Group relationships change what a company must do — whose accounts it consolidates, whose shares it may not hold, whose insolvent trading it may answer for. Sections 5 to 7 of the Companies Act 1997 draw the line.
Section 5(1) — when a company is a subsidiary
(a) that other company —
(i) controls the composition of the board of the company; or
(ii) is in a position to exercise, or control the exercise of, more than one-half of the maximum number of votes that can be exercised at a meeting of the company; or
(iii) holds more than one-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; or
(iv) is entitled to receive more than one-half of every dividend paid on shares issued by the company, other than shares of that same restricted kind; or
(b) the company is a subsidiary of a company that is that other company’s subsidiary.
Section 5(2) completes the pair: a company is another company’s holding company where, but only where, that other company is its subsidiary. Section 5(3) extends the vocabulary — in sections 5, 6 and 7, “company” includes a body corporate, so a statutory corporation or a foreign body corporate can be a holding company.
The phrase is exhaustive. Influence short of one of the four tests — a 40% stake, a long-term supply relationship, common directors without the power to appoint them — does not create a subsidiary, however real the commercial control. Paragraph (b) then carries the relationship down the chain: a sub-subsidiary is a subsidiary of the ultimate holding company.
Section 6 — “control” of the board
Without limiting the circumstances in which the composition of a board is taken to be controlled, it is so controlled where the other company, by exercising a power exercisable by it (whether with or without the consent or concurrence of any other person), can appoint or remove all the directors, or such number of directors as together hold a majority of the voting rights at board meetings.
For that purpose, the other company is taken to have power to make such an appointment where —
(a) a person cannot be appointed as a director without the exercise by the other company of such a power in the person’s favour; or
(b) a person’s appointment follows necessarily from the person being a director or other officer of the other company.
Paragraph (b) catches the common group structure in which the constitution provides that the managing director of the parent is ex officio a director of the subsidiary. Paragraph (a) catches a veto: if nobody can join the board without the parent’s say-so, the parent controls its composition.
Section 7 — shares and powers that are disregarded
| Rule | |
|---|---|
| (a) | Shares held, or a power exercisable, by the other company in a fiduciary capacity are not treated as held or exercisable by it |
| (b)(i) | Shares or powers held by a nominee for the other company are treated as its own — except where it is concerned only in a fiduciary capacity |
| (b)(ii) | Shares or powers held by, or by a nominee for, a subsidiary of the other company are treated as the other company’s — unless that subsidiary is concerned only in a fiduciary capacity |
| (c) | Shares or powers held under debentures or a trust deed securing an issue of debentures are disregarded |
| (d) | Shares or powers held by the other company or its subsidiary are not treated as theirs where the ordinary business includes the lending of money and the shares are held by way of security only for a transaction entered into in good faith in the ordinary course of that business |
First, look through nominees: shares parked with a nominee or a subsidiary count as the parent’s. Second, ignore security: a bank that takes a share mortgage over a majority stake does not thereby acquire a subsidiary, and neither does a debenture trustee. Paragraphs (c) and (d) exist so that lending is not accidentally turned into group ownership.
Where the definition bites
| Provision | Effect |
|---|---|
| s 64 | A subsidiary may not hold shares in its holding company, and an allotment or transfer to it is void, subject to the exceptions there stated |
| ss 181, 182 | A company with subsidiaries must prepare group financial statements, and section 182 sets their content |
| s 349 | Liability of a holding company for the insolvent trading of a subsidiary |
| ss 320A–320C | Pooling of assets of related companies in liquidation, and the guidelines for such orders |
| s 346 | A liquidator may recover from a related entity a benefit resulting from insolvent trading |
| ss 117, 124 | “Interested” and “relevant interest” both take in group holdings |
| s 235 | Short form amalgamation of a company with its wholly owned subsidiaries, or of subsidiaries with each other |
| s 110 | Whether a transaction is a major transaction is measured against the company’s assets, so group structure affects the calculation |
Practical points for group structures
- Map the group against the four tests, not against commercial intuition. Percentages of a class of restricted preference shares may not count under (iii) or (iv).
- Check section 64 before any cross-holding. A subsidiary acquiring shares in its parent risks a void allotment or transfer.
- Plan for consolidated accounts. Section 181 turns on the existence of subsidiaries at balance date.
- Watch the parent’s exposure. Sections 320A to 320C, 346 and 349 mean a solvent parent can be reached in a subsidiary’s liquidation.
- For lenders, structure security so that paragraphs (c) and (d) of section 7 apply — taking shares by way of security only, in the ordinary course of a money-lending business.
Sources
- Companies Act 1997 — ss 5–7, 64, 110, 117, 124, 181, 182, 235, 320A–320C, 346, 349
Before relying on anything here, read the current text of the Companies Act 1997 and check for later amendments. If a decision matters to you, get advice — start with the Office of the Public Solicitor, or find a firm in the law firms directory.