Piercing of Corporate veil: considerations of peculiarities of Armenian law
05/12/2020
Introduction
The basic principle of corporate law is that the members of a company are not responsible for the liabilities of the company with their property. Throughout all the modern jurisdictions an issue considered by courts and in corporate law doctrine has been the issue of whether a court can ignore this separate legal personality and can treat the company’s obligations or liability as to the obligations and liability of a person who owns and controls the company. The concept is widely known as “piercing the corporate veil” of the company. The issue has not been omitted by the Armenian judiciary either. This post will discuss the basic principles of piercing the corporate veil under Armenian law and will highlight the matters to be considered by the corporations, legal practitioners and researchers when evaluating the possibilities and cases of holding the members (and shareholders) of a company liable for the obligations thereof.
As a starting remark, Armenian law recognises the independent status of legal entities in Armenia (separate personality), ensuring the limited liability of the participants (shareholders) of companies. The standard rule of the Civil Code of the Republic of Armenia (“the Code”) under Article 60 determines that:
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“1. A legal person shall be liable for its obligations with all property belonging to it. 2. The founder of (or a participant in) a legal person shall not be liable for the obligations of the legal person, and the legal person shall not be liable for the obligations of the founder (or participant), with the exception of cases provided by the present Code or by the charter of the legal person.” |
Similar provisions are determined under the Law on Joint Stock Companies and the Law on Limited Liability Companies.
Simultaneously, Armenian legislation recognises the concept of the corporate veil in the following manner. Article 75 of the Code considers the relations between parent and subsidiary company and determines that:
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“1. A commercial entity is a subsidiary company, if another (principal) business company or partnership by virtue of dominant participation in its charter capital or in accordance with a contract concluded between them has the opportunity to predetermine decisions taken by such a company. 2. A subsidiary company is not liable for the debts of the principal partnership or company. 3. The principal partnership or company, which is entitled to give mandatory instructions to the subsidiary bears joint and several responsibility for the performance under the transactions concluded based on their instructions. The principal partnership or company shall be considered to have the right to give a subsidiary company instruction obligatory for it only in the case when this right is provided in a contract with the subsidiary company. ․․․ 5. In case of bankruptcy of a subsidiary company by the fault of the principal partnership or company, the principal partnership or company shall bear subsidiary liability for its debts. Bankruptcy of a subsidiary company shall be considered as occurred by the fault of the principal partnership or company, where it has occurred as a consequence of execution by the subsidiary company of mandatory instructions of the principal partnership or company.” (emphasis added) |
The Law further develops this concept by indicating (Article 7) that:
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“2. The Company shall be deemed as subsidiary, if another (principal entity) company or partnership by virtue of dominant participation in its charter capital or in accordance with a contract concluded between them or through other means not prohibited under the law is entitled to predetermine the decisions of that company. … 4.The subsidiary company shall not bear liability for the obligations of the principal company (partnership). The principal company (partnership) which has the right to give mandatory instructions to the subsidiary company, shall bear several and joint responsibility for the performance under the transactions concluded based on their instructions. … 7. In the cases established under points 4-6 of this article, the principal company (partnership) shall be liable if it knew or should have known about the arousal of respective consequences.” |
The Court of Cassation of the Republic of Armenia, in the decision No ԵԱՔԴ/2005/02/12 has addressed this concept and indicated that:
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“It derives from the systematic analysis of the norms mentioned above, that subsidiary company is not an independent organisational form of a legal entity, but with this definition, the lawmaker has aimed at protecting the interests of a company bound by instructions of another company or partnership, its creditors and shareholders. The opportunity of a subsidiary company to express independent will is limited by another principal company (partnership) due to economic dependence. <…> The court of cassation finds that the Civil code reflects the logic, based on which for a company to be subsidiary it is material that another company (partnership) have the right to predetermine the decisions of that company, and, due to that the lawmaker has foreseen certain cases of bearing responsibility arising from the activities of the subsidiary company. Thus, the necessity of special regulation of the subsidiary company is dictated by the opportunity to predetermine the decisions of one company by the other company (partnership) based on the relationships of these companies and the peculiarities of these relationships. Moreover, the lawmaker has determined in what manners the principal company must have an opportunity to predetermine the decisions of the other, for it to be considered as a subsidiary. Notably, these manners are the dominant participation in the charter capital of the company, or the agreement concluded between the companies. Continuing the logic of the RA Civil Code <…> The RA Law on Joint Stock Companies determines that a company may be considered as a subsidiary when one other company due to means not prohibited under the law has the right to determine the decisions of the company. Including, the principal company can have an impact on the subsidiary’s decisions, for example through taking the property of the subsidiary as a pledge, providing a loan, engaging its representatives in the management bodies of the company and through other means. Therefore, as a result of the systematic analysis of the regulations mentioned above, considering the regulations of the RA Law on Joint Stock Companies, the court of cassation establishes that to recognise a company as a subsidiary, the existence of the following facts is sufficient. a. A principal company (partnership) has the right to predetermine the decisions of another company, b. The opportunity of the principal company (partnership) is conditioned by the existence of a structure not prohibited under the law.” (emphasis added) |
