Sidestepping limited liability in corporate groups using the tort of interference with contract.

• Jurisdiction: Australia
• Author: Edmundson, Peter
• Date: 01 April 2006

[This article examines the tort of interference with contract. In particular it analyses the application of the tort to a holding company that 'starves "its subsidiary of funds. In this context the tort provides a potential mechanism to 'sidestep' the principle of limited liability. The elements of the tort are highly malleable and the tort is prone to expansion. Such expansion could erode the benefits of limited liability. For this reason the application of the tort in this context should be constrained with reference to the justifications of limited liability and courts should be reluctant to allow its application by a voluntary creditor who had other available mechanisms to protect their interests.]

CONTENTS I Introduction II Limited Liability and Corporate Groups III An Illustration of the Tort in a Corporate Group Context: Stocznia Gdanska IV Does the Tort Provide a Potentially Useful Remedy in Australia? V An Examination of the Tort in Australia A The Basis of Holding Company Liability B The Mental Element: Knowledge and Intention C Interference with the Contract 1 Failure to Act 2 Direct and Indirect Interference 3 Is the Interference Unlawful? D Damage E Justification VI The Breadth of the Application of the Tort in the Corporate Group Context VII Conclusion I INTRODUCTION

This article examines the tort of interference with contract. (1) It does so in the context of a potential claim by a third party against a holding company where the third party has contracted with a subsidiary of that holding company. (2) In particular, this analysis contemplates the application of the tort where a holding company 'starves' its subsidiary of funds, with the effect that the subsidiary is unable to perform its contractual obligations to the third party. (3)

Analysis of this matter is both timely and important. Recently there has been renewed focus on the ability of holding companies to distance themselves from the obligations of their subsidiaries. (4) Also, the recent High Court decision in Zhu v Treasurer (NSW) (5) has highlighted the application of the tort of interference with contract to commercial dealings and has demonstrated a divergence from the law in England. Discussion of the application of the tort to holding companies allows analysis of these issues and reveals the complexities of their interaction. It also illustrates the potential for the tort to apply in a manner that 'sidesteps' the principle of limited liability in corporate groups.

The analysis below first places the issue of holding company liability for interference with a subsidiary's contracts in the context of the limited liability of such a company for the debts of its subsidiary. This is followed by a discussion of the English case of Stocznia Gdanska SA v Latvian Shipping Co [No 3], (6) a recent Court of Appeal decision that illustrates the potential use of the tort against a holding company. Following this, there is a more detailed critical analysis of the elements of the tort in Australia, with a particular focus on the intricacies of those elements when there is a claim based on the 'starvation' of a subsidiary of funds. Finally, there is a discussion of whether a broad or narrow approach towards the scope of the tort should be taken in the case of corporate groups.

II LIMITED LIABILITY AND CORPORATE GROUPS

The issue of holding company liability for interference with a subsidiary's contract must be seen against the backdrop of two overlapping concepts that are the central legal features of corporate groups: the fact that corporations in groups are treated as separate juridical persons and the fact that limited liability applies to the constituent corporations in a group. These features, although subject to some limited exceptions, (7) give rise to the possibility that a holding company may, with limited risk of liability, allow one of its subsidiaries to 'wither on the vine' by refusing to provide the subsidiary with sufficient funds to operate. The problem was aptly described in the English context in Re Southard & Co Ltd by Templeman L J, who stated:

English company law possesses some curious features, which may generate curious results. A parent company may spawn a number of subsidiary companies, all controlled directly or indirectly by the shareholders of the parent company. If one of the subsidiary companies, to change the metaphor, turns out to be the runt of the litter and declines into insolvency to the dismay of its creditors, the parent company and the other subsidiary companies may prosper to the joy of the shareholders without any liability for the debts of the insolvent subsidiary. (8) Where this occurs and losses are left with a subsidiary, it may be that the holding company has 'externalised' risks while still taking rewards from its subsidiary. (9) However, if interference with contract provides a remedy against a holding company to a party contracting with a subsidiary, this may allow an important route to 'sidestep' the principle of limited liability. This in itself provides significant justification for an examination of the limits of the tort in this context. The tort is not alone in this regard and the 'sidestepping' of the principle of limited liability can be observed in the context of a number of other potential actions against holding companies. (10) The fact that the tort may join a developing range of paths around the corporate veil reinforces the importance of its examination.

