(Draft 8/1/2005 – Work in progress; please do not cite or quote.)
Relational Networks and Enterprise Law:
Comparative Trends of Network Liability
in the United States and Europe
René Reich-Graefe
University of Connecticut School of Law
65 Elizabeth Street
Hartford, Connecticut 06105
United States of America
rgraef@law.uconn.edu
Abstract. Corporate groups and relational networks (with franchising systems
presenting a prime example of the latter) share many functional and economic
attributes. Due to their paradoxical structures and dialectically opposed strategies for
organizational success, they present a complex challenge to the regulatory system.
Courts and legislators in the United States and Europe alike have increasingly turned
to concepts of enterprise law and – for the externalities of such conglomerates – to
principles of enterprise liability in order to better align the still vastly disparate
economic and legal realities of these modern-day ‘titans’ of collectivized commercial
cooperation. This paper endeavors to investigate and evaluate those international
trends – by necessity, in a rather eclectic and essayistic manner – with particular focus
being given to the product liability exposure of networks. In synthesis, it concludes
that comparative and interdisciplinary network research has become an indispensable,
yet largely unfulfilled prerequisite in order to fully grasp the unique nature and impact
of the dual phenomenon of corporate groups and relational networks in post-modern
economies and, further, that such undertakings may eventually become to be best
understood – and best regulated – as a higher-level form of commercial cooperation,
i.e., an organizational structuration and enterprise sui generis, within the evolutionary
process of industrial organization.
1
Introduction
Corporate groups and what are named here relational networks are both highly integrated,
polycorporate economic enterprises. Though their origins lie far back in the nineteenth
century, their emergence as a prevalent form of industrial organization in modern market
economies only occurred during the second half of the twentieth century. Arguably, it took
even longer before they squarely entered the res publica and before their regulation in the
public realm began in earnest. To this day, a convergence of the economic and legal
realities of group enterprises and relational networks has not been achieved by any
significant degree (in neither of such dualities).
Notwithstanding the striking similarities in the functional and structural attributes of
both types of networks as well as in their externalities, international comparative study (not
to mention uniform, network-specific regulation) is rather rare. However, it is the
experience from other network relations and from attempts at their regulation which should
give corporate group scholars cause for thought (Teubner 1991, p 118). Are there trends of
© René Reich-Graefe, 2005
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(regulatory) convergence which perhaps remain imperceptible to the analytical inquiry of
only one system (whether the particular network organization or academic discipline)? One
such (apparent) trend is made the object of investigation here: the increasing application of
principles of enterprise law and theories of enterprise liability to both corporate groups and
relational networks. Regarding the former typus of a collectivized commercial undertaking,
legal scholarship and regulation on the ‘twin’ topics of group aggregation and group
liability are already far advanced (as described in more detail in Part 2 below). They may
therefore provide a suitable frame of reference in order to examine more closely the
relevance of enterprise law principles in the domain of relational groups (as described in
Part 3 below, using franchising systems as a main example).
The objective of this investigation and analysis is to develop a better understanding (and
also a more adequate normative perspective) of the current, international trends coalescing
within various regulatory frameworks applicable to corporate and relational networks. It
presents a conceptual inquiry aimed at identifying – within the limited area of network
liability – where network regulation may be headed (‘sharpening the lens’) and, to a similar
extent, of where such regulation should be headed (‘calibrating the lens’) (see Part 4
below).
2
Corporate Groups and Enterprise Law
Pursuant to traditional, nineteenth century Anglo-American corporation law, each corporate
entity within a collective network of companies is recognized as a separate juridical entity
with its own legal rights and responsibilities independent of those of its corporate affiliates
(i.e., parent and subsidiary companies as well as side-stream affiliates under common
ownership and control). The same corporate ‘entity law’ approach (Blumberg 1990, pp
285-87; Blumberg 1993, pp 305-08; Blumberg et al. 2005, pp xii) is firmly established
today in each of the corporation laws on the European Continent – a development that can
be traced back to the first formulations of limited investor liability in the Napoleonic Code
de Commerce of 1807 (see Blumberg 1986, pp 595-96).
In contrast thereto, during most of the twentieth century the legal systems in Europe and
the United States have progressively crafted competing notions of group or enterprise law
(‘Konzernrecht’ in German) within various areas of the law of corporate networks. Such
enterprise principles have led to a re-attribution of legal rights and responsibilities among
the affiliated companies constituting the single economic enterprise and, in their most
far-reaching configuration, may impose a collective liability of all participants of such
conglomerate by way of penetrating the horizontal and vertical ‘corporate separateness
barriers’ traditionally accepted, but found anachronistic and dysfunctional in modern
polycorporate groups.
2.1
The Corporate Group Phenomenon
The corporate group or group of companies (‘Konzern’ in German) is, by no means, a
recent (legal) phenomenon. It has long been a reality throughout the world; legal
provisions applicable to group enterprises are nowadays legion (Blumberg 1990, p 287;
Blumberg et al. 2005; Embid Irujo 2005, pp 67, 81; Forum Europaeum 2000, pp 167-68,
258). The emergence of corporate groups in the United States commenced with a
liberalization of state corporation laws that permitted intercorporate stock ownership for the
first time, i.e., corporations itself, not only natural person investors, were allowed to acquire
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3
and own the shares of (other) corporations. New Jersey blazed the trail in 1889 and,
eventually, all other American jurisdictions followed suit (Blumberg 1986, pp 605, 607).
Similarly, the legal systems in England (1867) (see Blumberg 1986, pp 608-09), Germany
(where groups of companies had been observed already in the nineteenth century and legal
discussion of groups of companies began in 1910; see Hopt 1991, p 83) and France (1878)
(see Forum Europaeum 2000, p 167 n 2) have long acknowledged the legitimacy of
intercompany stock ownership – still the central structural element of group composition
today (Immenga 1985, p 13).
The paradigm features of the corporate group are its centralized structure (often a
hierarchical pyramid)1 based, in most cases, on equity participation, and the control
exercised downstream in a ceaseless, continual manner from the group’s vertex, i.e., the
ultimate parent company at the top of the pyramid, to the lowest, most removed tier of each
individual branch of subsidiary entities extending beneath such parent firm. Both such
features are designed in order to create the entrepreneurial integration and unity of the
collective enterprise. Forms of ‘control’ (sometimes also termed ‘dominance’) 2 may vary
but regularly include the ownership of a majority of the issued stock of the controlled
entity, the ownership of a majority of the voting rights, the right to determine the
composition of such entity’s governing body (board of directors, supervisory board, etc.),
the right to influence or direct such entity’s otherwise autonomous decision-making
process, and any combination thereof (Forum Europaeum 2000, pp 187-91; Kluver 2000,
pp 291-93; Nygh 2002, p 52).3 Furthermore, various legal systems – in particular,
Germany – allow for special organizational ‘control agreements’ (‘Beherrschungsverträge’
1
2
3
The term ‘pyramid’ is used here to describe the prevalent group structure where the ultimate
parent company (usually without operational business or assets) controls various sub-holding
companies (usually wholly-owned) which then independently own various second-tier
subsidiaries with operational businesses and/or consolidated ownership interests in further,
lower-tier subsidiaries, and so forth on each next level of group subordination. This very
common and legitimate pyramidal group structure should be distinguished from what are
sometimes termed ‘abusive pyramids’ or ‘pyramid schemes’ where (public) holding companies
are stacked up in a chain for the sole purpose of vesting ultimate control of such pyramids in a
small total investment due to the extensive use of external minority shareholders at each level
(chain link) of such pyramid schemes (see European Commission 2003; Winter 2002).
For purposes of this paper, the terms “control’ and ‘dominance’ are used interchangeably.
However, formal differentiations in the legal terminology can be made in various jurisdictions
(for details, see Forum Europaeum 2000, pp 187-91).
For example, art 1(1) of the Seventh Company Law Directive of the European Union on
Consolidated Group Annual Accounts, 83/349/EEC of June 13, 1983, OJ [1983] L 193 p 1,
defines ‘control’ by the presence of at least one of the following features which lead to the
constitution of a corporate group: (i) control by holding the majority of voting rights, (ii) control
by a contract establishing the dominance of one company over another, or (iii) the right to appoint
and remove the majority of the members of the board of directors or supervisory board (see
Forum Europaeum 2000, p 189). A much broader and more dynamic definition of ‘control’
(including so-called de facto control not necessarily conveyed by way of formal legal rights) is
included in sec 50AA of the Australian Corporations Law pursuant to which “(…) an entity
controls a second entity if the first entity has the capacity to determine the outcome of decisions
about the second entity’s financial and operating policies. In determining whether the first entity
has that capacity, (i) the practical influence the first entity can exert (rather than the rights it can
enforce) is the issue to be considered, and (ii) any practice or pattern of behaviour affecting the
second entity’s financial or operational policies is to be taken into account (even if it involves a
breach of an agreement or a breach of trust) (for details, see CASAC 2000; Kluver 2000).
