Holding company liability for debts of subsidiary

When advising on the suitability of corporate structures, we are commonly asked whether a holding company can be liable for the debts of a subsidiary.  The answer (of course) depends on a number of factors.

What is a holding company?

A holding company is defined in section 9 of the Corporations Act 2001 (Cth) (Act) in relation to a body corporate as a “body corporate of which the first body corporate is a subsidiary”.  A subsidiary in relation to a body corporate is also defined in section 9 to mean “a body corporate that is a subsidiary of the first-mentioned body by virtue of Division 6”.  Section 46 defines a subsidiary as follows:

“A body corporate (in this section called the first body) is a subsidiary of another body corporate if, and only if:

(a) the other body:

(i)    controls the composition of the first body’s board; or

(ii)   is in a position to cast, or control the casting of, more than one-half of the maximum number of votes that might be cast at a general meeting of the first body; or

(iii)  holds more than one-half of the issued share capital of the first body (excluding any part of that issued share capital that carries no right to participate beyond a specified amount in a distribution of either profits or capital); or

(b) the first body is a subsidiary of a subsidiary of the other body.”

Therefore section 46 is quite prescriptive.

When is a holding company liable for the debts of the subsidiary?

Pursuant to section 588V of the Act a holding company is only liable for the debts of a subsidiary if the following five (5) criteria are met:

“(a)  the corporation is the holding company of a company at the time when the company incurs a debt; and

(b)  the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and

(c)  at that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as the case may be; and

(d)  one or both of the following subparagraphs applies:

(i)  the corporation, or one or more of its directors, is or are aware at that time that there are such grounds for so suspecting;

(ii)  having regard to the nature and extent of the corporation’s control over the company’s affairs and to any other relevant circumstances, it is reasonable to expect that:

(A)  a holding company in the corporation’s circumstances would be so aware; or

(B)  one or more of such a holding company’s directors would be so aware; and

(e)  that time is at or after the commencement of this Act.”

In what circumstances can a liquidator of a subsidiary claim against the holding company?

Section 588W(1) of the Act states that a company’s liquidator may recover from the holding company an amount equal to the loss or damage suffered where:

“(a)  a corporation has contravened section 588V in relation to the incurring of a debt by a company; and

(b)  the person to whom the debt is owed has suffered loss or damage in relation to the debt because of the company’s insolvency; and

(c)  the debt was wholly or partly unsecured when the loss or damage was suffered; and

(d)  the company is being wound up”.

Pursuant to section 588W(2) of the Act, such proceedings must be started within six (6) years of the beginning of the winding up.

What are the defences are available to the holding company?

Section 588X of the Act describes four (4) defences:

• reasonable grounds to expect solvency – under section 588X(2) it is a defence if the holding company and each of its directors (if any) had reasonable grounds to expect, and did expect, that the subsidiary company was solvent and would remain solvent if it incurred the debt;
• reliance on information – under section 588X(3) it is a defence if the holding company and each of its directors (if any):
  • had reasonable grounds to believe, and did believe, that a competent and reliable person was responsible for providing to the holding company adequate information about whether the subsidiary was solvent, and that person was fulfilling that responsibility; and
  • expected, on the basis of the information provided to the holding company by the person, that the company was solvent and would remain solvent if the debt was incurred;
• justifiable non-participation of director with knowledge – under section 588X(4) it is a defence if a relevant director of the holding company was unable to participate in the management of the holding company due to illness or some other good reason; and
• taking all reasonable steps to prevent insolvent trading – under section 588X(5) it is a defence if the holding company took all reasonable steps to prevent the subsidiary from incurring the debt.

Case law

In the recent case of Giovanni Maurizio Carrello As Liquidator Of Perrinepod Pty Ltd (In Liq) v Perrine Architecture Pty Ltd [2016] WASC 145 Mr and Mrs Perrine were the directors and shareholders of Perrine Architecture Pty Ltd (PA).  PA held 39 million of the 49.5 million issued shares in Perrinepod Pty Ltd (PPL).  PPL was ordered to be wound up on the ground of insolvency on 1 March 2012.  It was argued that as Mr and Mrs Perrine failed to prevent PPL incurring debts while insolvent, PA was liable as the holding company of PPL under section 588V.

The West Australian Supreme Court held that there were reasonable grounds for Mr and Mrs Perrine to suspect PPL’s insolvency, therefore PA was liable under section 588V.  No defence was made out under section 588X, and a judgement for the amount of $1,354,911.85 plus interest was entered against the defendants.  Pursuant to section 588Y this amount was not available to pay the debts of PPL to PA unless all of PPL’s other unsecured debts had been paid in full.

Links and further references

Legislation

Corporations Act 2001 (Cth)

Further information about corporate structures

If you need advice on any aspect of corporate structures please feel free to telephone me for an obligation free and confidential discussion.

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

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