The European Company Statute:
The Vision v. the Reality and the Challenges Lying Ahead.
Essay LLC Company Law 2002
Jamie Dorman Storey (jldormouse@aol.com)
December 7, 2002
Professor J. Rickford
Leiden University, The Netherlands
Table of Contents
I. Introduction: The Vision
II. The ECS: The Reality
III. The Shortfalls of the ECS and the Challenges Lying Ahead
A. Multiple Layers of Regulation and the Lack of Harmonization
B. Taxation
C. Employee Contracts and Pensions
D. Cross Border Transfers: The Protection of Creditors, Shareholders & Employees
E. Employee Participation
F. Corporate Governance
IV. Was the ECS Worth It?
V. New Challenges Created by the ECJ: Uberseering and the ECS
VI. Conclusion
I. Introduction: The Vision
Over 30 years ago, the original drafters of the European Company Statute (ECS) envisioned the Societas Europea (SE) as a supra-national corporate form completely governed by European legislation. Their objective was to establish a truly "European" corporate perspective and create a simpler way for companies to do business in multiple member states. The drafters hoped to create a corporate form with a European identity that was not tied to or regulated by the laws of any individual member state. The original concept included the promulgation of comprehensive European legislation that would regulate nearly every aspect of the SE’s existence including formation, corporate structure, taxation, shareholder and employee rights, liquidation and insolvency matters. In hindsight, the vision of the original drafters may have been overly ambitious. Their vision, however, set the stage for a thirty-year debate over the necessity, feasibility and potential advantages of a European Company.
It became clear early on that achieving the drafters’ vision of creating a new company form entirely regulated by Community law would be nearly impossible. From its inception, the ECS was highly controversial, due in large part to the proposed participation of employees in the SE’s management. Several of the member states were completely opposed to the idea of worker participation, while others felt that it was an essential component of any new corporate form. Disagreement also erupted over the board structure of the SE, due to the differing corporate models employed in the various member states. Finally, after more than 30 years of discussions, compromises, stalemates, and revisions, the ECS was adopted by the European Union’s Council of Ministers in the fall of 2001. While the adopted regulation is not the embodiment of the drafters’ original vision, it does create a completely new corporate form that is partially governed by Community law. As with any legislative instrument, however, the ECS contains flaws that will need to be remedied in the future to ensure the SE form is truly advantageous for business.
This essay examines some of the flaws of the ECS and the challenges lying ahead. Part II of this essay considers the reality of the ECS and gives a brief overview of its benefits. Part III focuses on the shortfalls of the ECS and is broken down into 6 sub-parts which address (a) the multiple layers of regulation that will govern the SE and its lack of harmonization (b) taxation, (c) employee contracts and pensions, (d) the protection of creditors, shareholders and employees under Article 8, (e) employee participation and (f) corporate governance. Part III also considers some possible solutions to these problems, points out questions that remain unanswered in the ECS, and examines the challenges facing the Commission and legislators in the future. In light of the shortfalls of the ECS, Part IV of this essay considers whether the ECS was really worth a 30-year struggle and assesses what the SE brings to European Company law. Part V of this essay examines the potential conflict between the ECS and the EC Treaty and how the European Court of Justice’s (ECJ) recent ruling in Uberseering may handicap the SE. Finally, Section VI concludes.
II. The ECS: The Reality
While the adopted version of the ECS bears only a slight resemblance to the original concept, it nevertheless creates a potentially advantageous new corporate form. The ECS is a conglomeration of two instruments: (1) EC regulation No. 2157/200, setting forth the requirements for the formation, share capital, registration, structure and general meetings of the SE and (2) EC directive No. 2001/86 which sets forth the provisions on employee involvement in the SE. The SE form will allow companies currently operating through subsidiaries in more than one member state to combine their operations into a single company that will be recognized throughout the EU, and will benefit from a single management and reporting system.
One of the most important advantages of the SE form is that it allows a company to relocate to another member state without having to windup or sacrifice its legal personality as currently required. Like an American corporation, the SE has the ability to switch its internal corporate law by simply changing the place of its registration, enabling an SE to take advantage of new opportunities that arise in the common market. An SE’s freedom of movement, however, is not unlimited. Pursuant to article 7, an SE is required to have both its head office (real seat) and registered office in the same member state. Despite this limitation, the ECS allows for relocation possibilities that are unavailable to domestic companies. Moreover, the formation of an SE through the merger of two existing companies located in different member states creates opportunities for cross-frontier mergers that were previously not possible.
