The general position in company law is that a company is its own legal entity, separate from its shareholders. This principle allows a company to run its affairs without the risk of its shareholders or related companies being responsible for the liabilities incurred by the company, and is a major reason why subsidiaries are often favoured.

Section 271 of the Companies Act 1993 (Act) however provides an exception to this rule and effectively allows the lifting of the 'corporate veil', enabling a company to be responsible for its related company's liabilities. The provision provides that if the Court finds it just and equitable to do so, it may order that a company that is related to a company in liquidation, must pay to the liquidator all or part of the liquidation claims. Although the provision is not new, its effect has not been particularly worrying for businesspeople as it has rarely been considered by the courts. Recently however it has been applied in Lewis Holdings Limited v Steel & Tube Holdings Limited [2014] NZHC 3311 and as such directors and boards should be actively turning their minds to the implications of this decision.

Lewis Holdings Limited (Lewis) leased a property to Stube Industries Limited (Stube) which was a wholly owned subsidiary of Steel & Tube Holdings Limited (STH). Lewis and the liquidators made a claim against STH.

In determining whether the companies should be pooled together, the Court in this case focused predominately on the extent of which the related company (STH) took part in the management of the company in liquidation (Stube).

What makes this case particularly interesting is not that the Court found that the parent and subsidiary companies could be pooled together, but the reasons why they made this finding. The result rested on many factors that the Court acknowledged were common practice in the corporate world and while in and of themselves would not be indicative of a pooling order, their cumulative effect did warrant one. This should be of concern to boards of holding companies where their subsidiaries are operated in a similar fashion.

The Court considered the following in determining that STH and Stube were sufficiently connected to make it just and equitable to pool them together and order that STH pay all of the claims made against Stube in its liquidation:

  • the directors of Stube were both senior managers of STH, one being the CEO and the other being the CFO. While this is not uncommon, the Court found that when senior managers are appointed as directors of a subsidiary, they must approach their director duties in a way that makes a distinction between the two roles. The directors should have made decisions regarding Stube with their "Stube directors' hats on" and it was found in this case that they did not;
  • there was a provision in Stube's constitution allowing the directors to favour the interests of STH over Stube. The Court considered that while this is not determinative of a pooling order, the directors in effect combined the interests of the companies and did not consider Stube's interests in isolation. It found that there was no distinction between the best interests of Stube and the best interests of STH, there was only the interests of the group as a whole;
  • Stube had no financial capacity of its own - STH always paid Stube's rent and all of Stube's invoices and rates, and many contracts were made out to STH;
  • Stube had no bank accounts of its own, which again is not uncommon for subsidiaries. The Court however considered that the companies were sufficiently connected because all of Stube's receipts and payments were made through STH bank accounts and treated as STH transactions;
  • Stube had no employees of its own and therefore employees of STH carried out any necessary tasks on behalf of Stube; and
  • certain correspondence relating to Stube was written on a STH letterhead without the author stating that he or she was acting on behalf of Stube rather than STH.

The Court found that for a company to be afforded separate legal identity, it must operate in a way that reflects that - it must have a separate commercial identity. It was determined that taken together, the evidence pointed to the fact that STH and Stube were not separate companies in a commercial sense; they were in fact operated as one single unit. The actions of those involved in the running of the companies muddied the waters to the extent that a distinction between the two was not possible.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.