Download A Comparative Analysis of Reincorporations in the US and the EU

Shopping for Better Law? A Comparative Analysis of Reincorporations
in the US and the EU
(Master Thesis)
Ivona Skultetyova LLM
ANR: 868551
Supervisor:
Dr. G.J.H. van der Sangen
Second Reader:
Prof. C.F. van der Elst
1
Content
1.Introduction ................................................................................................................................................................... 3
1.1. Methodology ........................................................................................................................................................... 4
2. Reincorporations in the US and the EU .......................................................................................................... 5
2.1. Reincorporations in the US .............................................................................................................................. 6
2.2. Reincorporations in the EU............................................................................................................................... 7
2.3. Origins of Free Choice of Law in the US and the EU ............................................................................ 10
2.3.1. The Evolution of Internal Affairs Doctrine ..................................................................................... 10
2.3.2. The Evolution of Free Choice of Law in Europe .......................................................................... 12
2.4. The Scope of Free Choice of Law in the US and the EU ...................................................................... 13
2.4.1. Shareholders-Board Agency Relations............................................................................................. 13
2.4.2. Majority Shareholders – Minority Shareholders Agency Relations ..................................... 14
2.4.3. Creditors – Shareholders Agency Relations ................................................................................... 15
3. Cost-Benefit Analysis of Corporate Mobility in the US and the EU............................................... 16
3.1. Benefits of Corporate Mobility in the EU ................................................................................................. 17
3.2. Benefits of Corporate Mobility in the US .................................................................................................. 20
3.3. Costs of Corporate Mobility in the EU ....................................................................................................... 23
3.3.1. Costs of Incorporation Mobility .......................................................................................................... 24
3.3.2. Costs of Reincorporation Mobility ..................................................................................................... 24
3.4. Costs of Corporate Mobility in the EU ....................................................................................................... 27
3.4.1. Costs of Incorporation Mobility .......................................................................................................... 27
3.4.2. Costs of Reincorporation Mobility ..................................................................................................... 27
4. Conclusion ................................................................................................................................................................... 29
5. Bibliography............................................................................................................................................................... 31
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I. Introduction
The internal market of the European Union provides for a space, in which firms are
endowed with possibilities to move across the borders of member states and thus choose the
appropriate business form and applicable law offered by 28 EU jurisdictions.1 The cross-border
movement of companies might be also incentivized purely by the possibility to alter applicable
law. Such phenomenon can be coined as a law-shopping or free choice of law.2 Alteration of
the applicable law during the companies’ lifetime is facilitated by the reincorporation mobility,
the movement of the company’s registered office (statutory seat) and – in case of member states
following the real seat theory – also the movement of company’s head office to another EU
member state.3 While current research studies suggest that reincorporation mobility and
alteration of applicable law produce efficiencies and contribute to the enhanced performance of
companies, it provides also space for opportunistic behavior that may result in the deterioration
of stakeholders’ position. The EU reincorporations are still severely hampered by legal and nonlegal obstacles that prevent companies from intensified commuting within EU jurisdictions. That
is however not the case in the US, where reincorporation mobility is an established and fully
fletched phenomenon embedded in law and utilized by business community. Current empirical
evidence from the US suggest that “shopping for better law” in case of companies produce
substantive efficiencies and in general enhance the shareholders’ value.4 In contrast, the
reincorporation mobility in the EU is far from being comparable in volume to the American
counterpart. Some scholars contend, however, that American and European model of
reincorporation suffer from such fundamental differences that in result they do not seem to
serve the same purpose or be functionally equivalent. Hence the core question is whether
American experience with reincorporation could be in certain manner observed and translated
into the European settings.
In order to answer the given question, I will strive to analyze and compare reincorporation
mobility in the EU and the US on several different levels, that will provide contextual embedding
of the given research problem. The first part will be devoted to introduction of reincorporation
models in both countries, historical encounter of their development and subsequent analysis of
reincorporation with regard to alteration of applicable law. In the second part I will conduct a
1
Essers, P. et al. 2011
Law shopping or, as Rodl puts it, a private law beyond the state, empowers private parties to choose the law
applicable to their legal relations, p. 743
3 McCahery and Vermeulen 2007, p. 28
4 Romano 1985
2
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cost-benefit analysis of corporate mobility from the perspective of American and European
companies. This part will be enriched with the empirical evidence harvested on the both sides of
the Atlantic. The unique companies’ perspective is crucial, especially in European settings, to
understand the different outcomes of given phenomenon in the respective jurisdictions.
1.1.
Methodology
As Zweigert and Kötz correctly remarked comparative law can, by virtue of its methodology,
establish a vital cure for legal dogmatism.5 In case of reincorporation mobility the statement
applies even more, as many scholars resort to simple conclusion that American and European
model of reincorporation suffer from fundamental differences and thus American experience
cannot be translated into European terms. The selection of the US model for the purposes of
comparison was twofold. Firstly, the phenomenon of reincorporation mobility occurs only in
federal or quasi-federal states, in which the vertical distribution of powers allows individual
states to enact their very own company laws. Secondly, the language constraints did not allow
me to examine other models, for instance in South American countries, for which the literature
and statutory law is in the languages I currently do not master.
In order to examine aforementioned thesis of insurmountable differences between both models,
this article will use a principle of functional equivalence as described by Zweigert and Kötz.6
However, in a view of severe criticism, the functionalism will be used in a manner thoroughly
described by Adams and Griffiths.7 For Adams and Griffiths functional approach serves as an
analytic tool which helps a researcher to achieve comparability in the rules, institutions and
behavior. In theory, reincorporation models in the US and in the EU should serve very similar
purpose, concretely promoting efficiency and companies’ value maximization that should
simultaneously strengthen the competitiveness of the American and European companies.8
Adopting such thesis as a fundamental goal of both reincorporation models, I will use
comparative analysis to identify similarities and particularly differences of the models that are
currently perceived as obstacles of functional equivalence on the level of business practice. In
the analysis, I will scrutinize both models on a doctrinal and empirical level, especially with
regard to historical and societal context, which prima facie appears to be the cause of absence of
functional equivalence on the level of the business practice. Inclusion of historical and societal
Zweigert and Kötz 1998
Zweigert and Kötz 1998
7 Adams and Griffiths 2012
8 McCahery and Vermeulen 2007, p. 2
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context, on the other hand, is based on an advice provided by Zweigert and Kötz9, who
emphasize the importance of societal economic and historical context in a comparative analysis.
Part I
Reincorporations in the US and the EU
A reincorporation could be described as a movement of registered office from the state of
origin to the state of destination without the need to liquidate the given business entity in the
state of origin.10 Reincorporated entity in fact becomes a legal successor of the original
corporation. The specific feature of reincorporation resides in the fact that most of the
reincorporated companies do not relocate their business operation and thus reincorporation
encompasses purely formal relocation of a registered office. In order to make such
reincorporation available for companies, two regulatory requirements have to coincide. First,
the law system has to follow the conflict of law doctrine which enables companies to be formally
and materially resident in two different jurisdictions. Simultaneously the formal residence ought
to be a sufficient connecting factor for the application of the corporate law. In the US such
requirement is reflected in the internal affairs doctrine which stipulates that the internal affairs
of the corporation are governed by the state of incorporation, regardless of the place of business
activities.11 Most US jurisdictions nowadays adhere to the given doctrine and, with an exception
of several states, legally recognize the companies that have merely formal domicile in their
territory. On contrary, in the European Union, such policy embedded in the incorporation
doctrine, is followed only by approximately half of the member states.12 The other half of the
member states pursues the real seat doctrine which effectively rejects the double domicile (legal
and material) of the companies.13
Second, the legal regulation of the given states has to allow the migration of companies without
mandatory liquidation in the state of origin. Whereas in the US, the migration was enabled by
states themselves due to historical circumstances and significant pressure from business
community, the European Union states adamantly refused to allow companies to freely
commute from jurisdiction to jurisdiction. Despite the promise promulgated in the Article 49
and article 54 TFEU that should afford the companies with same freedom of movement as
natural persons, member states entered into implicit agreement that led to long decades of nonZweigert and Kötz 1998
Mucciarelli 2011, p. 463
11 Rammeloo 2001, p. 143
12 Member states that currently follow the real seat theory: Belgium, Germany, Spain, Portugal, France, Luxembourg,
Lithuania, Latvia, Poland, Estonia, Austria, Slovenia,
13 Rammeloo 2011, p. 143, In German literature the double domicile id often referred to as (DoppelSitz).
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mobility equilibrium.14 The reason for such implicit policy was simple, the fear of the outburst of
corporate mobility and subsequent regulatory competition as could be witnessed in the US.