Additionally, the ECS’s counterpart, the Directive on Employee Involvement,
requires corporations intending to form an SE to engage in negotiations with a Special Negotiating Body (SNB), made up of employee representatives, to reach an agreement on the involvement of employees in the affairs of the SE. This directive also provides default rules that will determine the level of employee involvement in the SE should the negotiations fail. Unlike the regulation establishing the ECS, which is directly applicable to the member states, the directive on employee involvement must be implemented into the national law of the member states. Therefore, the member states have been given until 2004 to comply with the directive and prepare for the formation of the first SE.
III. The Shortfalls of the ECS and the Challenges Lying Ahead
While the adopted version of the ECS offers several apparent benefits, the statute also embodies some potential shortfalls. In order to maximize the potential benefits of the SE form, the Commission faces additional challenges in harmonizing the statute. The following sections point out some of the flaws of the ECS and the challenges that lie ahead.
A. Multiple Layers of Regulation and the Lack of Harmonization
While the intention of the original drafters was to create a truly European corporate form that was completely autonomous of member state law, the reality of the ECS fell well short of this goal. Pursuant to Article 9 of the ECS, the SE will be regulated by a hierarchical and complex scheme of rules. First and foremost, the ECS and its accompanying documents will govern the SE. For matters not covered in the ECS, however, the SE will need to refer to the national law of the member state where it is registered. Within the national law, the SE will first be regulated by any rules promulgated by the member state that relate specifically to the SE and second, by the rules relating to public limited liability companies that have their registered office in the member state. The multiple layers of regulation will likely make understanding the ECS complicated for businesses and may lead to legal uncertainty.
Moreover, the ECS’s heavy reliance on member state law also falls short of the harmonization goals for European company law set forth in Article 44(2)(g) of the EC Treaty. The EU’s harmonization program has three objectives: (1) the harmonization of company law systems, (2) the promotion of uniform national conflict of law rules and (3) the creation of supranational European entities. The EU perceives the supranational form as beneficial because it would help to "ease cross-border economic operations and free companies . . . from national legal regulation." The SE was intended to provide these advantages. However, with all of its references to member state law, the ECS fails to attain the harmonization objective of creating a purely "supranational" corporate vehicle. In particular, the ECS has completely excluded a number of important, but problematic, areas including taxation, insolvency, intellectual property, directors’ liabilities and employment contracts and pensions. These exclusions not only fail to achieve the harmonization goals originally intended, but also create the possibility for the development of fifteen distinct SE forms, leaving the door open for exploitation and regulatory competition.
B. Taxation
Anna Diamantopoulou, Commissioner for Employment and Social Affairs, concedes that "the European Company Statute is not yet perfect and much work remains to be done on taxation matters." As matters currently stand, the ECS does not provide a significantly beneficial tax scheme that would entice corporations to opt for the SE form. Under the current ECS, the SE will be taxed in the same manner as a multinational corporation. Like a multinational corporation, an SE created by merger and operating through branches in different member states will be taxed on its worldwide income by the member state where the SE has its registered office. Taxing the SE on its worldwide income will enable it to offset the profits from some its branches with the losses from others, something that is impossible through the use of subsidiaries.
While the ECS does allow SE’s to be taxed like multinational corporations, it still leaves many questions on the taxation front unanswered. Any company considering the formation of an SE or an SE considering a cross-border migration would first need to fully understand the tax implications of such action. In the upcoming years, policy makers will need to focus on the taxation of the SE in relation to cross border transfers, mergers and legal mergers. Currently, the Merger Directive does not account for all the ways in which an SE can be formed. Therefore, prior to the formation of the first SE in 2004, the Merger Directive will need to be broadened to ensure that the formation or relocation of an SE does not create undesirable tax consequences.
Several proposals relating to the taxation of the SE have already been suggested. Two of the more popular proposals are the creation of (1) a home state taxation scheme or (2) a common base taxation scheme. Pursuant to a home state taxation scheme, all of the SE’s branches throughout the EU would be taxed according to the laws of the SE’s "home state." The SE’s "home state" would then determine how the tax revenues collected should be divided among the member states where the SE operates branches. A common base taxation scheme, on the other hand, is premised on the formulation of a single tax base and allocation system that would apply uniformly to all SE’s. The formula based approach to tax allocation in the common base scheme may prove easier and more uniform than the home state scheme because the member states will not be given discretion concerning tax allocation. Therefore, while the SE has the potential of becoming an instrument for tax planning, many challenges in the area of taxation still face the Commission before that possibility can become a reality.
