Legal Harmonization Seminar. Session 11: Regulatory Competition in company Law

Transcription

1 Legal Harmonization Seminar Session 11: Regulatory Competition in company Law Fernando Gomez Pomar Universitat Pompeu Fabra, Barcelona NYU School of Law NYU School of Law, Fall term 2012

2 Main goals Discuss the importance of regulatory competition in corporate law, and what conditions have produced its development, specially in the European market Discuss some possible effects and implications from the observed phenomena in this field Main texts: O Hara and Ribstein, The Law Market, Oxford University Press (2009), ch. 6 Becht, Mayer, Wagner, Where Do Firms Incorporate? Deregulation and the Cost of Entry Journal of Corporate Finance, vol. 14 (2008)

3 European regulatory competition in company Law In Europe, and elswhere, two theories compete to determine the legal rules applicable to companies The incorporation theory or IAD theory: The corporation is governed by the laws of the jurisdiction of incorporation, regardless of the physical location of their business, operations and activities The real seat theory: The corporation has to be governed by the rules of the jurisdiction of the corporation s main place of business In the US, the first theory is in force. In most European jurisdictions, the real seat theory dominated Under EU Treaty, the real seat theory is challenged by The right to establishment of undertakings (art. 48 TFEU) Mutual recognition of companies (art. 50 TFEU)

4 European regulatory competition in company Law RIGHT OF ESTABLISHMENT Article 49 (ex Article 43 TEC) Within the framework of the provisions set out below, restrictions on the freedom of establishment of nationals of a Member State in the territory of another Member State shall be prohibited. Such prohibition shall also apply to restrictions on the setting-up of agencies, branches or subsidiaries by nationals of any Member State established in the territory of any Member State. Freedom of establishment shall include the right to take up and pursue activities as self-employed persons and to set up and manage undertakings, in particular companies or firms within the meaning of the second paragraph of Article 54, under the conditions laid down for its own nationals by the law of the country where such establishment is effected, subject to the provisions of the Chapter relating to capital

5 European regulatory competition in company Law RIGHT OF ESTABLISHMENT Article 54 (ex Article 48 TEC) Companies or firms formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the Union shall, for the purposes of this Chapter, be treated in the same way as natural persons who are nationals of Member States. Companies or firms means companies or firms constituted under civil or commercial law, including cooperative societies, and other legal persons governed by public or private law, save for those which are non-profit-making.

6 European regulatory competition in company Law This was made clear through the case Law of ECJ CENTROS case (1999) Facts: A branch of a UK company, which had no significant relationship with the UK, requests registration at the Danish commercial registry The ECJ decides using right to establishment Right to establishment precludes denying registration of a branch, even when it is main center of operations, given that the choice of another MS to create a company is a lawful decision under right to establishment Right to establishment requires MS to allow companies incorporated under laws of any other MS, even when the place of incorporation and the main seat of operations or direction of company diverge

7 European regulatory competition in company Law An additional step in creating a law market for company law in Europe involves reducing barriers to moving business and centers of operations between MS Uberseering Case (2002) Facts: A Dutch company is bought by German citizens, and the only center of activity and operations is then located in Germany. The company files suit in a given case, but German court denies standing to sue, since the company, undeniablly having its actual place of business and center of operation in Germany, should have incorporated and registered in Germany under the real seat theory, but failed to do so. By this, it does not have the status of a legal entity and lacks standing to sue.

8 European regulatory competition in company Law Uberseering Case Decision by ECJ: The failure to allow full activity and operation of a company lawfully incorporated under the laws of another MS constitutes an infringement of freedom of establishment The MS receiving the company must accept and respect the type of company lawfully chosen in the incorporation MS and cannot force a transformation or change of the company form Open to question whether the receving MS could have forced the company to open a branch in the receiving state (and eventually in any other MS where it intended to have business activity)

9 European regulatory competition in company Law The next step refers to full choice of incorporation in a MS where there is no connection whatsoever, and the business is intende to be made in a different MS (pseudo-foreign companies) Inspire Art Case (2003) Facts: A UK company created by Dutch nationals intending to do business solely in the Netherlands. Dutch Law in this case tries to force upon the company, given that it is a pseudo-foreign company certain legal requirements (information, minimum capital, directors liability) more exacting than the ones required for Dutch companies

10 European regulatory competition in company Law Inspire Art Case ECJ decision: A company lawfully incorporated in a MS that operates in another MS cannot be subject to more exacting requirements than those that would apply to a domestic company It is lawful to choose to incorporate in another MS to avoid mandatory company law of the MS where business will be undertaken MS should grant equal treatment to foreign companies from other MS The use of the law market for incorporating should not be considered an abuse of the freedom of establishment