Member states thus effectively replaced competition with collusion. Even states that follow
incorporation doctrine, such as UK, rejected to add the dynamic feature of migration into their
legal system. Hence, once the company was incorporated in such state, it could conduct business
activities elsewhere but the formal domicile that determined the applicable law remained
cemented in the state of initial incorporation.
2.1. Reincorporations in the US
As mentioned before, in the US the fundamental “choice of law” doctrine for corporate law15 is
the internal affairs doctrine based on which the state of incorporation is mandated to regulate
the internal affairs of the corporation, while other states should mutually recognize the legal
status of the entity incorporated elsewhere.16 Most of the states follow the internal affairs
doctrine through case law or enacted statutory regulation.17 Although the doctrine is widely
respected, many states such as Connecticut, Louisiana and North Carolina adopted the approach
which does not completely exclude the application of domestic internal affairs on foreign
companies. 18
The basic rationale behind the doctrine is that subjecting the internal affairs of a corporation to
the regulation of state, selected by company’s representatives is in accordance with the
expectations of its founders and provides crucial legal certainty with regard to how these
internal relations will be governed in conflict of laws situations.19 Moreover, the internal affairs
do not encompass the corporation law in its entirety, but consists of rules concerned with
relations between managers and shareholders and several additional sets of rules.20 Therefore,
upon reincorporation, the applicable law alters only with regard to those constituencies that
were actively involved in the decision-making process related to reincorporation. The external
stakeholders such as creditors are usually not affected by reincorporation as creditors’
protection in the US is subject to bankruptcy law that is regulated on federal level and thus
substantially unified.21 In practice, the reincorporations are conducted through downstream
vertical merger, whereby the company merges itself with a wholly-owned subsidiary
incorporated in the state of destination that is merely a shell company created for the purposes
McCahery and Vermeulen 2008
With the certain portion of simplification, terms corporate law and company law are used as interchangeable.
16 Restatement (Second) of the Law: Conflict of Laws § 296 and § 279 (1969)
17 DeMott 1985, p. 163
18 Ibid.
19 Stevens 2006, p. 2
20 Tung 2006
21 Mucciarelli 2011
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of the reincorporation. Subsequently, upon merger, the subsidiary becomes a surviving entity
and a legal successor of the parent company which formally ceases to exist.22
Although US companies have a significant spectrum of choice of jurisdictions, it would be naive
to believe that all the states are equally attractive for immigration. It is quite the opposite. The
market for corporate charters has currently only few winners, with the State of Delaware,
dominating the market with almost unquestionable monopoly in reincorporations.23
2.2. Reincorporations in the EU
As already mentioned, reincorporations depend on two prerequisites of the given legal system
that has to coincide, the choice of law doctrine allowing dual domicile and legal possibility of
migration. In the EU, member states do not follow one, but two choice of law doctrines that are
of contradictory nature. Firstly, the incorporation doctrine determines the applicable company
law by referring to the country of incorporation.24 From a choice of law perspective, it can be
well concluded that incorporation doctrine, at least in its purest form follows the rationale of
party autonomy and contractual freedom, as company’s stakeholders can decide over the legal
system they would like the company to be subjected to.25 Various versions of incorporation
doctrine are applied in Scandinavian countries, UK and the Netherlands.26 In contrast, the real
seat doctrine prescribes that applicable company law is determined by the real seat of the
company in question. While in the past, the recognition of the real seat was rather simple,
nowadays the operation of the companies is frequently spread out to several countries and thus
the task to identify the one and only real seat becomes a brain teaser.27 Moreover, in the course
of application of the real seat doctrine, the nationality of company’s executives was frequently
considered as an important factor in identifying the real seat.
From this viewpoint,
incorporation doctrine at first glance appears to be significantly better aligned with the
objectives of the single market. However none of these doctrines were designed in view of
companies’ migration and thus this prerequisite had to be developed independently on the
doctrines (see Table I).
Mucciarelli 2011, p. 427
Ibid.
24 Rammeloo 2001
25 Ibid. p. 16
26 Ibid.,
27 Ibid., p. 12
22
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Table I
Allowed
Incorporation
Doctrine
Reincorporations
possible
Real Seat
Doctrine
Reincorporations
possible only upon
simultaneous transfer
of real seat
Migration
Not Allowed
Initial incorporations
with dual domicile
possible,
reincorporations not
possible
Reincorporations not
possible
Only Immigration
Allowed
Inbound
reincorporations
possible, outbound
reincorporations not
possible
Inbound
reincorporations
possible only upon
simultaneous transfer of
real seat
The reincorporations among EU member states are relatively recent achievement of EU
secondary law and judicature of CJEU. Formally, a legal mechanism to move the registered office
to another member state is available since the enactment and implementation of SE
Regulation.28 SE regulation endowed companies with the possibility to transfer the registered
office from the member state A to the member state B by means of cross-border merger.
Nevertheless this legal mechanism cannot be deemed as full blooded reincorporation, due to the
mandatory requirement of simultaneous transfer of the real seat.29 This senseless compromise
between proponents and opponents of reincorporations is deemed by some authors as a direct
infringement of freedom of establishment.30 Despite the obvious disappointment with regard to
reincorporation options, SE regulation undisputedly paved the way for the Cross-border Merger
Directive31 that eventually introduced legal mechanism for purely formal reincorporations.
Similarly to the US, a company can reincorporate to another member state by merging itself with
its subsidiary in another member state, whereby the subsidiary becomes the surviving entity
with registered office in the state of destination. Although in theory, cross-border merger would
be a sufficient tool to conduct reincorporations, in practice there have been many complaints
referring to such reincorporations as costly and procedurally burdensome. It didn’t take a long
time till the CJEU came with an alternative solution. In the most recent mobility-related case Vale
32,
CJEU proclaimed that the EU resident companies can convert to a business form of a state of
destination, as such right is captured by the freedom of establishment, which is in this case
Council Regulation (EC) No 2157/2001 of 8 October 2001 on the Statute for a European company (SE Regulation)
Ibid., Article 7
30 Ringe 2007, pp. 208-209
31 Directive 2005/56/EC of the European Parliament and of the Council of 26 October 2005 on cross-border mergers
of limited liability companies (Cross-border Merger Directive)
32 VALE Építési Kft. [2012] C-378/10
28
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directly applicable.33 Hence the new type of reincorporation transaction, cross-border
conversion, was born. However, there are several requirements in order to invoke freedom of
establishment. Firstly, the conversion as a legal mechanism of business reorganization has to be
available for domestic companies. Subsequently, the principle of equivalence does not allow
member states to discriminate foreign companies with regard to those types of business
reorganizations that are available for domestic companies. Secondly, the Court has reaffirmed
that the application of Article 49 TFEU presupposes the real establishment and genuine
economic activity in the state of destination.34 The requirement of genuine economic activity
mitigates the free-rider problem that would occur in case the companies would be allowed to be
registered in one member state and take advantage of its laws and conduct the entire business
activity in the other. This is however in direct contrast to the US reincorporation model, where
companies are not required and frequently do not conduct business in the state of incorporation.
