The case illustrates the risks of holding companies poorly managing subsidiaries. Although the decision was based on a unique set of facts, the following important lessons may be learned:
Usefully, the judgment confirmed that the practice of appointing holding company employees as directors of a subsidiary is appropriate and those directors may act in the best interests of the holding company provided that the constitution permits and the separation of interests is observed.
To provide greater context and detail, the case of Lewis Holdings Limited v Steel & Tube Holdings Limited is analysed below.
Lewis Holdings Limited (‘Lewis’) is the owner of a property which was leased to Stube Industries Limited (‘Stube’). Stube is a wholly owned subsidiary of Steel & Tube Holdings Limited (‘STH’). STH paid all of the lease expenses, including the rent. In 2009, the lease was deemed to have renewed under Schedule 1 of the Public Bodies Leases Act 1969. STH continued to pay the rent until 2013 when STH put Stube into liquidation and the lease was disclaimed. Lewis relied on section 271(1)(a) of the Companies Act 1993 (‘Act’) and claimed that STH should pay for its claim in the liquidation of Stube.
Section 271(1)(a) provides that if it is just and equitable to do so the Court may order a related company to pay claims in a liquidation. In making an order under this section the court must have regard to certain matters.
One of the important matters considered by the court was the extent to which STH took part in the management of Stube.
The two directors of Stube were also the CEO and CFO of STH. It is common practice for senior employees of a holding company to be appointed as directors of a subsidiary and this does not of itself amount to participation by the holding company in the management of the subsidiary. However, the directors’ actions were such that the court determined that their involvement in the management of Stube was in their capacity as CEO and CFO of STH and that their status as directors of Stube did not isolate STH from the management of Stube.
Stube’s constitution contained the usual provision permitting directors to act in the best interests of its holding company. However, it was determined that the proper application of such a provision requires directors to recognise the separate legal personality of the two entities and to distinguish between the different interests when deciding which is to be preferred.
Stube’s directors did not conduct its affairs separately, hold formal board meetings or discuss matters with their ‘Stube director hats on’. For many years, Stube had been unable to pay the rent without STH’s support and it did not have the financial capacity to continue to trade. Had the directors separately considered Stube’s liability as required by section 136 of the Act, the directors would not have had reasonable grounds to believe Stube would be able to perform the obligations incurred under the renewal of the lease, either from its own resources or by recourse to legally enforceable financial arrangements, as there were no formal arrangements in place to ensure STH’s support. In addition, the renewal of the lease was a major transaction which should not have been entered into without STH’s approval as shareholder by way of special resolution under section 129 of the Act.
In addition, Stube had no employees of its own and all matters were attended to by STH employees. However, there were no recorded arrangements for STH to provide management services to Stube, and no inter-company charge for the provision of services. Stube was also treated as a division of STH for financial purposes. Not only did Stube not have a separate bank account, but receipts and payments were accounted for as STH’s transactions. Accordingly, the court concluded that STH took part in the management of Stube to an extent which was total in all essential respects.
Another important factor was the conduct of STH towards Lewis as a creditor of Stube. STH conducted itself towards Lewis as if the property was STH’s by covering all lease expenses and failing to comply with provisions of the Act that would suggest Stube was a legal entity distinct from STH. The court held this conduct would reasonably lead Lewis to believe that Stube was not treated as a separate legal entity.
Interestingly, the court mentioned the possibility of a holding company becoming a shadow director of a subsidiary and therefore being subject to the directors’ duties in relation to that company. It was suggested that if employee directors have regard only to the interests of the holding company without giving separate consideration to the separate legal existence or the best interests of the subsidiary, the holding company may come within the scope of a shadow director. However, the court didn’t reach a decision on this point, concluding that it was just and equitable to make an order under s 271(1)(a) requiring STH to pay the whole of Lewis’ claim.
This case serves as an important reminder that the courts may be willing to look behind the corporate veil to uncover the true operating identity of subsidiaries. However, by following accepted commercial practice and ensuring directors recognise the different interests involved, holding companies can avoid a similar fate.
If there are any issues raised in this article that you would like to discuss with one of our corporate and commerical experts, please contact Martin Dalgleish in our Wellington office on 04 498 0827, or Chris Parke in our Auckland office on 09 375 1157.
This article was authored by Martin Dalgleish (partner) from our Wellington office.