The Ties That Bind Parent and Subsidiary Companies

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By Carlie Alcock, Associate

The holding company with subsidiary company structure is one commonly found in the not-for-profit and charity space, perhaps as much as it is found in the commercial arena. Commonly used to separate certain operations of a company into a distinct, albeit related, legal entity, either to minimise specific tax liabilities or maximise eligibility for tax concessions, the structure also enables organisations to protect assets and limit risk liability.

The symbiosis of the structure is evident in its definition under the Corporations Act 2001 (Cth) (the Act), which defines each entity by reference to the other. Section 46 of the Act provides that a company is a subsidiary of another company (the ‘holding company’) where:

  1. the holding company:
    1. controls the composition of that company’s board of directors; or
    2. controls more than half of that company’s maximum voting power at general meetings; or
    3. holds more than half of the share capital issued for that company; or
  2. that company is a subsidiary of a subsidiary of the holding company.

The amount of control that a holding (or parent) company exerts over a subsidiary will depend on how the relationship between them is structured in the subsidiary’s governing documents. Typically, in a not-for-profit or charity structure, the holding company will act as the sole member of the subsidiary and will be responsible for appointing and removing the directors on the board (or a majority of the directors if the board has the option to appoint co-opted directors) of the subsidiary, although this may vary in degrees between organisations. As well as other strategic decisions, the holding company (as the sole member) will often be responsible for the approval of significant decisions involving the subsidiary company’s direction or future, including any decision to wind up the company or amend its constitution. The subsidiary’s constitution may also contain additional reserve powers, specifically delegating the approval of some matters to the holding company, such as the appointment of a Chief Executive Officer or decisions around the buying or selling of certain assets.

While a holding company will have some degree of control over the subsidiary, there may be instances where the control exhibited by that company is so direct that it is held to be a director itself, and therefore liable for the debts of its subsidiary in the event that the subsidiary becomes insolvent. The definition of ‘director’ at section 9 of the Act includes a person whose ‘instructions or wishes’ the directors ‘are accustomed to act in accordance with’, even though that person is not properly appointed as a director. Often referred to as ‘shadow directors’, persons (including parent companies) meeting this definition under the Act will be held to the same standard as those validly appointed as directors.

It is important here to separate the notion of ‘instructions or wishes’ from ‘advice’, in the sense that ‘advice’ is not generally tied to an obligation to act. Under section 9, a person will not be held to be a director where that person provides advice in that person’s professional capacity or through their business relationship with the directors.

Further, the inclusion of the words ‘accustomed to act’ suggests that there has been a pattern formed whereby such instructions are anticipated and there is a reasonable expectation that they will be followed. Alternatively, there may be a relationship established through which an understanding exists that decisions of fundamental importance will be directed by an external person or body. In this situation, it is possible that even a single decision exclusive from any evident pattern could be considered to have been made under the instruction of a shadow director.

In the event that a subsidiary becomes insolvent, one of the first places that creditors will seek to look is the holding company. In times of economic uncertainty like the present, it is important for holding companies and subsidiaries to be clear on where the responsibility and control lies between them. It will not be unusual for a holding company to exercise greater direction or control over its subsidiary during times of financial instability, however, in order to ensure that the holding company is not seen to be a shadow director, it will be important for the board of the subsidiary to exercise its own analysis and independent decision making. This may be made more complex, but is no less important, where some of the directors of the subsidiary also sit on the board of the holding company.

In Standard Chartered Bank of Australia Ltd v Antico[1] the New South Wales Supreme Court reviewed the relationship between the holding company (Pioneer) and its subsidiary (Giant). Giant was being wound up and Standard Chartered Bank of Australia initiated proceedings against Pioneer alleging that Pioneer was in fact a shadow director of Giant and was therefore liable under the insolvent trading provisions for the actions of Giant. The Court held that the fact that Pioneer owned 42% of Giant and had three nominee directors appointed to its board, was not sufficient to hold Pioneer out as a director. However, in observing the various strategic decisions that had been made by Pioneer, along with other aspects of its management and financial control over Giant, the Court found that Pioneer was in fact a shadow director of Giant, stating that Pioneer had a ‘willingness and ability to exercise control, and an actuality of control, over the management and financial affairs of Giant’[2].

On the other hand, in the case of Dairy Containers Ltd v NZI Bank Ltd[3] the High Court in Wellington considered the allocation of control between the New Zealand Dairy Board (NZDB) and its wholly-owned subsidiary, Dairy Containers Ltd (Dairy). All of Dairy’s directors were appointed by NZDB and were employees of NZDB. However, despite the Court acknowledging that Dairy’s directors, as employees of NZDB, were used to acting in accordance with the instructions of NZDB, it held that, as the directors of Dairy, they were not accustomed to acting on the basis of instructions from NZDB.

In considering these two examples, it is clear that the form and content of communications between a holding company and its subsidiary will be fundamental in determining whether such communications are held to be instructions or directions, or simply advice. Similarly, it will be the pattern of those communications that will be important in concluding whether or not the subsidiary has become accustomed to acting on the instruction or direction of the holding company.

Since the decisions described above, an exemption has been introduced at section 187 of the Act which provides that a director of a wholly-owned subsidiary will be held to have acted in good faith and in the interests of the subsidiary where that director acts in good faith and in the interests of the holding company. In such circumstances, the director’s actions will be upheld, provided that the constitution of the subsidiary expressly authorises the director to act in the interests of the holding company and, that at the time of the director’s actions, the subsidiary is not insolvent and does not become insolvent as a result of the actions.

It is, however, important to recognise that the exemption at section 187 does not excuse the directors from independently evaluating each decision. Particularly in our current economic climate, where financial instability is being felt across all industries and sectors, and insolvency appears a bleak reality for many perhaps more than ever before, it is vital that directors identify where they may have dual responsibilities and ensure that they maintain a level of independent analysis at every stage of their decision making.

[1] [No. 1 and 2] (1995) 38 NSWLR 290.

[2] Standard Chartered Bank of Australia Ltd v Antico [Nos 1 and 2] (1995) 38 NSWLR 290, 328.

[3] (1995) 7 NZCLC 260.

For further information, please do not hesitate to contact us.

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