Introduction
A parent company, also known as a holding company, exercises control, power, and interest over a subsidiary company[i]. A company reveal itself to be a parent company only if it holds the controlling power, possesses more than 50% of shares and voting rights, and has the explicit or implicit authority to appoint the directors of the subsidiary company[ii]. This article examines the need for statutory provisions to hold a parent company liable for the actions of its subsidiary, including situations where the subsidiary is involved in fraudulent trading, wrongful or negligent trading.
The problem in context
In accordance with S.24 of the Companies Act, 1994, once the company is incorporated[iii] the principle of separate legal entity comes into force, which means the company and its members have distinct legal identities. Any wrongdoing by the company does not make the members personally liable, even if they are entirely involved in the company’s wrongdoing. The landmark case commonly used by practitioners in Bangladesh to enforce this principle of separate legal entity is Salomon v. Salomon and Co. Ltd (1897) A.C. 22, which protects members from the company’s liabilities. In this article, I will highlight the statutory provisions followed in other countries to lift the veil and emphasize the importance of having statutory provisions.
Why the separation of a company’s personality from its member is problematic, and approaches followed in other countries.
If the subsidiary company is formed with the ulterior intention to defraud creditors or for any fraudulent purposes, the veil should be lifted to hold the parent company liable for the wrongdoing of the subsidiary company. Bangladesh has been reported to be a high-risk zone for money laundering[iv], A subsidiary company might be at risk, , therefore, to be formed by a parent company for purposes of taking out a large loan from a bank in the name of a business., which might then be laundered. Later, when the company is wound up, there might be insufficient assets to recover the loan. There are currently no governing laws in Bangladesh that hold the parent company liable in such situations.
In the UK, S.213 of the Insolvency act 1986, has been introduced to deal with circumstances where a company has been formed for the purpose of fraudulent trading. As per S.213, (1) If in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, the following has effect; (2) The court, on the application of the liquidator may declare that any persons who were knowingly parties to the carrying on of the business in the manner above-mentioned are to be liable to make such contributions (if any) to the company’s assets as the court thinks proper[v].
A parent company may face liability if it acts as a “shadow director” of its subsidiary[vi]. For example, before the subsidiary company went into liquidation, the parent company knew or ought to have known that there was no reasonable expectation that the subsidiary company would avoid insolvent liquidation, and a reasonable director in such circumstances would have stopped further trading[vii]. In such case, if the subsidiary company goes into insolvent liquidation, the parent will have significant contribution to the debts of the subsidiary company. There are no statutory provisions in Bangladesh that hold a parent company liable in such circumstances. S.214 of the Insolvency Act 1986, has been enacted by the UK to tackle such a situation. In the case of Re PTZFM Ltd: 1995, a “shadow director” has been defined as someone, where the nominees are put up but in fact behind them strings are being pulled by some other persons who do not put themselves forward as appointed directors[viii].
What should the level of involvement be between the subsidiary and the parent company?
In the case of Re Hydrodam Ltd, the English Court held that to hold the parent company liable there must be a substantial level of involvement by the parent company in the business of the subsidiary; merely being a member of the parent company’s board won’t be sufficient[ix]. In the U.S., the parent company cannot be held liable unless the plaintiff can prove that the subsidiary acted as an agency or alter ego of the parent company. Following that, the parent company must have used the subsidiary for fraud or personal gain rather than operating it as a separate corporate business. To prove this, the standard is very high; the plaintiff must show that the parent company had “complete control” over the activities of the subsidiary[x].
Conclusion
The Companies Act, 1994, highlights the relationship between a parent company and a subsidiary company. However, the Companies Act,1994 or any other act does not provide specific statutory provisions for when the corporate veil can be lifted, leaving tremendous space for corporations to operate without statutory limitation. Practitioners of Bangladesh often rely on common law provisions to lift the veil. Introducing a statutory framework for lifting the corporate veil will ensure clarity and certainty for when the veil can be lifted, while also ensuring that corporations are being guided by regulatory frameworks.
Kanny Saha is a Barrister-at-Law at The Honourable Society of Lincoln’s Inn and an Associate at Saha & Associates. He can be reached at sahakanny8@gmail.com.
[i] S.2(5) of the Companies Act, 1994.
[ii] S.2(2) and (3) of the Companies Act, 1994.
[iii] S.24 of the Companies Act, 1994
[iv] https://www.thedailystar.net/business/news/bangladesh-ranks-46-drops-5-notches-3474621
[v] https://www.oliverelliot.co.uk/insolvency-guides-and-information/section-213-of-the-insolvency-act-1986/
[vi] S.214 (7) of the Insolvency Act 1986
[vii] https://www.legislation.gov.uk/ukpga/1986/45/section/214
[viii] https://swarb.co.uk/re-ptzfm-ltd-1995/
[ix] https://en.wikipedia.org/wiki/Re_Hydrodan_(Corby)_Ltd
[x] https://www.nortonrosefulbright.com/en/knowledge/publications/b304a31f/united-states-cross-border-guide-to-parent-company-liability-for-foreign-subsidiaries#5
