Parent companies: are you liable for your subsidiary’s debt?

The recent High Court decision involving Steel and Tube Holdings and Lewis Holdings  is a timely reminder of the importance of ensuring separate businesses between a parent company and its subsidiary. Directors who do not ensure independence between a parent and subsidiary company put the parent company at risk of being held responsible for the debts of a subsidiary in a liquidation event.

The law

The general rule in New Zealand is that a company is a separate legal entity and in a liquidation or receivership event a shareholder only risks losing the share capital they have invested in the company and will only be liable for any unpaid balance owing on that share capital. There is one exception to this rule found in section 271 of the Companies Act 1993.

Section 271 provides for the pooling of assets of related companies and allows a court, if satisfied it is just and equitable, to order a company that is a related company to a company in liquidation to pay the liquidator for claims made in the liquidation.

There are some limits to this rule, given the common practice of parent companies managing subsidiaries. The underlying test is the behaviour of the related company.

Background

Steel & Tube Holdings was the parent company to its wholly owned subsidiary Stube Industries. Stube entered into a lease with Lewis Holdings which in 2009 which was mistakenly renewed for a further 21 year term.  Following attempts to cancel the lease, Steel & Tube, put Stube into liquidation and then sought to end the lease arrangement.

The court looked at the day to day management of the subsidiary company. Whilst the Companies Act allows the director of a wholly owned subsidiary to act in the best interests of the parent company, even if it is not in the best interests of the subsidiary, it does not extend to the extent that the subsidiary loses its separate commercial existence.

The Court’s decision

After considering the behaviour of the two companies, the court determined that Steel & Tube could be held responsible for the debts of Stube following liquidation and was responsible for the claim made by Lewis Holdings.

The court considered that Steel and Tube had managed Stube more like a division rather than separating the management, decision making and third party relationships.  Factors considered by the Court included that:

– Stube did not hold formal board meetings where the directors recorded the decision making of Stube, as separate from Steel & Tube.
– Stube did not have its own separate bank account and its payments including the lease payments were recorded as coming from Steel & Tube.
– Stube did not have its own employees and relied on Steel and Tube’s employees who also sent correspondence on Steel & Tube letterhead without signing off as being from Stube.
– Stube did not obtain independent advice before entering into transactions such as the lease renewal.

Lessons to be learned

This case highlights the importance of maintaining separate legal identity between parent and subsidiary companies. Directors should ensure they keep each company’s interests separate to limit the risk, by taking such actions as follows:

– Ensuring separate board and shareholder meetings are held for each entity, recording the decisions and resolutions of each company acting in their capacity for the relevant company.
– When entering into any third party arrangements, ensure that the relevant company entered into that arrangement and then carries out any transactions or makes any payments in the name of that company.
– Where the parent entity is providing any funding to the subsidiary to satisfy any obligations to a third party, such payments should be made from the parent company to the subsidiary so it can then use it to satisfy debts, rather than the parent paying the third party direct.
– Maintain separate company records, accounts and minute books and ensure records are kept of decisions made and why.

Whilst the Steel & Tube case came down to the specific facts of that case, it is an important reminder that parent and subsidiary companies should ensure they maintain appropriate separate legal and corporate identity.

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