11 European regulatory competition in company Law A step back in the European law market for companies? Cartesio Case (2008) Facts: A Hungarian company, incorporated and registered in Hungary, wants to modify its Bylaws under Hungarian Law to change its center of activities or operations to Italy, but retaining being subject to Hungarian Law ECJ decision: It is not part of right of establishment that companies keep their law of incorporation and entirely move their center of operation to a different MS The Law of a MS may, without infringing freedom of establishment, that for a company to keep its nationality does not move the center of operations to a different MS. What companies are considered domestic companies is for each MS to decide ECJ thus does not consider the real seat theory per se against right of establishment

12 European regulatory competition in company Law Not quite: right of establishment includes the choice of law dimension Vale Case (July 2012) Facts: An Italian construction company cancels its registration in Italy and wants to reincorporate in Hungary without dissolution and liquidation, that is, preserving legal personality. Hungarian Law does not allow a foreign company to reincorporate in Hungary, even when complying with local requirements for the company, preserving the existing legal personality. Hungary, thus, did not authorize a change in applicable law without touching the existence of the company

13 European regulatory competition in company Law Vale Case ECJ decision: Hungarian Law was making a difference between legal predecessors of a company based on whether the preexisting incorporation was domestic or foreign This difference can be a serious obstacle to freedom of establishment,and although especial rules or different rules are not necessarily a breach of right of establishment, Hungarian Law was in practice banning the choice of Hungarian Law for companies who wanted to transform themselves without dissolving Right of establishment comprises right to choose law for companies

14 European regulatory competition in company Law Already before the Vale Case, in the Sevic case a related issue had been resolved Sevic Case (2005) Facts: A German company intended to merge with a Luxembourg company and transform itself. German Law prohibited this unless the two companies had real seat in Germany ECJ decision: The measure in the MS had the effect of preventing crossborder mergers and the change of seat of operations Forcing dissolution and liquidation in those circumstances does not conform with freedom of establishment

15 European regulatory competition in company Law Law Why U.K has been the European Delaware (for a while) Some advantages of UK Law Easy and cheap (no minimum capital requirements, low incorporation fees) Very evolved capital markets Good quality of complementary legal products Commercial courts Large, competent, law firms However, the attraction has been: Short-lived When other countries have reacted, the number of foreign Ltd s has declined significantly France dropping minimum capital requirements in 2003 Germany with the Unternehmergesselschaft in 2008 Facilidad de constitución: reducido capital mínimo, rápido registro (incluso on-line ) Does not affect public, listed companies, despite the appeal of London Stock Exchange

16 European regulatory competition in company Law Law Intuitively, direct cost of incorporation seems to have been the main driver of the process Set up costs and fees are important for incorporation decisions of small companies The marginal effect seems to be large, so that small differences in such costs result in large migration levels Substantive laws and complementary legal goods seem to play a very limited role In the case of UK v. Germany comparison 32 v. a 1850 In 3 years 40,000 incorporations by German entrepreneurs (out of 67,000 total foreign incorporations)

17 Empirical data about European regulatory competition Empirical data shows that the line of ECJ decisions starting with Centros is directly linked with an important international flow of private limited liability companies in the EU area The effect became perceptible with a time lag due to the reluctance of several laws and commentators to support the initial phases of case Law Between 2003 and 2006 Sizable numbers (67,000) new plc were create originating in antoher EU country These are companies incorporating in the UK but without any activity in that country The average per-country number of 146 every year raised to 671 over a three-year period

18 Empirical data about European regulatory competition Empirical analysis using differences in differences regressions show that such an increase was a result of the ECJ Case Law, since such phenomenon did not affect non-eu countries, not affected by such Case Law Data also show that the main drivers of the effect are Migration rates are driven by some country-specific factors Costs of the incorporation process, including registration and other fees Minimum capital requirements to start a limited liability company Other features of company law do not seem to have an effect, although most of them were not systematically analyzed The presence of intermediaries who are able to reduce the transaction costs of the UK incorporation process (language, knowledge of legal details) also play an important role, especially in markets with high formation costs possibilities of legal arbitrage are exploited

19 Empirical data about European regulatory competition The migrant countries were aware of the process, and they reacted reducing the incorporation costs and the minimum capital requirements The starting point was one of large differentials across EU countries in terms of Minimum capital requirements ranging from a maximum of 35,000, to a minimum of virtually zero. The variance was also high since many countries had cpaital requirements exceeding 10,000, and several others had low requirements The countries with higher requirements were Austria, Belgium, Denmark, Germany, Greece and the Netherlands The countries with lower ones were Cyprus, France, Ireland and UK Costs of incorporating also varied widely, from amaximum of 6,715 to a minimum of 425 Again variance was large, with several countries having costs above 2,000, while others had costs in the vicinity of 500 The countries with higher costs were Austria, Denmark, Italy and Luxembourg The countries with lower costs werefinland, France, Hungary and UK

20 Empirical data about European regulatory competition The regressions show that ECJ Case Law had an effect on incorporations The regression also shows that being a country with high costs of incorporation and high capital requirements is an statistically significant factor behind migration of incorporation to the UK, a low cost, low capital jurisdiction The first result is confirmed by the fact that non-eu countries with high incorporation costs and high minimum capital requirements are not influenced The second result is confirmed by the fact that for EU countries, other features of Laws dealing with incorporation, such as delay and number of legal steps and complexity in incorporation were not significant

