A corporation that owns more than 50% percent of the common stock of another corporation is the parent of that subsidiary corporation. A subsidiary may be wholly owned, or partially owned by its parent company. A wholly owned subsidiary is one in which the parent owns 100% of the outstanding common stock of the subsidiary. A parent company can and often does have more than one subsidiary company. In fact, it is not especially uncommon for subsidiary companies to themselves have subsidiaries resulting in this configuration:
Top Parent Company <--> Subsidiary Company <--> Subsidiary of the First Subsidiary
The parent and subsidiary must be considered by creditors to be completely separate business entities. This means neither the parent or the subsidiary have liability to creditors for the debts of the other corporation. An exception exists when an inter-corporate guarantee has been signed. An inter-corporate guarantee creates a contractual obligation in which one company, usually the parent company, agrees to guarantee payment of the debts of the other company. Thus, if a trade creditor company is asked to sell to a corporation that is not creditworthy but that company is related to a creditworthy company as is sometimes the case in a parent-subsidiary relationship, one way to make the sale more safely is to require the parent company to sign an inter-corporate guarantee.
Only under special circumstances do courts treat parent and subsidiaries as a single entity. Such cases are rare and do not fit in with the usual understanding of parent-subsidiary relationships as it relates to evaluating the credit risk associated with extending open account credit terms to a subsidiary.
Reprinted with the permission of Credit Research Foundation.
Edited by Michael C. Dennis.