On the other hand, the requirement of genuine economic activity and firm establishment is not
so clearly interpreted in all decisions. In fact, the CJEU has on several occasions adjudicated in
the manner which ignored the requirement of genuine economic activity (real establishment) in
the member state in which a company wished to invoke freedom of establishment. The Segers
case, for instance, involved a company incorporated under the English law which conducted its
entire business activities in the Netherlands. In its decision, the Court stated that as regards the
freedom of establishment, Article 48 (currently article 54) of the EC Treaty “…requires only that
the companies be formed in accordance with the law of a Member State and have their registered
office, central administration or principal place of business within the Community. Provided that
those requirements are satisfied, the fact that the company conducts its business through an
agency, branch or subsidiary solely in another Member State is immaterial.”35 Similarly in Centros,
the Court rejected the position that incorporation in one state and business operation in another
should be considered as an abuse of law.36 However it has to be noted that in Vale the Court
could afford to reaffirm the condition of genuine economic activity, due to the fact that the given
company was willing to transfer also real seat and thus this condition was not crucial in deciding
the case. It would be however interesting to see how the Court would cope with the situation
when company would like to convert only formally without an intention to conduct real business
activity in the state of destination.
Despite the fact that Vale offers an undisputable development in the legal framework of
corporate mobility, scholars as well as practitioners are skeptical with regard to practical
Ibid., para. 36
Ibid., para. 34-35
35 ECJ 10 July 1986, case 79/85, Segers, ECR
36 Case C-212/97 Centros v Erhvervs- og Selskabsstyreisen [1999] ECR I-01459
33
34
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application of this type of transaction. Currently, cross-border conversion is based only on the
Vale decision and the lack of procedural rules related to its implementation results in great legal
uncertainty and significant space for diverging interpretations of member states.
2.3. Origins of Free Choice of Law in the US and in the EU
As mentioned before, there are two legal requirements that must coincide in order to afford
companies with the possibility to migrate. Firstly, the conflict of law doctrine must allow the
double domicile of companies and secondly the law must permit post-incorporation change of
formal domicile. The evolution of the both factors in the US and in the EU occurred in a very
different manner and a different time-span and to great extent influenced the picture of
corporate mobility in both countries.
2.3.1. The Evolution of Internal Affairs Doctrine
In the US, free choice of corporate law is embedded in the so-called internal affairs doctrine.
Internal affairs doctrine emerged as a judge-made doctrine that requires the internal affairs of a
company e.g. relations among directors, officers and shareholders, to be governed by laws of the
state of incorporation.37 The wide-spread acceptance of internal affairs doctrine guarantees
companies that the disputes related to their internal affairs will be decided by legal rules of the
state of incorporation.38 Upon reincorporation to another state, the law governing internal
affairs changes together with the “formal residence” of a company. While in the EU, free choice of
company law is still in the center of the attention, the wide-spread acceptance of internal affairs
doctrine in the US points to relative lack of controversy surrounding the doctrine. Despite such
view by most of US scholars and practitioners, Tung correctly observes that shifting the choice of
applicable law to the addressee of law is in fact extremely liberal and rare approach of the lawmaker.39
According to prevalent opinion on the rationale behind the doctrine, it was designed for two
purposes. First and foremost the doctrine should ensure the consistency and predictability of
law applicable to the relations related to internal organization of the company.40 Secondly, it
should facilitate regulatory competition of states regarding the corporate law rules.41 The
historical context of internal affairs doctrine however proves that its original design should have
served a diametrically different purpose. In fact, the doctrine in its original interpretation
Tung 2006, p.36
Ibid.
39 Ibid.
40 DeMott 1985. p. 161
41 Tung 2006, p. 43
37
38
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affirmed the territorial nature of company law.42 In the times, when courts formulated the
doctrine in the late nineteenth century, business activities of American companies were usually
tied to the territory of one state without significant cross-border activities.43 Hence, companies
commonly incorporated and operated in their home state. Law-shopping across US jurisdictions
was in fact not viable, since a state frequently required domestic corporation to conduct
economic activities on its territory.
44
Such approach closely resembles the genuine economic
activity requirement related to the application of freedom of establishment in the EU. Put it
simply, the internal affairs doctrine in its original interpretation was rather static, not taking into
account the dynamic feature of migration. Paradoxically, such design of internal affairs doctrine
supported protectionist and restrictive attitude of states towards movement of their own
companies and promoted market sharing instead of regulatory competition.45 As Adam Smith
explained in his Wealth of Nations, those on the supply side will always have a tendency to
rather collude than compete.46 So what has actually caused the alteration in the design and
interpretation of internal affairs doctrine? The situation radically changed on the verge of
nineteenth century, when New Jersey as a pioneering state modified its corporation laws in
order to attract foreign companies.47 It offered a corporation law purged of the economic activity
requirement, earning itself a reputation of the “traitor state”.48 Moreover, New Jersey was the
first state to introduce the franchise fees, taxation of New Jersey incorporated companies based
on their authorized capital.49
Other states could have had effectively prevented their companies from reincorporation in New
Jersey by strict adherence to internal affairs doctrine in its original interpretation. If the new
design of the doctrine was not embraced and respected by other states, the companies
incorporated in New Jersey and operating in another state could not avoid the application of
their domestic law. Contrary to that, other states showed little interest in maintaining decadeslong protectionist status quo.50 Such inaction could be explained by the merger wave and
emergence of large interstate companies across the US. With regard to severe economic
upheaval in the 1890s, each state needed a participation of the great trusts and interstate
corporations in its local economy.51 Stubborn adherence to application of domestic company law
on “foreign companies” operating on their territory would have deprived them of the economic
Ibid.
Ibid.
44 Ibid, p. 44-45
45 Tung 2006, p.75
46Smith 1776
47 Ibid.
48 Grandy 1993, p.43
49 Tung 2006, p.75
50 Ibid.
51 Ibid.
42
43
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benefits stemming from cross-border activities of interstate companies.52 Moreover, legislators
were having problems to take a collective action against traitor state and unilateral action was
too risky from the economic point of view. In the meantime, interest groups within the state
started to heavily interact with these interstate corporations and thus any attempt to foreclose
the operation of interstate corporations would restrict these economic and trade relations that
turned to be very beneficial for the economy of the states.53 The new interpretation and purpose
of internal affairs doctrine was born. Simultaneously, the static interpretation of internal affairs
doctrine was enriched with the dynamic feature of migration that put a base stone for the
charter competition.
2.3.2. The Evolution of European Doctrines and Freedom of Establishment
On the other side of the Atlantic, the free choice of law has developed in rather different manner
and different time span. With regard to choice of law, EU member states follow not one but two
doctrines. Firstly, the real seat theory determines the applicable company law by the location of
the real seat, meaning the actual center of the company’s management.54 Incorporation theory,
on the other hand determines the nationality and applicable company law by the place of
incorporation, member state in which the company was legally formed. None of these theories
however were designed with a view to corporate mobility during the lifetime of the company.
