What is a Subsidiary?
Corporate business owners understand the value of creating companies to secure and safeguard the owner’s personal assets. Oftentimes, corporations with a large portfolio of assets create new legal entities to hold individual assets or a class of assets, such as real estate, stock, or materials, while controlling over 50% of the subsidiary’s shares, to protect the corporation’s assets. Each new legal entity that is wholly owned by the parent corporation is considered a subsidiary of the parent corporation.
Using subsidiaries as a holding company for the parent corporation’s assets provides significant legal protection from lawsuits against the parent corporation and precludes claimants from going after the parent corporation’s other assets by essentially removing the parent corporation’s liability to that of the subsidiary. Subsidiaries also allow quick and efficient due diligence if the parent corporation pursues liquidation. Further, if a parent corporation seeks financing, it can efficiently enable its subsidiaries to act as guarantors and grantors of security.
Creating subsidiaries introduces many legal and business complexities that require continuous attention. The benefits of corporate subsidiaries are manifold, but parent corporations often fall victim to being accountable for the subsidiary’s liabilities because of poor subsidiary management. This article suggests four steps corporations should take in managing their subsidiaries to ensure effective subsidiary management and the security of the parent corporation’s assets.
#1- Pre-Formation Planning
Before forming the subsidiary, the parent corporation should plan and organize which assets or functions of the business the subsidiary would hold, where the assets or functions will be located, and whether the subsidiary will conduct business and hire employees. The answers to these questions will allow each subsidiary to serve a precise purpose, which will increase efficiency at every stage and simplify its governance.
The parent corporation’s managing officers should also consider centralizing all decisions regarding the subsidiaries’ management with the corporation’s legal counsel or the corporate secretary and passing a resolution authorizing the corporation’s legal counsel or the corporate secretary to take certain actions on the corporation’s behalf, such as the formation of subsidiary companies, deciding the appropriate jurisdiction for each subsidiary’s formation, filing all necessary documents and reports for each subsidiary, maintaining each subsidiary’s records, and paying any required taxes and fees.
Initially, each subsidiary will prepare articles of incorporation and bylaws or an operating agreement. The parent corporation should pursue uniformity and should draft articles of incorporation and bylaws or operating agreements that are substantially similar in form to ensure no contradictory clauses or obligations. The subsidiary’s bylaws or operating agreement should include clauses that provide indemnification to the subsidiary’s directors and limit the directors’ personal liability. Both the parent corporation and subsidiary should also pass separate resolutions and a contribution agreement for the issuance of stock in return for capital contribution, which will allow the subsidiary to demonstrate it has adequate capital to exist as an independent company.
#2- Maintaining the Subsidiary’s Status
It is foreseeable that parent corporations may forget calendar dates when taxes or annual reports (or equivalent filings, as applicable under the jurisdiction’s laws) are due for each of its subsidiaries. When a subsidiary’s taxes or annual reports are past due, the subsidiary is considered not to be in good standing, and the parent corporation exposes itself to the liabilities of the subsidiary (depending on the jurisdiction’s laws and whether the parent company is a corporation). This scenario occurred in a recent case where the parent corporation was successfully sued for money the subsidiary owed to a contractor because the subsidiary was not in good standing.
Accordingly, it is paramount that parent corporations assign a person responsible within each subsidiary for keeping track of due dates for any taxes and annual reports. The subsidiary then should consider passing a resolution authorizing the person responsible within each subsidiary to explicitly take any actions necessary to maintain the subsidiary’s good standing. The person responsible could be one of the subsidiary’s directors or the subsidiary’s legal counsel.
Although the parent corporation wholly owns its subsidiary, the subsidiary should hold its own annual meetings or execute unanimous written consents. If the parent corporation has many subsidiaries, although the directors may be the same, each subsidiary should hold its own annual meetings or execute unanimous written consents rather than performing the same jointly. If possible, the directors of each subsidiary should be different individuals. Through the subsidiary’s resolutions, each subsidiary should be able to demonstrate that the subsidiary is its own company rather than the parent corporation acting through the subsidiary.
#3- Document Everything
If one were to ask a group of attorneys for some non-billable legal advice, they could probably agree on two words: Document everything. Such is the importance of maintaining accurate and up-to-date records on everything. Keep every conversation, contract, note, deed, receipt, complaint, settlement, change of information, and file.
More importantly, each subsidiary should diligently create corporate records for every action that requires board resolutions or consent, as provided by the bylaws or operating agreement. Every stock or asset transfer, material contract, annual meeting, director elections or appointments, and any significant corporate action should be documented in a board resolution. Within the resolution approving of certain actions, a catch-all clause approving of “all corporate actions necessary to further the company’s interests” should also be included to allow the flexibility of demonstrating that all actions performed were by the subsidiary rather than the parent corporation.
After creating subsidiaries, document recording systems often become—for lack of better words—sloppy. Papers get misplaced, lost, or confused. To remedy this, management should consider creating separate filing systems for each subsidiary rather than centralizing document management with the parent corporation. This function can also be achieved by having someone responsible for accurately filing documents and assigning them to the correct subsidiary’s folders. All documents should be well-organized and filed with the appropriate subsidiary.
#4- Invest in Tech Solutions
A cloud-based legal management system streamlines subsidiary management and allows its users to plan, maintain, and document each subsidiary’s records seamlessly. Further, a cloud-based entity management solution minimizes the risks of non-compliance with jurisdictional regulations. With a focus on increasing productivity, scalability, and an automating manual process, Athennian leverages user data to quickly populate reports, certificates, and other necessary documents in one accessible program, eliminating the headache that comes with managing subsidiaries the traditional, time-consuming way.
For a full overview of corporate subsidiary management best practices, you can download this eBook.