Can A Parent Company Be Held Liable For The Acts Of Its Subsidiaries And Vice Versa?

Imagine a local construction company is awarded a government contract for road construction. To execute the project, it forms a subsidiary company which handles procurement and subcontracting. Over time, the subsidiary accumulates substantial debts to suppliers and workers, then becomes insolvent. The affected parties seek compensation, but the subsidiary lacks sufficient assets to settle its obligations. This raises a crucial legal question: Can the parent company be held liable for its subsidiary’s financial obligations?

The contrary is also likely; a subsidiary thrives whereas the parent company becomes insolvent. In such cases, can the subsidiary be successfully pursued for the parent company’s liabilities?

While the principle of separate legal personality and the limited liability rule generally shield parent and subsidiary companies from bearing each other’s liabilities, exceptions exist. This article explores such circumstances.

Understanding the Legal Relationship Between Parent and Subsidiary Companies

A parent company is legally distinct from its subsidiaries, remaining a shareholder with the rights, obligations, and duties incumbent in that role. The vice versa is also true, a subsidiary company is separate and distinct from the parent company. The Companies Act, 2015, under Section 19, reinforces this recognition of the separate legal personalities of companies incorporated in Kenya. This is in line with the doctrine of separate legal personality, established in the landmark case of Salomon vs. A Salomon & Co Ltd [1897] AC 22, which presumes that each company is an artificial legal person, therefore, it can be regarded as separate from those who created it and thus liable for its own deeds and liabilities.

Thus, mere ownership of a subsidiary does not automatically mean they are considered a single entity for legal responsibility. They remain separate, and a parent company is not liable for the acts of its subsidiary.

Circumstances Where a Parent Company May Be Liable for its Subsidiary’s Acts and vice versa

Despite the general rule of separate legal personality, a parent company can be held liable for the acts of its subsidiaries and vice versa, particularly where there is question of liability arising from contractual and tortious acts.

1. Piercing the Corporate Veil

Piercing of the corporate veil is an exception to the principle of separate legal personality and limited liability. It refers to the situation where the Courts disregard the separate legal personality of a company and hold the parent company liable for its subsidiary’s actions/liabilities or the subsidiary liable for the parent company if certain conditions are met.

The Supreme Court of Kenya in Simon Wairobi Gatuma vs. Kenya Breweries Ltd & 3 Others [2024] KESC 52 (KLR), in applying the case of Adams vs. Cape Industries Plc [1990] Ch 433, set out three main instances where piercing of the corporate veil may be justified;

i) Where the subsidiary and parent should be regarded as a single economic unit;

ii) Where the subsidiary is set up as a façade concealing the true facts and avoid legal obligations; and

iii) Where an agency relationship exists between the parent and the subsidiaries.

In these instances, a court may look for specific requirements that allow it to disregard the separation between a company and its shareholder(s), which can extend to a subsidiary and its parent company.

Single economic unit

A parent and subsidiary may be treated as a single economic unit where the subsidiary lacks genuine independence and serves as an extension of the parent’s operations. It involves treating the parent and subsidiary as a single enterprise and holding the single enterprise responsible for harm caused by any individual company within the group.

To be considered a single economic unit, there has to be such a high degree of unity between the entities in question that their separate existence has de facto ceased and in light of this unity, treating the entities as separate would promote injustice.

The Court in Muthoni vs. Barium Capital Limited & Another [2024] KEELRC 2345 (KLR), lifted the corporate veil and treated the parent company, Centum Investment Company PLC and its subsidiary, Barium Capital Limited as a single economic unit. The Court held that Centum Investment Company PLC exercised complete control over

Barium Capital Ltd, including financial oversight, executive decisions, and payroll management. The court found that this level of control negated the legal distinction between the entities, justifying the piercing of the corporate veil to hold Centum liable for employment-related claims against Barium Capital.

Alter Ego Doctrine

In company law, an "alter ego" refers to a situation where a shareholder, typically holding a controlling interest, exercises such complete control and domination over a corporation that the company's separate legal existence is disregarded. This occurs when the shareholder's actions are used to perpetrate a fraud, wrong, or injustice. Essentially, the company becomes a mere instrumentality or "alter ego" of the controlling shareholder.

In Jayden Limited vs. Bradley Limited [2021] KEHC 127 (KLR), the Court lifted the corporate veil of Bradley Limited’s parent company, Pevans East Africa Limited, due to evidence of fraudulent dealings.

Agency Relationship

This is where a subsidiary company acts as an agent of the parent company rather than an independent entity. Where agency is established, then the legal personality principle might be disregarded and the veil lifted to attach liability on either the subsidiary or the parent company as the case may be.

Kenyan courts assess whether a subsidiary is a genuine independent entity or merely an agent of the parent company based on factors such as the degree of financial and managerial control exerted by the parent company, whether the subsidiary’s actions were expressly authorized by the parent company or whether the subsidiary and parent company share the same directors, operational structures, and business interests.

The Doctrine of Direct Parent Liability – what it is and when it arises?

This is different from the piercing of the corporate veil discussed above. It allows parties injured by conduct emanating from subsidiaries to bypass the complexities associated with veil piercing and pursue the parent company directly if the relevant threshold is met. The key aspect here is not that the parent controlled the subsidiary to such an extent the latter became a mere alter ego, but that the parent’s own conduct contributed to the harm. Imposing a duty on the parent company does not involve veil-piercing.

Under common law principles adopted in Kenya, a parent company may be held liable for the tortious acts of its subsidiary if it assumed direct responsibility for its operations,

particularly in cases of negligence. This aligns with the case of Chandler vs. Cape Plc [2012] EWCA Civ 525, where the Court held that a parent company owed a duty of care to employees of its subsidiary where it exercised significant control over its operations and had assumed responsibility for the health and safety policies.

Contractual Guarantees and Indemnities

A parent company can voluntarily assume liability for a subsidiary’s obligations through guarantees or indemnity agreements and the vice versa. This is common in financing arrangements where lenders require related companies to guarantee loans or contractual performance. If a parent company provides such a guarantee, it becomes directly liable for the subsidiary’s debts or breaches and vice versa.

In Embakasi Management Limited & 8 Others vs. Imperial Bank Limited (In Receivership) & Another [2022] KECA 7 (KLR), the Court of Appeal upheld the High Court’s decision, affirming that a company may be held liable for the debts of a related entity if it has voluntarily assumed such liability. In this case, the directors of Farm Africa Mills Investments Limited had signed a right of set-off agreement, which allowed Imperial Bank (in receivership) to recover the outstanding loan from any company within the Milly Group. Given the common ownership and directorship among the companies, the court found that the bank was justified in offsetting the debt against their deposits. By signing such an agreement, the parent and associated companies had voluntarily assumed liability for the subsidiary’s obligations.

Conclusion

While Kenyan law upholds the doctrine of separate legal personality, parent companies and their subsidiaries are not immune to each other’s liability. Courts continue to refine principles governing corporate group accountability, ensuring justice in cases where corporate structures are used to evade responsibility.

HOW CAN WE HELP?

The Debt Recovery Restructuring and Insolvency team at CM Advocates LLP prides itself in having a wide variety of resources, skills, and experience on recovery of debts, enforcement of guarantees, Realization of charged securities, Hire Purchase Debts and Asset Repossession. We are practical and innovative in our approach and offer quick turnaround timelines. We will be delighted to receive your feedback and inquiries and offer our services in this and any other of our practice areas.

Written by:

Caroline Kendi – Senior Associate

Mary Munjogu- Associate