The Jurisdiction Competition and the European Company
The Attraction of the SE: A Comparison with Canada *
The EU Context: Comparison with Canada and the United States *
Introduction
The issue of jurisdiction competition generally arises where corporations are able to freely choose their jurisdiction of incorporation and thus seek to enhance their gains by choosing states where they receive the most advantage. The controversy arises in whether this type of competition leads to betterment for society or instead to a ‘race to the bottom’. The freedom of movement required is commonly found in federal states where the issue has sparked heated debate over the years. Now with the passage of the new Company Law Statute and its potential to grant companies freer movement through E.U. member states, there is a potential that jurisdictional competition will come to exist or be greatly increased within the Community. Thus with the impending date of implementation of the statute due in October of 2004, it is important to assess the possibilities of jurisdictional competition and whether this sort of competition is desirable.
The European Company, or SE (Societas Europeae) is established by a Council Regulation that is directly applicable to all Member States and a Directive on employee involvement. The result of thirty years of negotiations, it was originally intended to create a company with uniform credibility in all member states, to allow the EU to achieve an internal market that is comparable to those found in the United States and Japan. To do this it was to help overcome the "legal, fiscal and psychological barriers" to cross frontier mergers. This was to help avoid the cost and hassle of setting up subsidiaries in every member state, each of which was to be governed by different national laws. In fact it has achieved the ability for SE’s to merge across borders but it has been argued that its creation will create more barriers than currently exist for domestic companies.
There is no central registry as such, thus creating fifteen different SE’s instead of a single uniform one. As it stands, the SE will be registered in each Member State and will need to abide by member state law in regards to the many issues that are not covered by the Regulation or Directive. Although SE law supersedes national law in areas that are regulated, the SE essentially draws its legal character from the law of its registration state. These include areas of taxation, employee status and contracts. While it does impose certain requirements like employee involvement, these could possibly be circumvented by member states.
All of these conditions raise the spectre of the possibility of jurisdictional competition and a fear of a race to the bottom. The success of such competition is dependent on a number of structural factors existing in the EU. Thus, before proceeding any further, it is essential to examine first whether the SE form offers competitive advantages not already available to domestic companies and if so whether the European framework itself will promote or negate any jurisdictional competition. To do this, is helpful to examine the experiences in other federal type jurisdictions.
The Attraction of the SE: A Comparison with Canada
The first issue of relevance is to determine whether incorporation as an SE offers any significant advantages over incorporation as a domestic company. Only in this way would SE’s be able to draw sufficient numbers of incorporations so as to create a market for jurisdictional competition. An appropriate comparator in this situation is the federal and provincial incorporations possible within the Canadian system.
In Canada, both the federal and provincial governments have enacted corporate law statutes. Despite this, there is very little difference in practice in the treatment of federal and provincial corporations. At the federal level, companies can incorporate to carry on business in more than one province, the only requirement being the filing of information in each province. The advantages to a federally incorporated company are almost non-existent when looking at provincial incorporation. At the provincial level, provincial incorporation laws allow corporations to only do business within the province of incorporation. However, each province has the capacity to grant corporations the ability to do business in other provinces subject to obtaining permission from the other jurisdiction. This permission is routinely granted, effectively creating unrestricted mobility of provincial corporations throughout Canada. In fact, many provinces have adopted bilateral agreements so as to ease the freedom of movement even more.
The distinction between federal and provincial company blurs even more when considering that Canadian provinces can legislate to directly affect federal companies if the legislation falls within the provinces "head of power" as set out by the Constitution and if the legislation is not inconsistent with federal law. They are limited only in that they are not able to restrict the powers of federal corporations nor create restrictions in relation to the intra-corporate relations of the company. Thus federal corporations are subject to the same regulations as provincial ones in regards to most of their activities, i.e. relations with employees, contracts and industry specific legislation. The federal government in turn has no power to regulate the provincial corporations in relation to their corporate status or characteristics, but it can directly affect provincial companies through legislation if it is primarily related to an area of jurisdiction assigned to the federal government.
Thus there is a lack of a significant difference in federal and provincial companies leading to little incentive to incorporate as a federal company outside of perhaps the prestige that it offers a company name in international affairs.
In the European context, it appears that the SE is similar to the Canadian federal company in that it may also have difficulty in attracting incorporations. Of relevance to our discussion are the rights guaranteed to domestic companies under Articles 43 and 48 of the Amsterdam Treaty. Article 43 sets out the following on freedom of establishment:
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.
