The Court of Appeal has held in Enviroco Ltd v Farstad Supply A/S [2009] EWCA Civ 1399 that where shares in a subsidiary have been pledged to a bank by the holding company and registered in the name of a bank’s nominee as security for the pledge, the subsidiary is no longer deemed to be a “subsidiary” in terms of sections 736 and 736A of the Companies Act 1985 (the “1985 Act”).

Section 736 (1) of the 1985 Act provides the following definition of a “subsidiary”:

“A company is a ‘subsidiary’ of another company, its ‘holding company’, if that other company: (a) holds a majority of the voting rights in it; or (b) is a member of it and has the right to appoint or remove a majority of its board of directors; or (c) is a member of it and controls, alone, pursuant to an agreement with other 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”

NB The above section is essentially reproduced in section 1159 of the Companies Act 2006.

Notably, this decision will not affect the majority of holding companies and their subsidiaries, whose relationship arises in terms of section 736 (1) (a) of the 1985 Act (section 1159 (1) (a) of the Companies Act 2006), i.e. the holding company has the majority of the voting rights in the subsidiary.

Enviroco have sought leave to appeal the decision to the Supreme Court, but a hearing date has not yet been fixed.

While (particularly from the Scottish perspective) it is to be hoped that the decision will be reversed on appeal or by amending legislation, until such time as that happens it would be prudent to consider adopting revised wording where drafting a contractual provision which incorporates the statutory definition of subsidiary, especially if the group contains Scottish subsidiaries. Lenders, in particular, will need to balance the need to take pledges over shares by registering title in a Nominee Company against ensuring they retain full ‘Group Security’