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When is a Subsidiary not a Subsidiary? WHEN IS A SUBSIDIARY NOT A SUBSIDIARY? Many contracts include special provisions or carve outs which apply to dealings between companies within the same group. Obvious examples are change of control provisions, rights to assign the contract or sub-license rights to other companies in the same group, commitments to provide services to one party and to other companies in its group, indemnities in favour of one party and other members of its group, provisions which trigger a grant of a parent company guarantee, VAT clauses, and limitations and exclusions of liability which limit or exclude liability of a party and its group companies. Usually, such clauses have based their definitions of concepts such as "subsidiary", "affiliate", "group" and "holding company" on the definitions in the Companies Act. The Supreme Court will shortly have the opportunity to decide whether these clauses are deficient. Section 1159 of the Companies Act 2006, like its predecessor section 736 of the Companies Act 1985, provides that a company is the "subsidiary" of its "holding company" if the holding company: (a) holds a majority of the voting rights in it; or (b) is a member of it and has the right to appoint or remove a majority of its board; or (c) is a member of it and (under an agreement with other members) controls alone a majority of the voting rights in it. There have been a number of tax avoidance schemes which have depended on complex company structures where the voting rights do not reflect the underlying economic value in order to exploit the definition in (a) above, but the recent case of Enviroco Ltd v Farstad Supply A/S, which concerned an indemnity in favour of group companies in a shipping charter, focussed on a different and more common issue. Under (b) and (c) above, the holding company must actually be a member of the subsidiary, which means it must be entered into the subsidiary's register of members as the holder of the shares. Sometimes, a shareholder will register his shareholding in the name of a nominee. Alternatively, when a shareholder mortgages his shares to a lender as security for a loan, it is possible to deposit the share certificate informally with the lender, together with a blank signed share transfer which the lender can complete to sell the shares if the borrower defaults, but the better course for the lender is to have the shares transferred into its own name (or the name of its nominee), with a covenant to transfer them back to the borrower once the debt has been repaid. In the Enviroco case, 50% of the shares in Enviroco were held by a third party and 50% were held by Asco plc but, pursuant to an agreement with the other member, Asco controlled alone a majority of the voting rights. The charter agreement defined "subsidiary" by reference to section 736 of the 1985 Act, and the case turned on whether or not Enviroco was a subsidiary of Asco. This was clearly the case when the agreement was signed but, subsequently, Asco had mortgaged its shares in Enviroco to a lender, and they were registered in Enviroco’s books in the name of the lender’s nominee. The High Court held that, in the context of the charterparty agreement, Enviroco remained a subsidiary of Asco, and so was entitled to the benefit of the indemnity, but the Court of Appeal held that, when the lender’s nominee was registered as the holder of the shares, Enviroco ceased to be a subsidiary of Asco. While this might not sit well with the commercial reality, the Court held that the wording was clear and it had no power to correct it to produce what might have been a more logical result. The Supreme Court has granted Enviroco leave to appeal the Court of Appeal's decision. Meanwhile, to avoid the problem which arose in the case, alternative definitions of "subsidiary" and "holding company" should be considered. The definitions of "subsidiary undertaking" and "parent undertaking" in section 1162 of the 2006 Act (section 258 of the 1985 Act) include tests that are similar to (b) and (c) above, but they also include a specific provision deeming an undertaking to be a member of another undertaking if its shares in that other undertaking are held by another person acting on its behalf. Defining “subsidiary” and “holding company” by reference to section 1162 instead of section 11559 would cover with position where the shares are registered in the name of the holding company’s nominee, but may not do so where the shares have been transferred to a third party to hold by way of security, so the better course - even if the Supreme Court decides this is the position anyway - may be to continue to refer to the definitions in section 1159, but to add a deeming provision similar to the one in section 1162(3). Please contact us if you require any assistance in this connection. |