Contagion Liability Risk in the United States and Australia for Parent Entities Arising from the Insolvency of a Subsidiary

This article first appeared in Volume 18, Issue 1 of International Corporate Rescue and is reproduced here with the permission of Chase Cambria Publishing - www.chasecambria.com.

With the influx of insolvency cases expected on a global basis in coming months as government support measures are wound back, now is an opportune time for businesses to consider the extent of their potential exposure if a subsidiary liquidates. In particular, can losses be isolated within a liquidating subsidiary, or will there be a contagion effect, so that a parent entity may be held liable for the outstanding debts of the subsidiary?

Given the global, cross-border nature of many modern businesses and the attendant complex corporate group structures, it is important for entities to understand the legal liability framework that applies in the different jurisdictions where they operate or are formally organised. The particular focus of this article is the potential liability of parent entities for the debts of their insolvent subsidiaries in Australia and the United States.

In these jurisdictions, the risk that parent entities will be liable for the debts of their insolvent subsidiaries is greatest where the corporate structure has been used in an improper attempt to avoid legal liabilities, or where assets have been intermingled across different entities within the corporate group, a parent has improperly benefited from the operations of the subsidiary, and/or the parent entirely controls and directs the operations of the subsidiary.

The liability risk in the United States is greater than in Australia, with parent entities potentially liable, on the basis of substantive consolidation, for a broad range of unsecured debts of a debtor subsidiary. Moreover, in certain circumstances a parent of a debtor subsidiary in the United States may have its intra-group loans subordinated to other creditors under equitable principles. However, those outcomes are far from the norm and, as a general rule, courts will respect corporate separateness and will enforce properly documented and incurred intercompany debts.

Significantly, in both the United States and Australia, the current legal principles adopted by the courts in assessing parent entity liability lack precision and are largely untested in the pandemic context, and this itself may serve as a deterrent to responsible risk-taking and value-creating activity within a corporate group. This is an area that could benefit from further legislative guidance as law reform becomes a more dominant focus in the economic recovery period across the world in response to COVID-19.

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