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A recent case has highlighted the need for directors of subsidiary companies to exercise independent judgement, according to Philip Round, a partner in the Corporate team at George Green LLP.
“There may be an expectation at group level that subsidiary directors will merely follow the wishes of the parent company,” says Mr Round. “A director of a UK subsidiary company does, however, have a duty to act in a way which he considers in good faith to be most likely to promote the success of the subsidiary. Whilst he is entitled to take into account the interests of the parent company, he will breach his legal duty to the subsidiary if he simply acts in accordance with the parent’s instructions.”
According to Mr Round, difficulties commonly arise when subsidiaries are asked to grant security for borrowings by another group company. “It is important in such situations for the directors of the relevant subsidiary to consider whether the decision to grant such security will indirectly benefit the subsidiary itself. A benefit conferred on the parent is insufficient in itself to justify the decision.”
Mr Round continues, “the risk of a challenge may be reduced by obtaining shareholder approval of the relevant transaction. A third party lender seeking security from the subsidiary will normally insist on this. It is also sensible to ensure that the subsidiary’s constitution expressly permits its directors to sit on the boards of other group companies. Such precautions will not, however, necessarily absolve from liability a director who sanctions a transaction which is clearly contrary to the interests of the subsidiary company, particularly if the subsidiary is insolvent at the time of the transaction.”
Mr Round cites a recent decision of the Privy Council. “In the case of Central Bank of Ecuador and others v Conticorp SA and others the Privy Council was required to consider the actions of a director of a subsidiary company incorporated in the Bahamas. The relevant director was subject to duties equivalent to those imposed on a UK director. The director was found to have breached his duty to act in the best interests of the subsidiary by following the parent’s instructions to transfer assets intra group at what was held to be an undervalue.”
Mr Round concludes that directors should take care to demonstrate that they have considered the interests of the subsidiary. “The risk of a transaction being set aside, or the director being held personally liable for breach of duty, will be greatly reduced if the directors document in detailed board minutes why they believe a transaction to be in the interests of the subsidiary. Standard wording will be inadequate for this purpose. Whether acting for the subsidiary company or a third party lender, we always strongly advise that the specific commercial benefit to the subsidiary is clearly recorded.”
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