The Case For Further Flexibility In Matters Of Cross-Border Corporate Mobility

The right of establishment provided for by the Treaty of Rome of 1957,1 one of the founding principles on which the European Union2 was built, consists in the abolition of restrictions to the freedom of nationals of a Member State to create a business activity on the territory of any Member State including by establishing a company or a branch or subsidiary of a company there.3

Soon enough, it became apparent that a natural extension of this right was to allow existing companies established in a Member State either to merge into a company established in another Member State or to move their corporate seat to another Member State and become subject to the national corporate laws of such jurisdiction (in the latter case, without triggering a loss of legal personality of the migrating company).

1. 'IT'S COMPLICATED ... '

   Regrettably however, three complicating factors delayed an early integration of this corollary of the freedom of establishment under EU law.

   First, the manner in which the right to establishment was worded in the EEC Treaty left sufficient room for interpretation on whether it did or did not include a right for corporate mobility and the constraints within which such a right would operate that most Member States did not feel compelled to adapt their decades-old limitations to inbound or outbound transfers of corporate seats in order to facilitate those operations. And while the EEC Treaty contained an undertaking from Member States to negotiate the terms of secondary legislation in respect of 'the maintenance of [companies'] legal personality in cases where the registered office is transferred from one country to another and the possibility for companies subject to the national laws of different Member States to form mergers',4 such commitment never materialized into positive law (with respect to changes of corporate seats5) or in a belated manner (with respect to cross-border mergers6).

   Second, to this date Member States are still allowed by European law to use a connecting factor of their choosing with regard to the applicability of their own lex societatis to companies. Variations of two legal theories are used in practice: the 'incorporation theory' and the 'real seat theory'. Under the former, a company must apply the corporate law of the place where its registered seat has been established (i.e. a 'form-over-substance' approach, which has the merit of clarity and simplicity) whereas under the latter, a company is made subject to the laws of the jurisdiction where its business is in fact managed (i.e. a 'substance-over-form' approach, which has the benefit of avoiding artificial situations and 'shopping' of national corporate laws). This lack of harmonization results in practical complications when it comes to cross-border mobility of EU companies. By way of example, a UK-registered company willing to move its effective place of management to France would be bound to apply the corporate laws of both the UK (applying the incorporation theory) and of France (applying the real seat theory), which renders this operation more complicated than necessary. If the example was reversed, the French company willing to migrate to France would in pure theory become 'stateless' since neither the UK nor France would consider that their national corporate laws apply to it under the connecting factor they have chosen, thereby preventing the proposed migration.

   Third, there appears to have been a growing uneasiness of some Member States about company migrations performed otherwise than for 'legitimate reasons' and deemed to prejudice the interests of stakeholders. An example would be a change of corporate seat carried out with the sole purpose of escaping the burden of unfavourable national tax or employment legislation. As a result, secondary legislation regarding matters of cross-border mobility, such as such as the European Company Regulation7 and the Cross-border Merger Directive, took a long time to negotiate and, in their final versions, contain measures protecting creditors, minority shareholders (at the option of Member States only, however) and employees.8 Until now, these restrictions however remained - in our eyes of practitioners - reasonable.

2. A BRIDGE TOO FAR?

   The case law developed by the Court of Justice of the European Union (CJEU) helped tremendously with the first (absence of secondary legislation) and second issues (conflicting theories on corporate seat) highlighted above but unfortunately exacerbated the third (a degree of anxiety over 'artificial' transfers of seat).

   A series of decisions of the CJEU indeed consecrated a right for EU companies to move their corporate seat to another EU jurisdiction without suffering substantial restrictions. These were notably the Sevic9 case (company transformations are a specific application of the freedom of establishment), Cartesio10 and Vale11 cases (cross-border transfers of seats and conversions are protected by the freedom of establishment; restrictions to transfers must be proportionate to the objective of protecting stakeholders) and finally Polbud12 case (cross-border conversions without relocation of the 'real seat' are also permissible; no further distinction between 'primary' and 'secondary' freedom of establishment).

   This last judicial decision however struck a nerve among Member States. Its most common interpretation is that EU-based companies may now pick the lex societatis of a Member State of their choosing without moving their effective place of management there. This far-reaching result generated fears of a 'race to the bottom' between national corporate laws on the one hand and of artificial cross-border migrations made for the sole purposes of gaining a tax or other advantage detrimental to stakeholders (e.g. creditors, minority shareholders or employees) on the other hand.

   Consequently, the EU Commission felt compelled to intervene in the form of a draft proposal for a directive relating to cross-border conversions, mergers and divisions13 aiming to harmonize the rules applicable to such matters.

3. PENDULUM EFFECT

   The stated objectives of the Draft Directive are twofold, i.e. to (1) facilitate cross-border conversions, mergers and divisions and (2) protect the interests of all stakeholders.14

   While these purposes do not seem inherently incompatible between them at first sight, the degree of complexity of certain provisions of the Draft Directive and generally the very high level of protection afforded to stakeholders in such text - even where the interests of certain stakeholders are not involved - suggest that the second objective of the Draft Directive may have been favoured over the historically important first, possibly as an overreaction to Polbud.

   This outcome is particularly problematic for practitioners since a low degree of flexibility of the proposed legislation is likely to result in more costly transfers of seats, avoidance behaviours aiming to achieve the desired purpose outside the framework of the New Directive (notably by small companies) or even, in some specific cases, a technical impossibility to relocate companies from a Member State to the other by way of cross-border merger, division or conversion. Legal certainty is also at fault on some particular matters.

   In order to underline their significance, we suggest illustrating these difficulties resulting from the approach taken by the EU legislator through two case studies15: (1) a cross-border...