Business Law & Compliance

The risks for a holding company when a subsidiary goes insolvent

6 min read

08 August 2018

Insolvency practitioner Gavin Jones discusses the kind of damages that might be claimed from a holding company or its directors in the event of the insolvency of a subsidiary – and the defences that might be available to mitigate these.

With the Company Voluntary Arrangement (CVA) of House of Fraser reportedly hanging in the balance, the well-publicised difficulties facing the retail sector are widespread. There have been significant criticisms made of CVAs, in particular in relation to complaints that they are being abused to avoid leasehold liabilities relating to unprofitable trading locations.

The House of Fraser CVA was subject to a pending legal challenge to the approval of the CVA on the basis that it was obtained through material irregularity and that its terms were unfairly prejudicial, although a settlement was recently reached before the dispute reached the courts.

One particular concern regarding CVAs is that whilst they prevent creditors from taking any further action in relation to their claims, they do not give any power to the officeholder appointed, known as a Supervisor, to investigate any prior dealings of the company and activities of the directors before the CVA was proposed.

Nor does the Supervisor make any reference to the disqualification unit of BEIS, being the government agency that reviews directors’ conduct in the lead up to the insolvency and ultimately takes the decision whether or not to take disqualification proceedings against them.

This is an understandable concern and it is quite natural to consider whether any third parties such as directors, holding companies or even auditors may be held liable for the debts that they are owed.

In the absence of written guarantees, they face significant difficulties in doing so: the principle of limited liability means that a company’s shareholders or parent company will not ordinarily be liable for the debts of their companies or subsidiaries. Nor are directors acting in the course of their office personally liable for the debts of a company.

Even where it is demonstrably the case that a director was seriously deficient in their conduct of a company’s affairs, any liability incurred is owed to the company itself and not to individual creditor.

In an insolvency scenario, this means it is for the insolvency officeholder, usually a liquidator or an administrator, to take legal action to recover for the benefit of creditors. Depending on the facts, these may include wrongful or fraudulent trading claims against the directors or parent or group companies.

Such proceedings are not straightforward and inevitably involve significant delay, and ultimately may only result in a particular creditor receiving a small portion of their claim, known as a dividend, as a creditor in the insolvency proceedings.

A liquidator may be without funds to pursue claims, and the fact that a portion only of recoveries may be recovered by an individual creditor can be a significant disincentive to creditors to put their hands in their pockets to fund litigation and risk throwing good money after bad….

Another option may be available to an unhappy creditor. Recent changes in the law mean that liquidators and administrators can sell rights of legal action against directors and others for wrongful trading. In fact, if an officeholder does not wish to pursue the claims themselves, they are under an obligation to properly consider any offer to purchase, and should sell unless there is good reason not to.

Whilst it is common practice for banks to require inter-company group cross guarantees to be provided, it is not so in ordinary trading or supply relationships. Where a subsidiary is dependant on a parent company for financial support, a company’s auditors may require that the parent company issue a “financial support” letter addressed to enable them to make a going concern statement for auditing purposes.

However, such letters are normally carefully drafted so as to avoid any enforceable financial obligation in the event of failure of the subsidiary. In relation to auditors themselves, the courts have held they have no direct “legal” duty of care to creditors generally, and so are not legally liable to them even when their work has been held to be seriously deficient.

In particular limited circumstances, a director may become personally liable for debts of a company, for example where they are involved in successive phoenix companies which have the same or similar trading names and where relevant procedures have not been followed to allow them to gain exemptions from liability.

Furthermore, if a director has made demonstrably false statements about the company’s financial position, they can be held to be directly and personally liable to a creditor for fraudulent misrepresentation or under the tort of deceit.

So, in general terms, whilst it can be seen that creditors’ main route to remedy following an insolvency is as a creditor of the insolvent company, and if appropriate, this may justify the creditors giving support to the officeholder to take action against the director or parent company, there may be options available to the creditors to make direct claims themselves.

Gavin Jones is a licensed insolvency practitioner and restructuring partner at Hill Dickinson LLP solicitors.