MHK Chartered Accountants On Lifting The Corporate Veil

A recent case held a parent company liable for its subsidiary's debts.  In common terminology, that’s “Lifting the corporate veil”.  This was an expensive outcome for the parent company, which could have been avoided. This case was Lewis Holdings Limited v Steel & Tube Holdings Limited (the STH case), and the Court of Appeal has upheld the decision of the High Court, and held the parent company responsible to pay the debts of its subsidiary.  
 

Ian Malcolm, Managing Director of MHK Chartered Accountants Ltd, comments. “Usually a Company is treated as a separate legal entity, which is solely responsible for the liabilities it incurs, and has the sole benefit of the income.  However, in this case, the Courts used one particular piece of legislation to “lift the corporate veil” - Section 271 of the Companies Act 1993 allows the Pooling of assets of related companies in some circumstances.”

Mr Malcolm continues,“This same position could apply to other companies such as property development companies, where a separate company is incorporated for each venture, with a common holding entity for all of them.  This is a clear warning that not all companies that have failed ventures will automatically ring-fence those losses, to the detriment of creditors of that company.”

In the STH case the problem was compounded by the level of involvement of the parent, which compromised the independence of the subsidiary.  For simplicity of operating, instead of opening a separate bank account, the parent treated the subsidiary as an economic division of itself and just separated out the accounting internally.  The directors did not conduct its affairs separately, nor hold separate directors’ meetings. There was no clear distinction other than by accounting records between the parent and their subsidiary.

Although this is common practice that subsidiaries often utilise Management and staff of their holding company, and provide common facilities, this judgment is a reminder to directors of group companies to segregate operations and maintain separate corporate governance. The Court held that STH was completely liable for all the claims made in the liquidation. 

Mr Malcolm concludes that the lessons are simple, following these would almost certainly have ring-fenced the losses in the subsidiary: 

Maintain independence from the parent company in as manty aspects as possible.
Run and document separate board meetings.
Run each subsidiary business as a separate entity with their own bank account.
Documented inter-entity charges;
Documents such as invoices in and out, and e-mails, should be in the name of the subsidiary and not confused with the parent company;
Assets and liabilities of the subsidiary should be registered and treated as their own.

MHK Chartered Accountants specialise in business structuring and legally minimising all types of taxation obligations and welcome a no-obligation discussion free of charge.  For more information on this, and MHK Chartered Accountants, see  http://aucklandaccountant.net.nz .