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Many large and complex businesses organise their business across several companies, which are ‘group companies’. The critical benefit of operating your business through group companies is that you ringfence risk into each individual company. However, the law imposes specific legal requirements on group companies, and you need to be aware of these legal considerations for group companies. This article will summarise group companies’ primary purpose and benefit before exploring critical legal and commercial issues.
Overview
Group companies are two or more companies engaged in the same business or enterprise.
Usually, companies in a group company share resources and funnel profits to a single group of shareholders, though this is not always the case.
You will find that most medium-sized and large companies operate through group companies. This is because the principal benefit of group companies is that each company benefits from the legal concept of limited liability. None of the individual companies within the group is responsible for any other company’s debts and obligations, aside from those obligations the group has expressly agreed to enter into.
Group Companies Structure
Group companies can vary in complexity, but most group companies tend to have the same fundamental structure. The business’ shareholders all own shares in an ultimate parent company — commonly called the holding company (“HoldCo”). The parent company then holds the shares in each company engaged in the business’s operational activities. These operating companies (or “OpCos”) are the parent company’s subsidiaries.
For example, suppose your company YouCo has a long-established business in manufacturing, and you want to expand into delivery and retail. To protect the value of the established business, you incorporate OpCo1 Ltd and OpCo 2 Ltd, which will operate the delivery and retail divisions. You then incorporate HoldCo to hold the shares in OpCo 2 and OpCo 3 and transfer the shares to you.
To the outside world, the entire business (YouCo) appears to act as a single entity, but legally, each is distinct. Provided there are no agreements stating otherwise, HoldCo is not responsible for the liabilities of any of the OpCos, nor is one OpCo responsible for the liabilities of the others. If the delivery operation (OpCo 2) does not work out, the rest of YouCo’s assets are safe from OpCo 2’s liabilities.
Legal Definitions
In the example given, HoldCo is the holding company for each of the OpCos because it owns all the shares in each of the companies. The legal definition of a holding company is any company that:
- has a majority of voting rights in another company; or
- holds shares in a company and has the right to appoint or remove a majority of the board of directors.
The other company is a subsidiary company. If the subsidiary itself is a holding company of another company, the subsidiary’s parent company is also the parent company of the third company (see below).
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Variations
In the above examples, each of the subsidiary companies has been wholly owned by a single parent company.
Additionally, a subsidiary can be owned by two or more companies (just as YouCo is owned by you and the other two shareholders) (see below).
In the above structure chart, if YouCo decides to expand into Italy, to ring-fence the risk, you should incorporate ForeignCo S.p.A. Also, due to specific accounting considerations, you would assign OpCo 1 70% of the shares and OpCo 2 30%. In this case, both OpCos would be parent companies of ForeignCo.
Finally, there are instances where a subsidiary company is partly owned by a company that sits outside the group company. You tend to see this in large multinational public companies.
Restrictions on Group Companies
Company law in England imposes certain restrictions on the operations of group companies. These are described below.
Membership in Holding Company
A subsidiary cannot own shares in its holding company. For instance, if you tried to transfer shares in HoldCo Ltd to OpCo 1 Ltd, the law would not recognise the transaction.
Substantial Property Transactions
YouCo may want to move certain assets across different group companies in practice. For instance, suppose YouCo identifies an opportunity to buy and sell land for the benefit of the business as a whole, then YouCo incorporates SubCo Ltd as the trading company for this business division. YouCo later determines that it wants to transfer a piece of land to OpCo 3.
As is often the case, you are a director on the board of SubCo and OpCo (and HoldCo).
Since the law requires that a director owes their duties to the individual company (and not the group), you must follow specific processes to transfer valuable assets between group companies:
- SubCo’s shareholders (OpCos 1 and 2) must pass an ordinary resolution authorising the sale of land; and
- HoldCo must pass an ordinary resolution authorising the transaction.
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Intra-group Loans
There are many commercial reasons for lending money from one company in a group to another — with tax benefits being one of the most common.
If OpCo 2 lends money to SubCo, this is treated much like a third-party loan from a legal perspective. For instance, if SubCo refused to repay for whatever reason, OpCo could claim against SubCo.
Likewise, if YouCo later wanted to sell SubCo to another company through a share sale, the obligation would follow SubCo unless SubCo repays the loan or OpCo 2 writes the claim off.
Group Guarantees
If YouCo as a whole wanted to raise money through debt financing (i.e. borrowing money from a bank), you determine that HoldCo should be the borrowing entity so that YouCo can effortlessly downstream the cash to the other companies as needed.
The principle of limited liability means that the bank can only recover its money from HoldCo’s assets if it defaults under the terms of the loan. This is not ideal for the bank, especially if HoldCo has no real assets because the subsidiary companies own YouCo’s valuable assets.
In practice, the bank may require other companies to guarantee the loan to get around this. The effect is that if HoldCo defaults under the terms of the loan, it can claim against any of the guarantors’ assets.
Group Accounts
The law requires the ultimate parent company to prepare separate “group accounts” for all of its subsidiaries. This is in addition to the parent company’s individual accounts, which all companies must prepare.
In YouCo’s case, HoldCo must file accounts assessing the profits, losses, and income for all subsidiaries and prepare its own accounts. However, the intermediate companies (the OpCos) are not obligated to prepare group accounts for their subsidiaries.
Key Takeaways
The use of group companies is common for large and complex businesses. This is because the effect is to ringfence the liabilities of each company so that the entire business is not at risk if one company is unsuccessful. Specific legal and commercial considerations are unique to group companies, such as accounting requirements, third-party guarantees, and restrictions on property transfers.
If you need help with the key legal and commercial considerations for group companies as part of your business in England, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today at 0808 196 8584 or visit our membership page.
Frequently Asked Questions
A group company structure is where a business’ shareholders all own shares in a parent company. The parent company then holds the shares in operating companies engaged in the business’s operational activities. These are the parent company’s subsidiaries.
If you want to move your business into a riskier area, such as by moving up or down the supply chain, you can ring-fence the risk by confining it to a newly incorporated company. By having two or more companies, you create a group company structure.
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