A holding company is often used in company structuring to minimise risk and liability. It doesn’t usually produce goods or services or have a role in the day-to-day operations of the business. Rather, it is created to buy and own the shares in other companies, known as subsidiary companies. However, when a subsidiary of a holding company continues to trade while it is insolvent (i.e. when it cannot pay its debts), the holding company may be liable for those debts. In these circumstances, a holding company may find itself facing a demand for payment from a liquidator.

This article discusses:

  1. the difference between a holding company and a subsidiary;
  2. when a holding company will be liable for the debts of a subsidiary;
  3. in what circumstances a liquidator can make a claim against a holding company for a subsidiary’s debt; and
  4. what defences may be available to the holding company.

What is the Difference Between a Holding Company and a Subsidiary Company?

Holding Company

A holding company is a company that has control over one or more other companies (known as subsidiary companies). A holding company will likely own all or a substantial amount of the shares in its subsidiary company (or companies).

The purpose of a holding company is to manage and oversee some of the more major operations of the subsidiary company. There are many advantages of operating with a holding company, such as minimising the risk of someone suing you and providing a more tax effective structure.

 

Subsidiary Company

A subsidiary company is a company that is under the control of a holding company. A holding company must wholly or partly own the subsidiary company. For a company to be classified as a subsidiary, the holding company must:

  • control the composition of the subsidiary’s board;
  • have control of over 50% of the total number of votes at a general meeting of the subsidiary company; or
  • hold more than 50% of the issued share capital of the subsidiary company (i.e. the funds that the company raises in exchange for shares).

 

When is a Holding Company Liable for the Debts of a Subsidiary Company?

A holding company will liable (i.e. responsible by law) if:

  • it was a holding company of the subsidiary at the time the debt arose;
  • the subsidiary company was insolvent when the debt arose, or became insolvent by incurring the debt;
  • at that time, there were reasonable grounds for suspecting that the subsidiary company was, or would become, insolvent; and
  • either the holding company, or one or more of its directors, was aware of the grounds for suspecting the subsidiary was insolvent or it would be reasonable for one or more of the directors to suspect the subsidiary was insolvent.

When Can a Liquidator of a Subsidiary Company Make a Claim Against the Holding Company?

A liquidator of a subsidiary company may recover a debt from a holding company when the:

  • holding company is liable (according to the above criteria);
  • person or company that is owed money has suffered loss or damage as a result of the subsidiary’s insolvency;
  • debt was wholly or partly unsecured when the loss or damage occurred; and
  • the subsidiary company is being wound up (i.e. being dissolved).

What Defences Can a Holding Company Raise?

1. ‘Safe Harbour’ Provisions

The directors of a holding company may have a defence if:

  • it is taking steps to ensure the directors of the subsidiary (who suspect insolvency) develop a course of action that is likely to lead to a better outcome for the company in liquidation;
  • the debt arose in connection with that course of action; and
  • the directors of the subsidiary were developing this course of action when the debt arose.

2. Reasonable Grounds to Suspect Solvency

The holding company may also have a defence if there are reasonable grounds to expect the subsidiary was solvent.

3. Reliance on Information Provided by the Subsidiary

The holding company may have a defence if the holding company and its directors believed (and had reasonable grounds to believe) that:

  • a competent and reliable person was responsible for providing the holding company with adequate information about the subsidiary’s solvency; and
  • based on the information provided by that person, the holding company expected that the subsidiary was solvent.

4. Director Unable to Participate

The holding company may not be liable if, due to illness or some other good reason, the relevant director of the holding company was unable to participate in the management of the holding company when the debt arose.

5. Reasonable Steps to Prevent Insolvent Trading

If the holding company took all reasonable steps to prevent the subsidiary from incurring the debt, the company may not be liable.

Key Takeaways

In certain circumstances, a holding company may be liable for debts incurred by a subsidiary company when the subsidiary company could not pay its debts. If the directors of the holding company were aware of, or should have been aware of, the insolvency, then the holding company may be liable for the debt. In those circumstances, a liquidator may pursue the holding company for the debt.

Directors of holding companies should therefore ensure they keep up to date on the finances and operations of both the holding company, and its subsidiaries. Furthermore, they should take steps to prevent all companies within their corporate group from engaging in insolvent trading. A failure to do so could result in the holding company paying for the subsidiaries debts. Have questions about the liability of companies and directors for company debts? You can contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

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