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in German) which permit the then dominant company to exercise far-reaching executive
powers over the contractually subordinated corporation and its no longer independent but
now group-integrated management (Forum Europaeum 2000, p 233; Reich-Graefe 2005, pp
788-90).
Corporate groups are complex, dynamic, multi-tiered and, at the same time, very
flexible and adaptable institutions, both economically and legally – but this complexity and
intricacy does not, in itself, explain the apparently concomitant necessity felt in many legal
systems to regulate groups of companies specifically (i.e., other than indirectly by means of
general company laws applicable to, and designed for, singlecorporate businesses). By way
of a general explanation, it should be noted that, structurally, the legal position of the
corporate group is marked by the tension of its unity as a commercial enterprise and its
diversity (or multiplicity) due to the legal segregation and insulation of its constituent
member companies (Forum Europaeum 2000, pp 193, 232; Teubner 1990, p 67). Such
tension is intentional; the objectives of economic unity and legal diversity – together and
simultaneously – cherished goals of the management and operational optimization of
modern corporate groups.
Consequently, the integration of group management and the harmonization and
coordination of operational group functions by legal means (through the manifestation and
continuous application of control over group subsidiaries) are principles aimed at achieving
commercial unity as one of the group’s predominant goals. To be effective, those
principles have to consciously disregard the legal diversity created by the plurality of
component group companies. Diversity, however, is the corresponding goal of a different,
if not opposite, principle governing the structural logic and raison d’être of corporate
groups – viz., subsidiarity. In a network context, subsidiarity ultimately translates into
network decentralization. As a true objective, it would allow each subsidiary corporation
to self-govern, i.e., to autonomously manage core areas of its commercial operations in
furtherance of the genuine economic interests of, and the resultant business objectives
independently set by, such subsidiary (which interests and objectives may or may not align
and coordinate with the identification and promotion of the group’s collective interests and
objectives).
The concurrent pursuance of the dual goals of commercial unity and legal multiplicity
within corporate groups may accordingly be considered a structural paradox: Disparate
legal strategies are utilized in order to structure the group internally (integration of
management to attain internal unity on the one hand and segregation of asset spheres to
realize external ‘owner shielding,’ i.e., a decentralization of liability to third parties, on the
other hand) and in order to position the collective enterprise to develop optimal legal and
economic frameworks for market success. Such success objectives, however, are obviously
set in a ‘group-immanent’ and autopoietic manner, i.e., they are self-referentially generated
from the inside of the group without reflection of the ‘outside’ world. In the legal
literature, Teubner (1990, p 67) has described the autopoiesis aspects of such constitutive
group functions as “closed networks of self-producing decisions.” As we know, however,
corporate groups do not operate in a hermetic, closed world. Whatever introvert reclusion
(and operation of disparate legal strategies) may be functional within corporate groups for
purposes of generating a unified organizational system, groups are also ‘grouptranscendent’ and effluent institutions in constant interaction with their outside
environment. Such interaction and “openness toward the environment” (Teubner 1990, p
67) is, among other things, characterized by a necessary actualization of group-extraneous
interests (i.e., those of outside, non-group parties that the enterprise comes in contact with)
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and an often reflexive externalization of the cost of network risks (for example, network
mismanagement, operational hazards, and the undercapitalization of individual network
units) which may give rise to contract and tort claims by outside creditors of the group’s
subsidiary firms.
Put briefly: Groups may be best understood as structural hybrids, and hybrid systems
often, by their very nature, generate (societal) friction and externalities which bring
regulators to the table. Groups collectivize action without simultaneously collectivizing
responsibility; they increase and externalize risks to outside parties without taking adequate
measures to ensure their absorption (see Collins 1990, p 737; Teubner 1991, p 106; 1993b,
p 230).4
2.2
Corporate Networks and Enterprise Law
Historically, the phenomenon of corporate groups was preceded in the nineteenth century
by an almost universal acceptance of two fundamental doctrines on the subject and juridical
status of companies: First, that an entity once incorporated and, thus, sanctioned by the
state became an independent legal subject, separated in personam and in rem from its
residual owners (i.e., its shareholders), and, next in chronological sequence, that the
personal liability of equity investors to the creditors of such incorporated entity was limited
(Blumberg 1986, p 607; Blumberg 1993b, pp 58-60; Buxbaum 1974; Easterbrook and
Fischel 1985).5 As the rule to this very day and as one of the cornerstones of modern
market economies, entrepreneurial liability of residual owners (NB – to the corporation, not
to its creditors) is strictly limited to the respective subscription or investment amount
undertaken by each such owner – and is further limited to a ‘call liability,’ i.e., the amount
of such agreed-upon capital contribution which has not yet been paid to the corporation (if
any). The concept of limited liability and the legal separation of the residual owner’s
personal assets from those of the firm is sometimes also described as ‘owner shielding.’
Such entity law approach – the ‘atomistic’ notion of the separate juridical personality of
each individual corporation with its rights and responsibilities (i.e., its jural relations)
rigorously confined by the legal and capital boundaries of such personality – is one of the
fundamental concepts of corporation law common today to all Western legal systems
(Blumberg 1990, pp 286-87, 297; Blumberg 1993b; Collins 1990, Forum Europaeum 2000,
p 169).
4
5
The central legal policy issues raised by coordinated group action as well as their regulatory
repercussions on both legal diversity (as a key goal within corporate groups) and entity law (as a
fundamental principle of company law) are discussed in more detail in the following part.
Although these two principles are often assumed to be essentially interrelated, Blumberg (1986)
has demonstrated that the early historic origins of entity law have long preceded the – in
comparison thereto – relatively recent doctrinal recognition of limited liability. In other words,
“[a]lthough entity law does not inevitably involve limited liability, limited liability cannot exist
without acceptance of entity law” (Blumberg 1990 p 286). The core attributes of entity law, i.e.,
those flowing from the recognition of the corporation as a separate juridical entity, may therefore
be summarized as the capacity to sue and be sued, to hold and to transfer property independent of,
and separate from, its shareholders, to have its own term of existence (typically perpetual and
irrespective of any changes in its shareholders as a result of death, transfer of share title or
otherwise), and to allow transfers of share ownership without any effect on the corporate
existence (see Blumberg 1990 pp 286, 295, 322).
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However, as Blumberg (Blumberg et al. 2005) has most convincingly and
systematically demonstrated,6 the once hallowed principle of entity law has been eroded
during the course of the twentieth century and has been supplanted in many areas of
corporate, tax and business regulatory law by modern notions of what may be designated as
‘enterprise law.’ Today, there is hardly a single developed jurisdiction in which the
specific risks within corporate groups to minority shareholders, to creditors of individual
group member companies, to the group’s labor relations, to market competition, etc. 7 and,
thus, the specific demands of corporate group regulation are not taken seriously (Forum
Europaeum 2000, p. 173; Kluver 2000, p 291). As a result, the legal fiction of the separate
juridical personality of each constituent group company as well as the insulation of its jural
relations from all other member companies of the group are more and more frequently
disregarded while, at the same time, the larger picture – the aggregate group enterprise –
becomes the focus and subject of regulatory attention today.
Faced with the modern reality of “highly intertwined operational and economic
relationships between parent and subsidiary corporations” (Blumberg 1993b, p 92), courts
and legislators have developed a variety of conceptual approaches leading, in essence, to a
re-ascription of legal responsibility for subsidiary acts and defaults to the parent company
as well as (sometimes) to the group at large. The segregated spheres of corporate
personality and (in-)action of individual group members pursuant to entity law principles,
and, likewise, the radii of influence and consequence of their individual (in-)action, thus
begin to converge into the legal (i.e., no longer only economic) recognition of a single
actor: the group in toto. In particular in the realm of statutory law (originating, in the
United States, with the New Deal legislation), traditional entity law strictures have been set
aside, and comprehensive ‘control’ concepts have been adopted by legislators – both in the
United States and in Europe8 – in order to bring not only the regulated company but also its
‘controlling’ corporations (and often also its ‘affiliated’ corporations and corporations
under its ‘common control’) within the ambit of the regulatory program (Blumberg 1990,
pp 288-89, Blumberg et al. 2005). American common law, today, equally recognizes the
inadequacies of nineteenth-century entity law paradigms in dealing with the profound
problems presented by the modern-day corporate group and its complex, multi-tiered (and
often also multinational) operation and governance structures (Blumberg 1990, pp 288-89).