The real seat theory allegedly emerged from the concept of territorial control of the sovereign
state around the middle of the nineteenth century.55 The real seat concept established the
nationality as the dominant connecting factor and allowed companies to subject themselves only
to the laws of the state, in which they conducted business activities.56 Naturally, at the time when
the real seat doctrine was developed, the states that adopted it were not members of any
supranational entity and thus the doctrine served as mean of protection against pseudo-foreign
companies.57
The incorporation theory in its purest form also does not consider the change in nationality of
the company in the company’s lifetime, as the only applicable law is the law under which the
company was formed. Its origins are not very certain but some scholars contend that it has been
firstly enforced in several cases in 1780.58 In the course of time, the incorporation theory
prevailed in all common law countries and in recent decades it was also adopted by several civil
Ibid.
Tung 2006, p. 84
54 Rammeloo 2001, pp. 11-16
55 Sandrock 1985, p. 505
56 Ibid.
57 Lombardo 2009, p. 636
58 Henriques vs Dutch West Indian Company (1728) 2 Ld. Raym 1532,
52
53
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law jurisdictions.59 Both doctrines, although different in nature, reflect protectionist attitude of
the member states towards the movement of the companies across EU jurisdictions and thus
represent similar rationale that originally motivated the emergence of internal affairs doctrine.
In contrast to the US, a change in the attitude towards mobility of companies and towards free
choice of corporate law was not effectuated by member states themselves but forced by
judicature of CJEU and EU secondary legislation. Since the 1957, when treaty of Rome was
concluded, the promise of free movement of companies remained unexercised for several
decades. Not sooner than four decades later, the triad of ground-breaking decisions, Centros,
Überseering and Inspire Art liberalized initial incorporations and forced also real seat countries
to legally recognize business entities operating on their territory but formally registered in
another member state. This was however by far not a farewell to real seat doctrine. According to
Daily Mail case, which chronologically preceded initial incorporation cases, companies are
creatures of domestic law and the requirements for their incorporation and further existence
depends entirely on their domestic jurisdiction.60 Such statement subsequently gave a powerful
weapon to member states that systematically through national law provisions reinvented
barriers to corporate mobility.
While incorporation mobility became possible in 2001, reincorporation mobility was put on
hold until 2005, when Cross-border Merger Directive was enacted. It was a first piece of
legislation that offered US-style reincorporation in form of a downstream vertical merger.
Nevertheless, such transactions remained still out of reach for many small and medium-sized
businesses as conducting a merger based on the aforementioned directive is procedurally very
burdensome and incurs significant costs on the merging entities. The calls for direct
reincorporation were answered initially in Cartesio ruling, in which the Court stated that
although domestic company law must be respected, member states cannot require the winding
up or liquidation of the company, which attempted to convert itself into foreign business form. 61
This obiter dictum served as a basis for subsequent judgment in Vale, in which the Court fully
legally recognized cross-border conversion as a new type of transaction that is captured under
freedom of establishment.62
Above-given comparison reveals very firm adherence to traditionalism in EU member states, as
opposed to the US states that adapted quickly to the changed circumstances in the business
environment. On the other hand, US model has been put in practice since the beginning of the
Rammeloo 2001, p. 12
Case C-81/87, The Queen v H.M. Treasury and Commissioners of Inland
Revenue, ex parte Daily Mail and General Trust plc [1988] ECR 5483
61 Cartesio Oktato es Szolgaltato bt, Case C-210/06 [2009] ECR I-0000
62 VALE Építési Kft. [2012] C-378/10
59
60
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20th centuries and thus almost hundred years difference suggests that the EU and the US are
with regard to reincorporations on the different levels of evolutionary ladder.
2.4. The Scope of Free Choice of Law in the US and in the EU
It has been stated that the reincorporation to another states alters the company law applicable
to the migrating company. Nevertheless, the question which set of rules will actually alter
remains. In that view, this sub-part will analyze the scope of company law that changes upon
reincorporation in the US and in the EU as it cannot be assumed that this concept is identical in
both jurisdictions.63 The major difference between internal affairs doctrine and the conflict of
laws mechanisms followed by the member state of the EU (real seat doctrine and incorporation
doctrine), is related to the set of rules to which the choice of law criterion applies. As a matter of
fact, the province of company law that alters after reincorporation is much narrower in the US
than in the EU. 64
In general, company law systems predominantly address so-called agency problems among
different company stakeholders.65 The manner and extent to which these agency problems are
dealt with by the company law rules, is determined by policy goals of a concrete legislator and to
great extent also by the ownership structure of the companies. The agency problems could be
broken down into three fundamental sub-categories, namely agency problems between
shareholders and the board, between majority and minority shareholders and between
shareholders and creditors.66 The set of rules that alters upon reincorporation will be in this part
examined according to the three types of agency relations.
2.4.1. Shareholder – Board Agency Relations in the US and in the EU
The agency relations between shareholders and the board are addressed primarily by the rules
of duties of the board, director’s liabilities and rules related to the appointment and removal of
the directors.67 Aforementioned sets of rules shall guarantee that board members will in any
case pursue the interest of shareholders and will not exploit their competences in order to
pursue personal benefits. In the US, company law rules subsumed under internal affairs doctrine
are predominantly related to this particular type of agency problems. A basic rationale behind
such company law design stems from the prevailing ownership structure that is typical for
common law jurisdictions. The ownership is usually wide-spread among different groups of
63
Mucciarelli 2011, p. 444
Ibid. p. 451
65 Hansmann 1996, p. 253
66 Ibid.
67 Ibid.
64
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shareholders, none of which holds the controlling portion of shares.68 Therefore, unless
shareholders cooperate in order to prevail over board’s decisions, they do not exert sufficient
control pressure on the members of the board and enable the board to act on their own terms. In
most of the EU civil jurisdictions, company law also involves thorough regulation of boardshareholders relations, however it is not by far limited to that.
2.4.2. Majority shareholder – Minority Shareholder Agency Relations in the US and in the
EU
Civil jurisdictions’ company law encompasses also second type of agency relations, concretely
those between majority and minority shareholders. The multiple focus of company law is again
determined by the ownership structure which is in most EU member states, with an exception of
UK, dominated by one or several controlling shareholders, which can effectively pursue their
own interest to the detriment of other minority shareholders.69 A controlling shareholder(s)
may misuse her dominant position either by transactions that bring private benefits to
controlling shareholders (colloquially known as a tunneling) or by transactions that dilute
minority ownership (mergers for instance) and thus further weaken the position of minority
shareholders.70 The goal of reducing agency costs stemming from the majority-minority
shareholders’ relations can be attained by several mechanisms such as (a) disclosure
requirements, (b) limitations on the abuse of majority position or (c) restrictions on
distributions to majority shareholders.71 Nevertheless, such difference between the scope of
company law in the US and in the EU cannot serve as an argument for restrictions on
reincorporation mobility, as ,in general, all civil jurisdictions within which the commuting of
companies shall occur, have developed this domain of company law. Some of them indeed
elaborated more on this type of agency relations, such as Germany with its Konzernrecht72,
nonetheless the differences in the regulation are not substantive and thus the change of
applicable company law, with slight exception of the UK, shall not result in the deterioration of
the minority shareholders’ position.
2.4.3.