Article 48 states:
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 Community shall, for the purposes of this Chapter, be treated in the same way as natural persons who are nationals of Member States.
These Articles, as interpreted by the European Court of Justice, afford expansive rights to domestic companies to move between member states. Of particular importance is the recent decision of Uberseering where the court held that states cannot refuse to recognize the existence of a company that was incorporated in another member state and that had moved its real seat into that member state. It follows from this that a company can have its incorporation seat in one location and its real seat in another as consistent with the previously decided cases of Segers and Centros.
These rights seem more expansive upon first glance than what is afforded under Articles 7 and 64 of the SE Regulation. Article 7 states:
The registered office of an SE shall be located within the Community, in the same Member State as its head office…
Article 64 states:
When an SE no longer complies with the requirement laid down in Article 7, the Member State in which the SE’s registered office is situated shall take appropriate measures to oblige the SE to regularize its position within a specified period either:
Comparing the provisions results in the conclusion that SE’s must have their real seat and seat of incorporation in the same state whereas domestic companies are free to have them in different member states. This essentially results in decreased appeal of the SE before it has even come into existence. Any attempts to reconcile the two issues results in difficulty as either the SE legislation must be found to be subordinate to the Court of Justice decision, thus putting into question the competency of the European Parliament and Council, or subordinating the Court’s decision could potentially take away from their respectability. Compared with the Canadian situation, it appears that the SE offers even less incentive for incorporation as it may even detract from company freedom.
Furthermore, like the Canadian situation, the SE is not treated substantially different than a domestically incorporated company. Article 10 of the SE regulation requires member states to treat the SE as if it were "a public limited-liability company formed in accordance with the law of the Member State in which it has its registered office." Leaving the situation at this stage, it would appear that the SE offers no advantage over the domestic company and thus would not offer enough additional freedom to affect jurisdictional competition.
However, the SE does have some obvious advantages over domestic companies, ones that do not exist in the Canadian context. Advantages offered by the SE include its ability to merge across borders (provided by Article 2) and transfer its registered office without winding up the company (as provided by Article 8) and possibly without suffering any tax consequences (although this is not yet concrete). The SE legislation also offers companies a considerable number of choices (for better or worse) that may not be available to them in the domestic setting, i.e. choosing the structure of the corporate board despite domestic regulations, i.e. choosing a two-tier structure in a one-tier system.
Although controversial, another advantage to companies choosing to incorporate as an SE is in the realm of governance. For example, taking the case of the UK where shareholders reign supreme, companies incorporated in the UK need only five percent of shareholder to call a general meeting and draft an agenda. Under the Company Statute Article 55, shareholders of an SE’s need "at least 10% of an SE’s subscribed capital" in order to request a general meeting and draw up an agenda. Differences of this sort between domestic and SE regulations could be sufficient to draw quite a number of SE registrations. Another possible advantage (with negative social effects) that firms could receive from incorporating as an SE is the avoidance of employment participation rules, especially in countries that place firm priority on these rules. For example, this could arise from SE formation from mergers, where one company did not have employee involvement rules mergers with one that did into a third member state with high standards of employee involvement, i.e. Germany. If the SE subsequently decides not to adopt the rules, or adopt a lax version of it, they can effectively be a German company without any of the employee participation rules.
It remains to be seen whether the SE offers enough advantages over domestic incorporation so as to facilitate increased jurisdictional competition. This will depend on issues like how the Directive on employee involvement is implemented and how the provisions in the statute will be interpreted and used by both businesses seeking incorporation and the Court of Justice. The market will determine if it which situation will prove to be more advantageous to corporate needs. If comparison to the Canadian market is any indication, use of the SE will attract only marginally greater incorporations and thus its effect on jurisdictional competition will be limited.
The EU Context: Comparison with Canada and the United States
Considering the importance of national legislation for the SE, it is also important to look outside of the SE legislation into the larger European context to determine whether the Community structure is facilitative of corporate jurisdictional competition. The comparators in this situation will necessarily involve a successful federal competition jurisdiction, the United States, and one where no notable competition exists, Canada.
Studies indicate that the success of jurisdictional competition depends on a state’s ability to offer corporations a credible commitment to predictability and stability of corporate rules. This type of constancy is typically achieved primarily through legislative actions, judicial decisions and inter-linkages between those two and the corporate bar.
