub 177 SEC v. WorldCom 94 Shlensky v. Wrigley 230, 231 Slayman v. FedEx Ground Package Sys. 441 Smith v. Isaacs 34 Smith v. Van Gorkom 208, 225, 228 Souder v. Brennan 442 Stanziale v. Nachtomi (In re Tower Air) 57, 58 State Farm Mutual Automobile Insurance Co. v. Campbell 124, 352 State of N.Y. v. ExxonMobil Corp. 406–8 Stevens v. Spec Inc. 439 Stone v. Ritter 55, 56, 205, 211, 224, 417 Taber v. Maine 340 Taylor v. Sturgell 359 Teamsters Local 443 Health Services & Insurance Plan v. Chou 55, 56, 206, 214, 216–17 In re Trados Inc. Shareholder Litigation 225 Trustees of Dartmouth College v. Woodward 27 TSC Indus. et al. v. Northway 178, 406 United States v. Bank of New England 106 United States v. Bonito 403

490  Research handbook on corporate liability United States v. Carroll Towing Co. 119 United States v. Dye Constr. Co. 106 United States v. Fokker Svcs. 110 United States v. Hilton Hotels Corp. 106 United States v. HSBC Bank USA 110 United States v. Kordel 389 United States v. Kunzman 177 United States v. Mendoza 359 United States v. O’Hagan 177 United Steelworkers of America, AFL-CIO-CLC v. Connors Steel Co 325 Unocal Corp. v. Mesa Petroleum Co. 225 Viega GmbH v. EighthJudicial District Court 374 Vincent v. Lake Erie 335, 337–8, 339 Vitol v. Primerose Shipping Co Ltd 326 Vosburg v. Putney 119, 336 Wal-Mart v. Dukes 123, 357 Walkovszky v. Carlton 117 In re Walt Disney Co 227 Western Weighing & Inspection Bureau v. Armstrong 153 White v. University of Idaho 336 Williams v. Progressive County Mutual Ins. Co. 374 In re World Health Alternatives 57 Xue Lu v. Powell 443 Zaslow v. Kroenert 336 Zippo Manufacturing Co v. Zippo dotcom Inc 372–3 value-enhancing activity, directors’ business judgments 243–4, 245–6 Van der Elst, C. 424, 453, 456, 462, 465 Van Rooij, B. 200–201, 244 Velasco, J. 221, 224, 226, 229, 230 vicarious liability 274–91 abusive behaviour 275–6 and agency liability see agency liability, vicarious liability casualisation and contracting-out practices 278–9 close connection/course of employment test 281–5 compensation 275, 285, 286, 289, 290 ‘deeper pockets’ argument 275, 279, 286, 287 deterrence reasoning 289 disclosure of data 275, 276 economic reality test 277, 278 enterprise liability 330–31, 340 enterprise risk reasoning 285–90 enterprise risk reasoning, as a principled explanation 286–8

and flexible working conditions 276–8 ‘gig’ economy effects 276–7 group accountability 296–7, 299, 308, 309, 311, 312 insurance impact 287, 288, 289 joint liability 257–8 law in practice 275–6 quasi-employee identification 278–81, 288 relationship test 276–81 respondeat superior doctrine, and AI labor see accountability for AI labor, employed algorithms, respondeat superior doctrine and vicarious liability Salmond test 149, 282, 285 sexual abuse claims 280, 284–5, 289 statutory liability, attribution models 68 strict vicarious criminal liability, environmental, social, and governmental (ESG) factors and future of criminal liability, fraud cases 403 systems perspective 58–9 ‘vindication of interests’ justification, directors’ business judgments 251, 252 Volkswagen scandal 400 voluntary codes, group accountability 304, 305, 306 voluntary disclosure, environmental, social and governance (ESG) matters 189, 190–91, 192 voting, blockchain technology, internal governance 452, 464–5 Wachter, M. 87, 91, 92, 96, 97, 464 Wall-Parker, A. 113, 405 Wan, W. 447–66 Watson, S. 7–23, 25, 28, 29, 141–2, 144, 263 Watts, P. 136, 141, 143, 144, 258, 263 Weinrib, E. 330, 339, 340, 443 welfare see social interests Wells, C. 70, 78, 247 Werbach, K. 413, 462, 463 whistleblowers, environmental, social, and governmental (ESG) factors, fraud cases 400 white-collar crime criminal liability 113, 115 environmental, social, and governmental (ESG) factors, fraud cases 388, 390, 396, 399, 402, 404, 405–6 Williams, G. 65, 78, 275 Williamson, O. 15, 295

Index  491 Witting, C. 1–5, 42–60, 77, 142, 145, 146, 153, 256, 258, 259, 274, 287, 289, 292, 306, 307, 310–11, 312 wrongful acts, agency liability 147–51, 152–5 see also criminal liability

Yates, S. 104, 183–4, 187, 403 Zetzsche, D. 410, 426, 464 Zipursky, B. 247, 330