Late last year, the High Court in the case of Lewis Holdings Limited v Steel and Tube Holdings Limited made a parent company responsible for its subsidiary’s debts in circumstances where the subsidiary had not been clearly operated as a separate commercial and legal entity from its parent.
The decision was made under Section 271 of the Companies Act which has been very rarely used. Section 271 allows the Court to order a parent company of a company in liquidation to pay the Liquidators the whole or part of any claims made against the subsidiary.
This case provides a serious warning to businesses with subsidiaries that the separate legal structure of the subsidiary must be given effect to in substance as well as in form.
The decision was made under Section 271 of the Companies Act which is very rarely used. Section 271 allows the Court to order a parent company of a subsidiary company in liquidation to pay the Liquidators the whole or part of any claims made against the subsidiary.
In the Lewis Holdings case, the creditor had leased a property to the subsidiary.. The rent and rates were invoiced to and paid by the parent company and all of the decisions in respect of the lease were made through the parent without independent consideration by the subsidiary.
The Court found that the subsidiary was effectively being run as a “division” of the parent company with decision making being handled as a single entity rather than identifying the subsidiary’s separate interests.
The subsidiary did not obtain its own legal advice, had no employees of its own and effectively failed to operate as a separate entity having regard to its own interests.
Failure of a subsidiary to act as an independent entity in its own right having regard to its own interests and risks can obviously have serious effect for the parent.
Where a subsidiary is receiving financial or administrative support from a parent, there needs to be appropriate legal and commercial arrangements in place to give effect to the separate legal status of the subsidiary and to document the support arrangements in an arm’s length manner.
Separate records and books of account should be maintained and separate decision making processes should be established.
The fact that the directors of a subsidiary might also be directors or employees of the holding company is not in itself fatal. It is the manner in which those directors behave as directors of the subsidiary that is important.