There are several principles which are now considered judicially acceptable on the subject of corporate tort and contractual liability.
by Dr. Ruwantissa Abeyratne
WHAT IS WHITE COLLAR CRIME?
(July 07, Montreal, Sri Lanka Guardian) White collar crime is a crime committed by a person of respectability and high social status in the course of his occupation. White collar crime is usually committed by executives or other white collar workers against the corporation or business entity they work for. The distinction between this and corporate crime is that white-collar crime is likely to be a crime against the corporation, whereas corporate crime is crime committed by the corporation, although the distinction is blurred when the given crime promotes the interests of the corporation and its senior employees because a business entity can only act through the agency of the natural persons whom it employs.
A corporation or business entity is considered a “person” in the legal context. Directors, officers and managers of such bodies are generally referred to as executives. Usually, a business entity is owed by its shareholders, operated by its employees and is under a legal obligation to pay its creditors. The seminal principle exempting shareholders from personal liability for their corporations’ contracts was established in 1896 by the House of Lords in the case of Salomon v. Salomon (a case in every casebook in every law school on the law of contract 101) which held that shareholders are not personally liable for their contracts and that what was called the “corporate veil” covered their personal assets. However, with the effluxion of time this principle was eroded and personal liability was attributed to directors and other executives as well. The Salomon decision decreed that the veil could only be lifted in cases of fraud, deceit, dishonesty and abuse of position. However, this overarching protection was withdrawn in North America in 1999 when the Ontario Court of Appeal. in the Valcom case decided that executives were prima facie personally liable for civil wrongs or torts they commit in the ordinary course of their office or employment.
Penal sanctions for white collar crime according to the guidelines are: restitution, where the victim can be identified and loss is quantifiable; community service order enforcing social service by the offender; remedial order that remedies damage such as environmental pollution where the miscreant will be ordered to clean up the mess he made; and payment of compensation and probation.
THE ENRON CASE
During the Enron fiasco in January 2002, the United States Justice Department confirmed that it had begun a criminal investigation of Enron, following the events of the company in October 2001 when Enron reported a $638 million third-quarter loss and disclosed a $1.2 billion reduction in shareholder equity, partly related to partnerships run by its Finance Chief that hid huge amounts of debt as well as write downs in money-losing broadband and water trading ventures. Enron went bankrupt on 2 December 2001, putting all its employees out of employment. Until this event, corporate executives were in a comfort zone of their own, as they believed they had only to act in the best interests of their employer by increasing the profits of their company. The Enron case highlighted the fact that an executive could be exposed for corporate misdeeds and for personal liability for such misdeeds. Therefore the executive has to be mindful of his responsibility to the shareholders, creditors and other stakeholders of his company, in terms of his personal liability.
Until fairly recently, executives were of the general belief that only responsibility was to maximize corporate profits and act in the best interest of their organizations. This myth was shattered by scandals such as those involving Enron, WorldCom and Adelphia and indeed several others where liability was imposed for corporate misdeeds by white collar workers resulting in their personal liability. Perhaps the most controversial and shocking was the Enron case. Enron Corporation was an American energy company based in Houston, Texas. Before its bankruptcy, in late 2001, Enron employed around 21,000 people and was one of the world's leading electricity, natural gas, pulp and paper, and communications companies, with claimed revenues of $111 billion in 2000. The magazine Fortune named Enron "America's Most Innovative Company" for six consecutive years.
Enron was disgraced at the end of 2001 when it was revealed that the corporation’s reported financial condition was sustained mostly by institutionalized, systematic, and creatively planned accounting fraud. Enron has since become a popular symbol of wilful corporate fraud and corruption. The lawsuit against Enron's directors, following the scandal, was notable in that the directors settled the suit by paying very significant amounts of money personally. Executives have a personal liability to their shareholders, employees, creditors and other stakeholders. This is not only applicable to the private sector but also apples to government departments and instrumentalities of States. The corporate veil that shielded executives from personal liability has now been lifted, often compelling executives to take precautionary measures before they act, particularly by seeking legal counsel.
INSIDER TRADING
Another offence, particularly in the United States, is insider trading which is a practice related to the trading of a corporation’s stock or other securities (e.g. bonds or stock options) by corporate insiders such as officers, directors, or holders of more than ten percent of the firm's shares. Insider trading may be perfectly legal, but the term is frequently used to refer to a practice which is illegal in many jurisdictions, in which an insider or a related party trades based on material non-public information obtained during the performance of the insider's duties at the corporation, or otherwise misappropriated.
Rules against insider trading on material non-public information exist in most jurisdictions around the world, though the details and the efforts to enforce them vary considerably. Usually, corporate insiders are a company's officers, directors and any beneficial owners of more than ten percent of a class of the company's equity securities. Transactions concluded by these types of insiders in the company's own stock, based on material non-public information, are considered to be fraudulent since the insiders are violating the trust or the fiduciary duty that they owe to the shareholders. The corporate insider, simply by accepting employment, has made a contract with the shareholders to put the shareholders' interests before their own, in matters related to the corporation. When the insider buys or sells based upon company owned information, he is violating his contract with the shareholders.
For example, illegal insider trading would occur if the chief executive officer of Company A learned (prior to a public announcement) that Company A will be taken over, and bought shares in Company A knowing that the share price would likely rise.
