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A European Nevada? Bad Enforcement as an Edge in State Competition for Incorporations

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Abstract

Though now possible, no European state is competing for incorporations, and this is unlikely to happen in a general fashion. In this article I argue, however, that the possibility of one state competing for one specific segment of the market for incorporations should not be ruled out altogether. As happened with Nevada in the US, a state could seek to attract companies that are looking for a very protective legal environment for their directors, officers and shareholders or for the company itself. Given the importance of enforcement, I argue that states could compete by capitalising on the inefficiency of their courts, rather than by changing the law on the books. The fact that no investment is necessary would change the perspective on incentives for states to compete: a very small incentive will be needed if the costs are negligible. I also consider the possible drawbacks of such competition and the possible reactions from other states.

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Notes

  1. Wouters (2000), at pp 269–270; Gelter (2015), at pp 7–8.

  2. It should be noted that although the distinction between regulatory arbitrage and regulatory competition is well established in English-language literature, it is not so in literature in other languages, where the two concepts sometimes overlap. See, e.g., Miola (2001), at p 339, note 43; compare Enriques (2004b), at p 78, note 11; Perrone (2001), at p 1292. For a recent and broad account of the issues surrounding competition for incorporations, see Kahan (2014).

  3. Johnston (2009), at p 126; Gelter (2015).

  4. Court of Justice, 9 March 1999, Case C-212/97, Centros Ltd. v. Erhvervs-og Selskabsstyrelsen.

  5. For a discussion of the Court’s decisions, see, e.g., Mucciarelli (2010), at pp 88–108; Johnston (2009), at pp 152–165; Gelter (2015), at pp 4–29; Armour and Ringe (2010), at pp 6–16. Before Centros, the Court had already announced its approach in the Segers case (1986), which was, however, widely ignored or even consciously downplayed by authors (Court of Justice, 10 July 1986, Case 79/85, Segers v. Bestuur Bedrijfsvereniging voor Bank- en Verzekeringswezen; see Halbhuber (2001), at pp 1387–1389). The year after Segers, the Court handed down a new decision, which was interpreted in the sense that the Court considered the Treaty freedoms compatible with the ‘real seat’ doctrine. The doctrine enables states to apply the law of the state where the company has its ‘real seat’, usually considering as such the place where the company is headquartered or carries out its main operations (but, as the Überseering case has shown, other criteria are also applied): see Court of Justice, 27 September 1988, Case 81/87, The Queen v. H.M. Treasury and Commissioners of Inland Revenue, ex parte Daily Mail and General Trust plc (on its reception as compared to that of Segers, see Gelter (2015), at pp 13–17).

  6. Court of Justice, 5 November 2002, Case C-208/00, Überseering BV v. Nordic Construction Company Baumanagement GmbH. According to the Court, the ‘real seat’ doctrine, even if qualified as a matter of (non-harmonised) private international law, could never lead to anyone questioning the legal status of a company duly formed under another Member State’s law. On the real seat doctrine and its variants, see Benedettelli (2015), at pp 269–270.

  7. On the Gebhard test, with reference to freedom of establishment of companies, see Mucciarelli (2010), at pp 88–90.

  8. Court of Justice, 30 September 2003, Case 167/01, Kamer van Koophandel en Fabrieken voor Amsterdam v. Inspire Art Ltd.

  9. Court of Justice (Grand Chamber), 13 December 2005, Case C-411/03, SEVIC Systems AG.

  10. Court of Justice (Grand Chamber), 16 December 2008, Case 210/06, Cartesio Oktató és Szolgáltató BT; see also the comment by Petronella (2010), at p 245.

  11. Court of Justice (Grand Chamber), 29 November 2011, Case C-371/10, National Grid Indus BV v. Inspecteur van de Belastingdienst Rijnmond/kantoor Rotterdam. The judgment is far from unambiguous. On the one hand, the Court deems that immediate taxation of capital gains is incompatible with the freedom of establishment laid down in the Treaty but, this time as an obiter dictum, repeats the principle set out in Daily Mail that the matter of the conditions to be met to transfer abroad the seat of the company is left to domestic law (which could forbid it and, hence, impose the liquidation of the company in order to transfer the seat, with the inevitable consequence of taxation of the (realised) capital gains). See De Pietro (2010); Pantazatou (2012), at pp 963–966; Kok ( 2012). On the subsequent developments, see Peeters (2013) (in particular at pp 513–515: ‘[I]t is noteworthy that Member States may prohibit a cross-border relocation, but may not impose fiscal requirements (which are less restrictive) on the occasion of a permitted relocation’).

