Corporate Governance of a Subsidiary in a Group Context

1. Introduction

Groups of companies are generally composed of a parent company being the shareholder of several subsidiaries where the parent company sets the strategy to be implemented by the subsidiaries. However, subsidiaries are individual legal entities with their own corporate governance requirements and regulations. This article highlights some potential risks for shareholders if they control subsidiaries and suggest some practical steps to minimise these risks by implementing and maintaining a proper corporate governance in the subsidiary.

2. Director’s duties of a subsidiary

When taking decisions, Directors of UK subsidiaries must consider their general directors’ duties as even if wholly owned by one shareholder, a subsidiary is a separate legal entity, and its directors owe their director’s duties to the company and not to the shareholders or another company of the group.

3. Corporate personality and limited liability

With its incorporation, a company has its own existence and legal personality and is subject to obligations and liabilities separated from those of its shareholders. Generally, for a company limited by shares, the consequence in particular is, that the shareholders are only required to pay the nominal value of the shares but are not liable for the debts of the company. Therefore, a separate subsidiary can be used to ringfence certain liabilities from the shareholder. However, in some circumstances the courts might disregard the separate personality and accept the liability of the shareholders, which is called piercing the veil.  Courts have pierced the veil if the company is a “mere cloak or sham”.  Also for groups of companies liability of the shareholder has been generally rejected unless there was an aspect of an improper use of a company structure. However, several decisions have emerged in litigation about industrial companies’ liabilities for personal injuries of employees of a subsidiary. In these instances, the parent company will not be liable only because of its shareholding, but because of a separate duty of care towards employees of the subsidiary. This will be more likely if the parent exercised control over the subsidiary’s affairs. Alternatively, the law may impose a duty of care where the businesses of the parent and subsidiary were the same, the parent had superior knowledge about relevant facts and matters (such as health and safety), knew or should have known that the subsidiary’s work system was unsafe, and knew or should have foreseen that employees would rely on the parent’s superior knowledge for their protection. In these cases the court may potentially identify a free standing duty of care owed by the parent to the claimant arising out of the relationship between the parent and subsidiary. Therefore, in cases where the parent company controls the subsidiary, the shareholder may potentially be held to be liable in particular for potential tort claims.

4. Alignment of the interests of group of companies

The goal of any parent company will be to align the interest of the group on one hand but to minimise the risk of liabilities of the shareholder on the other hand. Even though the directors of a subsidiary owe their directors duties to the subsidiary itself the corporate personality of the subsidiary does not prevent them from taking into account the interest of the group in their decisions and the interests of a subsidiary that is solvent are likely to include the interests of its shareholders generally.  Arguably, although consideration must be given to the interests of the particular company concerned, most commercial transactions inevitably involve the balancing of benefit and detriment. To combine the interests of the subsidiary with the interests of the parent company, a proper governance of the subsidiary will help. Such a proper Corporate Governance entails an effective board of the subsidiary that when implementing the strategy of the group takes decisions properly, making sure pros and cons are weighed for the subsidiary with sufficient information, without any conflicts of interest and adequately recording these decisions within the board meetings. This is helpful in demonstrating that the directors have independently taken the interests of the subsidiary into account, reducing the risk of it being held that there is complete control by the parent company, and in turn reducing the risk of the parent company being held liable by a court. For expert Corporate Governance advice for your business, please contact us to speak to a member of our Corporate Governance Team.