Creditor – Shareholder Agency Relations in the US and in the EU
Third type of agency problems stems from relations between shareholders and creditors of the
company. Shareholders, who enjoy limited liability, may be prone to engage in excessive profit
Kester 1986, p. 6
Easterbrook and Fischel 1991,p. 229
70 Conac, Enriques and Geltner 2007, p. 496
71 Mucciarelli 2011, p. 446
72 Damman 2004, p. 488
68
69
15
distributions or to undergo high-risk business decisions.73 In the US, some of the rules aiming at
prevention of opportunistic behavior of shareholders towards creditors are part of the internal
affairs doctrine and thus reincorporation to another jurisdiction will also change the rules
addressing this type of agency relations.74 However, creditors of US companies predominantly
rely on legal mechanisms embedded in the bankruptcy law that is to large extent federalized and
thus unified across states.75 Having said that, it becomes apparent that shareholder-creditor
relations are effectively unbundled from the other agency relations and do not form a set of the
rules that is encompassed by the internal affairs doctrine. On contrary, reincorporation to
another EU member state will also alter the rules regarding creditors’ protection that are in
most of the member states included in the scope of company law.76 Hence, theoretically the
reincorporation into a jurisdiction with less stringent rules regarding creditors’ protection may
lead to the significant deterioration of their position. On the other hand, the mechanisms of
creditors’ protection promulgated by company law have been for long time facing significant
critique for ineffectiveness. The most controversial, in that sense, is the minimum capital
requirement and rules related to capital maintenance doctrine.77 These rules are aimed at
retaining sufficient amount of capital in the company in order to distribute it among creditors in
case the company falls into default. However, initially invested capital is not static. It is declared
at the moment of the establishment of the company and thereafter the company can reinvest it
or purchase any kind of assets that it considers necessary for its business activity.78 Thus the
real liquidity of invested capital that shall cover the claims of creditors is, the least to say,
uncertain. Regarding that many scholars but also practitioners contend that creditors, similarly
to the US, rely predominantly on contractual arrangements, insolvency law and tort law
regulation, when seeking for the guarantees of their claims.79 As opposed to US, insolvency law
in the EU is not harmonized and belongs almost exclusively to the competence of member
states.80 Insolvency laws of member states are very inhomogeneous and thus the risk for
creditors remains in place. Applicable insolvency law is determined pursuant to Insolvency
regulation by the state in which Center of Main Interest (COMI) resides.81 COMI is however
presumed to be in the state of registered office, hence the reincorporation which involves the
movement of registered office alters also applicable insolvency law. On the other hand, the
Ibid., p. 446 , see also Armour, Hertig and Kanda 2009, p. 116; Bratton 2006, p. 48
Mucciarelli, p. 446
75Skeel 1994
76 Mucciarelli 2011, p. 456
73
74
77
Ibid.
Ibid.
Mucciarelli 2011, p. 456
80 Ibid.
81 Article 4, COUNCIL REGULATION (EC) No 1346/2000 of 29 May 2000 on Insolvency Proceedings
78
79
16
presumption of residence of COMI is rebuttable82 and therefore creditors would have to provide
an evidence that the place of company’s registered office is purely formal and does not effectuate
the change of applicable insolvency law.
The change of applicable company law or even insolvency law, however is not problematic for
all creditors. Especially so-called adjusting creditors with significant bargaining power towards
companies, such as banks or other financial institutions, usually negotiate certain contractual
covenants that guarantee the accelerated repayment of the loan in case of reincorporation83 or
securities, such as lien that has a primacy in case of insolvency proceedings.84 Hence, adjusting
creditors are usually not dependant on the statutory rules aimed at their protection. On
contrary, non-adjusting creditors, such as consumers, do not possess sufficient bargaining
power to negotiate special contractual covenants and thus have to rely on mandatory legal
regulation.85 The coordinative efforts of member states towards protection of non-adjusting
creditors of reincorporating companies could contribute to the resolution of this issue.
Ibid.
Smith and Warner 1979, p. 129
84 Bebchuk and Fried 1996, p.
85 Mucciarelli 2011, p. 471
82
83
17
Part II
Cost – Benefit Analysis of Corporate Mobility in the US and the EU
Empirical evidence on the “both sides of the pond” significantly contributes to the debate
about reincorporation mobility as it provides a genuine picture of the law in action and the
manners in which the companies react to the both reincorporation models. In order to depict a
complete mosaic of companies’ movement, not only reincorporation but also incorporation
mobility will be involved in this sub-part. Incorporation mobility includes cases when
entrepreneur decides over jurisdiction in which he will initially incorporate his company, while
reincorporation mobility encompasses movement of the companies from their original
jurisdiction to another state during the life-cycle of the company.86 The basic difference between
corporate mobility in Europe and in the US is that in the US migrating companies are large, often
publicly-held business concerns, which move to another jurisdiction predominantly at the
reincorporation stage, while in the EU, available empirical evidence suggests that the mobility is
primarily the domain of small closely-held companies at the initial stage of their existence (first
incorporation).87 Put it differently, corporate mobility options in Europe are utilized by start-up
entrepreneurs that seek for the lowest costs of company formation and to large extent disregard
more specific differences in company law.88 Given claim is strongly supported by empirical
evidence, which proved that in recent years, incorporations by foreign entrepreneurs have
increased in the jurisdictions that offer fast and low-cost incorporation scheme.89 Ventoruzzo
explains such difference by dividing underlying rationales for corporate mobility into two
distinct categories. The first cost-based rationale is motivated by lower financial costs associated
with the incorporation process itself. The variables, which entrepreneurs consider, involve
jurisdiction’s franchise taxes, administrative fees due upon incorporation, the costs of legal
services, the length of incorporation process and most importantly, the necessity to subscribe
and pay in a minimum capital determined by the state of incorporation.90 The second, rulesbased rationale focuses on the rules of company law that address the corporate governance and
overall operation of the company. In that sense, “rules” have to be perceived more broadly, not
limited to statutory law but also to effectiveness of law enforcement, existing legal
infrastructure, such as expertise of the judges and network externalities related to the general
knowledge in the financial industry of the chosen jurisdiction.91
86
Becht, Mayer and Wagner 2008, p. 4
Ventoruzzo 2006, p. 102
88 Becht, Mayer and Wagner 2008
89 Ibid.
90 Ventoruzzo 2006, p. 105
91 Ibid.
87
18
The different behavior of migrating companies in the EU and the US is arguably not related to
different style of companies’ strategies or decision-making. Assuming that companies
(entrepreneurs) act rationally, they will consider the migration into other jurisdiction on
condition that the benefits of such a corporate transaction outweigh its costs. That applies
regardless of the companies’ nationality. Thus the cost-benefit analysis conducted from
companies’ perspective will attempt to reveal the legal and non-legal factors that shape the
different behavior of American and European companies with regard to corporate mobility.
3.1. Benefits of Corporate Mobility in the EU
Company law differs significantly across the EU jurisdictions. The obvious benefit of formal
migration therefore resides in the selection of the law of business organizations that best fits the
individual needs of given entrepreneur or a company. Regarding the incorporation mobility,
European entrepreneurs that wish to incorporate a new company usually choose the jurisdiction
that offers low-cost and prompt incorporation scheme. The empirical evidence confirms that
particularly UK has in recent years attracted many foreign start-up companies that initially
incorporated in the UK and subsequently conducted its business activities exclusively in the
other EU jurisdiction.92 This phenomenon of foreign incorporations is ascribed to the UK
incorporation scheme, which offers significantly lower costs of entry.93 The incorporation
procedure there, as opposed to other European jurisdictions, is deprived of minimum capital
requirements and long and administratively burdensome formal registration. Becht et al. found
out that between 2003 and 2006 over 67,000 new private limited companies were established in
the U.K. from the other E.U. Member States, as opposed to around 4000 foreign incorporations
per year before 2001.94 Such increase occurred in the aftermath of the ground-breaking decision
Centros and its progenies that undoubtedly confirmed that incorporation mobility falls under the
freedom of establishment as stipulated by TFEU. Following the release of empirical studies,
which confirmed demand for low-cost jurisdictions95, several member states including the
Netherlands, Denmark, Germany and France initiated reforms of company law in order to lower
the instant costs of incorporation and do not provide their domestic entrepreneurs with an
incentive to incorporate elsewhere.96 Aforementioned countries effectively decreased the
attractiveness of originally low-cost jurisdictions by adjusting to the needs of start-up
companies and thus it is questionable whether the phenomenon of cost-based incorporation
mobility in the EU will further survive.
