Effective management of subsidiaries can be a challenge for corporate groups. A balance must be struck between control of a subsidiary (essential for risk management and compliance) and the autonomy it needs to operate as an independent legal entity. This briefing looks at some risk areas for directors and parent companies where too much control is exercised over a subsidiary, and offers some practical steps to achieve a balance.
A duty to whom?
A subsidiary must not be seen as an extension of the parent company. Even if a subsidiary is wholly-owned it is still a separate legal entity. In making decisions which affect the subsidiary its directors can consider the interests of the parent company or the group as a whole, but they have a duty to act in the interests of the subsidiary. This can cause problems where the subsidiary’s interests are at odds with, or conflict with, those of the parent. When the directors of a subsidiary prefer the interests of the parent company, they risk breaching their duty to the subsidiary. This is difficult to avoid where there are common directors between parent and subsidiary companies.
Control and management
Although the parent entity, typically being the sole shareholder of the wholly owned subsidiary, is entitled to appoint the directors of the subsidiary, the board of the subsidiary must be allowed to manage the affairs of the subsidiary and the parent should not interfere excessively. Declarations of restriction have been made against directors of an Irish subsidiary alleged to have operated as a division of the parent company, where the court has taken account of the fact that board minutes of the subsidiary related mostly to local regulatory matters of the company and not to the operation of the subsidiary’s business.
Depending on the involvement of the directors of the parent company in the management of the subsidiary, they may be considered as shadow directors (although a parent company itself is not to be regarded as a shadow director of its subsidiaries). Shadow directors are liable in many of the same ways as registered directors.
There are instances where regulators and the courts have powers to impose liability on the parent for a subsidiary breach in areas such as environmental damage, health and safety and bribery.
There are practical steps to avoid an over-controlling parent company:
Clearly, the parent must have the control and visibility over its subsidiary companies that is necessary to reduce operational risks, and subsidiary companies do need to operate within group policies in certain areas. However, this should not be used by the parent as a mandate to pressurise subsidiary directors into acting in accordance with the parent’s interests when those interests are not aligned with those of the subsidiary. Directors of a subsidiary are expected to run the subsidiary as an autonomous entity, and the independence of the board of a subsidiary to make decisions about its own management, separate from the parent group, must be emphasised and also facilitated in practice.