C. Employee Contracts and Pensions
Additionally, the ECS neglects to include any provisions on employee contracts and pensions. Rather, the national law of the member states where the SE’s head office and branches are located will regulate this area. Unfortunately, this requires the SE to have knowledge of the national laws relating to employment contracts and pensions in each of the member states where it conducts business. This is a far cry from the single set of rules the SE was intended to operate on throughout the EU.
The problem of employee pensions in the SE may be remedied, however, through the adoption of the proposed Directive on Occupational Retirement. This proposed directive would allow SE’s to set up a single pension fund for all of their employees throughout the EU. The adoption of the proposal would fill one of the gaps remaining in the ECS and would bring the SE one step closer to the vision of the original drafters.
D. Cross Border Transfers and the Protection of Creditors, Shareholders and Employees
Article 8 of the ECS also raises questions concerning the protection provided to creditors, shareholders and employees of an SE proposing a cross border transfer. It leaves member states a wide margin of appreciation in determining the degree and extent to which these rights will be protected. Paragraph 7 of article 8 requires that interests of an SE’s creditors are "adequately protected." However, the ECS never defines what "adequate protection" entails. Furthermore, Article 8 fails to specify how a transfer may affect the interests of the SE’s original creditors and whether the SE’s new creditors will take priority. While paragraph 24 of the Preamble to the ECS mentions the protection of creditors and states that a transfer should not affect any rights originating before the transfer, Article 8 does not clarify this.
Paragraph 5 of Article 8 also gives member states the ability to adopt provisions to protect the interests of minority shareholders. Presumably this means that a member state can adopt legislation that would provide a minority shareholder with the option of a fair price buyout prior to the transfer. However, it raises the question of whether Article 8(5) or 8(14) would also allow a member state to block a transfer where a minority shareholder contests the fair price of his buyout? While this seems unlikely, the ECS is silent on this matter.
Furthermore, under paragraph 4 of Article 8, creditors and shareholders are given the right to examine the transfer proposal and report drawn up by the SE’s management. However, nowhere in Article 8 is this right extended to the employees of the SE. Article 8 also fails to specify what impact, if any, a transfer may have on employee participation rights that existed prior to the transfer. Article 8(2)(c) appears to indicate that a transfer may have some "implications" on employee participation, but this is in conflict with paragraph 3 of the Directive’s Preamble which stresses that employee participation rights should never be reduced. While paragraph 3 of the Preamble is referring to the formation of an SE, it would seem that this same principle should apply to the transfer of an SE to a new member state. Once again, however, Article 8 leaves this issue unresolved.
In its present state, the uncertainties contained in Article 8 of the ECS seem to provide creditors, shareholders and employees with a fairly low level of protection regarding the transfer of an SE’s registered office to a different member state. The Commission may take action to clarify Article 8 in the future, but it is more likely that many of the questions in Article 8 will remain unanswered until they are litigated.
E. Employee Participation
Employee participation, the most controversial component of the SE, also presents several problems. First, the automatic default rules that apply in the event of failed negotiations may provide employees with an incentive not to negotiate in good faith. While management may still withdraw a proposal following failed negotiations rather than allow the default rules to apply, the existence of the default rules may cause employees to holdout in the negotiations in an attempt to force management to make additional concessions. Secondly, an SE that is formed without employee participation, but is gradually built up over time, may be able to escape employee participation completely. While Article 11 of the Directive speaks of "the misuse of the SE form for purposes of depriving employees of rights to employee involvement …", it is questionable whether member states will apply this provision where an SE grows organically. It appears that this is yet another uncertainty that may have to be dealt with by the courts.
Third, the default rules on employee participation may disadvantage German and Dutch companies that have a long tradition of worker participation. For example, a UK company may be hesitant to form an SE with a company that has a high level of employee participation in case the default rules apply. Where this happens, the highest level of participation that existed within the two participating companies will apply to the new SE. Therefore, it would be more beneficial for a UK company to form an SE with a company that also does not have employee participation. In this scenario, employee participation would not be required in the SE under the default rules. Finally, what happens if an SE with employee participation converts into a domestic company pursuant to Article 66 in a member state that does not require employee participation for its domestic companies? Do the employees lose their participation rights? The Directive and the ECS leave this question unresolved.