  12. Court of Justice, 12 July 2012, Case C-378/10, Vale Epitesi; see the note to this decision by Rammeloo (2012).

  13. Court of Justice, 10 December 2015, Case C-594/14, Kornhaas v. Dithmar; see the remarks by Ringe (2016).

  14. The case of Fiat Chrysler Automobiles (FCA) is a case in point: in order to take advantage of some features unavailable in Italian law, and in particular multiple voting shares, FCA transferred its seat (via a merger) to the Netherlands. Italy ‘reacted’ by introducing multiple-voting shares, probably both as a form of defensive competition and because it was planning the sale of significant stakes in major and strategic companies in which the state had a controlling stake. See Ventoruzzo (2015) and Pernazza (2015), at pp 450–456 and 478 (whose account of the FCA migration downplays the role of corporate law).

  15. The most notable example is perhaps what happened with the legal capital of private limited companies or limited liability companies: see Becht et al. (2008); for a recent account of the status quo, see Cappiello (2013).

  16. Regulation (EU) No 1215/2012 of the European Parliament and of the Council of 12 December 2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters. The Regulation is a consolidated and amended version of the more famous Council Regulation (EC) No 44/2001 of 22 December 2000 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (see Art. 22 of that Regulation). On the issue, see infra Sect. 4.1.

  17. Bebchuk and Hamdani (2002), at p 561. The literature on competition for incorporations and its effects is vast. Among many, see Romano (1989); Romano (1993); Fischel (1982); Winter (1977) (in general, on positive effects of state competition for incorporations); Cary (1974); Bebchuk (1992) (also on negative effects).

  18. Kahan and Kamar (2002–2003).

  19. Bebchuk and Hamdani (2002); Bebchuk et al. (2002).

  20. Roe (2003).

  21. See Kahan (2014), at pp 23–32.

  22. See, originally, Council Directive 69/335/EEC of 17 July 1969 concerning indirect taxes on the raising of capital, according to which ‘[t]ransactions subject to capital duty shall only be taxable in the Member State in whose territory the effective centre of management of a capital company is situated at the time when such transactions take place’ (Art. 2(1)); the tax is capped (Art. 7). The amended, consolidated version is now Council Directive 2008/7/EC of 12 February 2008 concerning indirect taxes on the raising of capital, which basically aims at abolishing any kind of tax on the raising of capital (see Recital 5 and Arts. 7 and 8(2)), and, in any case, caps it at 1% (Art. 8(4)) and, as before, only allows the state where the effective centre of management is situated to levy the tax (Art. 10).

  23. Dammann (2004), at p 524.

  24. See supra n. 22.

  25. Enriques (2004a) (focusing only on listed companies); Perrone (2001), at pp 1304–1305.

  26. See Ayres (1992), at pp 376–377; Manesh (2011), at pp 194 and 256 (noting that there are few incentives to compete to attract incorporations of LLCs, given that – for example – Delaware only charges LLCs a flat rate of $250 per year).

  27. Bainbridge (2008).

  28. Barzuza (2012), at pp 971–972.

  29. Barzuza (2012); Kobayashi and Ribstein (2011–2012).

  30. Kamar (2005–2006), at p 1765.

  31. Ringe (2013), at pp 262–263.

  32. See Kahan and Kamar (2002–2003), at p 717.

  33. Delaware Code, Title 8, Chapter 1 (General Corporation Law), § 102 Contents of certificate of incorporation, states that the certificate of incorporation ‘(b) […] may also contain any or all of the following matters […]:

    (7) A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) for any breach of the director’s duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit. […]’.

  34. Holland (2008–2009), at pp 691–693; Yeager (2014–2015), at pp 1391–1392.

  35. Hamermesh (1999–2000), at pp 489–491.

  36. Barzuza (2012), at pp 950–951; Kobayashi and Ribstein (2011–2012), at pp 1171–1172.

  37. Barzuza (2012), at pp 950–951.

  38. According to the Study on Directors’ Duties and Liability prepared for the European Commission DG Market (by Gerner-Beuerle et al. (2013), at pp 74–107), substantive rules seem very similar across Europe, and nothing can be found that is comparable either to the § 102(b)(7) Del. GCL option under Delaware law or to Nevada’s default. See also, Gerner-Beuerle and Schuster (2014), at pp 200–203.

  39. In many countries no contractual limitation of liability is available for intentional misconduct or gross negligence. See, e.g., Italy: Art. 1229 Civil Code; Switzerland: Art. 100 Code of Obligations; France: constant precedents since 1938 (Malaurie and Aynès (2011), at p 507); Germany: the same, for professional liability (Hirte (2012), at p 1359). In the UK, Section 232(1) Companies Act 2006 expressly states that ‘[a]ny provision that purports to exempt a director of a company (to any extent) from any liability that would otherwise attach to him in connection with any negligence, default, breach of duty or breach of trust in relation to the company is void’; in Israel, see Section 263 Companies Act 1999.