Pursuant to these – for traditional corporate law paradigms, revolutionary – legal techniques
applied by legislators and judges alike, the entire economic enterprise is suddenly
transposed into the bright spotlights of political and regulatory scrutiny.
6
7
8
Professor Phillip Blumberg’s encyclopedic treatise on the law of corporate groups, now in a
long-awaited, five-volume second edition (Blumberg et al. 2005), virtually constitutes the only
extensive consideration of the development and legal treatment of corporate groups in American
law. Many of his other seminal articles and works in this field have equally (and almost
single-handedly) pioneered and established corporate group law as a subject of academic
discussion and debate within its own right in the United States.
In other words, the corporate group’s ‘plural incidence’ in different branches of a given national
or supranational legal system (see Embid Irujo 2005, p 68).
The European Union has widely accepted and utilized ‘control’ as a regulatory concept (see the
Seventh Company Law Directive of the European Union on Consolidated Group Annual
Accounts described in note 3 above). As a result of such European legislation, all EU member
states today, for example, supervise their banks and insurance companies on a consolidated group
basis (Forum Europaeum 2000, p 170).
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A detailed discussion of these enterprise law techniques is beyond the scope of this
paper (though an example of the same in the area of product liability will be discussed more
specifically in the following part).9 But what is important to note here are the critical policy
issues – the ‘common threads’ – fueling the application of enterprise principles in various
areas of the legal systems in Europe and the United States. The first of such group-specific
policy issues must obviously be perceptual: Since the group as a whole becomes the
subject of regulatory activity (and inevitable perception), perceptual factors like the extent
of the interrelationships between the group and its controlled companies, the extent of
organizational direction (i.e., the exercise of intragroup control), the economic,
administrative and financial interdependence and integration of group companies, and the
use of a common public persona (see Blumberg 1990, p 291; Blumberg et al. 2005) become
vital aspects of (legal) policy-making. As regards the substance of those common policy
threads, the obvious starting point is the prevalence and size of corporate groups in today’s
global marketplace. Very large corporations (whose revenues rival or even exceed the
gross national products of many Western economies) dominated the economic system.
Legal fragmentation and decentralization among group companies (and further political and
regulatory fragmentation in the case of multinational groups) does not correspond to the
economic reality of centralized corporate decision-making within a single, integrated
(worldwide) enterprise, and to the magnitude of the collective, highly concentrated
socioeconomic impact such enterprise may have in each country of its operations.
In summary, corporate groups represent legitimate entrepreneurial structures whose
interests are to be recognized and protected by the regulatory system. However, having
said this, it is equally evident today that the legal regime of corporate groups often proves
insufficient, and hence unable, to ensure the safety of their members as well as the orderly
pursuit of their interests in balance with those of group-extraneous parties, in particular,
creditors and external minority shareholders of component group companies (Embid Irujo
2005, pp 74, 90; Forum Europaeum 2000; Winter et al. 2002). This reality has created
irresistible regulatory pressures to ensure effective group responsibility and accountability,
and to impose more effective societal controls through the development of new legal rules
in the regulatory dimension of unity (i.e., the commonality of the collective group
enterprise) and, simultaneously, the abandonment of the traditional corporate law
dimension of diversity (i.e., the multiplicity of the separate corporate ‘parts’ constituting the
group) (Blumberg 1990, p 285).
2.3
Corporate Networks and Enterprise Liability
The starting postulate of most, if not all Western legal systems in respect of personal
liability issues involving corporate groups is premised on a ‘relic’ of the traditional entity
law concept described above and originally developed and designed with singlecorporate
(instead of polycorporate) enterprises in mind – viz., that each subsidiary corporation within
a corporate network is (primarily) responsible and liable for its own acts and defaults and
that further (direct or derivative) recourse to the parent-company shareholder is generally
not permissible since such shareholder, as a separate juridical person, is entitled to the same
9
For a most detailed and literally volume-filling discussion of these techniques in the statutory and
common law of the United States, see the seminal works by Blumberg (most recently and
comprehensively, Blumberg et al. 2005).
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limited-liability investor protection (owner shielding) which an individual, natural-person
shareholder would enjoy under similar circumstances. (Nygh 2002, p 52).
However, a dogmatic re-examination of this postulate of juridical entity separation can
immediately claim central importance (both for corporate and law practice as well as for
economic and legal theory): When and to which extent should the financial liability and
responsibility for corporate debts created by the acts or defaults of any subsidiary be
attributed to the parent firm (or, even broader, the entire corporate network of affiliated
companies as an integrated commercial enterprise) in order to implement effectively the
regulatory policies and purposes of the underlying, substantive field(s) of law (for example,
contracts or torts) involved in each particular case? When is the principle of limited
liability applicable to each of the separate but vertically controlled group companies which
jointly and collectively conduct the group business still acceptable and when does (or
should) intragroup owner shielding, as a fundamental policy decision in all Western
corporate law systems, yield to competing policy issues and the legal interests
corresponding thereto, in particular, the protection of outside creditors of group companies
and the statutory compliance of groups in the governmental, regulatory arena?
As a side note, those enterprise approaches to liability and risk allocation by legal
systems wrestling with the phenomenon of corporate groups should be clearly distinguished
from particular exceptions to limited shareholder liability accepted in most, if not all
corporate law systems. The premise of those exceptions is that owner shielding is a legal
privilege. It is routed in the respect of the separate corporate form as demonstrated by its
owner(s) in each particular case. As with all privileges, it may be abused. In those cases –
as an exception to the fundamental rule of limited liability – legal systems have developed
certain notions of financial recourse against the company’s owner(s) described as ‘piercing’
or ‘lifting the corporate veil’ (‘Durchgriffshaftung’ in German). However, veil-piercing
cases remain stuck in the traditional corporate law paradigms. As exceptions (in order to be
doctrinally consistent), they continue to acknowledge the rule – the unchallenged primacy
of the entity principle in the corporate law systems of the United States and Europe (see
Blumberg 1990, p 290). Designed as legal ‘release valves’ to alleviate otherwise
inequitable results of too exacting, too rigorous corporate rules grounded in entity law
principles on a case-by-case basis, the precedental breadth and relevance of veil-piercing
jurisprudence is strictly limited by the unique pattern of specific, sometimes minute facts of
each particular case at bar which make it anomalous and exceptional enough in the eye of
the beholder, i.e., the courts, in order to break with the rule under, and only for purposes of,
the singular circumstances of such particular case. By design then, corporate veil-piercing
is not amenable to any systematic, regulatory approach but a rather chaotic (and frustrating)
area of corporate law with very little (if any) doctrinal relevance for the law of corporate
groups (for criticism of the American veil-piercing jurisprudence, see Antunes 1994, p 370;
Antunes 1999, p 216; Blumberg et al. 2005, p 10-6; Easterbrook and Fischel 1985, p 89;
and of the recent German judicial approach to de facto corporate groups, see Reich-Graefe
2005). Accordingly, it will not be further discussed here.
A prime example of the pressures on the regulatory system in order to ensure group
responsibility and accountability and of a growing acceptance of enterprise liability within
corporate groups – as a legal doctrine bypassing traditional entity law notions and finding
intragroup responsibility for corporate acts and defaults wherever they may have occurred
within the group and irrespective of which constituent part of the group system they could
be allocated and attributed to – may be found in product liability, a rapidly developing area
of the law of torts in the United States and Europe. In American law, issues of intragroup
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tort liability for the design, manufacturing, distribution, sale and installation of defective
products, no matter how legally (and operationally) segregated such different functions may
be among various subsidiaries of the same corporate group, are effectively controlled by the
key policy issues underlying the law of product liability – viz., consumer reliance;
consumer expectations in product quality, craftsmanship and freedom from defects; the
compensation of damages caused by defective products; and, thus, ultimately product safety
and consumer protection. In the group context, expectations and reliance by consumers on
product safety are premised, in particular, on the intentional (often pervasive) use of the
group’s trade name, its trademarks, logos and other uniform product labeling, and its joint
marketing and promotional efforts in all of the above-mentioned functions (i.e., the indicia
of the common public persona of the manufacturer, portraying the group as an operational
unit in the marketplace), and on the group’s systematic endeavors in trying to actualize in
the purchasing decisions of consumers the reputation and assumptions of quality and
integrity which its products and related services have achieved (or try to achieve) in the
group’s relevant product market(s). Increasingly, courts have begun to recognize that
consumer reliance may not be “defeated by a complicated corporate structure in which the
consumer has no interest or knowledge that his confidence in the product has been legally
thwarted through the mysteries of business technicalities and complications entirely foreign
to him” (as the U.S. Federal Court of Appeals for the Tenth Circuit has stated in a landmark
decision in 1971).10 Furthermore, the compensation aim of product liability law (as a
branch of the tort system) may obviously best be satisfied by holding the principal firm (the
ultimate parent) with the largest pool of resources and assets – effectively, the entire
enterprise – legally responsible (Collins 1990, p 735; Teubner 1993b, p 231).