It has to be noted that such constellation is only possible in those member states that follow the incorporation
theory that allows companies to be incorporated in one state and have their central place of management and all
business activities in the other member state.
93 Becht et al. 2007
94 Ibid.
95 Ibid.
96 Ventoruzzo 2006, p. 104
92
19
Arguably, there is considerable difference between costs of entry that were the decisive factor in
the case of foreign start-up incorporations and costs of compliance with mandatory rules during
the existence of the company. These costs simply represent the present value of all other
expenses related to maintaining the legal status of a company over its lifetime and liquidating
the company at the end of its life-cycle.97 As it will be demonstrated later, entrepreneurs seeking
to incorporate in a country with low entry costs usually suffer from information deficit on the
above-mentioned costs98 and thus are frequently boundedly rational when selecting the optimal
jurisdiction for incorporation.
Regarding the reincorporation mobility, the current empirical evidence shows that companies
frequently reincorporate due to simplified internal structure offered by the other EU
jurisdictions. For instance, German joint stock companies showed a tendency to reincorporate to
the UK in order to alter the two-tier structure of its board, which is mandatory in Germany, to
one tier structure that provided the company with greater flexibility in decision-making.99 On
the other hand, since the emergence of Societas Europea (SE), which offers also one-tier board,
German companies mustn’t reincorporate and have a domestic solution for alteration of their
internal structure.
Entrepreneurs can also decide to incorporate or reincorporate to another member state due to
specific business form that is not available in their home jurisdiction. In this regard, hybrid
business forms (or uncorporations) have attracted a great deal of attention. The category of
hybrid business forms involves business entities that effectively combine features of partnership
and corporation.100 While preserving the benefits of limited liability, the operation of hybrid
companies is subject to considerable contractual flexibility and favorable tax treatment that is
usually afforded only to partnerships (pass-through taxation).101 Especially the concept of
maximum contractual flexibility and autonomy of company’s participants to structure
company’s internal affairs is the key driver behind the success of hybrid business forms.102
Relative freedom to ascertain the internal affairs gives members of the firm unique opportunity
to contractually address specific agency problems that occur in their relations within the firm.
Family-owned businesses and high-growth start-up ventures show an example of firm’s that do
not face traditional agency problems and thus mandatory rules regulating traditional business
forms frequently cannot effectively address the information asymmetries arising within these
Ibid, p.11
For instance stringent disclosure requirements for limited liability companies in the UK that incur additional costs
on the limited liability companies incorporated in the UK.
99 Essers et al. 2011, p. 198
100 Ribstein 2010
101McCahery, Vermeulen and Priydershini 2013, p. 2
102 MacCahery and Vermeulen 2008, p.140
97
98
20
specific types of firms.103 Hence, the low portion of mandatory rules regulating hybrid business
forms appears as significant benefit and strong incentive for migration to another jurisdiction.
Besides more efficient internal structure, there are other sets of company law rules that in
theory could encourage migration. For instance, the US reality suggests that the reasons for
existing companies to reincorporate in other state are, amongst others, anti-takeover defenses,
prospects of future mergers and acquisitions or initial public offerings, protection of minority
shareholders etc.104 The situation in the EU is however different. Firstly most of the abovementioned matters are at least partially harmonized on the EU level and thus the EU regulatory
regime provided a level-playing field for the companies regardless of the place of their
incorporation. Moreover, the litigations on above-mentioned matters are still very uncommon in
European countries. Disputes related to minority shareholder or takeovers rarely get to court
and thus the benefits from more efficient rules that would prevent litigations in these matters
decrease in value for the companies.105
As mentioned before, superior and more efficient company law rules are not the only beneficial
factor that entrepreneurs and companies take into account when considering the migration. Due
to the fact that besides applicable company law also forum of litigation of company’s internal
affairs is determined by place of incorporation, more efficient judicial system can be also
considered as an incentive to migrate. For instance, the speed of rendering the judgments, the
superior expertise of judges and legal advisors in company law matters represent the network
externalities that can play also a significant role in company’s decision-making.106 Such thesis is
also reinforced by the substantial differences in the efficiency of judicial systems between the EU
member states. For instance, the average time from filing to enforcement of judgment in
commercial matters varies from 399 days in the UK (involving 28 procedures) to 1210 days in
Italy (involving 40 procedures).107 The organizational structure of the judiciary with specialized
commercial courts and substantive body of case law also count for important factors.
3.2. Benefits of Corporate Mobility in the US
Similarly to the situation in the EU, company law in the US is according to vertical division of
powers in the competence of states. However, the significant differences in legal rules are
reflected only in those that are subsumed under internal affairs doctrine and thus are subject to
competition among the states. In contrast to the EU, incorporation mobility is not very common
in the US. Gevurtz summarizes that this is due to the fact that initial incorporation in the state
Ibid.
Movsesyan 2007, p. 28
105Movsesyan 2007, p. 28
106 Damman 2004 p.35-39
107 www.doingbusiness.org
103
104
21
other than the one in which the company is materially resident brings additional costs that are
disproportionate to the benefits that could be possibly gained by such transaction.108 Firstly, the
incorporation costs do not differ significantly across the jurisdictions and thus the dominant
incentive of European firms for incorporation abroad is not present in the American
circumstances. Simultaneously, the process of incorporation is relatively simple and expedited,
thus the promptness of the business establishment is also not a major concern. Such difference
in the procedural burden stems from divergent approaches in stakeholders’ protection. Whereas
in EU states, stakeholders are protected ex ante by thorough control of the legality of
incorporation procedure, US system relies predominantly on ex post litigation as a proper mean
of protection.109 Hence, the US system afforded itself with an incorporation procedure purged
from formality and detailed control. Moreover, hybrid business forms, in contrast with EU
countries, are generally available almost in every state in the US. Despite that, Kobayashi and
Ribstein researched on the possibility that incumbent differences in laws regulating hybrid
business forms (specifically LLCs) could lead to the outburst of incorporation mobility of private
companies. Their theoretical and empirical analysis, however, concluded that more efficient LLC
laws do not have potential to encourage foreign incorporations.110
Secondly, the given company is subject to taxes in both states. In the state of formal registration,
the company is taxed to retain the legal status, while in the state of material residence it is taxed
due to the business activities it conducts on its territory.111 Therefore, the lack of incentives and
incumbent tax scheme result in relative reluctance of entrepreneurs to initially incorporate
abroad.
On the other hand, founders of start-up companies sometimes consider initial
incorporation in Delaware, as in the past, before the burst of dotcom bubble, such practice was
considered as a shortcut to initial public offering.112 Since then however, the number of initial
public offerings immensely decreased and so the incentive of start-ups to choose Delaware for
initial incorporation. Another factor discouraging the initial incorporations abroad (meaning
different state) is the considerable freedom to reincorporate in the later stages of company’s life
cycle.
In contrast with the EU, reincorporations create the core of corporate mobility in the United
States. Romano in her research suggested that the companies change their incorporation state
when they expect to undertake a transaction that could be more efficiently conducted under the
Gevurtz 1992, p.