Financial dependence on corporate incorporations seems to be a driving incentive for corporate charter competition in many American states. Revenues derived from incorporation and re-incorporation combined with all the side benefits, appear to be what prompts legislators and the judiciary to adopt corporate friendly policies. States are able to compete for this money because each state is essentially responsible for its own corporate policies. Taking the example of the most successful competitive state, Delaware, franchise fees make up a hugely significant percentage of the state income. In fact Delaware is largely dependent on this source of income as it brings with it the added revenues that accompany any business operation including law fees and court appearances. Thus Delaware’s legislators are motivated to create policies that are attractive to companies in the desire, and indeed the necessity, of maintaining its income.
Although each state has the option of imposing local regulations on foreign companies, this is very rarely done for fear that companies will relocate to other jurisdictions. In Delaware in particular the corporate lobby is small and well organized, giving them added leverage in lobbying the government for legislative changes favorable to their needs. Once legislation is adopted, Delaware legislative corporate policy requires that all amendments to corporate legislation need to be adopted by a two-thirds vote of both houses of the state legislature thus making it very difficult to change existing provisions. Thus, corporate knowledge of a states financial dependency and the stability of their legislation create an attractive environment for incorporation.
A lack of jurisdictional competition between provinces can reasonably be the result of a lack of competitive will among Canadian legislators. There are no significant incentives to Canadian legislators to make laws that favour incorporation. While in the U.S. franchise fees are often the motivating factor for competition, in Canada the fees involved make up such a small percentage of the provincial income that policy makers are unlikely to expend capital on corporate law reform. Having no dependency on incorporation, even factors like indirect revenues and employment considerations from incorporation are unlikely to be factors when policy makers decide to change corporate laws. In fact, even though fees vary from province to province, the fee amounts are so small that companies tend to incorporate in the province where they will do most of their business.
Added to the lack of financial incentive is the fact that Canadian lawmakers seem to suffer from a general impulse to achieve uniform provincial and federal laws in all fields, not just the corporate one. Within the corporate arena Canadian law has generally recognized that substantive regulation and a solid corporate structure is the best way to control corporate conduct. Even if slight advantages exist from jurisdiction to jurisdiction, these are easily overcome through private contracts and arrangements allowed under Canadian law.
Contrary to the situation in the U.S. the Canadian corporate bar is generally not the impetus for corporate law reforms. They do not hold much sway in matters of corporate legislation and usually are not extensively consulted on proposed reforms. Any reforms that are undertaken are typically at the initiative of administrators, academics and lawyers. Thus competition between provinces has been reduced to a minimum.
Charging fees for incorporation are prohibited by in the European Union. Thus it is unlikely that any jurisdictional competition could result from state desire to attract capital. Revenues from businesses incorporating in the state could prove to be a motivating factor but this was not found to be the case in Canada where substantially the same situation exists.
Also similarly to Canada, legislators at the EU level are motivated by a desire for harmonization. The Community has competence to regulate on a wide range of issues that affect the corporate laws of member states including issues like labour, environmental protection and takeovers. The Amsterdam Treaty gives the Community authorization to establish "minimum" standards for corporate law issues in areas including incorporation, creation and management of capital, mergers, corporate governance and takeover tactics. Thus, EU law does not seem to be substantially focused on corporate interests and generating jurisdictional competition.
In the American context, state legislators seemed to be very vulnerable from pressures from the corporate lobby. However, in the EU a similar situation is unlikely to exist as each member state is a sovereign nation and national governments have a whole host of other concerns and considerations that need to be taken into consideration. Thus the effect of one corporate lobby, however powerful, may not hold as much sway.
The judicial structure of the state adds to the predictability of the corporate law. At the state level judges are elected or appointed by the state government and are thus accountable or may feel obliged towards their previous careers, often in the corporate field. The judiciary of each state is left to its own devices to craft the corporate jurisprudence, with very little federal interference as corporate cases rarely ever go to the federal level. Thus each jurisdiction is able to offer a competitive collection of corporate case law to potential incorporators. In the particular situation of Delaware it also has the added attraction of a developed pool of corporate case law, an experienced judiciary and practiced lawyers. All these factors lower the cost of law to potential clients and encourage incorporation.
