The Companies Act in India and jurisdictions all over the world have statutorily recognised subsidiaries as a separate legal entity. Section 2(87)[1] of the Companies Act, 2013 (“CA 2013”), defines “subsidiary company” or “subsidiary” as a company in which the holding company controls the composition of the Board of Directors; or exercises or controls more than one-half of the total voting power either on its own or together with one or more of its subsidiary companies.
Subsidiaries are of different types, a vast majority of which are pure investment holding companies. However, there are many subsidiaries which have independent business activity, significant operations, and manufacturing facilities and also have an independent Board of Directors if it’s a listed subsidiary. The subsidiaries which are used as an investment vehicle are normally tightly controlled by the holding company and majority of the directors of such subsidiaries are generally the officials of the holding company. However, listed subsidiaries need to be treated very differently and they generally enjoy a good degree of autonomy in their operation due to provisions of the CA 2013 and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.
Foreign subsidiaries will be governed by the local laws of the place of incorporation, and they need to be treated very differently so they can comply with their local applicable law. The decision-making process of such foreign subsidiaries should be located outside India to avoid any potential tax implications in India.
Holding company and its subsidiary – Same or separate entity?
The Supreme Court in Vodafone International Holdings BV v. Union of India[2] (“Vodafone judgement”)held thatthe legal relationship between a holding company and its wholly owned subsidiary is that they are two distinct legal persons, and the holding company does not own the assets of the subsidiary and, in law, the management of the subsidiary’s business vests in its Board of Directors.
A company has a separate legal existence, irrespective of whether one person or one company (the holding/parent company) owns all its shares. When a holding company has a wholly owned subsidiary, it may appoint or remove any director through a resolution in the general body meeting of the subsidiary.
A holding company and its subsidiaries can be considered as single economic entity, with the consolidated balance sheet reflecting the accounting relationship between them and showcasing the status of the entire business enterprises. Although the parent company’s books hold the shares of stock in the subsidiary as assets and issue these as collateral for additional debt financing, the law still views the holding company and its subsidiary as separate legal entities. While the holding company could provide expert, efficient, and competent services for the subsidiaries’ benefit, each subsidiary is responsible for its own management personnel.
The Court in Small Industries Development Bank of Indian v. Creation Investments Equitas Holdings LLC[3],upheld that the holding company and the subsidiary are distinct entities and that the holding company does not own the subsidiary’s assets. However, in this case, both the holding company and the subsidiary were dissolved to avoid legal ramifications. Not only were the entities one and the same, they were, also operated by the same person. The sole purpose of the person who created such companies was to defeat the rights of the parties outside the countries. Therefore, the Court held that principles laid down in the Vodafone judgment could not be applied to defeat the rights and encourage fraudulent activities.
In LIC v. Escorts Ltd[4], the Court emphasised that in cases where associated companies were inextricably connected and appeared as a single concern/entity, the corporate veil should be lifted. Nonetheless, the Court stated that this was contingent on the relevant statutory provisions, intent, the extent of involvement of public interest, and the effect on parties.
In State of U.P. v. Renusagar Power Co[5],it was clear that Hindalco completely controlled its wholly owned subsidiary Renusagar, including its day-to-day affairs. Renusagar did not indicate any independent volition. Thus, the Court was of the opinion that the corporate veil should be lifted and Hindalco and Renusagar should be treated as one concern. Hence, it was held that Renusagar’s power plant was Hindalco’s own source of generation and was liable to duty on that basis.
In this case the holding company and the subsidiary had an inextricably link, where the subsidiary had no separate and independent existence apart from its holding company.
The question which arises here is – what is the “nature” and “how much” control does a holding company have on its subsidiary for the holding company to be held liable for the actions of its subsidiaries?
A holding company’s degree of control over its subsidiary
In the Vodafone judgment, the Supreme Court held that the parent company’s control or power over the subsidiary depended on the specific circumstances of each case. Citing an example, the Court said that if a man is the shareholder of perhaps 99 per cent of the shares of a one-man company and his wife holds 1 per cent, his control over the company is so complete that it is his alter ego. However, in case of multinationals, it is important to highlight that their subsidiaries operate with significant autonomy in the country concerned except when created or used as a legal façade.
It is not suggested that a parent company never has control over the subsidiary. For example, once the corporate veil is lifted, the parent company and the subsidiary form one entity. The Court held that “control” is a mixed question of law and fact, where ownership of shares may potentially confer a controlling interest in the management of the company. A subsidiary may generally comply with the request of a holding/parent company, but it is established that it is not merely a puppet of the parent company. The difference is between having power and having a persuasive position.
The directors of the subsidiary, as per their articles, are the managers of the companies. New directors still owe their duty to the subsidiary and must act in its best interest even if the parent company requests their appointment and removal. The Court highlighted that just because the parent company exercises shareholders’ influence on its subsidiaries, the directors of the subsidiaries should not allow the parent company dictate them and be reduced to puppets if it is not in the interests of the subsidiaries.
The Court observed that, “The decisive criterion is whether the parent company’s management has such steering interference with the subsidiary’s core activities that the subsidiary can no longer be regarded to perform those activities on the authority of its own executive Directors.”
