In April 2011, the Supreme Court upheld the Court of Appeal's narrow interpretation of the meaning of "subsidiary" under the Companies Act in the Enviroco case.

Facts

Enviroco was contracted to clean the oil tanks of a ship which was owned by Farstad and chartered to an affiliated company of Enviroco, Asco UK. Farstad claimed damages from Enviroco following a fire. Enviroco claimed that it was protected by an indemnity provision in the charter contract between Farstad and Asco UK. The key issue considered by the Court of Appeal and Supreme Court was whether Enviroco was a subsidiary of Asco UK's parent company and therefore an "affiliate" of Asco UK.

The contract between Farstad and Asco UK incorporated the definition of subsidiary from section 736 of the Companies Act 1985 into the definition of "affiliate". (The definition of subsidiary in section 736 and 736A of the Companies Act 1985 is in all material respects the same as that now in section 1159 and schedule 6 of the Companies Act 2006.) However, the parent company of both Enviroco and Asco UK had granted a Scottish legal charge over all of its shares in Enviroco to Bank of Scotland. The charge required the bank to become the registered shareholder and it was entered on Enviroco's register of members.

Decision

The Court of Appeal held that, because the parent company did not hold the majority of the voting rights and was not a member of Enviroco, Enviroco did not fall within any limb of the section 736 definition of "subsidiary".

The Supreme Court agreed with the Court of Appeal's narrow interpretation of section 736. It held that Enviroco ceased being a subsidiary of the parent company when the bank was entered into Enviroco's register of members, even though this was only done to perfect the Scottish security and the parent company retained the power to direct voting decisions. Enviroco therefore ceased to be an "affiliate" of Asco UK for the purposes of the contract.

Impact

The decision will need to be taken into account both in interpreting existing contracts and in drafting new contracts which use the subsidiary or group concepts. The decision will not impact on most parent/subsidiary relationships because the parent holds the majority of the voting rights in its subsidiary, falling squarely within the Companies Act definition. However, where contractual definitions adopt the Companies Act provisions, these may not capture all of the companies which the parties expect and intend to be caught. Also, where a third party, for example a lender, takes a legal charge over shares (rather than an equitable charge) and puts itself on the company's share register, it runs the risk that the company is treated as its "subsidiary".  

If a wide definition of group or subsidiary is needed in a contract, consideration should be given to using the "subsidiary undertaking" definition from the 2006 Act – it is wider than the definition of "subsidiary". Alternatively (as the definition of "subsidiary undertaking" also has certain limitations), parties should use bespoke drafting to ensure that all entities under the same de facto control are caught.

The Supreme Court judgment in Farstad Supply A/S (Respondent) v Enviroco Limited (Appellant) [2011] UKSC 16 is available on the British and Irish Legal Information Institute website.