In this second post of an eight-part series on “parental controls” (Part 1 is here), we explore the types of harm that parent companies may suffer for the wrongdoing that occurs at joint ventures, subsidiaries and franchisees.
Because of the ownership structure of JVs, partner organizations typically will not be held directly liable for the misconduct that may occur at the JV, unless the JV is acting as the organization’s agent in the wrongdoing.
There is a risk of reputational harm, however, and there will be loss to the extent of the partner’s ownership interest if the JV suffers economic loss. In the TAP case (mentioned in the first post in this series), each JV partner suffered a financial loss of half of the overall loss to the JV, which amounted to hundreds of millions of dollars.
There is also the rather interesting possibility of liability of the directors of the partner companies, even if the partner companies themselves cannot be held liable — a theory that is based on the 1996 Caremark case (698 A.2d 959) and its progeny.
In Caremark, the Delaware Chancery Court stated in dicta that a director’s obligations include a duty to attempt to assure that a corporate information and reporting system exists and that failure to do so may render a director liable for losses caused by non-compliance.
The standard for liability under Caremark is very high, requiring a sustained or systemic failure to implement oversight. But directors can be liable where they utterly fail to implement systems to alert the board to problems, or implement systems but then consciously fail to monitor them.
Extending this to the context of a JV, directors could be liable if they fail to implement monitoring systems at the joint venture, or if they are aware of a lack of controls or red flags and fail to respond.
In the next installment of this eight-part series, we will begin to look at the “how” of JV compliance measures, but first a word about the “when,” meaning at what points in time should one consider establishing or enhancing JV-related compliance measures?
Most obviously, one does this when forming a JV, and perhaps equally obvious, these measures should be taken when investing in an existing one.
Somewhat less obviously, they should be considered when significant changes are made regarding a JV in which a company is already invested.
Examples include changes to the size of a company’s ownership interests, the nature of the JV’s business or changes to the partner (e.g., what had been owned by a private party is acquired by a government official).
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Jeffrey M. Kaplan and Rebecca Walker are partners in Kaplan & Walker LLP.
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