Facts
Trust T wholly owns Company C.
Trust T also wholly owns Company D.
Trust T wishes to interpose a new holding company (Company H) which will wholly own both Companies C and D.
Question
If Company C is sued and becomes insolvent, are the assets of Company D protected?
Answer
Unlikely.
Tax Tip
Sections 588V and 588W of the Corporations Act 2001 (Cth) provides that a head company will be held liable for a subsidiary’s liability if such liability leads to insolvent trading of the subsidiary where one or more directors of the holding company have reasonable grounds for suspecting that the subsidiary is, or would become, insolvent.
Generally, for private companies, the director(s) of the holding company is/are the same, or at least mostly the same person(s), as the director(s) of the subsidiary. Therefore, such director(s) of the holding company would have reasonable grounds for suspecting that a subsidiary is, or would become, insolvent.
The usual defences are available for insolvent trading (e.g. better outcome actions, restructuring, refinancing).
However, outside those defences, the issue is that the risk of Company C can flow to Company H. As Company H also owns Company D, Company D will likely need to fund Company H’s liability, otherwise Company H will become insolvent (assuming Company H does not have other assets other than shares in Company C and D). This may mean a share sale of Company D, or a sale of Company D’s assets, to fund Company H's debt.
Thus, there is a significant effect on Company D (which has nothing to do with Company C) but is dragged into Company C’s risk profile and vice versa for Company C being dragged into Company D’s risk profile if Company D is at risk.
It is better for asset protection that Companies C and D are standalone entities unless there is a compelling reason to interpose Company H (e.g. IPO).
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