Canadian provinces lack the same ability to offer corporations different pools of case law to choose from. As a result of the ability to appeal provincial decisions to the Supreme Court of Canada, there is a common corporate jurisprudence. Thus no province can guarantee that its corporate jurisprudence will remain free from interference at the federal level. Additionally, common law decisions concerning corporations in one provincial jurisdiction are likely to be adopted in other provinces as well. Effectively then, there is no point in provincial competition in the area of case law and corporations can expect to be affected by federal decisions or other provincial decisions wherever they incorporate.
In the European situation, the European Court of Justice has jurisdiction to interpret EC Treaties and ensure that they are being properly implemented in member states, with the motivation of harmonization. To the extent that company law has been regulated, the Court can hear complaints related to non-uniform application of Treaty provisions. This may create a situation similar to that found in Canada in that all member states are not free from "federal" interference and cannot ensure the stability of their corporate jurisprudence. However, the Court is not bound by precedent as the courts in Canada are, creating potentially different obligations at the national level.
As far as an automatic appeal to a federal level is concerned, the EU is not in the same situation as Canada. The situation is more comparable to the one found in the U.S. in that each member state is essentially autonomous and responsible for its own corporate jurisprudence. Thus it is likely that the judicial system in Europe could help foster the requisite stability required for competition.
Delaware’s small size allows it to possess an extremely close (some would say too close) linkage between their judiciary, corporate bar and legislator. Delaware’s small bar is highly organized and has a larger personal stake in matters of corporate legislation. They are also wealthy and tend to have good political connections with members of the bar also being legislators. Thus the interests of the corporate bar are often directly translated into state legislation and upheld in the judiciary. The economic dependency of Delaware and the intimate linkages found in the state structure allow for the quick responsiveness necessary for the state to be responsive to the needs of corporations and remain the most attractive for incorporation.
In Canada the link between the corporate bar, the judiciary and the bureaucracy, at the federal or provincial level, is quite loose. There is no dependency on capital from incorporations and thus no dependency on the corporate bar. The judiciary is typically appointed for life and is never elected at any level. There is no specialized corporate judicial system and members of the corporate community do not sit in positions of legislative authority and drafting as often as compared to a state like Delaware. Thus the interests of the corporate sphere are not taken into necessarily consideration when considering the reform of legislation nor in judicial decisions.
It is doubtful whether any state in the EU possesses the requisite combination of small size, dependency on incorporation revenues and closely knit community between corporate interests to create an environment as conducive to competition as the one found in the United States.
The EU situation bears resemblance to both the Canadian and American systems. There is a strong emphasis on harmonization, but the reality that significant differences remain between member states. The policy makers are likely not focused solely on achieving incorporation dollars. Thus it is likely that with the implementation of the SE and the predicted increase in freedom of movement, the structure of the European context could support some jurisdictional competition. It is unlikely to reach the extremes that can be found in America and will likely not be as restricted as the situation now found in Canada due to its differences and similarities with each jurisdiction. In the future though, given the requirements that seem to be needed to foster a truly effective competitive market, Europe’s path towards harmonization will ensure that there is limited room for competition in the EU.
It is important to note that comparisons with the Canadian and American systems should be interpreted cautiously. Canada and the U.S. begin from a different starting point as federalist states while the EU, although in the process of achieving harmonization, is not necessarily comparable to a true federalist state. For example, freedom of movement and unification of the economy are not as complete as that found in Canada and the United States. These factors limit any conclusions that can be draw about the resemblance or divergence of the European company from Canadian federal and American state companies.
The Desirability of Competition
The debate concerning jurisdictional competition has been heated and intense, with proponents of the "race to the bottom" theory decrying the evils of competition and those that support a "race to the top" theory strongly advocating its benefits. Through all the dispute there seems to be a grudging acceptance that state competition, if it produces results that are socially desirable, produces more efficient rules than would a uniform federal regulation. The issue of contention is then whether competition between jurisdictions creates results that enhance social welfare or detract from it.
The primary concern in the debate revolves around the dance between management and state policy makers. This is premised on the assumption that management controls the location of a corporation and is thus the target of state legislation.
