Court of Appeal ruling on meaning of "subsidiary"

18/01/2010

The Court of Appeal has overturned a High Court decision, ruling that a subsidiary ceased to be a subsidiary of a holding company as a result of the holding company granting a pledge over the subsidiary's shares and registration of the shares in the name of the bank's nominee by way of security.

The ruling raises important questions on the meaning of "subsidiary" as set out in sections 736(1)(b) and (c) of the Companies Act 1985 (the "1985 Act") and sections 1159(1)(b) and (c) of the Companies Act 2006 (the "2006 Act"). (The latter provisions replicate the former provisions of the 1985 Act.)

Farstad Supply A/S (Farstad) chartered a vessel to Asco UK Ltd (Asco UK) in 1997. Enviroco Ltd (Enviroco) was subsequently appointed to clean the vessel's oil tanks. Considerable damage was caused to the vessel and an Enviroco employee died as a result of a fire which occurred during cleaning. Farstad issued proceedings against Enviroco, which argued that it was an affiliate of Asco UK pursuant to section 736(1)(c) of the 1985 Act (both being subsidiaries of Asco plc) and thus could rely on the benefit of an indemnity clause in the charterparty between Farstad and Asco UK. The definition of "affiliate" in the charterparty expressly referred to the definition of "subsidiary" in section 736 of the 1985 Act.

"Subsidiary" is defined in section 736(1) of the 1985 Act:
"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 which is itself a subsidiary of that other company."

Section 736A provides some explanation of section 736, sub-section (7) in particular referring to the situation where shares are used as security. Furthermore, section 736A(6) provides that where rights are held by a person as nominee for another the rights "shall be treated as held by the other; and rights shall be regarded as held as nominee for another if they are exercisable only on his instructions or with his consent or concurrence."

Enviroco argued that it was a subsidiary of Asco plc pursuant to section 736(1)(c). After the charterparty had been entered into, Asco plc had granted security over the Enviroco shares, the "deed of pledge" requiring the bank or its nominee to become registered holder of the shares. Registration, the deed specified, was for the purposes of security only and Asco plc was to retain its voting powers relating to the shares in Enviroco.

In considering whether Enviroco was an "affiliate" of Asco UK, the court looked at the true construction of the charterparty. Given the cross-reference to section 736, the latter had to be treated as being included in the charterparty. Despite the pledge and registration of the bank's nominee in Enviroco's register of members, Enviroco was held to be Asco UK's affiliate (and could, therefore, rely on the indemnity).

Obiter, the court did consider that the extended meaning of 'subsidiary' depended on the context of the definition.

The court held that Enviroco was no longer a subsidiary of Asco plc within the meaning of sections 736 and 736A of the 1985 Act as a result of the pledge of shares and registration of the shares in the name of the bank's nominee by way of security. Hence, Enviroco was not an affiliate of Asco UK and could not rely upon the benefit of the indemnity.

The majority of parent-subsidiary relationships exist pursuant to section 736(1)(a) or section 1159(1)(a) (i.e. where the parent holds the majority of the voting rights in the subsidiary) and these will not be affected by the judgment. Where a holding company grants particular types of security to a lender over shares in a subsidiary, however, there could be significant implications.

From a commercial viewpoint, this ruling has implications for contracts that define the concept of "subsidiary", "affiliate", "group" and "holding company" by reference to section 736 of the 1985 Act or section 1159 of the 2006 Act. Care will need to be taken when drafting such agreements. There will, no doubt, also be implications from a tax perspective and effects on employee share option plans, for example.

From a corporate law perspective, where a company would be a holding company under section 736(1)(b) or (c) were it not for the change in registration, such company may still be able to exercise certain rights (for example, appoint or remove a majority of the board of directors) without being a 'member' of the subsidiary in question and thus not a 'holding company' for the purposes of those sub-sections. Arguably, a parent company will be able to exercise certain rights but not be caught by them.

The Supreme Court recently granted Enviroco leave to appeal the Court of Appeal's decision. The hearing is apparently scheduled to take place in October 2010.

Contact: maustin@city-law.net

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