The CA 2013 also provides for a definition of the term “control” in Section 2(27)[6] as the right to appoint majority of the directors or to control the management or policy decisions either directly or indirectly by virtue of their shareholding or management rights.
In Balwant Rai Saluja v. Air India Ltd.[7], the Supreme Court held thatthe mere fact that Air India has a certain degree of control over its subsidiary HCI did not mean that the employees working in the canteen were Air India’s employees. The Court observed that Air India’s control is in the nature of supervision. As the primary shareholder in HCI and shouldering certain financial burdens, such as providing with the subsidies as required by law, Air India was entitled to have an opinion or a say in ensuring effective utilisation of resources, monetary or otherwise.
International Jurisprudence
The US Supreme Court in United States v. Bestfoods[8] explained that the general principle of corporate law and legal systems held that a parent corporation was not liable for the acts of its subsidiary. However, the corporate veil could be pierced and the parent company could be held liable for the conduct of its subsidiary if the corporal form was misused to accomplish certain wrongful purposes in which the parent company was a direct participant. Mere ownership, parental control, management, etc., of a subsidiary was not sufficient to pierce the status of their relationship and to hold parent company liable.
In the United Kingdom, the Supreme Court judgment in Vedanta Resources Plc and Konkola Copper Mines Plc v Lungowe and Others[9] demonstrated that a UK-based company could be sued for the acts taken of its overseas subsidiary. The Court noted that the parent company’s direct or indirect ownership of all or a majority of the shares of its subsidiary might enable the parent company to take control of the management of the operations, and the control of a company and the de facto management of part of its activities are two different things. The Court held that the parent company could assume liability for a subsidiary’s activities if it had a duty of care to third parties in relation to those activities. The Court rejected Vedanta and Konkola’s submission that a parent could never incur a duty of care by issuing group-wide policies and expecting the subsidiary to comply.
The Court of Justice of the European Union in its decision rendered in The Goldman Sachs Groups Inc. v. European Commission[10] observed that if a parent company directly or indirectly held all or almost all of the capital in a subsidiary and was able to exercise decisive influence over the conduct of the subsidiary that has committed an infringement of the competition rules, then there is a rebuttable presumption that the parent company exercises such influence. Accordingly, the parent company would be jointly and severally liable for the payment of the fine imposed on its subsidiary, unless the parent company can prove that its subsidiary acts independently on the market.
Conclusion
It is a settled legal position that a subsidiary is a separate legal entity and is different from its holding/parent company. However, the holding companies and its subsidiary cannot take a shelter under the legal position that they are two distinct legal entities in the following instances:
- “Parent company’s management has steering influence on the subsidiary’s core activities that the subsidiary can no longer be regarded to perform those activities on the authority of its own executive directors”;[11]
- “The company is the creature of the group and the mask which is held before its face in an attempt to avoid recognition by the eye of equity or is a mere cloak or sham and in truth the business was being carried on by one person and not by the company as a separate entity”;[12]
- “Two companies are inextricably inter-linked corporate entities”.[13]
In such cases, the Court can always lift the corporate veil, examine the substance of the transaction, and hold the holding company liable for the acts and omissions of its subsidiary.
* The Author was assisted by Anika Natani, Intern.
[1] Section 2(87) “subsidiary company” or “subsidiary.”, in relation to any other company (that is to say the holding company), means a company in which the holding company—
(i) controls the composition of the Board of Directors; or
(ii) exercises or controls more than one-half of the total voting power either at its own or together with one or more of its subsidiary companies:
Provided that such class or classes of holding companies as may be prescribed shall not have layers of subsidiaries beyond such numbers as may be prescribed.
Explanation.—For the purposes of this clause,—
(a) a company shall be deemed to be a subsidiary company of the holding company even if the control referred to in sub-clause (i) or sub-clause (ii) is of another subsidiary company of the holding company;
(b) the composition of a company’s Board of Directors shall be deemed to be controlled by another company if that other company by exercise of some power exercisable by it at its discretion can appoint or remove all or a majority of the Directors;
(c) the expression “company” includes any body corporate;
(d) “layer” in relation to a holding company means its subsidiary or subsidiaries;
[2] Vodafone International Holdings BV v. Union of India, (2012) 6 SCC 613.
[3] Small Industries Development Bank of Indian v. Creation Investments Equitas Holdings LLC, 2020 SCC OnLine Mad 25807.
[4] LIC v. Escorts Ltd, AIR 1986 SC 1370.
[5] State of U.P. v. Renusagar Power Co., (1988) 4 SCC 59.
[6] Section (27) “control” shall include the right to appoint majority of the Directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner
[7] Balwant Rai Saluja v. Air India Ltd., (2014) 9 SCC 407.
[8] United States v. Bestfoods [524 US 51 (1998)].
[9] Vedanta Resources Plc and Konkola Copper Mines Plc v Lungowe and Others [2019] UKSC 20.
[10] The Goldman Sachs Groups Inc. v. European Commission, Case C-595/18 P.
[11] Vodafone International Holdings BV v. Union of India, (2012) 6 SCC 613
[12] Bhatia Industries & Infrastructure Ltd. v. Asian Natural Resources (India) Ltd., 2016 SCC OnLine Bom 10695
[13] State of U.P. v. Renusagar Power Co., (1988) 4 SCC 59
