Subsidiary

• 1. Introduction

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  A subsidiary does not have to be the bigger company in the relationship. DanJaq is a closely held family company. It controls Eon Productions, the large corporation that manages the James Bond franchise. DanJaq is the parent, Eon is the subsidiary, and by ownership alone DanJaq calls the shots. That arrangement raises the questions this documentary will follow. What legally separates a subsidiary from an ordinary branch or division? How much of a company's shares does another company need before the law treats it as control? And why do the European Union, the United Kingdom, and Australia each define that control differently?

• 2. Distinct but Owned

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  Two subsidiaries controlled by the same parent are called sister companies of each other. A subsidiary is not the same as a branch or a division of its parent. It must follow the laws of the country where it is incorporated, and it keeps its own executive leadership, separate from the parent's.

  Subsidiaries are distinct legal entities for tax, regulation, and liability purposes. Divisions, by contrast, are fully integrated into the parent company and have no separate legal identity of their own. A subsidiary can sue and be sued independently, and its debts do not automatically become the parent's debts. Courts can pierce what is called the corporate veil, holding the parent liable if creditors of an insolvent subsidiary prove the two companies are functioning as a single alter ego. Copyrights, trademarks, and patents remain with the subsidiary until its parent shuts it down.

• 3. Portfolios Under One Roof

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  Berkshire Hathaway, Jefferies Financial Group, Bentley Motors Limited, The Walt Disney Company, Warner Bros. Discovery, and Citigroup all hold subsidiaries spread across many different fields. Other companies keep a narrower focus: IBM, Xerox, and Microsoft, along with their subsidiaries, operate mainly within the tech sector. Most multinational corporations organize their operations by creating or buying subsidiary companies. Many organize their subsidiaries by nation and by function, often stacking several levels of subsidiaries on top of each other.

• 4. The Majority Threshold

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  Owning a majority of a subsidiary's shares gives the parent enough votes to elect its own nominees to the subsidiary's board, and so exercise control. That mechanism produces a common shorthand: 50 percent of the shares plus one is generally treated as enough to create a subsidiary. Other paths to control exist too, and the exact rules of what counts, and how it is achieved, can get complicated. A subsidiary can itself have subsidiaries, and those subsidiaries can have subsidiaries of their own. A parent together with all of them is called a corporate. That term can also describe cooperating companies and their subsidiaries with varying degrees of shared ownership. What decides which company is the parent is the size of its ownership stake, not the number of people it employs.

  A hostile takeover, or a merger struck on friendly terms, can leave a parent and its subsidiary in completely different places or industries. The two can even end up as direct competitors in the same marketplace. Because the two remain separate entities, one of them can face legal proceedings, a bankruptcy, a tax delinquency, an indictment, or an investigation. The other can stay entirely clear of it.

• 5. Layers of Control

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  A first-tier subsidiary sits directly beneath the ultimate parent company. A second-tier subsidiary is a subsidiary of that first-tier company, in effect a grandchild of the parent. A third-tier subsidiary is, in turn, a subsidiary of a second-tier subsidiary, a great-grandchild of the original parent.

  The ownership chain behind Ford Component Sales, a small British specialist company, shows how these tiers stack up. Ford Component Sales sells Ford components to specialist car manufacturers and OEM manufacturers such as Morgan Motor Company and Caterham Cars. Its lineage runs back through Ford Motor Company Limited, the main British Ford company based in Brentwood with 10,500 employees. That entity is the third-tier subsidiary in the chain. Above that sits Ford Technologies Limited, a British holding company based at Ford's UK head office in Brentwood, Essex, with just five employees. It is the second-tier subsidiary. Above that is Ford International Capital LLC, an American holding company located in Dearborn, Michigan but registered in Delaware, the first-tier subsidiary. At the top is Ford Motor Company itself, the American parent based in Dearborn, Michigan. Every link in that chain counts as control in ordinary business terms, though the law does not always agree on what control means.