As a result, upstream intragroup liability of the manufacturer-parent otherwise not
responsible for the product defect (because, for example, it was modified by a distributorsubsidiary which modification alone introduced the defect) and, vice versa, of the parent
company of a manufacturer-subsidiary with defective output may be accepted under
American product liability principles despite the fact that the parent has not been involved
in the relevant stage(s) of the production and distribution processes in which the product
defect originated (for details, see Blumberg et al. 2005, ch 62). Of course, the exact details
and, in particular, the elements of this common law liability concept routed in enterprise
paradigms which have to be proven by consumer-plaintiffs may differ substantially from
jurisdiction to jurisdiction before a given court will accept the imputation of product
liability to a parent company not involved personally in the manufacturing conduct giving
rise to the claim. One such constitutive element of parent liability, sometimes even the
controlling element, may be the use of the group’s trade name and trademarks by
manufacturing subsidiary corporations. Since such trade name and trademarks are usually
associated with the entire group (or, at least, the ultimate parent company) and since it is
utilized to lead consumers to purchase the product in reliance on the skill and market
reputation associated with the trade name or trademarks (and, thus, again with the entire
commercial enterprise or, at least, the controlling parent), both case law 11 and legal
scholarship (see LoPucki 2002) in the United States clearly advocate a corresponding
attribution of product responsibility and legal accountability of the parent corporation (and,
to some extent, also of related group companies). Legal doctrines of corporate separateness
otherwise applicable within a group of companies pursuant to traditional corporate law
10
11
Vaughn v Chrysler Corp, 442 F2d 619, p 621-22 (10th Cir 1971).
See, for example, Brandimarti v Caterpillar Tractor Co, 527 A2d 134 (Pa Super Ct 1987).
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10 Relational Networks and Enterprise Law
paradigms are consciously disregarded and set aside in order to enforce consumer
protection as a principal (and, thus, prevailing) regulatory policy agenda in the law of
product liability. As Collins (1990, p 731) and Morgan and Stoltman (1997) have
summarized the overarching concept, the defective product is the product of the team, and
though the defect may spring from an individual group company’s carelessness, either in
design or execution, it should be the responsibility of the group to establish an organization
which prevents such defects.
Similar developments of effective group aggregation are evident in the European
experience of product liability (which has been strongly influenced by a reception of the
American developments in this field of law). Both the Council Directive Concerning
Liability for Defective Products from 198512 as well as the recently revised General Product
Safety Directive (applicable since early 2004) 13 utilize a ‘product-centric’ approach to
regulation: Under the two Directives, the ‘producer’ to whom product safety duties and
liabilities are attributed includes not only the actual manufacturer (for example, one of the
group’s manufacturing subsidiary) of the relevant product but also any other person –
natural or legal – who presents itself as the manufacturer by affixing to the product its
name, trade mark or other distinctive feature (thus, for example, the group’s parent
company). As a result, the insignia of the group’s commercial unity (its trade name,
trademarks and other distinguishing marks, labels, logos and features), as presented to the
market in connection with the particular product, control the imputation of group-wide
product duties and responsibilities irrespective of the actual manufacturing origin of the
particular product within the otherwise legally segregate enterprise.
2.4
A Word of Caution
Despite the manifold legal concepts and strategies developed during most of the last
century and aimed at a recognition of enterprise law principles over traditional entity law
doctrines in the law of corporate groups, much of the scope and limitations of enterprise
liability (and, in the larger perspective, of the application of enterprise law principles) to
this day remain to be explored and consolidated (Nygh 2002, p 81). Notwithstanding the
far-reaching Konzernrecht concepts in German corporate law and their abundant
application of enterprise law paradigms, Nygh (2002, p 53) has pointed out that the
tendency in Germany, thus far, has been to regard the group as an economic rather than as a
juristic unit. Likewise, Blumberg has argued that the experience with enterprise law
principles in the United States is still an “incipient movement away from entity law” and
has not (yet) led to any wholesale abandonment of entity law or any lack of the recognition
of the group-integrated corporation as a separate juridical unit (Blumberg 1990, pp 291,
297).14
12
13
14
Council Directive on the Approximation of the Laws, Regulations and Administrative Provisions
of the Member States Concerning Liability for Defective Products, 85/374/EEC of July 25, 1985,
OJ [1985] L 210 p 29.
Directive of the European Parliament and of the Council on General Product Safety, 2001/95/EC
of December 2, 2001, OJ [2002] L 11 p 4.
It should also be noted that the respect for the legal insulation (owner shielding) of public
shareholder-investors (i.e., the ultimate, diversified and often passive owners of corporate groups
who individually – whether as natural or legal persons – cannot control the group’s affairs)
continuous unabated in all legal systems (and rightly so), and that enterprise law principles are
only applied in the intragroup sphere, i.e., they intend to aggregate constituent group companies,
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Relational Networks and Enterprise Law 11
In the broader picture of group regulation and enterprise law, we are far from being
settled and from having achieved a principal consensus on what needs to be done from a
socioregulatory point of view in regard of corporate groups. The attention such groups
have received in the European Union may be symbolic and a telling tale in this respect:
According to most corporate law scholars in Europe, company law is the one area of
substantive law (private and public) most intensively harmonized within the European
Union (Grundmann 2004, p 604). Thus, one would have good reason to expect that the law
of corporate groups would long have found some form of systematic treatment and
regulation given, in particular, the importance and significance of large, multinational
enterprises for the European economy and the functionality of the European internal
market. Two noteworthy initiatives attempting a detailed, comprehensive regulation of
corporate groups have indeed been undertaken in the European Union but ultimately failed:
The original Regulation Proposing a Statute for a European Company of June 30, 197015
and the preparatory draft of a Ninth Company Law Directive on Links Between
Undertakings and, in Particular, on Groups of Companies of 1984 16 (see Embid Irujo 2005,
p 66; Forum Europaeum 2000, pp 174-75; Grundmann 2004, p 606). At the current stage,
corporate groups may be perceived as merely tolerated by European law – rather than
having been recognized by the European regulatory system as the prevalent, modern and
legitimate institutions of industrial organization and cooperation which they constitute in
today’s European economy (Embid Irujo 2005, p 68-69; Forum Europaeum 2000, p 174).
Nevertheless, doctrinal and regulatory attention given to corporate groups is, once
again, on the rise in the European Union (for details, see Embid Irujo 2005, pp 87-89).
New concerted initiatives for a harmonization of group regulation are being made: In
November 2002, the so-called High-Level Group of Company Law Experts, set up by the
European Commission and chaired by Professor Jaap Winter, presented their final report on
a modern regulatory framework for company law in Europe (Winter et al. 2002). The socalled Winter Report made ample use of the ‘voluminosity’ (see Blumberg 1996, p 345) of
comparative studies undertaken and international academic debate prevalent in this legal
field which clearly helped to re-focus and reactivate the European harmonization efforts
within the law of corporate groups (notably, the efforts of the Forum Europaeum Corporate
Group Law in 1998/2000, and of the Venice Corporate Group Congress of 1995,
documented in Balzarini 1996). As an immediate result of the expert consultation process
cumulating in the Winter Report, the European Commission in 2003 published an ‘Action
Plan on Company Law’ (European Commission 2003), defining therein the preparation of a
coordinated framework rule for corporate groups (i.e., an ‘umbrella’ group policy) and the
introduction of improved financial and non-financial disclosure requirements for groups of
companies (i.e., group transparency) as key medium- and short-term policy objectives,
15
16
not the group and its ultimate (public) shareholder-investors (see Blumberg 1990, p 289;
Blumberg et al. 2005).
