LIABILITY OF PARENT COMPANY IN A SUBSIDIARY COMPANY

An important question in corporate law is the effect of the connection between a parent
corporation and its subordinate branches, or subsidiaries.

One aspect of this many sided question relates to jurisdiction over foreign corporations. A
foreign corporation can be personally served with process only when it is doing business within a
state. It was already established law that the use of a subsidiary does not necessarily subject a
parent corporation to the jurisdiction of the state. A subsidiary transacting business in a state,
though a mere adjunct or instrumentality of a foreign corporation which owns and controls it, is a
separate entity so that the foreign corporation is not doing business there itself. 1 The foreign
corporation was considered to be doing business in the state through the local company as its
representative, and was liable to suit for personal injury by service of process on the officers of
the local company. The principal corporation, it was held, was really represented by the agents of
the subsidiary corporation and liable the same as if the business had been done in its name. 2 It
must, however, now be recognized in all states that an auxiliary company is not to be treated as
the representative of the parent company, nor are its agents to be regarded as agents of the parent
company for the purpose of service of process, nor is the parent corporation "doing business"
through the subsidiary.3

The doctrine that the parent corporation is not deemed to be doing business through its
subsidiaries, in the eye of the law, may be regarded as a somewhat technical rule adopted from
practical reasons of policy to limit the somewhat arbitrary power exercised by the various states
over foreign corporations. Our federal system making every corporation created in one state
foreign to every other state often renders it advisable to organize corporations in many different
states which are simply branches of the same concern.

1 Cannon Mfg. Co. v. Cudahy Packing Co. (1925) 69 L. Ed.

2 Buie v. Chicago R. I. & P, Ry. Co. (1901) 95 Tex. 51.

3 Peterson v. Railway Co. (1907) 205 U. S. 364. 51 L. Ed. 841.

The relation between dominant and subsidiary corporations while not a basis for jurisdiction over
a foreign corporation, may be treated as an entirely different question in considering such issues
as the liability of the holding company for the debts, contracts or torts of the subsidiary, or the
right of creditors of a bankrupt holding corporation to reach assets in the hands of a subsidiary, or
the right of a parent company to prove claims against a subsidiary in bankruptcy in competition
with other creditors.

The question is sometimes raised whether the parent corporation can prove its claims against the
insolvent subsidiary in competition with its creditors. A few cases have gone so far as to hold that
where the parent corporation has conducted its business through the instrumentality of the
subsidiary that capital advanced may not be treated as a loan to the subsidiary as against third
parties. The controlling corporation, it has been contended, cannot share as a creditor in the
assets of the insolvent subsidiary, on the theory that the parent which invests money in a branch
of its own business cannot in case of failure shift the loss to innocent parties, or enforce a claim
against itself.

The basic theory of corporation law is that a corporation exists as an entity entirely apart from its
stockholders. There is in many cases much loose talk about "ignoring the corporate fiction" and
"looking at the substance rather than the form." But the corporate capacity is a legal fact, not a
fiction. Problems of responsibility for fraud or for the acts of a corporation used as an agent are
to be solved not by "disregarding" the corporate personality, but by the application of the usual
principles of liability for the acts of other persons or for collusion with them. Before the acts and
obligations of a corporation can be legally recognized as those of particular individuals, and vice
versa, it must appear that the circumstances are such that there is an agency of the one for the
other or that the privilege is being abused so that an adherence to the distinction or separate
capacity would sanction a fraud or promote injustice.

If a wholly owned subsidiary signed an exclusive teaming agreement with another

company, does this exclusivity also bind the parent company?

It will be a matter of interpretation for the court, based on all the facts involved, to determine
whether the two companies should be treated as a single entity. The separate corporate entity
may be disregarded when it is used as a cover for fraud or illegality, when it is used to work an
injustice, when it is deemed necessary to achieve equity, or when failure to achieve equity would
enable the corporate device to be used to circumvent a statute. When courts have faced the
question of whether or not a firm and its subsidiary amount to a single "person", they have
answered it by examining the extent of common ownership and the degree of control that the one
exercises over the other.

PROVISIONS OF COMPANIES ACT, 1956

The specific sections which are in this connection are Sections 4, 42, 212, 213, 214(2), 295(2)
(b), 370, 370(2)(a)(i) and 370(14)(d). These show that the subsidiaries still remain separate and
distinct under these sections. These special rights and restrictions emphasize the distinctiveness
of the holding company vis-a-vis its subsidiaries.

Section 4 of the Companies Act, 1956, defines holding company and subsidiaries. It provides
that if company B is a subsidiary of company A, and company C is a subsidiary of company B,
then company C is a subsidiary of company A by virtue of Clause (c) above.