Ventoruzzo 2006, p. 111
110 Kobayashi and Ribstein 2011, p. 136
111 Gevurtz 1992, p.
112 Davie 2011, available at http://www.strictlybusinesslawblog.com/2011/08/09/should-new-business-ownersincorporate-in-delaware/
108
109
22
law of the other state.113 Such incentive for reincorporation is often referred to as transaction
explanation. The cost savings could be either direct, the destination state’s law reduces the costs
of specific transaction, or indirect, the firm’s new activities are more likely to bring it into
contact with the legal system more intensively than before.114 In accordance with such thesis,
empirical evidence shows that the reincorporations frequently coincide or shortly precede other
important corporate transactions such as initial public offerings, mergers and acquisitions or the
adoption of anti-takeover provisions.115 Heron and Lewellyn in their research scrutinized the
proxy statements of publicly traded companies in order to reveal their incentives to
reincorporate. The research ascertained six recurring rationales that were predominantly of
cost-efficient nature (see Figure I).
Figure I
(Source: Heron and Lewellen 1998)
Whereas most of the incentives identified in the given research at least in theory can lead to
improvement of shareholders’ value, specifically reduction of director’s liability and erection of
takeover defenses (anti-takeover laws) represent motives that may not be in the best interest of
shareholders and simultaneously may not lead to the enhancement of their value.116 In fact,
proponents of the “race to the bottom” phenomenon suggest that occurrence of such motivated
reincorporations in return incentivize states’ legislators to design laws that enable managers to
reduce their personal liability and/or increase their personal protection from the market for
corporate control.
The negative attitude towards such motivated reincorporations is also
reflected in the reaction of the market. Heron and Lewellen discovered that upon announcement
Romano 1985, p. 226
Ibid.
115 Ibid.
116 Heron and Lewellen 1998
113
114
23
of such reincorporations in 95% of the cases researched the stock price of the given companies
dropped more than 1.5%. Apart from these two controversial reincorporation rationales, the
other motives cited in the Heron and Lewellen study are generally in accordance with the costefficiency thesis.
3.3. Costs of Corporate Mobility in the EU
From the perspective of the company (or entrepreneur) any regulation or practical matter that
burdens the process of mobility could be translated into extra costs that the companies
necessarily confront and weigh with enumerated benefits. These costs significantly differ in case
of incorporation and reincorporation mobility.
3.3.1 Costs of Incorporation Mobility
When an entrepreneur is seeking for a jurisdiction of initial incorporation ,the selected business
form is established ex nihilo and does not have to cope with set of legal relations concluded in
the former jurisdiction that are affected by the alteration of applicable company law.
Nevertheless, there are other costs to be considered by an entrepreneur. When an entrepreneur
decides to incorporate in a state A and simultaneously conduct business partially or entirely in
member state B, he has to establish a branch of the company in a member state B, which is
obliged to be registered in that member state.117 Economically, the branch is therefore a true
parent company and the legal parent company is a legal shell without real business activity. 118
The costs of branching vary from country to country and may not be negligible, especially for
starting entrepreneurs. On the other hand, Becht et al. discovered that only a fraction of
companies in fact register the branches and since the branches are not separate legal entities
their registration is typically not enforced.119 Unless the member states start to strictly enforce
the registration of branches of foreign companies costs related thereto will not impact the
decision of entrepreneurs to incorporate abroad.
While the low costs of entry appear to attract initial incorporations, the further costs of
maintaining the legal status of the firm and costs of compliance with mandatory rules in the
given jurisdiction are usually neglected or ignored. The case of German firms incorporated in the
UK serves as an example of such negligence. Smaller firms in Germany rarely meet the disclosure
requirements under Fourth and Seventh Directives on the annual accounts and consolidated
Essers et al., p. 190
Becht et. al., p. 13
119 Ibid.
117
118
24
accounts of limited liability entities.120 These are however rarely enforced in Germany and
generally small firms would rather pay an insignificant fine than to disclose sensitive internal
information that could be used by their market competitors. In contrast, in the UK, small
businesses tend to make their financial disclosures in a timely and accurate manner. 121
Moreover, directors of companies can be held personally liable for filling of annual returns and
accounts under UK criminal law. German small firms incorporated in the UK, unaware of
possible consequences, adhered to their common practice gained in the interaction with German
legal system. Subsequent fines and criminal charges significantly raised the costs of seemingly
low-cost foreign incorporation.122 Indeed the costs of getting acquainted with foreign legal
system can be sometimes higher than expected. On the other hand, the market is currently
penetrated by various intermediaries and registration agents that for not an excessive fee
provide entrepreneurs with necessary information and thus minimize the costs of shifting
between legal jurisdictions.123
3.3.2 Costs of Reincorporation Mobility
Existing companies that wish to relocate to another jurisdiction within the EU also encounter the
costs of branching and costs of becoming familiar with foreign legal system. Moreover,
reincorporating companies have to bear costs related to the mitigation of negative externalities
that arise from alteration of applicable company law. As the migrating company has previously
operated in a domestic jurisdiction, it has established myriad of legal relations with different
stakeholders, whose position may be affected by the change in applicable law. National laws of
member states as well as European legislation provide several mitigating mechanisms that aim
to protect company’s stakeholders from redistributive effect. Redistributive effect occurs, when
the alteration of applicable law reshapes the legal relations among company’s stakeholders.
Rules of corporate governance represent implicit elements of the contract between the different
company’s stakeholders.124 In consequence, any alteration of the applicable law amends also
these implicit contracts. Some changes may advantage some stakeholders at the expenses of the
other.125 Whether these rules are optimal or not is more of a policy question. Nevertheless, from
the perspective of a company, they often create additional costs that usually discourage
companies from migration.
McCahery and Vermeulen 2008, p. 79
Ibid.
122 Williamson 2006
123 Becht et al, p. 7
124 Mucciarelli 2011, p. 51
125 Ibid.
120
121
25
Firstly, according to EU legislation, employees have a right to maintain their board participation
in case state of origin provides for such right, even if the state of destination’s legislation does
not afford them with equivalent rights. Moreover, the SE regulation designed a negotiation
procedure with regard to participation rights of employees that can last up to 6 months and
hence prolong the accomplishment of the conversion.126 Such arrangement, especially the time
extension, could indeed endanger smooth and swift execution of the transaction therefore it is
questionable, whether the preservation of employee’s rights should have a primacy in this
respect.
Secondly, the reincorporation can also reshape relations between company and its creditors. For
instance, supposing that member state of destination offers less stringent rules on fraudulent
conveyance, creditor’s position may be deteriorated, unless there are other mechanisms put in
place in order to compensate for such deficiency.127 The EU derivative law, with an aim to
protect creditors from opportunistic behavior, authorized member states to design such
mechanisms according to their will.128 This, on the other hand, means that member states may
use this opportunity to once again erect barriers to reincorporation mobility by over-regulating
the creditors’ protection. Currently, most of the member states require companies to pay a
security or to pay in advance all outstanding debts before the reincorporation takes place.129 In
principle, these protection mechanisms serve as a creditors’ exit option from the nexus of
contracts.130
Thirdly, if member states are considered as a company’s stakeholders with regard to tax
payments, then so called-exit taxes intend to protect states as tax collectors. Exit taxes are all
types of charges and upfront tax payments imposed on a company upon the emigration.
Emigration in this case has to involve the shift of tax residency to another jurisdiction.131 Such
shift will not occur automatically with the relocation of registration office, however the tax
residency, at least partially, may change upon the simultaneous transfer of central place of
management.