III AN ILLUSTRATION OF THE TORT IN A CORPORATE GROUP CONTEXT: STOCZNIA GDANSKA

The application of the tort in a corporate group context can be observed in the case of Stocznia Gdanska. (11) In the case, the Latvian Shipping Company ('Latvian Shipping') negotiated for the manufacture and purchase of a number of vessels from Stocznia Gdanska SA ('Stocznia'). (12) The negotiations were conducted on the basis that the ultimate purchaser was to be a company nominated by Latmar Holdings Corporation ('Latmar'), a subsidiary of Latvian Shipping. (13) When negotiations reached their final stages, Stocznia was informed that the purchaser was to be Latreefers Inc ('Latreefers'), a company that was to be a wholly owned subsidiary of Latmar. (14) Stocznia did not seek a guarantee of Latreefers' performance from either Latvian Shipping or Latmar (although there was evidence that Latvian Shipping would have given such a guarantee if pressed). (15)

Latreefers was incorporated a few days before the contracts for the manufacture and supply of the vessels were entered into. (16) While the shares in Latreefers were held by Latmar, the directors of Latreefers were employees of a service company called Capco Trust (Isle of Man) Ltd ('Capco'), which was connected with a firm of solicitors on the Isle of Man. Capco and Latvian Shipping had entered into a contract that provided that Latreefers would 'be kept in sufficient funds by [Latvian Shipping] to honour its liabilities as and when they become due'. (17)

The contracts required the provision of six vessels (once certain options had been exercised) and the general structure of the consideration was the same in relation to each vessel. (18) A payment of five per cent of the total price was due on signing, to be followed by 20 per cent on the laying of the keel, 25 per cent upon launch and the remaining 50 per cent upon delivery. The five per cent deposit was paid in each case. Unfortunately, the market for the charter of the vessels (and hence the commercial value of the vessels) collapsed and it was suggested that, from the perspective of Latreefers, this made the contracts 'economically unrealistic.' (19) There was evidence that Latreefers, if unsupported by its holding companies, would not have been able to raise sufficient funds to pay for the vessels. (20)

Notice was given to Latreefers that the 20 per cent keel laying deposit was due for the first (21) and second (22) vessels. No payment was made. Stocznia gave notices of rescission in respect of these two contracts. Stocznia then purported to appropriate the keels laid for the first two vessels to the contracts for the third and fourth vessels and issued 'keel laying notices' in relation to these. (23) Again, the keel laying deposits were unpaid and notices of rescission were issued by Stocznia. A similar process ensued in respect of the contracts for the fifth and sixth vessels. (24)

As Latreefers was unfunded, any remedies against it would have proved hollow. Therefore, Stocznia brought a number of claims including one against Latvian Shipping on the basis that Latvian Shipping had induced Latreefers' breach of contract. It was found at trial that Latvian Shipping had not directly induced Latreefers to breach its contract with Stocznia as Latvian Shipping had not specifically told Latreefers' directors not to pay the relevant instalments. (25) However, the trial judge, Thomas J, was satisfied that the task of raising finance for the vessels was the responsibility of Latvian Shipping and not of Latreefers, that Latvian Shipping had instructed Latreefers that it did not intend to provide funds for the instalments (at the time of the keel laying notices) and that Latreefers was told to do nothing to respond to the notices. (26) Thomas J further found that this was a deliberate breach of the agreement that Latvian Shipping had with Capco to keep Latreefers in sufficient funds and that the objective of refusing to fund Latreefers was to prevent it performing its contract with Stocznia. (27) On this basis it was found at first instance that Latvian Shipping was liable to Stocznia for indirectly inducing a breach of contract by Latreefers. (28)

Several issues were considered on appeal. In relation to the actions in tort, Rix LJ (with Tuckey and Aldous LJJ agreeing) found that the trial judge's decision that there was no liability for direct inducement of breach should not be disturbed. (29) However, Latvian Shipping was liable for 'indirect...