Section 271 Companies Act 1993

The High Court accepted a claim that the parent company, Steel & Tube Holdings Ltd, was liable for the debts of its wholly owned subsidiary, Stube Industries Ltd (in liquidation), by applying the pooling provision in s 271(a), Companies Act 1993.

Background of the Case

Lewis Holdings Ltd (“Lewis Holdings”) was the owner of a property at 15 Fisher Crescent, Mt Wellington, Auckland (“Property”).  Lewis Holdings leased the Property to Stube Industries Ltd (“Stube”) under a perpetual renewal 21 year ground lease.  Stube is a 100% owned subsidiary of Steel & Tube Holdings Ltd (“STH”).

The lease expired in 2009 and was mistakenly renewed for another 21 year term.

Stube was placed in liquidation by way of shareholder resolution on 4 June 2013.  The liquidation followed a number of unsuccessful attempts to exit Stube from the lease.

The liquidators appointed by the shareholders disclaimed the lease as onerous property under s 269 of the Companies Act 1993 (“the Act”).

Lewis Holdings subsequently filed a proof of debt with the liquidators for $2,618,528, being the sum Lewis Holdings calculated as the discounted present value of the loss of its right to future rent under the lease.

Lewis and the liquidators claimed that STH was liable to pay to the liquidators the whole of Lewis’ claim in the liquidation pursuant to s 271(1)(a) of the Act.

Section 271

New Zealand company law is grounded in the principle that a company is a separate legal entity from its shareholders.

Section 271 is a rarely used provision and is unique to New Zealand’s company law.

It states:

Section 271 is an exception to the general principle that a company is a separate legal entity from its shareholders and that those shareholders are not generally liable to meet the company’s debts beyond the extent of their shareholdings.  Section 271 allows the Court to order a related company of a company in liquidation to pay to the liquidator the whole or part of any claims made in the liquidation.

In considering a s271(a) claim, the Court is required to have regard to the guidelines set out in s272(1) of the Act.  They are:

The Court therefore has a wide discretion regarding the extent of any contribution which it considers is “just and equitable” for a parent or related company to make to a subsidiary’s debt.

High Court Decision

The Court issued an interim judgment on 18 December 2014 under which it held that STH was liable to pay all of Lewis’ claim in the liquidation.  The judgment was made on the interim basis to enable the parties to advise further evidence and make submissions to the extent of the claim to be admitted in the liquidation.

The Court considered the following factors in reaching its ultimate finding:

• STH appointed its CEO and CFO as directors of Stube.  It is a relatively common practice to appoint senior employees of the parent company as directors of a subsidiary, however it is vital that the interests of the subsidiary are considered independently of the parent.
• The Court found that Stube was managed as a division of STH and not as an independent company.  Although the constitution of Stube allowed Stube’s directions to prefer STH’s interests, the Court held that this necessarily required consideration of the separate interests of each company.  Rather than doing this, Stube’s directors considered only the interests of the group.
• Stube had a significant property interest in the form of the lease.  However, STH treated the leasehold rights and obligations as belonging to it.  That included:
  • making rent payments; and
  • requiring all rates invoices to be addressed to STH for payment
• Stube had no employees of its own.  It relied on STH’s employees to conduct its business.  It also corresponded on STH’s letterhead.
• The financial affairs of Stube were intermingled with STH to the extent that Stube did not have its own bank account and all transactions were coded as STH’s transactions.
• Stube did not take independent advice before entering into a major transaction (the lease) and did not take advice while trying to exit the lease.  STH did take legal advice on that issue and claimed privilege in respect of that advice.

The Court concluded that Stube was entirely “devoid of any capacity to conduct its own affairs”.

The Court also considered the following factors supported an order being made under s271:

• Section 136 of the Act requires directors of a company not to agree to the company incurring an obligation unless the directors believe, at the time, and on reasonable grounds, that the company would be able to perform the obligation when it was required to do so.  The directors were aware that Stube had no financial capacity to enter into the renewal of the lease, yet did so anyway (albeit inadvertently).
• The liquidation of Stube was a direct consequence of STH withdrawing its financial support from Stube.
• The Court also attached weight to the argument that STH, as a publicly listed company with a company solicitor, ought to have ensured that each entity’s separate legal identity was maintained.

Lessons

The Court was careful to say that the formal distinction between parent and subsidiary was not something that the directors needed to make on an operational basis.  However, directors must approach their duties as directors in a way which recognises the independence of the subsidiary.

This case therefore highlights the need for directors to ensure that a subsidiary’s separate legal identity is kept distinct from that of the parent and that the management, financial and legal matters of both are not intermingled.  Formal documentation is required if there is to be any sharing of rights and interests between the parent and subsidiary to ensure that those separate identities are kept distinct.

In considering whether a subsidiary’s interests are separate and distinct from that of its parent, it may be helpful to ask the following questions:

• Are the interests of the subsidiary considered separately to the interests of the parent company, any related company, or the group at board level?
• Are the assets and liabilities of the subsidiary treated as being distinct and separate or are they treated as though they are the assets and liabilities of the parent company?
• Are records of the subsidiary kept distinct and separate from those of the parent or any other company within a group?  This includes minutes of board meetings, resolutions, financial records, and any legal records or legal advice.
• In the event the parent company is providing significant financial support to the subsidiary, have those financial arrangements been formally documented?

Failure to maintain the distinction between parent, subsidiary, or other related companies will create the risk of the parent, or related company, becoming liable for the debts of the subsidiary on liquidation.

This article is current as at the date of publication and is only intended to provide general comments about the law. Harkness Henry accepts no responsibility for reliance by any person or organisation on the content of the article. Please contact the author of the article if you require specific advice about how the law applies to you.