Biggart Baillie Solicitors

The facts and the court's reasoning

by Derek Ellery

The Enviroco case, decided by the English Court of Appeal in December 2009, related to an indemnity granted by Farstad (F) to Asco UK (A) and A’s Affiliates.  In the indemnity agreement the term “Affiliates” relied on the definition of “subsidiary” in Section 736 of the Companies Act 1985.

Click here to view the case report.

Section 736(1)(c) provides that a company is a subsidiary of another company (the holding company) if that other company “is a member of it and controls alone, pursuant to an agreement with other shareholders or members, a majority of the voting rights in it, or if it is a subsidiary of a company which is itself a subsidiary of that other company”.

It was under that “subsidiary” test that E was, initially, a subsidiary of Asco plc.  On that basis both A and Enviroco (E) were subsidiaries of Asco plc, and were Affiliates in terms of the indemnity agreement.

However, Asco plc then granted security to its bankers over its shares in E and, as part of that security, the bank’s name was entered in the register of members of E as being the holder of those charged shares.

E sought to rely on the indemnity.  F resisted the claim on the basis that since (as a result of the share charge) Asco plc was no longer a member of E, E was no longer an Affiliate of A in terms of the indemnity agreement.

E therefore commenced an action against F seeking the court’s declaration that E could rely on the indemnity.

E argued that it could rely on Section 739A(7) of the 1985 Act which provides that rights attached to shares held by way of security are to be treated as held by the person providing the security, where:-

• apart from in relation to preserving or realising its security, those rights are exercisable only in accordance with the instructions of the party granting the security; and
• the shares are held as security in connection with the granting of loans as part of normal business activities.

The security agreement with Asco plc’s bankers satisfied those requirements.

E argued that membership was one of the rights contemplated by Section 739A(7) and that the court should regard the shares in E as being held by Asco plc for the purposes of the definition of “subsidiary” in the 1985 Act, and in applying the definition of Affiliate in the indemnity agreement.

The court did not agree with E’s arguments.  It held that as a result of Asco plc’s bank having the shares registered in its name, the bank, rather than Asco plc, was the member of E in respect of the shares.  As a consequence E was neither a subsidiary of Asco plc in terms of the 1985 Act nor an Affiliate of A in terms of the indemnity agreement.