• 6. A Word With Many Meanings

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  If Company A buys shares in Company B, the deal might not trigger merger control rules at all. That could happen because competition law already treated Company A as being in control of Company B before the purchase took place. At the very same time, accounting rules might require Company A to start consolidating Company B into its financial statements. For accounting purposes, Company B had previously been treated as a joint venture.

  Control can be direct, as when an ultimate parent controls a first-tier subsidiary outright. Or it can be indirect, as when that same parent reaches second and lower tiers only through the first-tier subsidiary in between. The word control, and its relatives subsidiary and parent, can shift meaning depending on the field of law in play. Corporate law, competition law, and capital markets law each frame it differently, and accounting standards frame it differently again.

• 7. The European Test

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  Recital 31 of Directive 2013/34/EU states that control should normally rest on holding a majority of voting rights. It adds that control can also exist through agreements with fellow shareholders or members. In some cases a parent can hold a minority stake, or no shares at all, and still exercise real control.

  Article 22 of the same directive spells out when an undertaking counts as a parent, and it lists several separate paths to that status. Holding a majority of the voting rights in another undertaking is one path. Holding the right to appoint or remove a majority of that undertaking's management or supervisory body is a second path. That path also requires being a shareholder in the undertaking at the same time. A third path exists where the parent can exercise a dominant influence over the other undertaking, through a contract or through its articles of association. That path only applies where the law governing the subsidiary permits such arrangements. A fourth path applies when the parent is a shareholder or member of the other undertaking. One route requires that most of the undertaking's board members were appointed solely through the parent's voting power. Those members must have held office through the current and preceding financial years, right up until the consolidated financial statements were drawn up. A second route requires that the parent alone controls a majority of the voting rights through an agreement with fellow shareholders. Control can also arise in two further ways. It exists when a parent has the power to exercise, or actually exercises, dominant influence over another undertaking. It also exists when the parent and that undertaking are managed on a unified basis.

  IFRS 10, paragraph 7, sets a three-part test for control under the international accounting standards the EU has adopted. A company must hold power over the other company. It must also have exposure, or rights, to variable returns from its involvement with that company. And it must be able to use its power to affect the size of those returns. IFRS 11, paragraph 4, adds that a subsidiary can have only one parent. If two or more parties share control instead, the arrangement counts as a joint venture or joint operation. Any decision on its core activities then needs the unanimous consent of every party sharing that control.

• 8. Britain and the Commonwealth

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  The Companies Act 2006 sets out two separate definitions, one for 'subsidiary' and one for the broader term 'subsidiary undertaking'. Under section 1159, a company counts as a subsidiary of its holding company under any of three tests. The holding company might hold a majority of its voting rights. It might be a member of the company with the right to appoint or remove a majority of its board. Or it might be a member that controls a majority of the voting rights through an agreement with other members. A company is also a subsidiary if it is itself a subsidiary of a company that is a subsidiary of that same holding company.

  Section 1162 defines the broader term, 'subsidiary undertaking', and its counterpart, 'parent undertaking'. An undertaking is a parent if it holds a majority of the voting rights in the other undertaking. It also qualifies if it has the right to appoint or remove a majority of that undertaking's board. A third route is the right to exercise a dominant influence over it, whether through the undertaking's own articles or through a separate control contract. It also qualifies as a parent through membership plus control of a majority of voting rights, achieved through an agreement with other shareholders. The narrower 'subsidiary' definition is used for general purposes, while the broader 'subsidiary undertaking' definition governs the accounting provisions of the Act.

  In Oceania, accounting standards take a different approach. They define control as one entity's capacity to dominate another's financial and operating decisions, so the two can pursue the controlling entity's objectives together. Australia adapted that definition directly into its Corporations Act 2001, at section 50AA. That same legal capacity can work in a company's favor as well. It gives management room to pursue new projects and adapt to whatever rules currently apply.