Beware of parent trap, directors told

David Levene. Photo / Wayne Drought

Law firm gives warning about liability for subsidiaries after ruling on seldom-used part of Companies Act.

Company directors are being warned that unless they keep a subsidiary independent, a parent firm can be liable for its debts.

The advice, from law firm Chapman Tripp, comes in the wake of a High Court ruling involving rich-lister Sir David Levene's investment company and a rarely used part of the Companies Act.

Levene's Lewis Holdings took action against Stube Industries - a liquidated subsidiary of NZX-listed Steel & Tube Holdings. Before being wound up, Stube leased a Mt Wellington property owned by Lewis Holdings, which filed a $2.62 million proof of debt with the liquidators.

Levene's firm and the liquidators last year took Steel & Tube Holdings to the High Court at Wellington, wanting the parent firm to pay for Lewis Holdings' claim in the liquidation.

The claim was brought under part 271 of the Companies Act, a section which is rarely invoked and unique to New Zealand. It provides an exception to the principle that shareholders are not exposed to the obligations of a company beyond the extent of their liability for payment of share capital.

In an interim decision, Justice Alan Mackenzie said Stube's directors did not make a distinction between the interests of Steel & Tube and those of the subsidiary.

"They saw only one set of interests involved, the overall interests of the group ... they did not hold formal board meetings for Stube. Nor did they sit down together to discuss matters with a conscious appreciation that they were doing so with their Stube directors' hats on."

The judge also said the evidence supported the proposition that Stube was treated as a division of Steel & Tube Holdings, for financial purposes.

Justice Mackenzie found it was just and equitable that Steel & Tube Holdings should pay the whole of Lewis' claim but what that amounted to would be determined after another hearing.

Steel & Tube Holdings said it was still considering its legal position in the wake of the interim judgment.

Law firm Chapman Tripp, in a commentary released yesterday, said directors must be careful to ensure the interests of a parent and subsidiary are kept distinct.

This included keeping separate records and resolutions and ensuring outgoings are being invoiced to and paid by the appropriate company.

There also needed to be formal legal arrangements when providing financial support from parent to a subsidiary.

"Failure to take these steps will create a risk that a court will hold the parent liable for the debts of its wholly owned subsidiary," said the law firm, which was not involved in the case.

Section 271 of the Companies Act

• Provides an exception to the principle that shareholders are not normally exposed to the obligations of a company beyond the extent of their liability for payment of share capital.

• Is rarely used.

• Is unique to New Zealand, although Ireland does have a similar section in its laws.