Is your company liable for the actions of its subsidiaries?

It is a well-known principle of corporations law that company directors are personally liable for debts incurred by their company whilst it is insolvent. However, company directors should also be aware that despite the ‘separate legal entity’ doctrine, the Corporations Act sets out circumstances where a company may be liable for the debts of a subsidiary company where that subsidiary has been trading whilst insolvent.

This liability may create a significant financial burden for the parent company and the potential for it to arise should be considered carefully.

Your company will be a holding company if it:

· controls the composition of the another company’s board; or

· controls over 50% of the votes at another company’s general meeting; or

· owns more than 50% of another company’s share capital.

If you are a holding company, there is a 5 stage test to determine when you will be liable for the debts of your subsidiaries, similar to the test for directors trading while insolvent.

1. Where you the holding company at the time the subsidiary incurred the debt?

2. Did the subsidiary incur the debt while insolvent or did it become insolvent as a result of incurring the debt?

3. Were there reasonable grounds for suspecting that the subsidiary was insolvent?

4. Were you or another director in your company aware of those grounds, or is it reasonable to expect that you would have been aware?

5. Was the debt incurred after the commencement of the Corporations Act in 2001?

If you answer yes to all five questions, your holding company will be liable for the debts of the subsidiary. However, your company may escape this liability if one of the four defences set out in the Corporations Act can be raised.

The first defence requires that the company and each relevant director had reasonable grounds to expect, and did expect, that the subsidiary was solvent. This ‘expectation’ of solvency needs more than a ‘mere hope or possibility’ of solvency and is considerably harder to establish than the ‘suspicion’ of insolvency required for holding company liability.

The second defence allows the holding company to escape liability where they relied on a suitably competent person to inform them of the subsidiary’s expected solvency. This also maintains the stringent requirement of ‘expectation’ rather than ‘suspicion’ of solvency, and consequently can be difficult to establish.

The third defence applies to directors of holding companies that, at the time the subsidiary incurred the debt, were not in a position to influence the holding company’s management for illness or ‘another good reason’. This is applied strictly with deceit, undue influence, or unconscionable conduct not being considered a ‘good reason’ by the Courts.

The final defence is one of pre-emptive action, allowing the holding company to avoid liability if it has taken reasonable steps to prevent the subsidiary incurring debt, most often by winding up the subsidiary or placing it in administration.

If none of these defences are successfully raised, the holding company will be required to repay all debts of the subsidiary incurred whilst it engaged in insolvent trading.

In addition, directors of holding companies may be liable for the actions of subsidiary companies where the holding company has been sufficiently involved in those actions.

In 2009, the Federal Court of Australia found Austcorp International Ltd liable for the misleading and deceptive representations of its subsidiary, Austcorp Development Management Pty Ltd. In that case, the subsidiary had used Austcorp International’s name and logo on its deceptive marketing material, which was found to sufficiently connect Austcorp International to the subsidiary’s unlawful actions.

This serves as a cautionary note to directors of holding companies, and emphasises the importance of monitoring the actions and financial position of subsidiary companies. A failure to do this may result in significant penalties or court sanctions.

For further information on company structures and potential liability, please contact Certus Legal Group.