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The UK Supreme Court has upheld the Court of Appeal's counter-intuitive decision in the Enviroco case1 on the meaning of "subsidiary". This could affect the interpretation of any commercial contract that defines "subsidiary" or "holding company" by reference to the Companies Acts.
Background
Enviroco needed to establish that it was a subsidiary of Asco plc to benefit from an indemnity under a commercial contract. For the purposes of the contract, the meaning of "subsidiary" was defined by reference to the statutory definition contained in section 736 of the Companies Act 1985 (CA 1985), now substantially reproduced by section 1159 of the Companies Act 2006 (CA 2006).
As we previously reported here, the Court of Appeal decided that Enviroco was not a subsidiary of Asco.
Subsidiary defined
Enviroco was relying on section 736(1)(c) of the CA 1985, which states that a company is a "subsidiary" of another company if that other company "is a member of it and controls alone, pursuant to an agreement with other shareholders or members, a majority of the voting rights in it" (emphasis added).
Asco had the requisite voting rights in Enviroco, but was not found to be a "member" of Enviroco. The Supreme Court agreed with the Court of Appeal that the law was entirely clear in this area, i.e. that a member of a company is "a person whose name is entered in its register of members" under section 22 of the CA 1985 (now section 112 of the CA 2006). Here, however, Asco had executed a Deed of Pledge charging its shares in Enviroco in favour of a bank. Unusually, the Deed of Pledge required Asco to transfer legal ownership of the shares to the bank as part of the security terms, and the bank's name was entered in Enviroco's register of members. As a result, the relevant member of Enviroco, according to the statutory definition, was the bank and not Asco.
Unexpected outcome
The Supreme Court acknowledged that the parties would not have anticipated this "unexpected outcome", where Enviroco was denied the benefit of the indemnity simply because its shares were charged to a bank – not least because the bank's security had not actually been enforced. The Court was not, however, in a position to re-write the contract for the parties when the statutory definition of "subsidiary" was clearly incorporated into the contract.
What to watch out for
The terms "subsidiary" and "holding company" are often defined by reference to the CA 2006. They are widely used in a variety of commercial contract provisions – e.g. in change-of-control clauses or where defining group rights, or setting out permitted assignments of rights.
If you have group companies whose shares are registered in the name of a third party such as a bank (whether under security arrangements, nominee arrangements or otherwise), you should review your contracts to see whether that has had, or could have, unintended consequences. Contractual definitions of subsidiaries and holding companies should also be carefully considered in the future.
See here for more details about the impact and key points to take away from the Enviroco decision.
If you would like any help in reviewing existing or standard-form commercial contracts following the Enviroco case, please contact Caroline Copeland.
1 Farstad Supply A/S v Enviroco Ltd [2011] UKSC 16.
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