Section 4(2) of the Companies Act, 1956, proceeds to explain what is meant by controlling the
composition of the Board of Directors and defines, inter alia, that this control shall be deemed
to exist if any of the following conditions is satisfied

(a) that a person cannot be appointed thereto without, the exercise in his favour by that other
company of such a power as aforesaid;

(b) that a person's appointment thereto follows necessarily from his appointment as director,
managing agent, secretaries and treasurers, or manager of, or to any other office or
employment in, that other company; or

(c) that the directorship is held by an individual nominated by that other company or a
subsidiary thereof.
These provisions are clear enough to show where the control of the composition of the Board
of Directors may be said to arise. Thereafter Section 4(3) of the Act proceeds to lay down the
tests by which one company is to be regarded as a subsidiary of another.

Thereafter Sub-sections (4), (5), (6) and (7) of Section 4 proceed, inter alia, to prove--(a) that a
company shall be deemed to be the holding company of another if, but only if, that other is its
subsidiary; (b) the expression 'company' in this section includes any body corporate and the
expression 'equity share capital' has the same meaning as in Section 85(2), (c) in the case of a
body corporate which is incorporated in a country outside India, as subsidiary or holding
company of the body corporate under the law of such country shall be deemed to be a
subsidiary or" holding company of the body corporate within the meaning and for the purposes
of this Act also, whether the requirements of this section are fulfilled or not; and (d) a private
company being a subsidiary of a body corporate incorporated outside India which, if
incorporated in India, would be a public company within the meaning of this Act, shall be
deemed for the purposes of this Act to be a subsidiary of a public company if the entire share
capital in that private company is not held by that body corporate whether alone or together
with one or more other bodies corporate incorporated outside India.

A glance at this definition would at once show how involved the concept is. The attempt in
Section 4 is to specify certain instances which are commonly met in company management
and to formulate the tests which should govern the definition of a holding company and its
subsidiaries.

Corresponding provisions of Companies Act, 2013 are Section 2(46) and 2(87). These
define what a holding and a subsidiary company is.

Section 42 of the Companies Act is the next relevant section in this connection. It deals with
the membership of the holding company. It provides, inter alia, that except in the cases
mentioned in the section a body corporate cannot be a member of a company which is its
holding company and any allotment or transfer of shares in a company to its subsidiary shall
be void.
Having said that Section 42 engrafts certain exceptions by saying that nothing in that section
shall apply, (a) where the subsidiary is concerned as the legal representative of a deceased
member of the holding company ; or (b) where the subsidiary is concerned as trustee unless
the holding company or a subsidiary thereof is beneficially interested under the trust and is not
so interested only by way of security for the purposes of a transaction entered into by it in the
ordinary course of a business which includes the lending of money.

This is the provision of Section 42(2) of the Companies Act. By Sub-section (3) of
Section 42 further direction is made by saying that this section shall not prevent a subsidiary
from continuing to be a member of its holding company if it was a member thereof, either at
the commencement of this Act or before, becoming a subsidiary of the holding company, but
except in the cases referred to in Sub-section (2), the subsidiary shall have no right to vote at
the meetings of the holding company or of any class of members thereof.
Section 42(4) provides that subject to Sub-section (2), Sub-section (1) and (3) of
Section 42 shall apply even in relation to a nominee for a body corporate which is a subsidiary.
In short, the principle recognized in Section 42 is a bar to a, subsidiary company being a
member of its holding company and a bar to the allotment or transfer of shares in a company
to its subsidiary with the exceptions and qualifications mentioned as above.

Corresponding provision of Companies Act 2013 is Section 19 which states that

subsidiary company cant hold shares in its holding company.

Sections 212, 213 and 214(2) of the Companies Act, 1956, in relation to this point.
Section 212 deals with balance-sheets of holding companies and directs that they should
include certain particulars as to their subsidiaries. It provides, inter alia, that there shall be
attached to the balance-sheet of a holding company having a subsidiary or subsidiaries at the
end of a financial year as at which the holding company's balance-sheet is made out such
documents as, (a) a copy of the balance-sheet of the subsidiary; (b) a copy of its profit and loss
account; (c) a copy of the report of its Board of Directors; and (d) a copy of the report of its
auditors. Further details about these requirements are to be found in the different Sub-sections
(2), (3), (4), (5), (6), (7), (8), (9) and (10) of Section 212. This is followed by
Section 213 providing for the financial year of a holding company and its subsidiary and for
equating the financial year of the holding company and its subsidiary.

No corresponding provisions are provided in the Companies Act, 2013 for the above
mentioned sections.

The next significant section is Section 214 of the Companies Act dealing with the rights of the
holding company's representatives and members. It provides, inter alia, that a holding
company may by resolution authorise representatives named in the resolution to inspect the
books of account kept by any of its subsidiaries, and the books of account of any such
subsidiary shall be open to inspection by those representatives at any time during business
hours and that the rights conferred by Section 235 upon members of a company may be
exercised, in respect of any subsidiary, by members of the holding company as if they were
alone members of the subsidiary. This will be clear from Sub-section (1) and (2) of
Section 214 of the Companies Act, 1956. Reading Sections 212 and 214 together it will be
plain that the holding company's inspecting and dealing with the accounts of its subsidiaries is
provided by the sections themselves and, therefore, the argument of the Petitioner that in each
Board meeting. of the T.M. summary of accounts of the subsidiaries was considered cannot be
any illegality whatever. In fact, that is a statutory obligation in the relationship between the
holding company and its subsidiaries.

