I was prompted to consider the word subsidiary when I realized that it’s not necessarily clear what kind of entities can be a subsidiary. And I stuck around to consider how one might define subsidiary.
What Kind of Entities?
The main problem with subsidiary is that it can create confusion regarding what kind of entities can be a subsidiary.
Let’s consider first a relatively easy case, the phrase subsidiary corporation. This newsletter by Edwards Angell Palmer & Dodge on the ACC Newstand describes how in American Electric Power Co. v. Affiliated FM Insurance Co., No. 07-31061, 2009 U.S. App. LEXIS 1056 (5th Cir. Jan. 21, 2009), the Fifth Circuit affirmed a district court decision holding that coverage for “subsidiary corporations” doesn’t ordinarily include limited liability companies.
If you’re looking to include LLCs and other non-corporate entities, referring instead to subsidiary would seem to be a better bet. After all, it’s easy enough to find court opinions that refer to LLCs as subsidiaries of another company. See, e.g., In re Owens Corning, 419 F.3d 195, 200 (3d Cir. 2005) (“OCD and its subsidiaries (which include corporations and limited liability companies) comprise a multinational corporate group.”).
But the word subsidiary is a truncation of subsidiary corporation, so it would seem that as originally conceived, subsidiary didn’t include LLCs. And Black’s Law Dictionary doesn’t offer a definition for subsidiary distinct from its definition of subsidiary corporation. So in the absence of any generally accepted definition of subsidiary that specifies what kind of entities can be a subsidiary, the cautious thing to do would be to create a definition for subsidiary.
Creating a Definition
But defining subsidiary raises issues beyond the kind of entities involved:
- Should the definition be generic, so that Subsidiary can refer to anyone’s subsidiary, or should Subsidiary mean a subsidiary of Acme?
- Should the definition consider the parent acting alone, or also acting with others?
- Should the definition consider both direct and indirect ownership?
- Should the definition refer to ownership of voting interest or economic interest, or both?
- Should the key proportion be half, or more than half?
After mulling over these issues, I came with the following prototype generic definition:
“Subsidiary” means, with respect to any given Person, any corporation, partnership, limited liability company, trust, or other legal entity of which that Person or one of that Persons’ Subsidiaries, in either case acting alone or with one or more of that Person’s other Subsidiaries, owns, or has the power to vote or exercise a controlling influence with respect to, more than half of the capital stock or other ownership interest giving holders the right to do one or both of the following: (1) elect the board of directors or other governing body of that legal entity and (2) receive the net assets of that legal entity available for distribution to holders of all stock or other ownership interests upon liquidation or dissolution of that legal entity.
I expect that as I work on this definition it will go through plenty of changes.
Note that in the context of stock option grants, you’d presumably need to refer instead to the definition of “subsidiary corporation” contained in section 424(f) of the IRS Code.
Your suggested definition implies that a trust and a partnership are legal entities which may not be the case. The term “legal entity” is not unduly strained by extending to a partnership even though a partnership is not a legal “person” in the same way that a corporation is. But for some trusts – such as non-commercial trusts – the real owners of the trust assets are the beneficiaries who often have no say in the choice of the trustees. Perhaps your definition is not intended to extend to trusts other than those whose governance resembles that of corporations.
Bruce: Great comment. Even when coming up with language as unexciting as a definition of subsidiary, one encounters specialized issues. Ken
The UK Companies Act has definitions of “subsidiary” (companies only), “subsidiary undertaking” (including partnerships and unincorporated associations – we do not have LLCs), “group undertaking”, “holding company” etc, and UK agreements tend to refer back to the Companies Act when defining those terms.
The definitions are fairly immune to work-arounds (via informal control), the principles are well-established and understood by the courts and the parties are likely to be both be comfortable with using them, which make them generally by far the best option. However, I have no idea whether there are similarly useful definitions in any US statutes.
It is most likely that the term “subsidiary” will be used in the context of a commercial transaction. If the intent is to encompass all forms of legal entities, then the term “business organization” as defined in the ALI’s Principles of Corporate Governance may suffice. A business organization is defined as “an organization of any form (other than an agency or instrumentality of government) that is primarily engaged in business, including a corporation, a partnership or any other form of association, a sole proprietorship, or any form of trust or estate.”
Section 1173(1) of the Companies Act 2006 has a somewhat similar concept encapsulated in the term “firm,” which means “any entity, whether or not a legal person, that is not an individual and includes a body corporate, a corporation sole and a partnership or other unincorporated association.” According to general usage, a firm is associated with a commercial or business undertaking. So I do not think it is a stretch to say that a firm is basically the same as a business organization.