4.4.4.2.2 In the context of parent and subsidiary companies

In Re a company, Nicholas,1 Sound Craft Electronics Ltd (hereinafter Electronics) owned 75 per cent of its subsidiary's shares. The business of the subsidiary was to manufacture high quality tape recorders for business use. Electronics was to finance the company until it was able to stand on its own feet, but the extent and period of the financial support were never discussed or defined. Besides the support from Electronics, there was no agreement on longterm Joan capital from the bank or any other source to secure the financial safety or stability of the subsidiary. The subsidiary sold most of its output through Electronics' sales force abroad, but there was no specific agreement between the two companies as to the terms of trade. The subsidiary also relied on Electronics for financial management and Electronics' finance director was in charge of signing the subsidiary's cheques. In return, the subsidiary paid Electronics a management fee for administering its export sales and finances. The petitioner (Alexander Nicholas), holding 12.5 per cent of the subsidiary's shares, alleged that Electronics had conducted the subsidiary's affairs in an unfairly prejudicial way by failing to pay debts owed to the subsidiary in 1984 and 1985. The central question the court had to answer was whether the parent's failure to pay debts to its subsidiary was conduct of the subsidiary's affairs and in what situations the parent's decisions were to be considered as the affairs of the subsidiary.

Harman J gave a negative answer to the first question: "the mere fact that a parent company fails to pay a debt due to a subsidiary does not per se amount to an act in the business of the subsidiary."2 So if the only fact was withholding payments which were due to the subsidiary, the parent company was simply conducting its own business. The facts of this case, however, were more complex and special. Electronics, in effect, "treated the financial affairs of the two companies as that of a single enterprise over which it had control." There was no division of the financial affairs between the two and there appeared to be no financial management whatsoever at the level of the subsidiary; it simply relied on Electronics to look after the financial aspect of the company's business. Considering the blurred structure within the group, therefore, when Electronics withheld payments from the subsidiary, it was conducting the affairs of the subsidiary. We see now that when the relationships within a group are unclearly structured, individual identities are not properly respected and affairs are loosely planned, the parent and its subsidiary (or subsidiaries) will be treated as one. Conduct such as withholding payments, although this will normally be viewed only affairs of the parent, can be viewed in this case as affairs of the subsidiary as well. Such a position been supported by later cases. In Brentfield,3 the court established that the directors had failed to draw a proper distinction between the parent's affairs and those of its subsidiary. They had caused B (the subsidiary) to provide F, the parent's bank, with security for B's assets without any benefit accruing to B. Relief was granted based on the fact that the affairs of B had been conducted in a way that was unfairly prejudicial to the petitioner. When the parent company and the subsidiary have exactly the same directors, there is a great chances that the decisions of the parent will be taken as conduct of the subsidiary's affairs, because in this situation, subject to tight control by the parent company, it is really doubtful whether the board of the subsidiary would be capable of taking independent decisions.

By ignoring the independent status of the subsidiary, either through loosely planned structure or allowing no possibility of independent decisions, the parent company can easily be held to be conducting the affairs of the subsidiary. In Gross v. Rackind, Sir Martin Nourse ruled that "the expression "the affairs of the company" is one of the widest imports which can include the affairs of a subsidiary. Equally, I would hold that the affairs of a sub sidiary can also be the affairs of its holding company, especially where, as here, the directors of the holding company, which necessarily controls the affairs of the subsidiary, also represent a majority of the directors of the subsidiary"4

In conclusion, it is possible for actions carried out by a parent company to be ruled as related to the affairs of the subsidiary company, and anyone engaging in conduct within subsidiary companies could be sued by shareholders in the parent company as falling within the parent's affairs for the purposes of the unfair prejudice remedy under s. 994.5 The fact that the parent and the subsidiary are engaged in the same business or share the same board of directors invites more suspicion and tighter scrutiny by the court.

Even if conduct by one entity is considered the company affairs of another, owing to the special relationship between a parent and its subsidiary, should every act unfairly prejudicial in a normal setting be decided to be so and punishable in a parent-subsidiary setting? In other words, is the standard for judging unfair prejudice different in the context of parent and subsidiary companies?

The issue was discussed in Scottish Co-operative Wholesale Society Ltd v. Meyer, in which it was held that when exercising its rights in the subsidiary, the parent company was facing a "more incumbent" duty and must behave with "scrupulous fairness" to the minority shareholders in the subsidiary.6 Whenever a subsidiary is formed with an independent minority of shareholders, the parent company must avoid "betraying the interests of the minority", and "deal fairly" with its subsidiary.7 The standard of fair dealing set in this case is that the parent should not subordinate the interests of the subsidiary to those of itself.8 Three directors out of five on the board of the subsidiary were nominated by the parent company. They followed the instructions from the parent company to let the subsidiary perish gradually and disregarded their duties to protect the business in the subsidiary. The court ruled that by subordinating the interests of the subsidiary to those of the parent, the affairs of the subsidiary were being conducted oppressively to the other shareholders under s. 210.9 And this also became the standard for s. 459 (now s. 994).

In the Electronics case (Re a company, Nicholas), the Court of Appeal accepted the above statements as a guiding principle.10 In this case, it was pointed out that Electronics exerted general control over the financial affairs of the subsidiary regarding how much the company should receive and spend, but no intention to harm or subordinate the interests of shareholders in its subsidiary was found, nor did the shareholders in the subsidiary have any complaints about that.11 The only allegation was the failure to pay back the debt. The court ruled that the failure to pay its debts to the subsidiary was due to its difficult financial situation. By withholding the debt, the parent company was trying to "keep the group afloat", rather than subordinating the interests of the subsidiary to those of itself. In fact, "it was in the interests of the company (the subsidiary) that Electronics should not go into liquidation."12 In this case, therefore, the conduct of the parent company was regarded as the company affairs of its subsidiary, but because of its genuine efforts for the interests of the whole group and no demonstration of subordination, it was not unfairly prejudicial.

In sum, even if an act or decision is recognized as the affairs of the company, and would probably be unfairly prejudicial in a normal setting, this would not be a guarantee of a successful petition onder s. 994 in relation to a parent and subsidiary companies. The established standards do not entail the subordination of interests of one to the other, and it is even safer to say that the entity will not be punishable if the action, without subordination of interests, is also in the interests of the group. But the criterion of `an action in the interests of the whole group' alone is not a convincing position. Thinking further based on the case above, I believe that an action of a temporary nature, which is harmful to the subsidiary but desirable for the whole group, should also be exempted from unfairly prejudicial conduct by the court, provided that the subsidiary receives assurance that it will be compensated later.