This article is written by Kashish Khattar, Amity Law School, Delhi [IPU], currently enrolled in the Ace your Internship course at Lawsikho.

Introduction

A subsidiary is a company that is wholly owned or majority controlled by another company, the “parent.” Subsidiaries are made to serve different business purposes starting from corporate structuring, to developing new products and services, regulatory compliance, tax efficiencies and mergers and acquisitions, to expanding into new geographical markets.

Subsidiary Governance

When it comes to governance of subsidiaries, the companies face a variety of challenges such as extending sound corporate governance practices and policies downstream to the subsidiaries and the appropriate governance structures of the subsidiaries which would lead to effective governance. Subsidiaries come with their own problems and dilemmas. One such dilemma is how the parent should control the subsidiaries and the level of independence that should be given to them.

There is the search for the classic balance between the degree of control that needs to be exercised by the parent over its subsidiaries and the degree of independence that needs to be provided to them and between standardisation of the systems and processes across the organisation and local adaptation at the subsidiary levels. On the other is the question how do the parent and the board place systems and processes which will assure them that “downstream governance” of the subsidiaries reflects the same values, ethics, controls and processes as at the parent board level.

Ineffective working of the subsidiary board can cause problems, they often relate to the role of the subsidiary board, the matters which the subsidiary board should discuss, extent to which a subsidiary board could take decisions independent of the parent board’s policy. There is no clear way that is to have effective solutions, subsidiary board in different jurisdictions must be objective about the management of the business of the subsidiary and be well versed with the business philosophy, culture and strategic direction of the parent.

Domestic v. Overseas Subsidiaries Governance

Culture and jurisdiction always influence the way a company is governed. Organisations have to recognise influence of culture and diversity while building systems of effective corporate governance. The parent board may often view the company as one organization and does not differentiate decision making based on a legal structure of a subsidiary, but overseas subsidiaries are distinct from domestic ones, due to a difference in language, a different legal and tax environment, cultural differences as well as time differences.

Overseas subsidiaries always carry greater risk, particularly those operating in developing countries such as India, where there is a greater emphasis on having parent management control the subsidiary, directly or indirectly through different ways. International subsidiaries mostly have a country controller’s office that can handle local issues and can coordinate with the parent company management in case of a crisis. The domestic subsidiaries are included in the parent governance practice principally because it simply resides in the same country. Most decisions can easily be made centrally under the same governance structure for domestic subsidiaries.

Subsidiary Governance Manual – A Checklist

The initial steps include:

• obtaining holding company and subsidiary boards, setting the tone from the top;
• Audit subsidiaries in the group and collate key information on them.
• Establish the team for the project;
• Setting key goals for the project;
• Communicating the rationale for the project with the key people to be involved in setting up the subsidiary governance framework.

The key considerations would include:

• implementing best practice corporate governance throughout the group bearing in mind the region’s best regulatory and legal practices impacting corporate governance;
• being mindful of the local laws and regulations, including customs. Involving subsidiary boards and management.

Key issues concerning documents, policies and procedures would be:

• to draft group wide policies, statements and procedures (eg. anti-bribery, ethics, health and safety and human rights.) and make them easily accessible;
• making terms of reference as to what is expected of the subsidiary company about their interaction with the parent company, mainly;
• ensuring delegation of authority is properly defined in the terms of reference;
• establishing clear reporting lines to the parent company and making a communications guide;
• drafting and implementing board meeting procedures for matters including circulation and form of agenda and board meetings and how to deal with the minutes of the meeting;
• drafting and implementing conflicts of interest policy and ensuring that the documents of subsidiary companies permit independent directors to authorize any conflicts.

Implementation and the ongoing procedure include:

• communicating best subsidiary practice to the staff of the said subsidiary;
• appointing the best people with a lot of corporate governance experience under their belt to subsidiary boards;
• maintaining close relationship with the board and inculcate regular review process on the operations of the subsidiary.

Software Systems – Legal Entity Management System

Corporate governance, compliance and legal departments have to be updated with all the complex due diligence, notifications and administrative maintenance data. Regulatory information reporting is significant in almost every part of the world. All major departments require some kind of access to corporate data for the conduct of daily business.

For basic entity management, these points should be kept in mind-

Be updated with the fiduciary, regulatory and statutory duties of the entity as a whole and the directors, officers, managers and partners etc.

Advising the board on management and committees on corporate governance and updating records to support all transactions, filings, reports and audits to fulfill responsibilities. Also giving secure access to support internal and external business requirements.

Reporting Structure

If a company holds an interest in a subsidiary company, this information must be consolidated into the parent’s annual report. Each company maintains its own records so typically subsidiaries maintain their own records and submit them to the parent company for review and consolidation.

Annual Reports – They are the key information to all the interested parties in a company. The parent’s report should basically include the percentage of stock and a list of all subsidiaries they hold interest in.

Consolidated Financial Statements – Heart of the annual report is the company’s financial information. They give the real picture of the enterprise. A complete set of financial statements consist of balance sheets, income statements, statement of cash flow and statement of equity. Correct consolidation method depends on the equity the parent holds in the subsidiary.

Disclosures and Footnotes – They should include any other information that may have an impact on company’s stability or future growth.

Conclusion

A subsidiary company is a company controlled by a holding company. Subsidiary basically means supplementary. It is not fundamental for groups to only focus on parent company governance. The risks attached to subsidiaries can be huge if there are loopholes in it’s governance. Some of the legal risks involved can be about regulatory compliance failure, personal exposure to directors and officers, potentially unauthorised commitments, and greater tax, commercial and operational risk etc.

Good subsidiary governance practice can include establishment of a subsidiary board, explicit group management philosophy, group decision making policies and guidelines and Central governance policy stipulating subsidiary framework governance. It can also include practices such as clearly defined relationship parents and subsidiary, Clear reporting structure between subsidiaries and parent company and an independent audit committee. Problems regarding subsidiaries can mainly revolve around regulatory conflicts, commercial and managerial conflicts, conflicts between different interests of subsidiaries and conflicts between the organisational and national cultures of the parents and the subsidiary.

Subsidiary is a separate legal entity. The primary aspects of subsidiary management are separate entities, management, liabilities and independence. Directors of the subsidiary are responsible for the affairs of a wholly-owned subsidiary. The directors must act in best interests of the subsidiary even when they are in the conflict of the parent company. The directors of a subsidiary are subject to statutory and regulatory duties under the applicable local laws. Governance practices for the subsidiary need to be consistent with the purpose for which the subsidiary was established.