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Holding On

By Vineta Čukste . 29.09.2008

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In recent years, the number of M&A transactions in Latvia has significantly increased. This has resulted not only in market consolidation but also in spin-offs of different businesses into separate companies. This in turn has led to the creation of new groups of companies owned by one holding (or parent) company. These holding firms face a number of legal issues to which specific solutions may be applied.     

The legal issues faced by Latvian holding companies are not very different from those in other countries. They relate mainly to ensuring control over joint business operations, of subsidiaries, and of their mutual transactions. When subsidiaries have different opinions from the parent company on their business goals, complexities in corporate governance have been known to arise.

 Part of the reason for such potential complexities is based on the general concept of commercial law which provides that every company is an autonomous, independent legal entity governed by its shareholders meeting, council (supervisory institution) and board (management institution). This means that decisions made by the parent company are not directly binding upon subsidiaries. These become binding only after the respective decision of a competent management body of the subsidiary (shareholders meeting, board, or board upon council’s acceptance) has been adopted.  It is therefore necessary to ensure that governing bodies of the subsidiaries adopt decisions which are in line with those of the parent company. 

 In practice, two main types of legal solutions are seen for ensuring joint business operations of holding companies:

1.a centralised approach which provides very strict control over the subsidiaries, bringing almost all business decisions to the level of the parent company, or

2.a decentralised approach which only imposes certain holding policies on the subsidiaries, leaving almost all business decisions to the discretion of the subsidiary’s management.

Centralised approach

 Under the centralised approach, the parent company has legal authority to adopt decisions which are directly binding upon its subsidiaries. This approach might seem tempting because it eliminates any risk of conflicting decisions by subsidiaries. However, in practice it has a potentially more problematic side: as the parent company adopts decisions, it also takes over liability for such decisions, which means that the management bodies of the parent company must be competent in all – even the most specific aspects – of subsidiary’s business, which usually makes the implementation of this solution unworkable. Also, in keeping with the Law on Concerns, a parent company must cover all damages incurred by the subsidiary as a result of the parent company’s decisions.

 In practice, the centralised approach is implemented either by the conclusion of a concern agreement among the group companies or by amendments to a subsidiary’s articles of association bringing the decisions to the level of the shareholders' meeting.

 If a subsidiary is a Latvian joint stock company, the competence of its shareholders' meeting is limited to the issues prescribed by the Commercial law, therefore the only mechanism for implementation of the centralised approach is the concluding of a concern agreement.

Decentralised approach

 The decentralised approach provides that the parent company is not authorised to adopt specific business decisions which are directly binding upon its subsidiary.  Instead, the parent company develops and adopts concern-wide policies in the main areas of operations (for instance, financial management, accounting procedures, HR management, PR and external communications, procurement, etc.) and makes them binding upon the subsidiaries either through a concern agreement or amendments to a subsidiary’s articles of association. Further, the management bodies of the subsidiaries must act in line with the approved concern policies, which is monitored by means of evaluation of board and council members and may result in their discharge.

The best solution

 When it comes to finding the best solution for a specific group of holding companies, there is no substitute for a tailor-made approach that takes into consideration various aspects – the type of industry, a company's culture and management style as well as  its existing policies and priorities. In each specific case, the suitability and efficiency of either of the above-mentioned models must be carefully evaluated with regard to specific business issues and the balancing of liabilities, control and freedom of all group companies.