Race to the bottom supporters believe that state competition for corporate charter will harm the shareholder by driving states to create corporate law rules that are lax towards management. State governments, it is argued, will favour managers in the hopes of attracting business and thus incorporation fees to their jurisdiction. This results ultimately in a deterioration of corporation standards raising concerns for corporate governance and the rights of shareholders. They believe that there is no incentive for states to legislate in favour of shareholder interests at any time because the management can easily reincorporate the firm in different jurisdiction that will favour them over all other interests.
This is opposed by the race to the top faction that believes that market factors will control management behaviour so as to align manager interests with shareholder interests. The market controlling devices characteristically provide that managers will want to increase share prices to prevent takeovers, to ensure their employability and to make certain that they can acquire capital for future endeavours. According to their research on state competition, all competition is value maximizing for the stock price, which advocates interpret as meaning beneficial to the economy and to shareholders.
Race to the bottom authors however, have refuted the claim that market incentives are strong enough to prevent management corruption. Market controls will be disrupted wherever there is the possibility of a divergence between the interests of the managers and the interests of the public shareholders. In particular, competition will result in negative results where there is a significant transfer or redistribution to the management compared to the shareholders, i.e. insider trading and with issues that directly affect market discipline, i.e. anti-takeover legislation or rules that ensure compensation to management regardless of the performance of the company. Here the temptation to profit will be too great for managers for market controls to be effective.
It thus seems likely that competition for corporate charters does not necessarily produce socially positive results. This is evinced in the American context where it has been shown that due to competition, states have given to management extremely strong powers, i.e. to protect against takeovers, beyond what shareholders have wanted to give them and without consultation.
Competition also appears to be negative for any external parties or factors, i.e. creditors, bidders on takeovers and environmental issues. This is because the in the realm of corporate law, due to the corporate structure, states tends to ignore the needs of other interests in their desire to focus on shareholders and management. Compounding this is that managers generally have no interest in areas outside of the immediate realm of business and share price. Management often claims to believe that it cannot put efforts into helping mankind when they should actually be focused on helping stockholders profit. Thus any competition that favours management, even if they are working for the benefit of shareholders, is bound to affect non-shareholders in a negative fashion.
Taking into account the foregoing analysis, it appears that there are many potential problems that could result from unhindered jurisdictional competition in the E.U., mostly involving a slide down in good corporate governance and accountability to shareholders. However, given the great emphasis that some Community Members place on issues like shareholder control, competition to attract incorporations could be even more devastating than what has been seen in the American context. For example, charter competition could result in diminished employee participation rules that are so important to many EU member states. This is because, as a Directive, employee involvement can be implemented by different states in different ways so as to promote "shopping" for the jurisdiction that has the most relaxed rules. As an easily identifiable issue that has to be dealt with by member states, some may be tempted to legislate in employee-unfriendly ways so as to attract them to their jurisdictions. This would be socially undesirable in the European context and could inevitably lead to a race to the bottom.
All of the preceding analysis has been premised on the assumption that managers control where a corporation is located. It is important to note that while this may be true in an American situation, it is not true in all jurisdictions. Given the limits to jurisdictional competition in the EU context as examined in the preceding section, it is likely that jurisdictional competition in the EU will be mild at any rate and may not require significant amounts of intervention. For example, the UK system favours shareholders and all UK laws aim to strengthen their control in a corporation. In such a situation, where legislators compete to attract shareholders, jurisdictional competition may indeed be desirable in promotion of efficient and socially responsible legislation. Given that many other EU states place emphasis on issues of shareholder rights, employee involvement and external issues, the potential for an American style competition in the EU context is not substantial.
Another potential positive outcome that could result from jurisdictional competition is in that competition frequently results in a variety of rules being made available to companies, which allows them to sort themselves out according to their needs. This in effect could enhance the market economy and reduce costs. In the European context, given the wide diversity of regulation and country policies, competition along these lines could indeed result in encouraging social results.
There is no doubt however that competition in the sense that exists in Delaware, favouring management, is not desirable or necessarily achievable in the E.U.. The competition that does result in the EU from implementation of the SE will likely be mild. Whether this competition is fostered as to produce positive results or let free to create a race to the bottom will be up to the legislators of the Community and each national government. While recognizing the competition can be socially enhancing, both levels of government need to ensure a greater level of harmonization of corporate issues that are known to result in decreased standards. This will ensure that a race to the bottom does not occur. This approach would recognize and accept the benefits of both competition and harmonization, thus producing maximum efficiency where appropriate, while at the same time protecting shareholders and ensuring societal benefits.