Proposal for a Council Regulation on the Statute for a European Company of June 30, 1970, EEC
Bulletin Supplement 8/70, arts 223 et seq. (as amended by Amended Proposal for a Council
Regulation on the Statute for European Companies, COM (75) 150 final of April 30, 1975, EEC
Bulletin Supplement 4/75, art 239).
EEC Doc No XV 593/75-E, arts 7, 29. An English version appears in Böhlhoff K, Budde J
(1984) Company Groups – The EEC Proposal for a Ninth Directive in the Light of the Legal
Situation in the Federal Republic of Germany. Journal for Comparative Business & Capital
Markets Law 6:163-97.
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12 Relational Networks and Enterprise Law
respectively, for further regulatory action at the level of the European Union. 17 In essence,
it may be said that the period of Europe’s “legislative dissonance” (Embid Irujo 2005, p 83)
and its resultant regulatory stagnancy in the area of corporate groups are most likely a thing
of the past. And it is equally evident in the laws of the United States that the traditional
theories of the separate corporate personality are increasingly supplemented by modern
legal doctrines “emphasizing enterprise over entity” (Blumberg 1990, p 299).
3
Relational Networks and Enterprise Law
In contrast to corporate groups, relational networks are not connected through means of
equity ownership. However, similar to the pressures on traditional entity law doctrines
created by the economic reality of today’s omnipresent corporate groups, the attribution of
liabilities (and other legal rights and responsibilities) among the members of relational
systems of economic cooperation has become a central issue of legal concern. And again,
contrary to traditional legal concepts, such attribution (where it occurs) is increasingly no
longer controlled by the contractual or other consensual arrangements made between the
individual parties constituting the integrated economic venture. Rather, it derives
immediately from the fabric of the functional economic substance and interdependence of a
relational network, in particular, the depth of economic integration, the distribution of
network control between dominant and subservient participants, and the interpenetration of
their respective interests for network participation.
In this regard, enterprise principles when applied to relational groups may be
understood to mandate network aggregation and liability based on the economic
organizational status of the aggregate commercial undertaking (i.e., the quality of the
interrelations among participants actually present in such network) and irrespective of the
legal organizational forms (i.e., the contractual and other consensual party dealings)
utilized in order to structure such undertaking internally.
3.1
The Relational Network Phenomenon
Like corporate groups, relational networks are part and parcel of the modern-day
phenomenon of business alliances. In particular, franchise systems (as one of the most
prevalent, though non-corporate, forms of economic integration) represent a major segment
of the American and European economies (Blumberg 1996, p 344; Blumberg et al. 2005,
pp; Morgan and Stoltman 1997).
The term ‘relational’ as used here with respect to networks of economic cooperation and
integration attempts to distinguish such networks from other forms of collective business
undertakings in two different (but still complementary and partially overlapping)
dimensions: In the first such dimension, the term ‘relational’ connotes the fact that the
17
Furthermore, it should be noted that de lege ferenda – because of the governing principles of
subsidiarity and proportionality under the European Treaty – a European core regime on corporate
groups (once attained) will, by necessity, not become exhaustive. Each European member state
will always retain its ability to adopt more detailed regulation of corporate groups within its
national legal system in order to complement and supplement the basic European framework
(Embid Irujo 2005, pp 72, 83). Indeed, it may be argued that most, if not all the European
member states can be expected to continue to regulate corporate groups as they do already today
de lege lata, i.e., either by legislative (some states) or judicial means (most, if not all states).
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Relational Networks and Enterprise Law 13
enterprise at issue, in its technical (legal) form of organization, rests on contractual and/or
other consensual arrangements made by network participants, 18 not – as corporate networks
predominantly do – on stock ownership (Blumberg et al. 2005, pp 160-4, 161-4; Teubner
1991, p 129). As a fundamental difference, the system-building energy and network
control exerted in relational enterprises is consensual in nature whereas the control
discussed in the context of corporate groups above is organizational and sanctioned by
means of corporate law.19 To put it briefly, relational networks rest on contract, not equity.
In contrast, the second (much broader) dimension of the ‘relational’ terminology used
here is characterized by the fact that relational networks rest on status, not contract. Under
this aspect, the term ‘relational’ indicates that the contractual sphere of organization, i.e.,
the private party negotiations and other consensual arrangements made among network
participants, is legally irrelevant in order to address the fundamental status issues of such
participants, in particular, the identification of those of their respective participation
interests meriting legal protection and the attribution of operational networks risks and
resulting rights and responsibilities vis-à-vis outside, third parties among such participants
independent of their bargain. Hadfield (1990), approaching the issue from the American
legal discussion of relational contracts, has stated that “[t]he necessary incompleteness of
the franchise contract prompts an examination of the norms and practices – the relational
structure of franchising – to identify the complete content of the franchisor and franchisee’s
exchange.” Blumberg (1996, p 346; Blumberg et al. 2005), however, has clearly
demonstrated that such ‘relational’ norms and practices are not only complementary gapfillers of incomplete contracting, but that the quality of being ‘relational’ in this second
dimension of the terminology also signals a complete reversal of Sir Henry Sumner
Maine’s famous finding in 1861 that the history and evolution of English law – in terms of
legal anthropology or sociological theory – are best understood as a movement from status
(as the controlling feature of relationships in primitive societies) to contract (as a
characteristic and key determinant of relationships in progressive societies). 20 Nowadays,
the evolutionary process of industrial organization and its regulation seems to be in reverse
gear, representing a movement (though largely ambiguous) from contract to status. 21
18
19
20
21
In this respect, ‘relational’ is also congruent (though broader in scope) with the discussion of
‘relational’ contract theories and perspectives by (mostly) American legal scholars and
economists (i.e., relational networks are indeed a phenomenon of long-term continuing relations
resting on non-classical contractual structures).
It may be argued that corporate groups utilizing organizational agreements (i.e., control contracts
as discussed under 2.1 above) are also premised on contractual links between group participants
rather than corporate ties. However, it should be noted that a control agreement is often only one
instance of the various control powers vested in and used by ultimate parent companies, and that
the conclusion of such agreement (though formally a ‘consensual’ act), in the vast majority of
cases, is dictated to the subsidiary by the parent company through other, pre-existing means of
(organizational) control. In contrast thereto, there is always a true bargain (no matter how
‘asymmetrical’ it is in substance), an exchange of independent promises, in relational networks –
at least, at the outset of the organizational relationship (for example, in franchising systems the
future franchisee is usually free to choose whether to accept or reject – take or leave – the offered
franchise contract) (see Schanze 1991, p 69).
Maine HS (1861) Ancient Law: Its Connection with the Early History of Society, and Its Relation
to Modern Ideas. Murray, London, p 168 (see also Joerges 1991, p 17-19; Schanze 1991, p 86).
Blumberg has also been first to point out that the legal regulatory action in this dimension
constitutes what Roscoe Pound has coined ‘relational law,’ an area of regulatory intervention
where the legal rights and duties arise independent of any consensual act and where law is
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14 Relational Networks and Enterprise Law
In this second hermeneutic dimension of ‘relational’ networks, corporate groups
themselves may also be understood as being ‘relational’ in nature. Indeed, there are many
striking similarities between non-corporate networks (for example, business format
franchising systems) and corporate networks of economic integration. Blumberg (1996, p
343) has pointed out that the application of enterprise principles for the attribution of rights
and liabilities between parent and subsidiary corporations is only a sub-set of the larger
legal problem of attributing rights and liabilities among the participants in collective
commercial undertakings generally. In all such relational systems, 22 the economic reality of
network operations raises equal (legal) concerns with respect to the entrepreneurial
independence of subservient network members. The application of enterprise doctrines
appears to occur in response to the presence of the following core structural features of such
networks: the depth of economic integration, the pervasiveness of network control, and the
interdependence and interpenetration of existing (collective and individual) network
participation interests among the separate functional units of the network. Thus, from a
structural perspective, relational networks (in particular, franchising systems as a
predominant form of vertical network cooperation) are characterized by the same hybrid
arrangements between contract and organization (the sociological dichotomy), between
market and hierarchy (the distinction drawn in institutional economic theory), and between
network unity (via economic integration and the harmonization of network structures) and
network diversity (via the decentralization of operational autonomy among many
subservient network participants) (Dnes 1991, pp 133, 141; Imai and Itami 1984, p 296;
Macaulay 1991, p 230; Norton 1988, p 198; Schanze 1991, pp 72, 75; Teubner 1990, p 67;
1991, p 105; 1993b, pp 211-12; Thorelli 1986, p 37; Williamson 1988, p 73).
