In Enviroco Limited v Farstad Supply A/S, the Court of Appeal held that where a parent company provided shares in its subsidiary as security for a loan and the shares were registered in the name of the lender, the subsidiary would no longer be a ‘subsidiary’ within the meaning of sections 736 and 736A of the Companies Act 1985.

Facts

Enviroco Limited (Enviroco) and Asco UK Limited (Asco UK) were both subsidiaries of Asco PLC.

The Bank of Scotland accepted Asco PLC’s shares in Enviroco as security for a loan. As a condition of the loan, the shares were registered in the name of the bank. It was agreed that Asco PLC could continue to exercise the voting rights attached to the shares subject to the proviso that those rights should not be exercised in such a way as to prejudice the value of the security.

Subsequently, Farstad engaged Enviroco to clean the oil tanks of an oil rig supply boat owned by Farstad. The boat was chartered to Asco UK. During the cleaning operation, some oil ignited causing substantial damage to the boat and killing one of Enviroco’s employees. Farstad commenced proceedings against Enviroco seeking damages in respect of its losses.

As a term of the charterparty between Farstad and Asco UK, Farstad agreed to indemnify Asco UK “and its affiliates” against all losses resulting from loss or damage to the boat. “Affiliates” were defined in the charterparty as:

“any Subsidiary of [Asco UK] or a company of which [Asco UK] is a Subsidiary or a company which is another Subsidiary of a company of which [Asco UK] is a Subsidiary. For the purposes of this definition, “Subsidiary” shall have the meaning assigned to it in Section 736 of the Companies Act 1985.”

By way of defence to Farstad’s claim, Enviroco sought to rely on this indemnity, specifically the words which have been underlined above. Enviroco argued that as both it and Asco UK were subsidiaries of Asco PLC, Enviroco was an “affiliate” of Asco UK. It was, it argued, therefore entitled to benefit from the indemnity.

Central to the success of Enviroco’s argument was the question of whether both it and Asco UK were subsidiaries of Asco PLC, within the meaning of section 736 of the Companies Act 1985. Section 736(1) stated:

“a company is a “subsidiary” of another company, its “holding company”, if that other company:

  1. holds a majority of the voting rights in it; or
  2. is a member of it and has the right to appoint or remove a majority of its board of directors; or
  3. is a member of it and controls alone, pursuant to an agreement with shareholders or members, a majority of the voting rights in it, or if it is a subsidiary of a company which is itself a subsidiary of that other company.”

Enviroco relied on subsection c.

Section 22(2) of the Companies Act 1985 stated:

“[every] person who agrees to become a member of a company and whose name is entered in its register of members, is a member of the company.”

Farstad argued that Asco PLC was no longer a member of Enviroco as its shares in Enviroco had been charged to and were now in the name of the Bank of Scotland. That meant that Enviroco was no longer Asco PLC’s subsidiary which in turn meant that Enviroco was not an affiliate of Asco UK and so could not benefit from the indemnity in the charterparty.

Enviroco’s counter argument was that Asco PLC was able to exercise the full voting rights attached to the shares it had charged. Asco PLC was, it argued, still a member of Enviroco under the terms of section 736A(7) which provided:

“rights attached to shares held by way of security shall be treated as held by the person providing the security:

  1. where apart from the right to exercise them for the purpose of preserving the value of the security, or of realising it, the rights are exercisable only in accordance with its instructions;
  2. where the shares are held in connection with the granting of loans as part of normal business activities and apart from the right to exercise them for the purpose of preserving the value of the security, or of realising it, the rights are exercisable only in his interests.”

Decision

On appeal, the Court of Appeal held that, as the shares were registered in the name of the bank, Enviroco was not a subsidiary of Asco PLC within the meaning of section 736 of the Companies Act 1985. Enviroco could not therefore claim to be an affiliate of Asco UK under the charterparty and was not entitled to the benefit of the indemnity.

The court looked into the legislative background of section 736A(7) and determined that the purpose of this section was to explain and supplement the expressions used in section 736. Section 736A(7) only determined who held the voting rights and the right to appoint or remove a majority of the board as mentioned in section 736(1) and did not otherwise affect or override the definition of subsidiary in section 736(1).

Comment

This case is relevant to those drafting commercial agreements and referring to the Companies Act definition of subsidiary in the definitions section. Following this decision a group company may unintentionally fall outside the remit of the agreement (outside the definition of subsidiary) where its holding company has charged its shares in the subsidiary and the shares have been registered in the name of the lender. Where contractual provisions are intended to extend to ‘subsidiaries’, some careful analysis of the factual position may be needed prior to drafting.

Note that the provisions of sections 736 and 736A of the Companies Act 1985 are repeated, without material amendment, in section 1159 of the Companies Act 2006. This decision is therefore still relevant to the definition of subsidiary under the new Companies Act 2006.

Further reading

Click here for a copy of the judgment