Can related companies become liable to pay in a liquidation scenario?

Whilst the separate corporate identity of a related company must be respected, consideration for what is just and equitable must be made. The courts act to balance these two competing interests.

Section 271 of the Companies Act 1993 (the Act) grants the court the power to make an order under conditions when companies related to a company in liquidation may have intertwined assets, creditors, or management.

A court may pool the assets of related companies in liquidation, or order that one company not in liquidation contribute towards all or part of the claims made in the liquidation of another.

This highlights the importance of substance over form, meaning that courts are more concerned with the reality of the operations of related companies than the legal separation between them.

As stated by the Court of Appeal in Steel & Tube Holdings Ltd v Lewis Holdings Ltd – If it is the case that a related company’s business is conducted as a mere facade or “front” for a business carried on by others, the “corporate veil” will not shield.

When is a company related?

As defined in section 2(3) of the Act:

(a) The other company is its holding company or subsidiary; or

(b) More than half of the issued shares of the company, other than shares that carry no right to participate beyond a specified amount in a distribution of either profits or capital is held by the other company and companies related to that other company (whether directly or indirectly, but other than in a fiduciary capacity); or

(c) more than half of the issued shares, other than shares that carry no right to participate beyond a specified amount in a distribution of either profits or capital, of each of them is held by members of the other (whether directly or indirectly, but other than in a fiduciary capacity); or

(d) the businesses of the companies have been so carried on that the separate business of each company, or a substantial part of it, is not readily identifiable; or

(e) there is another company to which both companies are related;

With regards to (d) above, Potter J noted in Grant v Independent Livestock 2010 Ltd the following overlapping factors:

• The companies carry on business simultaneously.
• The companies’ businesses involve the same subject matter and possibly the same clients.
• External persons (such as creditors) are unsure of which entity they were dealing with, or deal with both companies interchangeably.
• An overlap in finances, such as inter-company borrowing, operating the same bank account, or one company paying the creditors of another company, etc.
• Intermingled and/or poorly maintained records.
• An overlap between directors, shareholders and/or support staff.

When should a pooling or contribution order be made?

Pursuant to section 272 of the Act, general factors the courts must have regard for when making pooling and contribution orders include:

• The extent to which any of the companies took part in the management of any of the other companies.
• The conduct of any of the companies towards the creditors of any of the other companies.
• The extent to which the circumstances that gave rise to the liquidation of any of the companies are attributable to the actions of any of the other companies.
• The extent to which the businesses of the companies have been combined.

Cases where contribution orders have been made:

HEB Contractors Ltd v Westbrook Development Ltd

• A creditor had submitted a tender, on the basis of documents received in the name of a related solvent company.
• The contract was awarded in the name of the company in liquidation, a detail which wasn’t noticed by the creditor.
• The company in liquidation had never traded.
• The creditor executed the contract to the benefit of the solvent company.

Lewis Holdings Ltd v Steel & Tube Holdings Ltd

• The subsidiary’s only asset was a lease with the creditor.
• Management of the property was not independent of the parent company.
• The parent company made ongoing representations that it stood behind its subsidiary.
• The lease was funded by the parent company and for its own benefit.
• The parent company ceased its support, and the subsidiary was put into liquidation.

Cases where pooling orders have been made:

Re Pacific Syndicates (NZ) Ltd

• Funds from investors in related companies had been pooled into a single account.
• Complex intercompany debt was impractical to disentangle.

Re Dalhoff and King Holdings Ltd (in liq)

• Three related companies substantially operated as one, and their conduct confused creditors as to which company they were dealing.

Mountfort v Tasman Pacific Airlines of NZ Ltd

• The parent company traded whilst insolvent and caused the subsidiary to do the same, leading to liquidation of the subsidiary.

Directors need to be mindful that related companies can become liable for each other’s debts, when those companies operate together in a manner which alludes to a unified economic entity. To best understand the risks, we recommend seeking expert advice from a professional.

Read the full article by Waterstone Wellington manager, Bede Henderson