Corresponding provision of Companies Act 2013 is Section 128 which talks about the
protection of employees when the holding company takeovers the subsidiary company.

The next section relevant in this context is Section 295(2)(b) of the Companies Act, 1956.
Section 295 deals with loans to Directors and others. Section 295(2)(b) makes the provisions
that the principle mentioned in Sub-section (1) of Section 295, disabling a company to make
any loan to or give any guarantee or provide any security in connection with a loan made by
any other person to, or to any other person by, a Director of the lending company or of a
company which is its holding company or any partner or relative of any such Director, shall
not apply to any loan made by a holding company to a subsidiary or to any guarantee given or
security provided by a holding company in respect of any loan made to its subsidiary.
Section 295(2)(b) of the Companies Act, therefore, is a direct recognition of the relationship
between the holding company and its subsidiaries and the normal bar as provided in
Section 295(1) will not be applicable in the case of loans, securities or guarantees, provided by
a holding company to its subsidiaries.

Corresponding provision of Companies Act 2013 is Section 185 which talks about loan to
directors.

Section 370, Section 370(2)(a)(i) and Section 372(14)(d) of the Companies Act, 1956.
Section 370 deals with loans etc. to companies under the same management. It provides, inter
alia, that no company shall make any loan to, or give any guarantee, or provide any security in
connection with a loan made by any other person to, or to any other person by, anybody
corporate unless the making of such loan, the giving of such guarantee or the provision of such
security has been previously authorised by a special resolution of the lending company
provided that no special resolution shall be necessary in the case of loans made to other bodies
corporate not under the same management as the lending company where the aggregate of
such loans does not exceed 10 % of the aggregate of the subscribed capital of the lending
company and its free reserves; provided further that the aggregate of the loans made to all
bodies corporate shall not exceed without the proper approval of the Central Government
certain limits. This is a provision which is intended to prevent interlocking of finance between
the holding company and its subsidiary. But, then here again an exception is made in
Section 370(2) (a) (i) of the Companies Act by saying that this provision shall not apply to 'any
loan made, by a holding company to its subsidiary'. This again is an illustration that a holding
company is permitted to lend to its subsidiary without the usual restriction mentioned in
Section 370(1) of the Act. Therefore, such transactions between the holding company and its
subsidiaries are within the exemption of the law expressly granted. Finally, Section 372 of the
Companies Act deals with purchases by a company of shares etc. of other companies. The
main principle there is that a company mentioned there shall not be entitled to subscribe for or
purchase (whether by itself, or by any individual or association of individuals in trust for it or
for its benefit or on its account) the shares of any other body corporate except in accordance
with the restrictions and conditions specified in that section. This is followed by different
provisions in different Sub-sections. But, by Sub-section (14) of Section 372 and specially by
Sub-clause (d) thereof, it is expressly provided, that Section 372 shall not apply to investments
by a holding company in its subsidiary. Here, again, is a clear and direct recognition in favour
of the holding company and subsidiaries who are treated separately.

It follows that all these express statutory provisions of the Indian Companies Act, 1956,
maintain the distinction between a holding company and its subsidiaries as separate legal
entities and, although certain provisions are made, there are also equally certain exemptions
made in defence to common managerial concepts between the holding company and its
subsidiaries.

No corresponding provisions are provided in the Companies Act, 2013 for the above
mentioned section.

CASES

Life Insurance Corporation of India v. Haridas Mundhra & Ors. (36 Comp. Cases 371)

The ratio of this decision is that though a holding company and its subsidiary are separate legal
entities, yet, for certain purposes, the affairs of a subsidiary have been treated by the Companies
Act, 1956, as affairs of the holding company also.

Regina v. Board of Trade (1965)) 1 Q.B. 603

It contains an exposition of the expression 'affairs of the company' in construing Section 165(a)
of the English Act of 1948. The ratio of the observation is that the affairs of the company would
include those of its subsidiaries.

Scottish Co-operative Wholesale Society Ltd. v Meyer [1958] 3 All E.R. 56 : [1959] 39
Comp Cas 1

" In law, the society and the company were, it is true, separate legal entities. But they were in the
relation of parent and subsidiary companies, ..."
" The truth is that, whenever a subsidiary is formed as in this case ... the parent company must, if
it is engaged in the same class of business, accept as a result of having formed such a subsidiary
an obligation so to conduct what are in a sense its own affairs as to deal fairly with its
subsidiary.

Hungerford Investment Trust Ltd vs Turner Morrison & Co. Ltd ( ILR (1972) 1 Cal 286)

A holding and a subsidiary company are separate legal entities.