Franchise systems also provide an additional aspect of this structural paradox. The
diversity aspirations of a franchise network not only aim at legal diversity of the overall
enterprise (since, if the network is composed of several capital units with separate legal
identity, it loses the necessary legal unity for the application of traditional entity law
principles on personal liability; see Collins 1990, p 732) and at perceived economic autarky
of individual network members in the eyes of regulators. The franchise network, by design,
also intends to instill – this time in the eyes of franchisees who, in reality, are tightly
integrated in the network – the incentives and the mind-set of individual, independent
entrepreneurs (which, if successful, will generate the extra measure of energy and initiative
for the whole system known as ‘positive network feedback’ or ‘network effect’). Blumberg
et al. (2005, pp 161-5 and 161-6) have described such phenomenon as follows: “When the
system works well, it results in local franchise operations run with the energy of
entrepreneurs and supported by highly developed modern management systems, effective
national advertising, and effective control over substandard franchisees” (see also Macaulay
1991, p 193). This shows that the structural hybrid character of non-corporate networks not
only resembles the structural paradox of corporate groups – viz., the tensions created
between the economic and the legal objectives of such groups, between commercial unity
and legal diversity – but also that such networks are (dually) oriented between two diverse,
22
flowing from status or relationship rather than an exchange of promises. In this regard, enterprise
law is relational law (see Blumberg 1996, p 343-45; Blumberg et al. 2005, p xix).
Collins (1990, p 733) distinguishes among three forms of status bonding within what he terms
‘complex economic organizations’ of productive relations: ownership (i.e., groups of companies),
contract (i.e., what is termed here ‘relational networks’), and authority (i.e., coordinated economic
activity pursuant to de facto control).
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Relational Networks and Enterprise Law 15
purely economic objectives of the franchise system – namely, the goal of economic
network unity through network integration and a highly organized, hierarchical distribution
organization on the one hand and the goal of (qualified) entrepreneurial diversity through
dispersed commercial ‘independence’ among franchisees on the other hand. Not only are
economic and legal realities mixed (Blumberg et al. 2005, p 161-7), but so are economic
and economic realities. As Teubner (1991, pp 120–21) has summarized, “in economic
practice, closely organized franchising systems are ‘observed’ as a paradoxical unitas
multiplex, i.e., as an organizational unit and simultaneously as a plurality of actors.”
3.2
Franchise Networks and Enterprise Liability
The increasing application of enterprise doctrines in relational networks may be
demonstrated comparatively by focusing on external network liability in franchise
organizations as an excellent example. As Blumberg et al. (2005, pp 169-3, 169-4) have
pointed out, in such hierarchical organizations the subservient network participants (i.e., the
franchisees) collectively conduct separate and fragmented, though closely related and
integrated business operations under the trade name, franchise logo, and other indicia of the
common public persona of the dominant participant (i.e., the franchisor) in a vertically
structured and horizontally standardized system.
Similar to the more prevalent aspects of parent liability for subsidiary torts in corporate
groups (as discussed under 2.3 above), the ‘relational’ dimension of status-based network
systems here also suggests that one of the areas in which most of the regulatory action of
the legal system may be established (as evidenced by the academic discussion spurred by
such action) is in the realm of tort liability of dominant network participants to outside,
non-network parties for the acts or defaults of subordinated network members (Blumberg
1996, p 345; Nygh 2002). As with corporate groups, this is an area of important public
interests and policies where state regulation overriding private sector arrangements (and the
resultant network systems resting on such consensual acts) is a predictable response of the
legal system – similar to the acceptance of enterprise liability in corporate groups for
purposes of creditor and consumer protection (as discussed above) or, within the statutory
sphere of governmental policing, the ubiquitous antitrust regulation of corporate and
relational groups for purposes of maintaining market competition (see Hüschelrath 2004).
Tort victims of network activity are not in any position to bargain in advance the (then only
potential) externalization and realization of network risks ultimately affecting them to their
disadvantage. It therefore comes at no surprise that legal developments in the United States
and Europe over the last decades appear to confirm a trend towards recognizing a theory of
enterprise liability for franchising networks, in particular, in the areas of product liability
and liability for defective services.
A large number of franchise systems involve the design, manufacturing, distribution,
sale and installation of products bearing a franchisor’s trademark and/or trade name
(Blumberg et al. 2005, p 169-29). In many instances, a franchisor will not itself
manufacture a certain product but will license the right to do so to the franchisee-licensee
who will attach the franchisor’s trade name and trademark(s) to the goods it produces and
sells.23 Accordingly, the franchisor’s only involvement in the stream of commerce is its
23
If the franchisor itself is the manufacturer of goods, strict product liability will apply directly and
the issue of vicarious liability (i.e., the attribution of responsibilities to the franchisor for acts and
defaults of its franchisees) will be moot.
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16 Relational Networks and Enterprise Law
ownership and control over the trade name and trademark(s) affixed to the defective
product. Decades ago, various jurisdictions in the United States have begun to accept the
theory of strict product liability for non-manufacturing franchisors if such network
participants proved to be causal links in the overall marketing enterprise which put the
defective product in the marketplace.24 Similarly, courts have utilized and adapted
century-old common law agency principles in order to address the regulatory pressures
created by modern-day franchising operations. Under such agency principles,25 the
franchisee (as agent) is deemed an extension of the franchisor (as principal) in the
marketplace once a legally significant amount of control and oversight (i.e., monitoring) is
exercised by the franchisor over the franchisee’s activities – either pursuant to the
contractual relationship (contractual control) or in fact (de facto control). Consequently,
acts and defaults by the franchisee-agent which injure third parties within the reach of the
overall franchise operation will be attributed to the franchisor-principal and vicarious
liability will be imposed on the latter vis-à-vis third parties harmed by the acts and defaults
of the former.26
American courts applying enterprise principles to non-manufacturing franchisors
(though not openly but clothed in legal concepts of strict tort liability or common law
agency) have increasingly focused on the economic integration and close interrelation
between non-manufacturing franchisors’ operations and those of their manufacturing
franchisees. Sponsorship, management and extensive control of the franchise network by
the franchisor (i.e., the degree to which franchisors control the business practices of their
franchisees) as well as the public’s perception of franchised businesses (i.e., the
franchisees’ use of the franchisor’s public persona and ‘corporate identity’ – trade name,
trademarks, logos, etc. – and the centralized advertising and other promotional activities by
the franchisor, both creating the necessary uniformity of appearance and operations of the
franchised businesses as well as consumer reliance that the franchisor as trademark owner
is ultimately responsible for the product) are the two key factors for the imposition of
vicarious liability for torts of the franchisees (for details, see Blumberg et al. 2005, ch 169;
24
25
26
See, for example, Kasel v Remington Arms Co, 24 Cal App 3d 711, 725 (1972).
Obviously, the legal agency concepts discussed here must be distinguished from the so-called
agency problem in economic science (i.e., the issues arising from the delegation of decisionmaking competences and the resultant, necessary alignment of the agent’s motivational and
behavioral sphere with the principal’s economic interest sphere through efficient incentivizing).
The acceptance of traditional agency law principles by courts in the United States in an attempt to
regulate intra-network liability issues of franchising systems presents an interesting theoretical
issue. Though the concept of vicarious liability indicates that legal accountability will be
imposed on one person (the principal) for the actionable conduct of another (the agent), agency
law translates this (internal) two-person structure into an external single-person unity and
prescribes, for purposes of vicarious liability, that only one – natural or juridical – person (the
principal) is recognizable (and responsible) from the perspective of the outside third party. The
franchisee-agent is thus reduced to nothing more than an employee or other functional
representative of the franchisor (an ‘organ’ of the franchisor, not an independent legal ‘actor’). In
other words, the relevant jural relationship created by vicarious liability originates directly
(‘agent-blindly’) between franchisor and third party. As such, ascription of liability to the
franchisor under common law agency principles is not an application, but rather an obfuscation of
the principles of enterprise law. The cardinal paradigmatic shift from individual network actor to
the enterprise in toto is still (and perpetually) incomplete. Arguably then, traditional agency
structures may be regarded as immanently inadequate (since they include an insurmountable
conceptual barrier) for the regulation of external liability aspects in relational enterprises.
