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Servants who become masters should remember their place...

21 August 2009

Company employees who sit on subsidiary boards should appreciate that those directorships are not continuations of their employment.  Because companies are distinct legal entities, the law treats directors in a company-specific way.  Employment by the parent is irrelevant.  Directors’ obligations concern the subsidiary alone.

If the constitution permits, directors may act in the parent’s interests rather than the subsidiary’s.  But their other duties remain focused solely on the subsidiary.  “I can act in the parent’s interest” does not excuse reckless trading or negligence.

The parent/subsidiary distinction is particularly relevant to:

  • Intra-group dealings.  Subsidiaries often deal with group companies (inter-company loans, cash-pooling, etc).  These arrangements should be properly documented and on terms which are appropriate for the subsidiary.  That the deal would be different were it not intra-group is not necessarily fatal.  But it does mean the directors should think critically about the differences and whether they are appropriate.
  • Distributions.  Directors must reasonably expect the subsidiary to satisfy the solvency test after distributions.  This means assessing liquidity, asset values and (actual and contingent) liabilities - which can necessitate considering the parent’s situation.  Where solvency test conclusions rely on assumptions about parental support or financial health, those assumptions should be properly articulated and founded on reasonable grounds.
  • Third party dealings.  Subsidiaries are often party to group contracts - eg as guarantors of parent borrowings.  They also often transact with third parties in the expectation of parental support (eg raw materials, management services or funding).  That the subsidiary would not enter into the transaction on those terms were it not part of the group does not automatically mean directors are breaching their duties.  But its directors should nevertheless ensure the transaction is defensible from the subsidiary’s perspective.  Is reliance on the parent reasonable and appropriate?
  • Governance.  Unless the constitution says otherwise, governance is the responsibility of directors.  Do they meet (or pass written resolutions) when required? What reports/information do they receive and consider? What monitoring do they do? Understandably, group transactions are often decided on the basis of group information (papers, reports, etc) and group processes (eg senior management meetings).  But the decisions (and supporting information) must be adequate for each subsidiary.  And appropriate resolutions should be passed and records maintained for each subsidiary individually.
  • Delegations.  Boards should monitor delegates by ‘reasonable methods properly used’ – even if the delegate is group CEO.  What delegations exist? How are they monitored? Is this reasonable?

No-one expects subsidiaries to disregard group requirements.  Intra-group dealings will nearly always have a different character to third party ones.  But subsidiary directors should not forget that they are ultimately directors of the subsidiary, not of the group.

What they do in practice will vary with their circumstances.  Directors of a debt-free asset-holding subsidiary of a solvent parent are in a different position to directors of a highly-leveraged trading subsidiary which has guaranteed the debt of a parent in distress.  (The significance of a subsidiary-specific perspective is most acute in the latter case.  Ironically, so is the parental pressure for a ‘whole of group’ approach.)  But whatever their circumstances, directors should remember the differences between their parent employee hat and their subsidiary director one.

So, before joining a subsidiary board, what should an employee of the parent do? Here are some starters:

  • Understand the legal significance of being a director.  (If the subsidiary is incorporated overseas, consider seeking specific advice in that jurisdiction.)  Ensure the parent shares this understanding, and that there is no mismatch with the parent’s expectations concerning subsidiary governance.
  • Understand the subsidiary’s current and intended business and financial position.  What contracts and arrangements is it/will it be party to? Is it/will it be liable for any group/parent obligations? Is it financially viable on a standalone basis, or reliant on parental support? If the latter, what is the nature of the support, is it adequately documented, and is the parent able to deliver? Is there sufficient information to make an informed assessment of these matters?
  • Understand the parent’s dividend expectations.
  • Ensure that governance, record-keeping, delegation and reporting will be adequate, from the subsidiary’s perspective.
  • Consider the subsidiary’s constitution.  May directors act in the parent’s interests? May the parent exercise decision-making powers in place of the directors? May the subsidiary indemnify and insure directors?
  • Check that there are adequate indemnification and D&O insurance arrangements.  If (as is common) D&O insurance is via a group policy, ensure it appropriately covers directors of the particular subsidiary.  Has the parent promised to maintain that coverage during the directorship and for a reasonable subsequent period? Could coverage be threatened by actions or omissions elsewhere in the group? If so, what (and how likely) are they?
  • And, of course, if in doubt, seek expert advice.

This article first appeared in the August 2009 issue of Boardroom.

Geof Shirtcliffe is a partner at Chapman Tripp. The views expressed in this article are his own and do not necessarily reflect those of the firm or its clients.

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