The corporate veil is not a new concept and is in place to limit exposure of shareholders, directors, private equity investment and corporate structures. However, this structural protection can be pierced in certain circumstances and holding companies can be exposed to liability for the actions of their subsidiaries, including for insolvent trading if that subsidiary is placed into liquidation.
This article outlines the risks for holding companies as well as protective measures that may be taken. Albeit typically considered in the context of directors and their personal liability since its inception in 2017, safe harbour is also available to holding companies should certain criteria be met.
Liability for insolvent trading
When a company enters liquidation, its liquidators will investigate the company’s affairs and look to recover funds for the benefit of creditors. One of the key areas a liquidator will investigate is whether any director has traded the company whilst it was insolvent and if so the director may be personally liable for those debts that were incurred at such time (or for debts which made the company insolvent) (see ss 588G and 588M of the Corporations Act 2001 (Cth) (the Act)).
The liquidator may also look at the liability of a holding company for the insolvent trading of its subsidiary.
Pursuant to s588V of the Act, a holding company must prevent its subsidiary from incurring debts at a time when the subsidiary was insolvent (or incurring debts which cause the subsidiary to become insolvent) in circumstances where:
- at the time there were reasonable grounds for suspecting the subsidiary was insolvent or would become insolvent; and
- one or both of the following apply:
- the holding company, or one or more of its directors, was aware at that time that there were such grounds for so suspecting the insolvency of the subsidiary; and/or
- having regard to the nature and extent of the holding company’s control over the subsidiary’s affairs and to any other relevant circumstances, it was reasonable to expect that:
- a holding company in the holding company’s circumstances would be so aware; or
- one or more of such a holding company’s directors would be so aware.
Where a holding company contravenes s 588V of the Act, it may be liable for an amount equal to the loss or damage suffered in relation to the debt incurred by the subsidiary during the breach (s 588W of the Act).
It is important to note that, a holding company does not need to own 100% of the subsidiary for it to be liable for insolvent trading. Under the Act a company is a ‘holding company’ of another company (in this paragraph called the first body) if one of the following apply:
- the company controls the composition of the first body’s board; or
- the company is in a position to cast, or control the casting of, more than one-half of the maximum number of votes that might be cast at a general meeting of the first body; or
- the company holds more than one-half of the issued share capital of the first body (excluding any part of that issued share capital that carries no right to participate beyond a specified amount in a distribution of either profits or capital); or
- the first body is a subsidiary of a subsidiary of the company.
Safe Harbour Protection
The safe harbour regime is designed to encourage directors, where they have a suspicion that the company may become or be insolvent, to formulate a plan (or plans) that deliver a better outcome to a company than an immediate voluntary administration or liquidation.
If the protections are available the safe harbour provisions operate as a carve out (rather than a defence) to the insolvent trading prohibitions in the Act. There are parallel safe harbour provisions that apply to directors of a company and the holding company of that company.
Specifically, section 588WA of the Act, provides that the safe harbour protections are available to a holding company if:
- the holding company took reasonable steps to ensure that s 588GA of the Act applied to each of the directors of the subsidiary and in relation to the relevant debt; and
- s 588GA did apply in relation to those directors and the debt.
Pursuant to s588GA of the Act, a director will not be liable for certain debts incurred by the company whilst the company was insolvent if the director, after suspecting prospective or actual insolvency of the company, starts developing one or more courses of action that is/are reasonably likely to lead to a better outcome for the company than an immediate voluntary administration or liquidation. Directors and officers cannot avail themselves of the benefit of the safe harbour if, at a time a debt is incurred, the company was not meeting its obligations in relation to employee entitlements (including superannuation contributions) when they fell due or its taxation reporting obligations (see s 588GA(4) of the Act). More information can be found in our previous article here.
The aim of the safe harbour is to provide directors (and by extension holding companies) with breathing space to explore and pursue solutions in a stressed or distressed scenario.
Directors and holding companies wishing to rely on the safe harbour provisions in any insolvent trading proceedings bear the evidentiary burden to establish the relevant requirements have been met (ss 588GA and 588WA of the Act).
Directors of holding companies within large corporate structures and private equity investors, need to be mindful of the potential liability holding companies may have for insolvent trading of downstream entities. Boards of holding companies should be mindful when making and recording their decisions and deliberations when it comes to the businesses of subsidiaries. Active steps should be taken to ensure that all subsidiaries within the corporate structure are complying with their obligations to minimise any potential exposure to not only themselves but also the holding company. Practically this means directors of holding companies need to properly inform themselves of the subsidiaries financial position and ensure directors at that level are taking steps to prevent any misconduct by officers or employees, ensure company records are maintained and seek advice from an appropriately qualified entity/person to help develop and implement a plan or course of action for the subsidiary to improve its financial position. The directors at a holding company level also need to ensure that the subsidiaries are up to date with their ATO reporting obligations and payment of employee entitlements. For many businesses, this granular level of detail may not be front of mind in a healthy environment, but in a stressed or distressed scenario or times of uncertainty, holding companies should ensure steps are taken to protect not only the subsidiaries but also the holding company itself from potential exposure.
If you have any questions on the safe harbours, the classification of holdings companies, or structuring considerations please don’t hesitate to reach out.
For more information, please contact Nick Edwards, Kassandra Adams or Katrina Zivkovic of the Restructuring and Insolvency team or for more corporate questions please don’t hesitate to contact Gordon McCann, Cristin McCoy or James Delesclefs.