Holding company liability for insolvent subsidiary companies
When is a holding company liable for the debts incurred by its subsidiary company?
Holding or parent companies control the shares of other companies, being subsidiary companies. These holding companies can be liable for the debts incurred by their subsidiary companies, without having been involved in the transaction that incurred the debt.
Section 588V of the Corporations Act sets out the criteria for liability, which basically involves the holding company directors being aware of the subsidiary company’s insolvency or inability to pay its debts.
There are defences provided under section 588X of the Corporations Act, being:
- the holding company directors had reasonable grounds to expect that the subsidiary company was solvent (able to pay its debts when due and payable) when it incurred the debts;
- that a competent and reliable person was providing information in respect of the subsidiary company’s solvency;
- the holding company director did not take part in the management of the subsidiary company because of illness or some other good reason; or
- the holding company took all reasonable steps to prevent the subsidiary company from incurring the debt.
The definition of ‘subsidiary company’ is found in section 9 of the Corporations Act. That is, a company controlled by another entity, meaning either having a majority of the same directors and/or shareholders, or control over the subsidiary company directors/shareholders.
To avoid holding company liability, a business can:
- enter into joint venture arrangements; or
- retain a shareholding of less than 50% in the subsidiary company.
Restructuring business activities to allow related companies to trade whilst insolvent, with the assets beyond the reach of unsecured creditors trading with the insolvent entity, presents a very common risk.
The reasons for company expansion are also common. These include taking advantage of taxation advantages, the introduction of new parties/capital in a new venture not related to the existing company assets and limiting liability in new ventures. These are all part of the limited liability principles of corporate law.
Although it may seem an impractical or awkward request, even for the most sophisticated of parties, creditors could ask these companies for security, such as a Security Interest capable of registration on the Personal Property Security Register or director personal guarantees.
Please contact SRM Lawyers to answer any enquiry you have relating to holding/subsidiary company liabilities.