21 Empirical data about European regulatory competition Why the UK may have an interest in obtaining incorporations from other EU Member States? Some extra income due to setup fees paid to UK intermediaries and registration agents Additional demand for their legal professionals: Litigation Subsequent legal work Reputation effect incorporating of being an attractive jurisdiction for Spillover effects from large number of companies The end result is that there is some convergence on the factors leading to regulatory competition (incorporation costs and minimum capital requirements)

22 Empirical data about European regulatory competition The bulk of substantive company law rules is not affected by regulatory competition, so there is little evidence of Incentives arising from regulatory competition to produce more attractive company Law rules Convergence in substantive legal solutions affecting companies as a result from the regulatory competition In the end, the current level of harmonization of company Law in the EU seems the product of the explicitly harmonizing directives, and not of regulatory competition

23 The optional European approach The EU has also created, in addition to regulatory competition between company laws of MS, an optional regime for incorporation, the European Company or Societas Europaea (Council Regulation 2157/2001) The European Company provides an alternative optional regime to regulate (many, but not all) issues in the internal affairs of the corporation After a slow and unpromising start, the number of incorporations seems to have increased substantially

24 The optional European approach The empirical studies on the European Company have so far failed to identify Demand for quality of substantive law as a main driver of decisions An effect of creating incentives for the laws of MS to make changes along lines of European Company solutions The European Company as a tool of regulatory competition between national company laws (the idea that that firms use the European Company form to search for the best national regime to fill the gaps in the rules set out for the European Company by Regulation 2157/201)

25 The optional European approach The main drivers of incorporations under the European Company seem to have been To mitigate the effect of mandatory codetermination rules, and to create a onetier board structure, in those MS imposing a two-tier structure on corporations To take advantage of the special mobility granted to the European Company in order to maximize tax efficiency

26 The US case In the area of company and corporate Law, there is evidence that firms in the US do actually engage in purposeful choice of laws and incorporate in a given state taking into account the legal environment and the company law of such state, or at least part of it In the US, the incorporation or IAD rule seem solidly grounded. It is accepted and enforced by all states, and there is even some (weak) basis for a constitutional protection of the rule

27 The US case Prior to late years in XIX century, most US states resorted to real seat, and forced firms to incorporate in states where they had significant activity The first globalization of markets (railroads, telecommunications, mass production) started a process of change in economic policy that affected this matter New Jersey got the lead in becoming a charter haven When the general climate of New Jersey Law went less business-friendly, Delaware saw a market niche, and swiftly replaced NJ

28 The US case The incentives for Delaware to compete in attracting incorporations are clear Small state which may enjoy a competitive advantage in a narrow niche High incorporation fees Revenue from incorporation business (fees and taxes on lawyers) is 40% of state budget Self-sustaining alliance between local lawyers and local politicians to offer a business friendly corporate law and supporting quality institutions (courts and bar)

29 The US case Where does demand come from? Large corporations have a preference for uniform law to govern all internal issues of corporation The more widely dispersed ownership of corporation is, the higher the benefits of one Law governing all corporate (internal) affairs In disperse corporations, managers enjoy significant control and decision rights which allow them to take lead in choice of incorporation or re-incorporation location A good quality, stable (but adaptive) corporate law catering to corporate managers will be in high demand

30 The US case Why other states respect the incorporation decision in Delaware? States not respecting incorporation in Delaware may fear that companies headquarters may leave their territories The matter is not politically salient enough to generate a powerful coalition against Why are no other serious competitors? Less advantages from such an specialized activity Lead and cost advantage of incumbent Network externality from having a uniform language and rules for corporate Law

31 The US case For other company forms (close corporations, LLC) the demand for a uniform, high quality law for their internal matters is lower Usually a controlling owner or shareholder in close corporations, or shareholders agreement Issues are decided by authority, or by contract, not by default law Less litigation on those internal matters Typically lower size, so less willingness to incur costs of incorporating in a foreign jurisdiction

32 The US case The success of Delaware in the incorporation competition is obvious for public corporations 60% of 500 largest firms are Delaware corporations (very few with hq in Delaware) In LLC, there seems to have been a competition, albeit of smaller scale Of the 50% of LLC formed out-of-state, a high percentage have been in Delaware Other states, especially Florida, have been very successful in attracting LLC together with direct investment and company formation through Advantageous taxation Asset protection rules in bankruptcy Active real estate investment business

33 The implications Are the lessons from both the European and the US regulatory competition experiences in company law relevant for the general harmonization debate? The drivers of regulatory competition are not universal: demand and supply factors may vary and have enormous effect on the nature of competitive process The actual effect on the level of disparity after regulatory competition is hard to predict However, the lower and simpler the relevant factors, the higher seems the expected level of resulting uniformity The social desirability of outcomes is difficult to assess generally

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