The Anti Corporate Fraud Initiative of President Bush of the United States is a good example of State action against white collar crime. The Administration continues to pursue an aggressive agenda to fight corporate fraud and abuse by exposing and punishing acts of corruption, holding corporate officers and directors accountable, protecting small investors, pension holders and workers, moving corporate accounting out of the shadows, developing a stronger, more independent corporate audit system, and providing better information to investors. Since the exposure of the corporate fraud scandals, the President has taken decisive action to combat corporate fraud and punish corporate wrongdoers.
President Bush's Corporate Fraud Task Force was led by the Deputy Attorney General. The President's Corporate Fraud Task Force comprises both a Department of Justice group that focuses on enhancing the criminal enforcement activities within the Department, and an inter agency group that focuses on maximizing cooperation and joint regulatory and enforcement efforts throughout the federal law enforcement community.
The United States adopted its Sentencing Guidelines for Organizations in 1991 with a view to ensuring that Organizations are precluded from profiting from wrongdoing and offering guidelines to Organizations in order that they ensure that appropriate programmes for the prevention of such wrongdoings are enforced. These programmes identify seven characteristics of a prudent company: existence of established standards of conduct and internal controls that are reasonably capable of reducing the likelihood of criminal conduct and detecting it when it occurs; familiarity of the Board of Directors with such standards; the use of reasonable efforts to avoid recruiting a person who is suspect or has committed white collar crime; communication to all employees on a periodic basis of the Organization’s standards and procedures on prevention of white collar crime; reasonable steps in monitoring and auditing on a periodic basis to ensure that the preventive programme is being properly implemented; promotion of a compliance programme and enforcement of that programme on a periodic basis; and reasonably quick response to white collar crime and efficient efforts to prevent recurrence.
Deterrence, early detection and prosecutorial discretion to obviate indictment are compelling reasons to implement a compliance programme. However, when offences are committed the prosecutor should take into consideration the nature and seriousness of the offence; pervasiveness of wrongdoing within the corporation; the corporation’s history of similar conduct; the corporation’s timely and voluntary disclosure of the offence; the existence and adequacy of the preventive programme; remedial actions employed by the corporation; the extent of harm to shareholders and others who are victims of collateral damage; the adequacy of prosecution of the miscreants responsible for the corporation’s malfeasance; and the adequacy of remedies such as civil actions or regulatory enforcement.
LIABILITY ISSUES
Usually, such personal liability is imposed through a blend of tortious liability (liability usually pertaining to a civil wrong involving a duty of care owed by one to another), contractual and corporate liability. Although it has been argued that personal liability of a white collar worker can be invoked only in regard to intentional acts, and that negligent or careless acts might not come within the Valcom principle, there are arguments both ways, particularly in the instance of the availability of insurance against professional malpractice. Usually, since the employer is the most knowledgeable about the risks posed by the acts of his employees, he is the most efficient insurer of negligent acts. Therefore, it has been judicially recognized that directors, officers and employees should be held jointly and severally liable on the understanding that they are indemnified by their employers.
There are several principles which are now considered judicially acceptable on the subject of corporate tort and contractual liability. They are: a person should be actively involved in wrongdoing if he is to be found personally liable under tort law. This effectively precludes agents and partners in being found liable for activities of their companies or corporations in which they do not participate. Therefore, ipso facto, by reason of their official capacities, they cannot be held liable for breach of contract or negligence; an employee, partner or agent can invoke his complete faithfulness to his company[i] in acting in the best interests of the company in breaching a contract and paying compensation for the breach rather than go ahead with performing the contract; and, an employee, agent or partner is personally liable for intentional torts or breaches of contract committed, irrespective of whether such acts were performed or not performance within the scope of employment.
Besides professional negligence and liability for expert opinions, white collar employees have to be acutely mindful of fraud which was highlighted by the Enron decision. Some post Enron offences which have been brought to the attention of authorities is planned bankruptcy, “bustouts”, “firesales”, “bleedouts”and “bloodsuckers”. A planned bankruptcy occurs when a monumental amount of credit is extended in the market place. In a “bustout”, credit is legitimately obtained for the purpose of purchasing inventory. The buyer then sells the inventory, frequently below cost and for cash up front, pays out the proceeds as salaries and declares bankruptcy. In what is seemingly a legitimate business, the operators begin to purchase additional merchandise from new suppliers whilst at the same time slowing payment to existing suppliers. Eventually, the orders are increased with all suppliers. The increased inventory is quickly sold and the buyer receives quick payment by way of a “firesale” and closes the establishment.
Bleedouts and bustouts can be back to back of each other. In such instances, typically a stable target company with highly liquid assets is acquired in a leveraged buyout. The acquired company is exclusively operated in order to allow the new insiders to plunder the company’s assets. The new insiders could masquerade as consultants hired by the besieged business to assist in acquiring new financing and streamlining operations. The consultant would, at a substantially bloated salary, take control of the financial operations and siphon money to insiders to the detriment of unsecured creditors and shareholders.
A “bloodsucker” is an instance where a long standing target company experiences financial difficulties, opening the door to insiders to form another company in the same industry just prior to bankruptcy filing. The debtor target transfers some of its valuable assets to the new company just before bankruptcy, leading the way for the insiders to transfer the most valuable assets of the debtor’s inventory, receivables, customers and goodwill to the new company. There could also be an instance where a debtor with substantial bank debt secured by personal loans could maximize his its credit purchases and then declare bankruptcy, leaving it to the bank to realize on the sale of the new inventory, and then apply the proceeds to pay down the personally guaranteed corporate debt.
Corporate foresight in avoiding white collar crime, and indeed any exposure of a corporate entity to liability is a growing area of management. It should be in the legislative and executive conscience of all democratic States.
Post a Comment