Putting these technical problems aside, the notion of employee participation is totally foreign to many of the member states within the EU. Even the concept of employee consultation and information will be alien to U.S. corporations and the idea of board level participation of employees may deter American corporations from forming an SE. One of the main remaining questions is whether, in practice, the SE’s system of employee involvement will be able to bridge the gap between the German and UK models? While co-determination has worked well in Germany and has resulted in a more employee sensitive management, reduced strikes, increased board diversification and has acted a barrier to takeovers, convincing the rest of the EU of its benefits will be an uphill battle.
Unfortunately, much of the success or failure of employee participation in the SE rides on the implementation of the Directive itself. Therefore, it falls to the national legislators to determine if employee participation in the SE will truly be feasible in practice.
F. Corporate Governance
The freedom to adopt either a one-tier or two-tier board structure when forming an SE is likely to be problematic. Similar to employee participation, the SE’s choice of board structure may cause most member states to be confronted with a form of corporate governance that is completely foreign from the one employed in their domestic companies. For example, all domestic companies in the UK are required to adopt the one-tiered structure, while all German domestic companies must adopt a two-tier structure. Thus, the adoption of the ECS will require member states, which limit the structure of domestic companies, to undergo a legislative overhaul in order to allow an SE to properly function within their jurisdiction.
Moreover, as with employee participation, the conversion of an SE into a domestic company raises questions concerning board structure. For instance, if a two-tiered SE registered in the UK wishes to convert into a UK domestic company, will its conversion require a structural rearrangement? Once again, it appears that the ECS has failed to consider this possibility.
IV. Was the ECS Worth It?
All of the shortfalls and uncertainties of the ECS may lead drafters to ask whether the ECS was really worth fighting a 30-year battle? The answer to this question is undeniably, yes! While the ECS contains some flaws, the SE form will allow a company to combine its subsidiaries and function throughout the EU as a single unit. The ECS also provides a solution to the lack of freedom of movement of companies. Pursuant to Article 8 of the ECS, "[t]he registered office of an SE may be transferred to another Member State . . . and such transfer shall not result in the winding up of the SE or in the creation of a new legal person." Article 52 of the EC treaty was originally intended to facilitate this objective. However, some member states were concerned about not having jurisdiction over corporations doing business within their state. To avoid this, certain member states chose to maintain the real seat theory of incorporation which provides that "the law of the country where the company has its real seat (i.e. its management and control centre) is the law applicable to company relationships. Essentially the real seat doctrine prevents companies from placing their real seat outside of their place of registration and prevents European companies from developing multi-national corporations. Instead, European companies have been forced to operate through subsidiaries and holding companies, which are inefficient, prevent the development of economies of scale and create higher administrative costs.
However, in terms of movement, the ECS takes back in Article 7 some of what it gives in article 8. Article 7 places limitations on the SE’s freedom of movement by requiring the SE to locate its real seat in the same member state as its registered office. Moreover, when the requirements of article 7 are no longer met, article 64 requires the member state where the SE is registered to force the SE to either move its real seat back to state of its registration or re-register in the new member state. If the SE fails to comply with this demand, it will be liquidated. Despite the limitations of Article 7, however, the ability to re-register across frontiers provides a considerable benefit over other domestic corporate forms and therefore, should solidify the SE as viable corporate form for years to come.
V. New Challenges Created by the ECJ: Uberseering and the ECS
Recent developments within ECJ, however, have begun to question even this benefit. The Uberseering decision raises the question of whether articles 7 and 64 of ECS conflict with the freedom of movement set forth in the EC Treaty. The judgment also raises concerns that the limitations set forth in Article 7 and 64 will have a crippling effect on the ECS.
After two years of consideration and a lot of speculation over the outcome, the ECJ stated in Uberseering that a member state can not refuse to recognize the legal capacity of a company registered in one member state but with its real seat in another member state. Pursuant to this decision, companies already registered in a member state now have the option of moving their real seat to another member state and will be recognized by their host state so long as the company is still recognized in its state of origin. Thus, companies will now be able to forum shop by registering their company in the member state with the most beneficial laws and locating their real seat elsewhere. However, even after Uberseering, a domestic company is still unable to re-register in a new member state without first winding up. Therefore, the court’s decision is the most advantageous for new companies. Consequently, the SE still retains the advantage of being the only corporate form that is able to perform a cross border migration without winding up. Unfortunately, the rights granted to an SE by Article 8 do not mitigate the direct and injurious conflict between the court’s ruling in Uberseering and Articles 7 and 64 of the ECS.
