Claiming for group losses
Good Company October 2014 edition
- Corporate manslaughter cases in 2014
- Directors' personal guarantees
- Directors' duties in a third party fraud
- Holding company directors – potential liability as director of subsidiaries?
- Claiming for group losses
- The employee ownership business model
The Scottish equivalent of the Court of Appeal has recently confirmed that a parent company, which has made a contract with a third party, is not able to claim for losses suffered by its subsidiaries if the third party breaches the contract. The decision itself is not surprising, being based on the principle, well established both in England and Scotland, that a parent company and its subsidiary have separate legal personalities. However, the case highlights the pitfalls that can arise in the contractual arrangements of groups of companies. The case is The Harbro Group Ltd v MHA Auchlochan.
Harbro Group Ltd bought some land. Under the purchase contract, the sellers agreed to construct an access road to the land, but there was delay in completing the road and Harbro claimed they were in breach of contract.
Harbro said it had bought the land intending to construct a factory and move its production, distribution and sales of animal feed to the new site. It claimed it had suffered loss as a result of the delay in construction of the access road, as it had to extend the lease at the premises where it was currently operating and lost profits as it was unable to achieve a seamless transfer of production to the new site.
The problem for Harbro was that the lease which had to be extended was in the name of one of its subsidiaries, not its own name, and it was the subsidiary which carried on the business of manufacturing and selling animal feed. It was therefore the subsidiary which had to extend the existing lease and suffered any loss of profit.
Harbro claimed that profits and losses on the trading activities were only earned or incurred at the holding company level, relying in part on the Companies Act requirement to prepare consolidated group accounts.
The lower Scottish court allowed Harbro's claim to proceed, but on appeal the court said their arguments "betray a complete lack of understanding of the principles of the law of contract and company law where a group of companies is involved".
The assets and liabilities of individual group companies are treated as their own, as they are distinct legal entities. Unless an agency or trustee relationship is created between such companies, a parent company is not treated as the owner of any of its subsidiary's assets and there is no common group liability for the obligations of individual members of the group. In the same way, the rights and obligations of third parties are not affected by the fact that they are dealing with a company which is a member of a group.
The result in this case is that Harbro could not recover the losses suffered by its trading subsidiary. This was the case even if the sellers were aware, when they sold the land to Harbro, that it was being purchased so that the new factory could be built there and even if the sellers were in material breach of their obligations to build the access road.
It is not uncommon for groups of companies to be organised in such a way that assets are held by one subsidiary and used in the trading operations of another. So what can groups do to avoid the situation that arose in this case?
One approach would be to establish formal agency arrangements between group companies so that, for example, one group company holds assets or enters into contracts as agent for another. This, however, would mean that the assets or contractual rights would not be beneficially owned by the company acting as agent but by the other company, and this may negate the original reason for holding the assets or rights in a separate company in the first place.
An alternative would be to take advantage of the Contract (Rights of Third Parties) Act 1999. If Harbro, when entering into the contract to buy the land, had made it clear in the contract that the requirement for the sellers to build the access road was intended for the benefit of its trading subsidiary, that subsidiary would have been able to bring an action in its own name against the sellers for breach of that obligation.
Andrew Blankfield is a Partner and Fiona Morris a Trainee Solicitor in Fieldfisher's Corporate Group in London.