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Relational Networks and Enterprise Law 17
Morgan and Stoltman 1997). As part of the public policy underpinnings favoring
imputation of liability to the franchisor, courts have pointed out that consumers cannot
distinguish from the outside between a franchised and a franchisor-owned outlet and that
they have come to expect the franchisor to fully ‘stand behind’ the product in either case
(i.e., protection of third party reliance), that the franchisor as the dominant network
participant is in a better position to spread the externalized cost of the network’s economic
activity among consumers of the franchised merchandise and services through greater
access to insurance coverage and marginally higher operating expenses and prices which
are then redistributed across all customer-consumers rather than the network members (i.e.,
adequate risk allocation and risk spreading through social insurance rather than consumer
self-insurance), and that vicarious liability provides a more effective incentive to
franchisors to monitor the selection and performance of franchisees and, thereby, to deter
network risks for external parties (i.e., promoting the prevention of future harm).
As a result of such jurisprudential developments, enterprise principles have been
introduced – though unadmittedly – to the American law of franchising networks in order
to replicate their economic aggregation in the legal realm and, thus, to better align the
attribution of rights and responsibilities in the legal system with the economic realities of
major commercial networks conducted in the form of franchising systems. American
courts have implicitly accepted enterprise liability doctrines in various areas of the
franchise industry, relying on and reformulating general common law concepts of agency
and strict product liability (Blumberg et al. 2005, p 169-48). As Morgan and Stoltman
(1997) and Hanson and Logue (1990) have demonstrated respectively, such doctrinal
adaptation, in essence, demands that the franchising system as a whole – the entire
marketing channel – act as an insurer vis-à-vis its customers for the harm caused by its
offerings, and that the constituent members of such marketing enterprise ascertain their
internal, individual responsibility and monetary liability vis-à-vis each other only in a
second, subsequent step (i.e., after the consumer-customer has recovered from the entire
network).
To date, the European regulatory harmonization efforts in the field of franchising
networks and enterprise liability have not produced any specific legislation applicable to
the franchisor-franchisee relationship, including the external liability of the franchisor to
third parties (customers, creditors, employees, etc.) harmed by acts or omissions of its
franchisees. The only piece of European legislation in force today and, though of much
broader scope, also applicable to the attribution of responsibilities and resultant liabilities of
franchisors is the Council Directive Concerning Liability for Defective Products of 1985
which has already been discussed above (under 2.3) in the context of corporate group
liability. Similar to its effect on intragroup product liability exposure, the significance of
such Directive to franchise networks here again lies in the extensive factual scope of the
‘producer’ definition employed by the Directive. Non-manufacturing parent companies and
franchisors alike may be held responsible for all defects in products which bear their
respective trade names, trademarks or other distinguishing features, regardless of whether
such franchisors (or parent companies) or the franchisees (or group subsidiaries)
manufactured them. Obviously, there may be multiple ‘producers’ of a single, particular
product under the statutory construction of the Directive and all such responsible parties (in
particular, the name-lending franchisor and the manufacturing franchisee) would be jointly
and severally liable to the injured consumer.
A second instance of European regulatory action which would have amounted to a
significantly increased external liability exposure of franchisors (and also would have
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18 Relational Networks and Enterprise Law
constituted an explicit example of the recognition of enterprise principles by the European
Union) never made it past the drafting stage: In December 1990, the European commission
proposed a Council Directive on the Liability of Suppliers of Services. 27 The main
objective of such proposal was the introduction of a uniform system of (fault-based)
services provider liability. Unlike the EU Products Liability Directive, the draft of the
Service Liability Directive explicitly made franchisors, master-franchisees and regular
franchisees jointly and severally liable for defective services. In consequence, service
franchisors would have been exposed to a significant risk of liability for acts and omissions
of their franchisees and could have only avoided liability upon proving that there was no
negligent behavior on their part which could have contributed to the damages sustained by
the customers of their franchisees. After meeting considerable opposition from the
European services sector, the proposal was finally withdrawn by the European Commission
in June 1994 for lack of gaining sufficient support among the European member states.
Nonetheless, the mere fact that a proposal on this particular issue of network liability had
been adopted by an important and sophisticated international legal system and had been
supported by, at least, a minority of European nation states, holds paradigmatic significance
to this day in demonstrating how strongly a given regulatory system may expose franchise
systems (and, by the same token, any relational network in the manufacturing and services
industries) to principles of enterprise law and aggregated network liability. Its eventual,
quite formidable failure reveals in equal portions of significance how far the regulatory
process – the law – still trails behind the evolutionary process of modern organizations of
productive relations – the economic realities of relational networks in our time.
4
Comparative Network Research: Cross-Fertilization and
Convergence
Franchising firms often maintain dual (or parallel) network structures for their business
operations, thereby adopting a further layer of structural diversification to the overall
enterprise in an effort to improve vertical integration and organizational efficiency through
the combination of franchisor-owned and franchised outlets (Blumberg et al. 2005;
Ehrmann and Spranger 2004; Windsperger 2004). In most cases, national advertising, a
global internet presence and other universal promotional activities by such plural-structured
franchise organizations do not distinguish between the company-owned and the franchiseeowned units, and the latter might not even indicate its independent ownership and market
position to customers in the course of its operations. This picture of dual franchising
networks becomes even more blurring if franchisor stores and franchisee outlets are further
linked by combined customer services, for example, a national reservation system for a
hotel chain (Morgan and Stoltman 1997).
The coexistence and plurality of organizational forms and strategies applied within the
same polycorporate, hybrid network enterprise give scholars of corporate group law
sufficient reason for pause. Among the first impressions one might register from observing
the dual operating structures employed by franchising networks is the question of why the
legal consequences of the two network structures employed should be any different (see
Morgan and Stoltman 1997)? Why should it yield different legal results if the vertically
integrated business operations – which present themselves to the outside world in
27
Proposal for a Council Directive on the Liability of Suppliers of Services, COM (90) 482 final of
December 20, 1990, OJ [1991] C 012, p 8.
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Relational Networks and Enterprise Law 19
completely identical fashion – have been organized and arranged under a franchising
scheme rather than pursuant to a corporate group scheme. Of course, a somewhat cursory
response to such inquiry could be (and often indeed is) that an integrated, polycorporate
commercial unit may not be treated, ipso facto, also as a single legal unit. Put differently:
The argument always centers around the notion that the network as a whole lacks separate
corporate personality (see Blumberg 1990; Embid Irujo 2005, p 82). As Lord Goff of
Chieveley once succinctly stated in a 1987 opinion of the House of Lords, the highest court
in England and Wales: “[W]e are concerned not with economics but with law. The
distinction between the two is, in law, fundamental and cannot be bridged.” 28 Furthermore,
one could further question whether the plurality of legal regulation for corporate and
relational groups may not also imply that any necessity to devise a homogeneous,
systematic legal regime for cooperative networks and their operations is either non-existent
or too complex and convoluted a task to be accomplishable in any satisfactory manner (see
Blumberg 1996b, pp 423-24; Embid Irujo 2005, p 71; Forum Europaeum 2000, p 170).
Such first impression and responses, however, point towards a more fundamental issue.
Any inquiry into whether the legal results are indeed different or whether they are indeed
identical (though certainly an important and necessary inquiry to be made) pales in
comparison to the further, more pressing question of what the results should actually be.
Likewise, it should become obvious that academic research which pays attention to only
one form of network ‘bonding’ (i.e., ownership or contract) whilst ignoring the other must
fly in the face of the factual similarities of, and the overlap of conceptual strategies applied
in, both types of network structures (see Collins 1990, p 744; Teubner 1991, p 121).
Accordingly, it seems legitimate and prudent to squarely include the following queries
(among others) in the current agenda of network research: May and should the regulatory
liability system be utilized in order to eliminate functionally irrelevant differences among
corporate and non-corporate network systems (see Teubner 1991, p 108)? If so, which
type(s) of networks should be allowed to utilize the legal fragmentation and resultant
(vertical) layers and/or (horizontal) blocks of limited recourse among the various,
independently incorporated network members in order to externalize network risks to third,
non-network parties? Is it even possible for the regulatory system to arrive at a satisfactory
typology of networks and distinctive and universal network-constitutive features (see
Schanze 1991, p 69). If so, what should be accepted as the common criteria of such
regulatory taxonomy which, simultaneously, would seem to form the sedes materiae for
rules on individual and collective liability (Teubner 1993b, p 231)? Where may or even
should we draw the line of regulatory intervention in order to safeguard justifiable modes of
conduct (see Joerges 1991, p 66) while, at the same time, protecting the crucial residuum of
entrepreneurial energy and structural dynamism within networks which allows them to
succeed? These questions cannot be answered by either economic or legal scholars alone.
