Question

In the following independent situations, discuss and determine whether a parent–subsidiary relationship exists, and which entity, if any, is a parent. You must fully explain and support your answer. This includes identifying and discussing each of the important facts or considerations in each case.

(a). Tom Ltd is a company that was hurt by a major downturn in the economy. It previously obtained a significant loan from Jenson Bank, and when Tom Ltd was unable to make its loan repayments, the bank made an agreement with Tom Ltd to become involved in the management of that company. Under the agreement between the two entities, Tom Ltd.’s managers had to obtain authority from the bank for acquisitions over $10 000 and were required to have bank approval for the company’s budgets.

(b) Sawyer Ltd is a major financing company whose interest in investing is return on the investment. Sawyer Ltd does not get involved in the management of its investments. If an investee is not managed properly, Sawyer Ltd sells its shares in that investee and selects a more profitable investee to invest in. It previously held a 35% interest in Anderson Ltd as well as providing substantial convertible debt finance to that entity. Recently, Anderson Ltd was having cash flow difficulties and persuaded Sawyer Ltd to convert some of the convertible debt into equity so as to ease the effects of interest payments on cash flow. As a result, Sawyer Ltd’s equity interest in Anderson Ltd increased to 52%. Sawyer Ltd still wanted to remain as a passive investor, with no changes in the directors on the board of Anderson Ltd. These directors were appointed by the holders of the 48% of shares not held by Sawyer Ltd.

(c) Penny Ltd has recently acquired a 35% interest in Leonard Ltd, a company that has discovered large deposits of iron ore. Penny Ltd has extensive experience in the mining industry and, as a result, has been able to have four of its directors elected to the board of Leonard Ltd, which has six directors in total.         

Answer 1

1) In this case, parent-subsidiary relationship does not exist between Jenson and Tom Ltd. merely because Jenson is involved in the management of Tom Ltd. and controls all its important business operations like managers of Tom Ltd. have to obtain authority from Jenson bank for acquisitions over $10,000 and approvals for the budgets of Tom Ltd. but still it cannot be said that Jenson exercises control because in this case, Jenson has decided to get involved in Tom Ltd.'s management because Tom Ltd. was going through a financial downturn and as a result been unable to repay the loan granted by Jenson Bank. Jenson bank's intention is to ensure the recovery of its loan granted to Tom, therefore, it is participating in the affairs of Tom Ltd. having no intention to exercise control over Tom Ltd.

2) Parent-subsidiary relationship exists in this case, because Sawyer Ltd. exercises or controls more than half of the voting share capital in Anderson Ltd. thus making Anderson Ltd. a subsidiary of Sawyer Ltd.which is the parent company. It does not matter whether Sawyer Ltd. wanted to remain as a passive investor or not. The moment its equity shareholding in Anderson Ltd. gets more than 51%, it becomes the parent company of Anderson Ltd.

3) In this case, parent-subsidiary relationship also exists between Penny and Leonard Ltd.,where Penny Ltd. is the parent company and Leonard Ltd. is the subsidiary company. The basis of such a relationship is not acquisition of equity shareholding in Leonard Ltd. but exercising the power of controlling the composition of the board of directors of subsidiary company i.e. Leonard Ltd. In the given case, even though Penny Ltd. has acquired only 35% interest in Penny Ltd. but out of the 6 directors of Leonard Ltd., 4 have been appointed by Penny Ltd., which is more than half of the the total composition of the board. Therefore, by virtue of controlling the composition of directors, Penny Ltd. becomes the parent company of Leonard Ltd.