Ceasing To Be A Subsidiary

In Enviroco Ltd v Farstad Supply A/S [2009] EWCA Civ 1399, the Court of Appeal concluded that, in certain circumstances, a company which is a subsidiary of a holding company may cease to be a subsidiary following the grant of security over shares in the subsidiary by its holding company to a bank.

The result may seem surprising at first and may cause lenders to be concerned about the risk of the company whose shares are charged becoming a subsidiary of the secured lender. The decision is, however, applicable only to a limited range of circumstances and, as explained below, there should not be a risk for the lender in most situations.

The case concerned the vessel M.V. Far Service which was chartered by Farstad to Asco UK Limited, a subsidiary of ASCO plc. Enviroco was engaged to clean the vessel including its oil tanks. During the operation, oil from the tanks caught fire, resulting in the death of an Enviroco employee and damage to the vessel.

Farstad sued Enviroco. However, Enviroco claimed it was an "affiliate" of Asco UK, by virtue of also being a subsidiary of ASCO plc, and that it was therefore entitled to the benefit of an indemnity from Enviroco in respect of its liability. This indemnity was contained in the charter of the vessel and was expressed to be in favour of Asco UK and its "affiliates".

In the period prior to the incident giving rise to the claim, ASCO plc had entered into a Scottish law "Deed of Pledge" in favour of the Bank of Scotland (the "Bank") in respect of its shares in Enviroco. This document had a similar effect to an English law legal mortgage of the shares (shares being intangible assets incapable of being "pledged" under English law). Pursuant to this security, the Bank had become registered as the holder of the relevant shares.

Prior to the grant of security, it was clear that Enviroco was a subsidiary of ASCO plc since, although it held only a minority of the shares in Enviroco, ASCO plc was also able to control, pursuant to an agreement with another shareholder, the majority of the voting rights in Enviroco in accordance with section 736(1)(c) of the Companies Act 1985 (now section 1159(1)(c) of the Companies Act 2006). The other tests of a "subsidiary" were inapplicable since ASCO plc did not alone hold the majority of voting rights in Enviroco (paragraph (1)(a)), nor did it have the ability to appoint a majority of the directors of Enviroco (paragraph (1)(b)).

The terms of the security were such that, as...