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Limited Liability - why risk losing it on the basis of an implied contract?

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A recent decision by the Court of Appeal raises potential risks for companies (and their directors) who are part of a group, about the limited liability protections most companies take for granted. The decision could allow the use of the assets of a subsidiary within the group as security for the debts of the parent company. From the point of view of a potential purchaser, this opens up the possible danger of finding, post-completion, that a newly-acquired company has a commitment to pay towards the liabilities of the group.

The Facts

The case centred around whether a business arrangement between two subsidiary companies in the same group had created a contract between them which could be enforced. The two companies formed part of a group within the financial markets industry.  One subsidiary supplied staff to the remainder of the group on a not-for-profit charge-back arrangement, in line with written confirmation from the parent company to one of the subsidiaries, that this would be the arrangement. The case related to whether the arrangement meant that one of the subsidiaries had an obligation to indemnify the other for liabilities related to paying into a defined benefit pension scheme.

The Result

Although there was no written contract, the Court of Appeal came to a unanimous decision that there was an implied contract in place between the two companies which could be enforced by one or the other.  In its decision the court accepted that this type of arrangement was a normal course of dealing between large group companies and that with such arrangements, a contract would have been normal in the circumstances.

Wider Implications

It is also prudent to note the potential liability of the directors.  Directors owe a duty under the Companies Act to apply their independent judgment and promote the success of the company.  If a director of a subsidiary company decides to rely on the board of the holding company to make the decisions for its subsidiaries and so allows the subsidiary (to which he owes his fiduciary duties) to be used by the group for purposes which are not beneficial to that subsidiary, the director in question will not be fulfilling his duties to the company. Even within the circumstances of an intra-company arrangement, directors should still consider what protections they would have negotiated if they had been contracting with a company outside of the group and identify the benefit to the particular company.

This is not the only circumstance in which there could be an implied contract. A number of other functions are usually delegated to a subsidiary within a group on a not-for-profit charge-back arrangement; including, sales, purchasing and taking finance. These arrangements are not always evidenced with sufficient documentation putting the directors in charge at risk.

If you would like any advice please contact our Company Commercial team.

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