Can A Holding Company Be Liable For Its Subsidiaries’ Debts?

If you’re a company director in New Zealand, you may be considering the establishment of a holding company to protect your business structure. A holding company can offer benefits such as risk mitigation and potential tax advantages as your company expands. However, it’s crucial to understand that a holding company may still be held accountable for the debts of its subsidiary companies under certain circumstances.

Before we delve into the specifics of when a holding company might be liable, let’s clarify some essential terminology relevant to New Zealand’s legal context.

What Is A Holding Company?

A holding company is typically established to own shares in other companies, known as subsidiaries. The holding company itself usually does not engage in operational activities such as manufacturing or sales. This structure is advantageous for asset protection within a growing business, as it can shield assets from certain liabilities.

For instance, if a customer were to take legal action against your business, they would generally be limited to suing the subsidiary company with which they have a contractual relationship. Consequently, assets owned by the holding company are safeguarded from such claims.

What Is A Subsidiary Company?

A subsidiary company is one that is controlled by a holding company. The subsidiary is typically the entity that interacts directly with customers and faces the majority of operational risks. To mitigate these risks, the holding company often holds the significant assets of the business.

This arrangement is also referred to as a dual company structure in New Zealand.

Here’s a visual representation to illustrate the relationship between holding companies and their subsidiaries.

What Happens When The Subsidiary Company Is In Debt?

Although a subsidiary company operates as a distinct legal entity, the holding company may still face liability for the subsidiary’s debts in certain situations.

In New Zealand, the holding company could be liable for the debts of its subsidiaries if the subsidiary was trading while insolvent and the holding company’s directors were, or ought to have been, aware of the insolvency.

To assess potential liability, consider the following questions:

1. Was it a holding company of the subsidiary at the time the debt was incurred?
2. Was the subsidiary company insolvent at that time?
3. Were there reasonable grounds for suspecting insolvency, or that insolvency was imminent?
4. Were one or more directors aware, or should they have been aware, of these grounds?

If any of these conditions apply, the holding company could be held responsible for the debts of the subsidiary.

As a director of a holding company in New Zealand, it is vital to monitor the financial health of your subsidiaries to prevent such liabilities.

What Can A Liquidator Do?

If a subsidiary company becomes insolvent, a liquidator will be appointed to oversee the resolution of its financial affairs. In New Zealand, under the Companies Act 1993, a liquidator has the authority to pursue the holding company for the subsidiary’s debts if certain conditions are met.

• The holding company was at fault for not recognising the subsidiary’s insolvency.
• Creditors have incurred losses due to the subsidiary’s insolvency.
• The debts were unsecured at the time the losses were suffered.
• The subsidiary is undergoing liquidation.

Under these circumstances, the liquidator may seek to recover the outstanding debts from the holding company.

What Defences Can I Use?

While a holding company structure does not completely eliminate liability risks, there are defences available in New Zealand law that may protect the holding company in certain situations.

Safe Harbour Provisions

If your holding company is facing liability for a subsidiary’s debts, you may be able to invoke the ‘safe harbour’ provisions. These provisions can protect directors who were actively working on a turnaround plan that was ‘reasonably likely to lead to a better outcome’ for the company.

These provisions are particularly relevant during challenging economic times, allowing directors to demonstrate that they were taking proactive steps to address insolvency.

Reasonable Grounds

A holding company can also argue that there were reasonable grounds to believe that the subsidiary was solvent, meaning it could pay its debts as they fell due.

Reliance On Information

The holding company might claim reliance on information provided by a competent and reliable person, which led them to believe that the subsidiary was solvent.

Director’s Non-Participation

Another defence is that the directors were unable to manage the company due to illness or other valid reasons, preventing them from being aware of the subsidiary’s financial distress.

Reasonable Steps Taken To Prevent Insolvent Trading

Finally, the holding company may contend that they took reasonable steps to prevent the subsidiary from incurring debts while insolvent, potentially absolving them from liability.

Although defences exist, the best practice is to proactively manage the risk of liability by regularly reviewing the financial status of subsidiary companies and ensuring solvency is maintained.

Next Steps

Establishing a holding company in New Zealand offers advantages, but it does not automatically protect you from liability for your subsidiary’s debts.

Fortunately, our team of legal experts can provide guidance on setting up a Dual Company Structure and help address any concerns you may have regarding liability.
Feel free to reach out to us at [email protected] or contact us on 0800 002 184 for an obligation-free chat.

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