In the discussed case, the Court of Cassation addressed the liability of a parent company for the bankruptcy of a subsidiary. While the law does determine certain peculiarities in case of liability of a subsidiary in case of the court’s considerations of the relationships between two companies are still noteworthy as they can be equally applicable to the relationships when an issue related to contractual liability arises. Particularly, when considering whether a company should be considered as a subsidiary to another, and, respectively, bear joint and severe liability, the court, in consideration of the evidence, has noted:
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“The Organisation has had the authority to predetermine and give instructions of mandatory performance to the company and is liable for the arousal of grounds of bankruptcy due to non-payment of the salary as the Organisation has factually managed the overall activities of the company. Particularly, the following expressions in the above facts: “discuss the question and report”, “please formulate”, “as a performance” as well in the evaluation of the combination of the facts, the Court of Cassation finds that the Organization, through giving instructions in a manner not prohibited under the law, has predetermined the decisions of the company, which, on merits, has been reflected through receiving any decision of the company by the Organization. Moreover, the overall economic activity of the company, on merits, has been under the management of the Organization. Therefore, in the conditions of control of economic activity of company by the organisation, the arousal of the bankruptcy of the company has also occurred due to the instructions given by the Organisation irrespective of the existence of evidence on providing explicit instructions on non-payment of salary[6].” |
Accordingly, the Armenian law does recognise the concept of piercing the corporate veil and determines cases when a parent company can be held liable for the obligations of the subsidiary.
Still, it is safe to say that the bar is very high: a company can be considered as a parent company and can be held liable exclusively in the existence of specific circumstances establishing the dominance of the parent company towards the subsidiary.
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For the sake of this article, it is further necessary to address two main issues: 1. What requirements are necessary for two companies to be considered as parent and subsidiary and when a parent company shall be liable for obligations of the subsidiary? 2. For what types of obligations can the parent company be held liable? |
(i) the essential criteria for piercing the corporate veil.
Based on the regulations presented above, as well as the precedential decision of the Court of Cassation of Armenia, a company can be deemed as a parent to another company and be jointly and severally liable for the subsidiary’s obligations, when the following criteria simultaneously exist:
- The parent company is entitled to predetermine the decisions of the subsidiary,
- The subsidiary has economic dependence on the parent company,
- Such opportunity to predetermine the decisions arises
- by virtue of its participation in the subsidiaries charter capital, or
- based on an agreement between the parent and the subsidiary companies, or
- through other means not prohibited under the law,
- The parent company is entitled to give mandatory instructions to the subsidiary. This criterion exists, when the right to give mandatory instructions arises:
- Based on an agreement concluded between the subsidiary and the parent company,
- Through other means not prohibited under the law.
- The obligation of a subsidiary company has arisen from a transaction, which has been concluded based on the instruction of a parent company,
- The parent company knew or should have known about the arousal of the respective consequences, e.g. breach of obligations under the agreement.
Therefore, should the claimant be able to establish the existence of the criteria mentioned above, the parent company may be held liable for breach of obligations of a subsidiary company.
(ii) Scope of liabilities
The second issue, which is vital in the discussed case is the scope of obligations for which the parent company may be held liable.
As a general remark, it must be noted that the civil liability under Armenian law can derive either from breach under a contract, or a violation of non-contractual liabilities, i.e. tort.
As can be derived from the above-referred regulations, the concept has its limitations to the extent that the responsibility of the parent company bears joint and several responsibility only for contractual obligations, rather than tort. Even when the creditor can establish that the above-indicated criteria for considering two companies as parent and subsidiary exist, the Parent company would still be liable for obligations arising only from contractual obligations of a subsidiary.
Finally, the RA Legislation determines the possibility of holding the parent company liable in case of bankruptcy of the subsidiary, when the bankruptcy of the subsidiary has arisen due to the mandatory instructions of the parent company. Moreover, in the discussed case the law does not separate between the contractual and non-contractual obligations, which serves as a basis to conclude that in case of existence of respective circumstances the parent company may be held as liable.
Conclusions
The following conclusions can be made:
- The Armenian legislation recognises the concept of piercing the corporate veil,
- For the corporate veil to be pierced, there are several criteria that must be met, including the establishment of the Parent-Subsidiary relationship, the authority to give binding instructions to the subsidiary,
3. Should the piercing of corporate veil be successful, the parent company will be liable only for the performance of a transaction concluded based on the instruction of the parent company, except for the cases of bankruptcy of the subsidiary company, in which case limitation of the scope of obligations does not exist.
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