What Happens to Subsidiary Companies If a Parent Company Is Liquidated?
If you own multiple businesses, you may find it convenient to limit your liability and risk by creating subsidiary companies.
Subsidiary companies are wholly owned by a parent company, but what happens when the parent company is facing liquidation?
The liquidation of parent companies is a complex and often messy event. In this article, the experts at Irwin Insolvency explain what could happen.
What Is a Subsidiary Company?
A subsidiary company is a specific type of legal entity that’s wholly owned by a parent company. A subsidiary company’s operations and assets are distinct from the parent company, but the parent company is the sole shareholder in the subsidiary.
This allows a number of advantages, with subsidiary companies often opened as a way to limit the risk of the parent company. This could be necessary if the parent company is opening new businesses in new locations, or entering into new markets it’s unsure of.
For example, imagine you are the director of a car rental company. You decide that you want to expand your business, but given the volatile nature of the current economy, you decide to limit the risk to the parent company by opening a new subsidiary company.
A subsidiary company is operated as a separate entity from the parent company. Consequently, it will have its own management, accounts, assets and capital. There may be some crossover and influence from the parent company, but legally the subsidiary is free to carry out its own operations if necessary.
But while the subsidiary company has this operational freedom, it is still limited by the fact that it will appear on the books of its parent company as an asset. When both companies are doing well this isn’t a problem, but if either company is liquidated things become complex.
What Happens to a Subsidiary Company If It Becomes Insolvent?
A subsidiary company exists to limit the risk and liability of its parent company. Because the subsidiary company is a separate legal entity, the parent company has no liability for the subsidiary’s losses.
This means that if the subsidiary begins to lose money, the parent company isn’t obliged to pay its debts or bail it out (although it can if it feels the subsidiary can be saved). It also means that if the subsidiary owes money, creditors aren’t legally able to chase the parent company for payment.
In the car rental company example above, the parent company may choose to liquidate the subsidiary if its sales are poor and it begins to lose money. This would have no bearing on the parent company’s operations or finances.
What Happens to a Subsidiary During the Liquidation of Parent Companies?
Things become much more complex when the parent company, rather than the subsidiary, is in trouble.
Technically, both are individual legal entities. This means that theoretically if a parent company were to be liquidated, there should be no effect on the subsidiary’s operations. The subsidiary could carry on trading while the parent company attempts to rectify its financial position. Legally, the subsidiary company has no obligation to pay the parent company’s debts. Likewise, creditors cannot chase a subsidiary in order to recoup debts incurred by its parent company.
However this isn’t the case in practice, and that’s because the subsidiary is classed as an asset of the parent company. If the parent company needs to pay debts or refinance itself, then it has the option of selling the subsidiary company in order to raise funds.
This means that while the parent company does not have operational control, the very existence of a subsidiary company is under the control of the parent company. If the parent company is facing financial trouble, then the directors could choose to sell parts of its subsidiaries or sell the subsidiary’s assets.
If the parent company is going through a liquidation process, then even if the subsidiary is solvent it could be sold in order to pay the parent company’s creditors. If a parent company is liquidated, then it’s unlikely the subsidiary will survive unless it’s sold whole to a new owner who continues operations.
Contact Irwin Insolvency Today to Find Out More About the Liquidation of Parent Companies
If you’re a company director in need of insolvency advice, our team of experienced insolvency practitioners are here to help. We can provide expertise and impartial advice that could save your parent company or its subsidiaries from liquidation.
Contact Irwin Insolvency today to find out more about how the liquidation of parent companies will affect subsidiaries.