Relational Networks and Enterprise Lawemnet.univie.ac.at/fileadmin/user_upload/conf_EMNet/2005/papers… · Web viewTwo noteworthy initiatives attempting a detailed, comprehensive

(Draft 8/1/2005 – Work in progress; please do not cite or quote.)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 Law65 Elizabeth Street

Hartford, Connecticut 06105United States of America

[email protected]

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

2 Relational Networks and Enterprise Law

(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

(Draft 8/1/2005 – Work in progress; please do not cite or quote.) © René Reich-Graefe, 2005

Relational Networks and Enterprise Law 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’ in

1 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).

2 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).

3 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).



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 ‘group-transcendent’ 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)



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 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.

5 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).



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.

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 6 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.

7 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).

8 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 Error: Reference source not found 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).



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 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 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).



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 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 distributor-subsidiary 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 law11 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 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 10 Vaughn v Chrysler Corp, 442 F2d 619, p 621-22 (10th Cir 1971).11 See, for example, Brandimarti v Caterpillar Tractor Co, 527 A2d 134 (Pa Super Ct 1987).



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

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 12 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.

13 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.

14 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, not the group and its ultimate (public) shareholder-investors (see Blumberg 1990, p 289; Blumberg et al. 2005).



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 198416 (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 so-called 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, respectively, for further regulatory action at the level of the European Union.17 In essence,

15 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).

16 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.

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



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).


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 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

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).

18 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).



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 gap-fillers 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

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

19 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).

20 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).

21 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 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).



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, 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.”

22 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).



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 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

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.

24 See, for example, Kasel v Remington Arms Co, 24 Cal App 3d 711, 725 (1972).25 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 decision-



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; 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

making competences and the resultant, necessary alignment of the agent’s motivational and behavioral sphere with the principal’s economic interest sphere through efficient incentivizing).

26 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.



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 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 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.



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 franchisee-owned 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 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,

28 Bank of Tokyo Ltd v Karoon [1987] AC 45, p 64. See also Nygh 2002, p 70.



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, cross-jurisdictional 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 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 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):

“[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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