Lifting the corporate veil - a parent company held liable for its subsidiary's debts

The Court of Appeal has upheld the decision of the High Court in Lewis Holdings Limited v Steel & Tube Holdings Limited, and held the parent company responsible to pay the debts of its subsidiary.  

In this case the level of involvement of the parent compromised the independence of the subsidiary.  There was no clear distinction between parent and subsidiary.  The parent treated the subsidiary as an economic division of itself, akin to a "de facto amalgamation".  The cumulative factors supporting lack of independence led to this decision.

The case relied on a rarely used section of the Companies Act 1993 ("the Act").  It highlights the importance of subsidiary companies maintaining independence from their parents.  Failure to do so may result in the Court lifting the corporate veil under Section 271 of the Act.

Section 271 of the Act gives the Court the power to make a contribution order where the parent has stripped the subsidiary of separate legal status.  It creates an exception to the general principal that a company is a legal entity separate from its shareholders.

Usually a corporation is treated as a separate legal person who is solely responsible for the debts it incurs and the sole beneficiary of the credit it is owed.  In exceptional circumstances such as under Section 271 the Court may "pierce" or "lift" the corporate veil. 

The facts

Lewis Holdings Limited ("Lewis") as owner leased a property to Stube Industries Limited ("Stube").  Stube was a wholly owned subsidiary of Steel & Tube Holdings Limited ("STH").  Stube (by virtue of STH's management inaction) renewed a 21 year lease.  STH, after renewal and some years passing the renewal withdraw funding to Stube.  The rent and rates for Stube prior to this were paid by STH.

Stube was put into liquidation on 4 June 2013 by STH and shortly after its liquidators disclaimed the lease as onerous property.  Lewis filed a claim in the liquidation for its losses.  Lewis and the liquidators claimed against STH under Section 271(1)(a) of the Act seeking that STH pay the whole Lewis claim in the liquidation. 

The decision

1. It was held that the directors of Stube did not conduct its affairs separately from STH;
2. No independent management formal board meetings were held for Stube.  Decision making did not distinguish the subsidiaries interests sufficiently, it considered the group;
3. Stube did not gain independent advice.  Decisions for Stube were often made on advice of STH's legal counsel;
4. The subsidiary was run as a division of the parent company for accounting purposes and the parent gained tax advantages;
5. The directors of Stube and STH treated Stube's property as STH's;
6. Stube's liabilities were not considered separately from STH;
7. The subsidiary did not have the financial capacity to trade without the support of STH;
8. Invoices to Stube were addressed to STH and paid by STH;
9. The liquidation of Stube was attributable to the parent company;
10. No separate bank account was held by Stube;
11. Financial intermingling occurred such as board reports confirmed STH treating leashold assets as its own;
12. Stube had no employees of its own and STH did not charge Stube for employee time;
13. Employees used STH letterhead without stating that he or she was acting for Stube;
14. Lack of reporting supported the argument STH did not distinguish between divisions and subsidiaries;
15. There were no recorded arrangements for STH to provide management services to Stube;
16. STH obtained legal advice regarding Stube's liabilities but Stube did not obtain its own independent advice; and
17. A sub-lease recorded STH as sub-lessor.

Lewis and the liquidators sought an order under Section 271(1)(a) of the Act that STH pay damages related to Stube. The High Court found it just and equitable that STH pay the Lewis claim.  That judgment was appealed on legal basis and quantum however the Court of Appeal dismissed the appeal.

Section 272 of the Act provided guidelines for the orders.  The Court had regard to and took a detailed factual assessment under the guidelines.  These required consideration of:

1. The extent to which the related company took part in the management of the company in liquidation;
2. The conduct of the related company towards creditors of the company in liquidation;
3. The extent to which the circumstances gave rise to the liquidation being attributable to the actions of the related company; and
4. Such other matters the Court thinks fit. 

Submissions in support of a contribution order

It was argued that the conduct of a parent company and a subsidiary must be addressed on an ongoing basis.  In the submissions legal counsel said:

"Section 271 is not there to attack the underlying principles of the corporate veil and limited liability.  It was enacted to address situations where subsidiaries are treated as a branch and ignored."

"If parents want the benefit of a subsidiary with separate personality then the subsidiary must act with that degree of separation at both management and board level."

The judgment is a reminder to directors of group companies to improve the standards of corporate governance.

The Court ultimately held that whilst it is common practice in company groups that a range of services are undertaken centrally, the level of involvement from STH in Stube's affairs supported the claim Stube was a "slave of STH".  Additionally, it was held that the circumstances that gave rise to Stube's liquidation were attributable to the actions of STH.  The Court held that STH was liable for the total claims made in the liquidation of Stube, being to Lewis. 

Key lessons

While the company law regime is grounded in the principle that a company is a separate legal entity in its own right from its shareholders, the Courts are willing to depart from this principle in certain circumstances and the consequences can be far reaching.  Proper steps and commercial practices need to be adopted so that the separate identities of each company are maintained.  These should include:

1. Each subsidiary business should be run as a separate commercial and legal entity and not as a division of the parent;
2. In board meetings consideration should be given to the subsidiary's interests distinct from the parent;
3. Separate records should be kept for each subsidiary including board minutes and resolutions.  Get the paperwork right!
4. Separate meetings are recommended;
5. Any support, financial or management should be clearly documented;
6. Separate independent legal advice should be gained for the subsidiary to protect its own interests;
7. Liabilities of the subsidiary should be paid by the appropriate company and accounted for;
8. Communications should be clearly in the name of the subsidiary and not confused with the parent company;
9. Assets and liabilities of the subsidiary should be treated as its own and not that of the parent.

Separate corporate personality within a group of companies and limited liability of the corporate shareholders are cornerstones in company law.  Subsidiary companies must act with a degree of separation at management and board level to protect the parent against liability for the subsidiary's debts.