The Supreme Court for the first time looked at the statutory definition of the term 'subsidiary' in the Companies Acts and confirmed the narrow interpretation of the Court of Appeal in the widely reported case of Farstad Supply A/S v Enviroco Limited.
In this case, the parent company of Enviroco Ltd (Enviroco), ASCO plc (ASCO), had pledged, charged and assigned to a lender all of its shares in Enviroco under Scottish law. Under Scottish law, the only way in which a fixed security over shares can be taken is by fiduciary transfer of the shares to the lender and registration of the lender as holder of the shares. The deed of pledge in this case provided that ASCO agreed to register the shares in the name of the bank or its nominee until the secured liabilities were repaid although the full voting rights and other rights and powers in respect of the shares (including the right to receive a dividend) should remain exercisable by ASCO until the security became enforceable. The shares in Enviroco were then registered in the name of the bank's nominee. Neither the bank nor its nominee exercised voting rights or other powers, all dividends were paid to ASCO and the security was never enforced.
The question before the court was whether, for the purpose of interpreting a contractual provision which incorporated the definition of subsidiary in section 736 of the Companies Act 1985 (1985 Act; now section 1159 of the Companies Act 2006 (2006 Act)), Enviroco was a subsidiary of ASCO at the relevant time notwithstanding the fact that the Enviroco shares which ASCO owned were charged to, and registered in the name of, the lender's nominee.
The Court of Appeal held that Enviroco was not a subsidiary of ASCO within the meaning of section 736 of the 1985 Act as:-
- ASCO was at the relevant time not registered as a member, and
- the attribution provisions in section 736A of the 1985 Act were concerned with membership rights rather than membership status.
The Supreme Court agreed with the Court of Appeal holding that, even though the shares have been transferred to the lender's nominee in security only, Enviroco ceased being a subsidiary of ASCO as soon as its name on the register was replaced by that of the nominee.
The circumstances of this case are unusual and it will not have an effect on most group relationships where the parent company holds the majority of the voting rights in its subsidiaries. Such a relationship will without doubt qualify as a parent/subsidiary relationship within the meaning of section 1159 of the 2006 Act (and its predecessor section 736 of the 1985 Act).
However, it is common practice in finance and commercial contracts to define the term 'subsidiary' by reference to the Companies Acts, and when reviewing or drafting such contracts Enviroco will need to be considered. Provisions in such contracts that typically rely on such a definition of 'subsidiary' include change of control provisions, rights to assign the contract to other group companies, indemnities which benefit group companies, and VAT clauses which rely on a definition of group.