Last year the High Court issued an interim judgment making a company held liable to pay a subsidiary’s debts even though they are separate legal entities.
The High Court case relied upon little used section 271 in the Companies Act which allows the Court to order a parent company of a subsidiary in liquidation to pay the liquidator all or any part of the claims against the subsidiary. This creates an exception to the general principle that a company is a legal entity separate from its shareholders and although the use of Section 271 has been rare, this case does give a clear warning to companies about the risks of poorly managed subsidiaries.
The Court found that a subsidiary’s business must be conducted so that the company has a separate commercial and legal existence from its parent. The Court recognised that many corporate groups pay lip service to this concept and operate as a “whole of group”. Clearly there are risks associated with doing that.
It is important for Directors to structure their decision making to recognise the subsidiary’s separate legal status. Separate board meetings must be held and there must be conscious appreciation of the entity in respect of which decisions are being made.
Where a holding company provides financial or managerial support to a subsidiary, there should be appropriate legal and commercial arrangements in place to give effect to and recognise the separate legal status of the subsidiary.
Subsidiaries should have their own records both financially in and in respect of governance issues. Assets and liabilities of the subsidiaries must also be treated as belonging to the subsidiary rather than the parent company.
The Court did confirm that the practise of appointing holding company employees as directors of a subsidiary is appropriate. This is useful confirmation for businesses structured in that way. Those directors may also whilst acting as directors of the subsidiary act in the best interests of the holding company provided that the subsidiary constitution allows that to occur. However, the directors must not lose sight of the separate status of the subsidiary. Too often, the legal requirements with regard to such matters are overlooked.
The High Court judgment is under appeal so this is not the final word on this issue. However, the warning sounded by the High Court decision is useful and should be heeded.