132
Exit taxes are levied on unrealized capital gains before their realization.133
However the latest development in the CJEU judicature in National Grid Indus case confirmed
that immediate taxation due to migration is in contradiction to freedom of establishment and
thus the exit taxes are deferred until the capital gains are realized.134
Council Directive 2001/86/EC supplementing the Statute of a European Company with regard to the Involvement
of Employees
127 Mucciarelli 2011 p. 51
128 Cross-border merger directive article 4 § 2
129 Mucciarelli 2011, p. 51
130 Lombardo 2009, p. 647
131 Chand 2013, p.2
132 Chand 2013, p. 2
133 McCahery and Vermeulen 2008
134 National Grid Indus BV v Inspecteur van de Belastingdienst Rijnmond C-371/10, Article 37
126
26
National or EU legislative measures designed to avoid redistribution effect of reincorporation
obviously impose significant additional costs for the migrating companies. As demonstrated on
the examples of employees, creditors and member states as tax collectors, legal regulation favors
transactions that are Pareto efficient. A reincorporation is Pareto optimal if it increases the
overall value of the nexus of contracts and is at least neutral to those stakeholders that do not
benefit from it.135 The number of company’s stakeholders is however frequently very high,
therefore complying with all measures mitigating the negative effects simply outweighs the
expected benefits. While Pareto efficiency is highly unattainable, many more reincorporations
would satisfy the Kaldor-Hicks efficiency criterion.
According to Kaldor-Hicks efficiency
criterion, a reincorporation is efficient if the benefits of some stakeholders outweigh the losses
of other stakeholders so the former can at least theoretically compensate the latter and be
nonetheless better off.136 Certainly, the Kaldor-Hicks criterion may seem much more permissible
to reincorporations, however it would cover very extensive set of transactions, by which many
stakeholders could end up severely harmed. Translating Kaldor-Hicks efficiency into legislation
would have to sacrifice legal certainty on the side of stakeholders in general.
3.4. Costs of Corporate Mobility in the US
3.4.1. Costs of Incorporation Mobility
As mentioned before, the incorporation costs for newly established companies as well as for
reincorporating companies are in comparison with EU states almost negligible. Common law
systems have abandoned the idea of minimum capital requirement and additional rules related
thereto. Generally, common law systems are based on ex post protection by litigation and
therefore the instant costs of formal registration (incorporation) are significantly reduced.137 For
instance, the cost of incorporation in Delaware are approximately $150 and in Colorado around
$50.138 Some states even allow an online registration through so-called incorporation agents and
thus the registration process can take as little as twenty minutes. However any omissions, errors
or information asymmetries that occur between stakeholders in this stage of company’s life
cycle can be deemed as latent costs that will materialize later in the process of litigation. Hence
the quality of judicial system and promptness of litigation process play a much more important
role in the decision-making of US companies. Similarly to the EU countries, if US companies
Muccirallli 2011, p.51
Ibid. p. 51
137 Ventoruzzo 2006, p. 14
138 Ibid.
135
136
27
conduct a business in state other than the state of their incorporation, they have to formally
register there as a foreign company. The costs of registration and maintenance of foreign
company status that will allow a company to conduct business in the territory of that state are
usually negligible for larger companies but may create and obstacle for smaller companies.139
3.4.2. Costs of Reincorporation Mobility
With regard to costs of reincorporation the situation in the US is far less complex than in the EU.
Similarly to the EU reincorporating company has established numerous legal relations with
different types of stakeholders in the state of their original incorporation. On the other hand,
upon reincorporation, the only set of rules that is altered with regard to company law are those
that are subsumed under internal affairs doctrine. Moreover, the US law system has never
embraced the concept of the employee board participation. In fact, the unions completely refuse
such concept as they put the main emphasis on their collective bargaining with the management
of the company, for which the employee positions on the board would be directly
contradictory.140 The reincorporation in the US also does not have far reaching effects on
creditors of the company, due to the fact that creditors’ protection is regulated by bankruptcy
law which is to large extent federal and thus unified across the US states.141
On the other hand, the companies may consider the compatibility of the chosen company law
with the other applicable laws of states in which they conduct business or are listed on the stock
exchange.
In the US, the securities law may create additional costs or even discourage
companies from reincorporation.142 The Securities Act of 1933 provides an exemption from all
the registration obligations and mandatory disclosure, on condition that the issuer and offeree
are both residents of the same state. Such exemption automatically does not apply to companies
that have a double domicile.143 Although these additional costs may matter for smaller and
medium-sized businesses, larger corporations already conducting business in multiple states
usually do not consider such costs as a major disincentive to reincorporate.144
With regard to the costs of switching the legal counsel, the US lawyers are usually well
acquainted with the laws of attractive jurisdictions like Delaware or Nevada and thus there is
frequently no need to change the law firm upon reincorporation.145 Thus the main portion of
reincorporation costs consists of instant payments for legal fees, additional expenses related to
Ibid.
Summers 1980, pp. 367-392.
141 Mucciarelli 2011, p. 463
142 Ventoruzzo 2006, p. 15
139
140
Ayres 1992, p. 375
Ventoruzzo 2006, p. 16
145 Ibid, p. 19
143
144
28
proxy statements, costs related to organization of shareholder meeting and also more indirect
costs such as registration of patents and trademarks and applications for licenses and permits in
the state of destination.146 The above-given analysis of corporate mobility costs proves that the
costs of reincorporation in the US are significantly lower than in the EU and that legislators on a
state level have adjusted their legal system in a manner which does not give rise to additional
costs related to reincorporation.
4. Conclusion
The comparative analysis has revealed similarities and also substantial differences of
reincorporation mobility in both countries on historical, doctrinal and empirical level. Regarding
the development of doctrinal approach, state law-makers in the US proved to be significantly
more business-sensitive, as changing economic environment forced them to abandon
protectionist attitude towards movement of companies. On the other side of the Atlantic, the EU
member states seem to react with certain delay to the growing business demand for corporate
mobility. Currently the EU law and judicature of the CJEU serve as a driver behind the legal rules
that should liberalize reincorporation mobility.147
Secondly, the comparison has revealed significant difference in set of rules that change upon
reincorporation in the US and the EU. This leads to two observations. In the US, the alteration of
applicable law is limited to the rules that are subsumed under internal affairs doctrine and
therefore the reincorporation does not substantially affect position of most sensitive
constituencies, creditors and employees. Hence it is obvious that the American model of
reincorporation did not have to cope with the possibility of redistributive reincorporations to
the detriment of these constituencies. On the other hand the broader scope of legal rules that
change upon reincorporation and substantial differences in legal rules among EU member states
could contribute to the attractiveness of reincorporation in the European settings.
Comparison of the empirical evidence and cost-benefit analysis of corporate mobility showed
that, in principle, companies, whether European or American, utilize the free choice of law in
order to reduce costs of “doing business”. Companies regardless of nationality act rationally and
thus migrate only in case the benefits of migration outweigh its costs. However the structural
differences in the corporate mobility phenomenon are again determined by currently divergent
focuses of individual states in the US and the EU. While EU member states are coping with the
intervention of EU legislator, who enabled incorporation and reincorporation mobility, US states
146
147
Romano 1985, p. 285
Mucciarelli 2011, p. 467
29
are firmly focused on accommodating needs of larger corporations. The cost-benefit analysis
also confirmed that so far European legislator and member states have not agreed on an efficient
way to conduct inbound and outbound reincorporations. The lack of coordination in this matter
could be ascribed to pertaining negative attitude of member states towards corporate mobility.
The empirical evidence also showed that incorporation mobility could be quite short-lived
phenomenon as the member states started to adjust its legal regulation in order to reduce costs
of incorporation. Hence the core of corporate mobility could potentially shift towards larger
companies, similarly as in the US, but that is also directly dependant on the willingness of
member states to cooperate in this matter. Nevertheless, it has to be noted that according to
development of reincorporation mobility and free choice of law concept, the EU and the US are
standing on different steps of evolutionary ladder and thus the EU and member states may need
more time to refine the contours of mobility phenomenon.
30
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