Article 10 of the ECS adds additional fuel to the fire because it requires member states to treat SE’s in the same manner as public limited liability companies. Thus, if after Uberseering a public company can move its real seat out of the state of its registration, doesn’t it follow that an SE should be able to as well? When the Regulation takes effect in 2004, should Articles 7 and 64 simply be treated as non-existent? The answers to these questions remain unclear. What is clear, however, is that the Uberseering judgment creates new challenges for the Commission and requires the re-evaluation of the provisions in the ECS regulating an SE’s freedom of movement.
One possible solution to the dilemma created by Uberseering may be found by examining the purpose behind articles 7 and 64. The two articles were designed to serve as a monitoring device to ensure that the SE form "was not being manipulated for fraudulent or abusive purposes." Focusing on this purpose, Articles 7 and 64 could be removed from the ECS, in line with Uberseering, and replaced with a provision that would "nullify the effects of an SE’s transfer, if the transfer was deemed to have been carried out for fraudulent purposes."
A similar approach has worked in American courts with respect to the misdeeds of corporations. When an American court has reason to believe a corporation has ignored corporate formalities or engaged in fraudulent conduct, it may pierce the corporate veil to expose these practices. Similarly, replacing Articles 7 and 64 of the ECS with a provision designed to curb abusive practices would give the SE the same freedom of movement granted domestic companies in Uberseering, while still upholding the spirit and purpose behind Articles 7 and 64. Moreover, substituting articles 7 and 64 with a provision to control abusive practices would also be more in line with the generous transfer and relocation options given to an SE under Article 8. Article 8(14) of the ECS and Article 11 of the Directive appear to provide a step in this direction. However, in order to be effective against abuse, the provisions of these articles would need to be expanded and strengthened.
Another possibility would be for an SE to migrate and re-register in an incorporation theory state with the most beneficial corporate laws. Two years later, the SE could convert back into a domestic company under Article 66. Following conversion, the company would then be free to move its real seat out of the member state it choose for its re- registration. While this requires some complex maneuvering, it allows a company to take advantage of the ease of cross border migration provided by the SE form and the new freedom of movement granted domestic companies after Uberseering. The best solution, however, would be for the Commission to address this problem before the first SE is formed in 2004.
VI. Conclusion
In sum, the ECS has failed to achieve the drafters original vision of creating a corporate form governed exclusively by Community law. The original concept has been diluted throughout the ECS’s long and treacherous 30-year journey to adoption. While the end result resembles the drafters’ vision more in name than in form, the ECS still has something to offer the European business community and is a step in the right direction towards the harmonization of European Company law. Companies that adopt the SE form will benefit from the ease of cross border transfers and will be able to function more efficiently throughout the EU as a single entity. The SE form also compliments the development of a common market and will allow companies to take full advantage of new opportunities.
Unfortunately, the ECS is not without flaws. Much work still remains in the area of taxation and employee pensions. The adoption of uniform legislation in these areas would add tremendously to the attractiveness of SE form for businesses and would secure the SE’s place in the European Community. Additionally, the uncertainties and unanswered questions that are prevalent throughout the ECS will need to be addressed in the future. Clarification is especially needed concerning the level of protection afforded creditors, shareholders and employees when an SE decides to transfer its seat and registered office to a new jurisdiction.
Moreover, it remains to be seen how the compromises reached in the ECS concerning employee involvement and corporate governance will translate into reality. The formation of the first SE will force some member states to accept an expanded role for employees, while others will have to accommodate a new form of corporate governance within their jurisdiction. The responsibility for the success or failure of the SE in these areas largely falls to the member states.
Finally, the ECJ’s ruling in Uberseering creates additional challenges for the ECS. The Commission will need to hammer out what the ECS’s conflict with the EC Treaty means for its future and determine how this conflict can be resolved so that the SE is not grounded before it ever takes flight in 2004. Overall, the Commission and the legislators face the difficult task of securing that the ECS will not only create an entirely new business form that will function effectively in the common market, but also that its presence will signify a meaningful step towards the harmonization of European company law.