Supreme Court and Parent Companies

The Supreme Court is soon to hear a case on what constitutes a parent company under the Companies Act 1985 s736. The Court of Appeal decision is available here.

I thought it would be interesting to digress from other tasks for the day, due to adverse weather conditions in the UK affecting everyone's schedule, to look at what actually constitutes a subsidiary under the 2006 Act rather than the 1985 Act which the case is considering.

The facts of the Supreme Court case 'Farstad Supply A/S v Enviroco' (hereinafter Enviroco) are as follows:

A parent company pledged its controlling shares in one of its subsidiaries to a bank as security and the issue is whether it remains a subsidiary of that parent company.

On July 7th, the Appellant (E) was instructed to clean some tanks of an oil rig supply vessel owned by the Respondent (F), but chartered by Asco UK Ltd (C) under a charterparty. Included in the charterparty was an indemnity by F in favour of C and its affiliates, which included subsidiaries. E claimed that both it and C were subsidiaries of the parent company (P), who had given its shares in E to the bank as security and the bank's nominee became the holder of the shares but P retained the voting power. F claimed as a result, P ceased to be a member of E and could not obtain a benefit of the indemnity clause.

During cleaning, a fire killed one of E's employees and caused considerable damage. E, in the Supreme Court, launched proceedings for a declaration to the effect that at all material times it was an affiliate of C and entitled to an indeminty in the Charterparty.

The Deputy Judge decided under the 1985 Act that the person giving the security would be the registered holder of the shares otherwise that would lead to an easy evasion of s736. However, the Court of Appeal allowed the appeal and applied the Statutory definition of "subsidiary". They highlighted that merely providing security would not in itself, make you a member of the company within the meaning of s736. Membership was a status derived from the entry of the shareholder's name in the register of members.

Arguably the Deputy Judge also failed to consider the duty on a shareholder to make decisions in good faith (Allen v Gold Reefs [1900] 1 Ch 656 pp 671-2).

Importantly the Judge noted that the wording of the 1985 Act may lead to results that produce uncommercial result but they were not in a position to re-word the Statute.

The CA 2006 s1159 now defines the meaning of a "subsidiary" as:

(1) A company is a “subsidiary” of another company, its “holding company”, if that other 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 of directors, or

(c) is a member of it and controls alone, pursuant to an agreement with other members, a majority of the voting rights in it,

or if it is a subsidiary of a company that is itself a subsidiary of that other company.

(2) A company is a “wholly-owned subsidiary” of another company if it has no members except that other and that other's wholly-owned subsidiaries or persons acting on behalf of that other or its wholly-owned subsidiaries.

My initial thoughts on the wording of the legislation, in relation to the facts of the case, would be that the outcome would highly depend on the content of the security arrangements between the parent company and the bank.

What the new section seems to infer is that what is important in determing whether the company is a subsidiary of the parent company is control. It would seem from the COA that the important factor is the wording of the Statute. The 2006 Act seems to have made improvements on the wording of the legislation itself in determining what is a subsidiary of a parent company and not based on whose name is on the register of members or the rights they may hold within the company.

I will await the verdict of the Supreme Court before making any more contributions to this discussion.