The contrary must be true: Each group would go astray, would be ‘orphaned’ without input
from the other. It is interdisciplinary-comparative research in the area of corporate and
relational networks, undertaken by both economists and jurists on an international, crossjurisdictional basis, which seems highly relevant, but not yet fully developed, in order to
undertake the task.
Economists and organization theorists are concerned, not with the individual corporate
unit, but with the firm, the enterprise at large. Similarly, marketers themselves conceive the
channel(s) of product and services distribution used by the cooperative networks they put in
28
Bank of Tokyo Ltd v Karoon [1987] AC 45, p 64. See also Nygh 2002, p 70.
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20 Relational Networks and Enterprise Law
place as a single, though collectivized economic endeavor. Series of intermediate
organizations which move products from manufacturers to the ultimate consumers are
perceived as integral parts of a single ‘marketing system’ or ‘distribution chain’ (a
phenomenon which Morgan and Stoltman (1997) have labeled ‘the channel as an entity’).
Thus, in the respective analyses of market scholars and market practitioners alike, corporate
legal structures are not merely unimportant; they are irrelevant (Blumberg 1990, p 326).
Naturally, it is mainly economists who discuss in detail how cooperative commercial
systems should be structured in order to survive and prosper in their respective business
environments, including, for example, the market positioning of such systems, their
entrepreneurial orientation, the degree of strategic participation to be allowed to, or to be
supported among, subservient system participants, and the configuration of exploration and
exploitation objectives of the dominant network participant(s) in order to adequately
incentivize the operational members of such networks and help secure an optimal economic
return (for example, Croonen 2004; Windsperger 2004). However, if one is serious as a
corporate law scholar about making an attempt to answer the fundamental questions on the
regulation of networks as outlined above, then one has to be more attuned to what
economic science reveals about networks and how they function (or should function in an
ideal economic scenario) (Schanze 1991, p 76). This would seem a crucial step in order to
better understand and calibrate the legal responses by the regulatory system aimed at
balancing the various and, as often, competing or otherwise conflicting interests of the
internal and external network participants involved. Vice versa, economists, too, should
actively participate in establishing legal mechanisms and structures to ensure the socially
efficient operation of networks and to prove the ‘seriousness’ of such networks’ respective
entrepreneurial purposes (see Embid Irujo 2005, p 90).
A significant potential and abundance of untapped resources for what may be termed
‘cross-fertilization’ in the academic study of networks appears to exist. If the economic and
legal sciences succeed in achieving a commonality of approach, network research will
become directly relevant – both by way of comparison and by contrast. For example, the
legal aspects of modern corporate groups may be characterized by complexity, but certainly
not by singularity. Many of the economic objectives, hybrid structures, interest conflicts,
public policy underpinnings, etc. which are prevalent in corporate groups and immediately
affect their legal treatment are also relevant in relational networks and have a similar
impact on the regulatory responses to such non-corporate groups (Schanze 1991, pp 71-72;
Teubner 1991, pp 109, 128). It may be further argued, that the same interrelation and
intertwined research potential exists between what economists and legal scholars do in the
field of networks. Pursued through these conjoint avenues of collaborative network
research, ‘convergence’ should begin to raise its head. Not only would it entail a more
comprehensive picture and understanding of the economics, management and legal
implications of modern commercial networks (whether organized along corporate or
relational lines), it would also expose the common themes which lend those networks their
propriety and authenticity and which, at the same time, characterize and distinguish them
from all other forms of cooperative economic activity. Such quality of a convergence of
network research may also ultimately validate the thesis that the dual phenomenon of
corporate groups and relational networks – within the overall evolutionary process of
industrial organization – should best be understood dialectically as an emerging
higher-level form of commercial cooperation, i.e., an organizational structuration and
polycorporate enterprise sui generis, thereby spurring the necessity for corresponding,
network-specific and network-adequate norms of relational regulation in order to ensure the
(Draft 8/1/2005 – Work in progress; please do not cite or quote.) © René Reich-Graefe, 2005
Relational Networks and Enterprise Law 21
social responsibility and accountability of such enterprises (see Joerges 1991, p. 33; Powell
1990; Schanze 1991, pp 68-69; Teubner 1991, p 116; 1993b, pp 226, 232).
5
Conclusion
Legal developments in the United States and Europe over the last decades confirm
mutual, fundamental trends towards recognizing concepts of enterprise law, including
theories of enterprise liability (in particular, in the area of product liability), for both
corporate groups and relational networks. Their emergence occurs within a dynamic area
of the law (Blumberg 1990, p 364) where regulatory attempts at formulating explicit and
unequivocal national and international enterprise standards remain often nascent and in
flux. The responses by the legal system to the economic realities of modern, highly
integrated and collectivized network systems have, thus far, resulted in a dogmatical
‘piecemeal’ approach to enterprise concepts. The law’s recognition of a corporate group in
toto or of a relational network in aggregate for the purpose of ascribing legal responsibility
for network acts and defaults is still a rare circumstance.
Taking stock accordingly, a somewhat skeptical observer might conclude that –
notwithstanding the introduction of enterprise law principles to (though often reticent), and
the acceptance of enterprise liability in (though rather limited), the law of networks – the
legal systems in Europe and the United States have not (yet) been able to cope with the
unique ‘synthetic’ interpenetration of network and nodes, of ‘net’ and ‘knots’ which
characterizes modern-day corporate and relational networks of collectivized economic
cooperation. Hence, such inability (if diagnosed correctly) will raise the profound and
legitimate question whether enterprise law principles (shifting the focus from the individual
network unit to the collective network) are conceptually adequate and sufficient as a legal
strategy of network regulation, or whether (using enterprise law as a first crucial step in the
right direction) the regulatory focus should be – simultaneously and dialectically – on both
nodes and network in order to replicate the organizational and economic synthesis of such
undertakings.
Obvious difficulties exist in adequately regulating corporate groups and relational
networks from a technical point of view. Trends of regulation (and their academic
discussion) surpass the realities of existing regulation by a considerable extent (Embid Irujo
2005, 89). As Teubner (1990, p 67) has argued from the theoretical study of autopoietic
systems, the law’s role has always been limited in the evolutionary processes of industrial
organization. But even when modest as a legal scholar, there appears rather good reason
for optimism. It would be absolutely wrong, as Embid Irujo (2005, p 89) has recently
argued, to assume that the phenomenon of networks has little to do with the entrepreneurial
reality of modern industrial organization and that, due to such networks’ more complex and
abstract nature, it should solely be an object of academic discussion among economic and
legal theorists. Complexity has been introduced by the economic realities, not the
regulatory system. Thus, likewise, networks as objects of regulation require a complex and
diverse legal policy to correspond to the realities of the marketplace. As has been discussed
herein, product liability law in the United States and Europe – with its dual focus on unit
(the manufacturing network member) and network (though not in the aggregate but in the
form of other network members separately involved in production and distribution other
than by means of manufacture) provides an exemplary starting point in this respect.
According to Teubner (1991, p 123):
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22 Relational Networks and Enterprise Law
“[T]he instrument of product liability … is sufficiently decentralized insofar as ‘net’ and
‘knot’ are burdened with complementary duties of care according to the internal division of
labor. The sharing of tortious duties of care means that product liability reflects exactly the
internal division of labour within the network. In this way it would seem that product liability
‘hits’ the self-regulation of the network with sufficient precision. Finally, product liability is
neutral in regard to legal form. It imposes duties of care on the actors according to their
factual competence, independently of whether franchising is clothed with the laws of contract,
company or group enterprise.”
Where does this leave us? The ‘capital boundary problem’ (Collins 1990, p 732;
Teubner 1993b, p 218) – still fundamentally unresolved in relational networks and equally
responsible for systemic lacunae in the law of corporate groups – remains upon us. In
Schanze’s terms (1991, p 87), we are (still) in search of new legal regimes. Nonetheless, a
substantial, largely unexploited potential for practical, doctrinal and academic
‘convergence’ has been located herein which may significantly advance the understanding
of hierarchical, highly integrated, polycorporate network phenomena and the calibration of
adequate regulatory responses in the legal system. That convergence is eminently relevant
in the realm of corporate and relational networks, one only needs to be reminded that today,
structural convergence is already an economic reality in the dual network strategies pursued
by franchising firms.
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(Draft 8/1/2005 – Work in progress; please do not cite or quote.) © René Reich-Graefe, 2005