Corporate governance issues for UK subsidiaries of international corporates

The globalisation of business is ever-increasing. Corporate entities are becoming more familiar with the experience of working in numerous locations, often with different legal jurisdictions. However, the manner in which international business is conducted can lead to potential breaches of UK company law, sometimes leading directors to incur personal liability. Even organisations whose top level corporate governance is exemplary can be at risk if they do not extend the same level of diligence to their subsidiaries.

Issues arising can include the following:

• Subsidiary boards of directors are often dominated by representatives of the overseas parent (typically in-house counsel) with little, or in some cases no, local management representation. Formal board meetings may be held only infrequently, perhaps to approve substantial transactions or board appointments. In these cases, directors risk losing sight of the fact that they owe statutory duties to each separate company, not to the group as a whole. These duties include the promotion of the success of the subsidiary and the exercise of independent judgment. Of course, the interests of subsidiaries and parent will often be closely aligned. But in some cases, they will be very different. Some transactions (for example, a bank or other financing guarantee) or other arrangements (such as cash pooling for treasury purposes) may promote the business of the parent, or another part of the group, but have no demonstrable benefit for the subsidiary itself. Directors approving such transactions without believing, in good faith, that they will promote the subsidiary's business, or who may have conflicts of interest, are in breach of duty and may be liable to fines or other penalties.
• In these circumstances, it may be that key business decisions are taken in practice by top level divisional managers or other individuals who are not actually on the subsidiary board at all. These individuals are then at risk of being "shadow directors". Shadow directors owe many of the same legal duties as directors who are properly appointed to the board and may incur liabilities for breach of duty or other legal requirements including fines and, in extreme cases, imprisonment.
• These issues can be compounded where, as is commonly the case, businesses are run on divisional lines. A single UK subsidiary may be involved in the business activities of a number of separate divisions. If the local management of each division reports up the line to divisional heads at the parent, this may mean that no formal board or other proper decision-making process occurs at all below parent level. However, the subsidiary will still have directors appointed to its board; those individuals owe legal duties to the subsidiary. It would be difficult to demonstrate in these circumstances that those duties were being properly discharged. The risk is particularly acute where breaches of duty may give rise to strict liability (that is, where a criminal prosecution will succeed even without any proof of intention to break the law). This is often the case in respect of regulations governing such areas as health and safety, environmental protection and consumer protection.

For suggestions on how to avoid issues arising, read Wragge & Co's tips for action.