  40. Mucciarelli (2011–2012), at pp 454–458.

  41. See Perrone (2001), at p 1304 (of the opposite opinion that the absence of comparability may hinder competition).

  42. Bebchuk (1992), at p 1475 (see also more generally on charter amendments, Bebchuk (1989)).

  43. Barzuza (2012), at pp 988–992.

  44. Kobayashi and Ribstein (2011–2012); Eldar and Magnolfi (2015).

  45. Director disqualification, including recognition of director disqualification orders, has been a relevant topic in various European-level initiatives in company and insolvency law over the past years, and still is. See, e.g., the Report of the Reflection Group on the Future of EU Company Law (2011), at pp 34–35 (§ 2.8.3), and Art. 22(6) of the Proposal for a Directive of the European Parliament and of the Council on single-member private limited liability companies (COM/2014/0212 final—2014/0120 (COD)). In insolvency law, the issue is now being addressed by the Group of Experts on Restructuring and Insolvency Law Assisting the European Commission (JUST - DG Justice and Consumers); see also the United Nations (2013) UNCITRAL Legislative Guide on Insolvency Law, Part four: Directors’ obligations in the period approaching insolvency, New York, at pp 22–24.

  46. Drawing an example from Italy, delay in filing for insolvency, knowingly (not intentionally), is punishable by up to two years of imprisonment (Art. 217(1), n. 4, Bankruptcy Act). It should be noted that a director seldom actually goes to jail for such a crime, or even for much more serious economic crimes, due to the inefficiency of the Italian criminal court system; even when someone is convicted, parole is the norm and there are many ways offenders avoid actually serving in prison. This makes criminal law very harsh on occasional offenders, such as professionals, who suffer the stigma and the cost of the trial, but easy on real crooks, who will basically never face any jail time except in really egregious cases.

  47. In Italy, for example, each shareholder of a limited liability company, irrespective of the size of his stake, has an unwaivable right to access any kind of company document (Art. 2476 Civil Code); in Finland, under certain circumstances, minority shareholders have a statutory right to the distribution of dividends (so-called ‘minority dividend’, Part IV, Chapter 13, Section 7, Limited Liability Companies Act).

  48. See Kobayashi and Ribstein (2011), at pp 106–107; Kobayashi and Ribstein (2012–2013), at p 551. See the relevant rules in Nevada Revised Statutes, Chapter 78 – Private corporations:

    Ԥ 78.746 Action against stockholder by judgment creditor; limitations.

    1. 1.

      On application to a court of competent jurisdiction by any judgment creditor of a stockholder, the court may charge the stockholder’s stock with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the stockholder’s stock.

    2. 2.

      Subject to the provisions of NRS 78.747, this section:[…]

      (c) Provides the exclusive remedy by which a judgment creditor of a stockholder or an assignee of a stockholder may satisfy a judgment out of the stock of the judgment debtor. No other remedy, including, without limitation, foreclosure on the stockholder’s stock or a court order for directions, accounts and inquiries that the debtor or stockholder might have made, is available to the judgment creditor attempting to satisfy the judgment out of the judgment debtor’s interest in the corporation, and no other remedy may be ordered by a court.

      […]

    3. 3.

      As used in this section, “rights of an assignee” means the rights to receive the share of the distributions or dividends paid by the corporation to which the judgment debtor would otherwise be entitled. The term does not include the rights to participate in the management of the business or affairs of the corporation or to become a director of the corporation.’

  49. See, e.g., UK: Section 23(2), Partnership Act 1890; Italy: Arts. 2270 and 2304 Civil Code; Switzerland: Arts. 544 and 572 Code of Obligations.

  50. Barzuza (2012), at p 941.

  51. However, the cost is perhaps overestimated, at least according to Delaware’s budget for the Court of Chancery: see Kahan and Kamar (2002–2003), at pp 725–726 (discussing modest economic entry barriers).

  52. Manesh (2011), at pp 211–212; see also Kahan and Kamar (2002–2003), at pp 742–743.

  53. See Dammann (2004), at p 492 ff., on the fact that the need to litigate abroad may be perceived as a ‘burden’ due to various factors, such as, amongst others, the very different length of procedures in different jurisdictions (at pp 498–499).

  54. Kirchner et al. (2005).

  55. See recently, for example, Glover (2015). The literature on the subject matter is vast, and a heated debate was recently sparked by the American Express case, discussed in Glover (2015).

  56. See, e.g., Gilson et al. 2010–2011 (discussing the compulsory arbitration clauses for companies wishing to list on the Novo Mercado in Brazil).

  57. Benedettelli (2015), at p 33; Lehmann (2015), at pp 269–270.

  58. Art. 63(1) states that, ‘[f]or the purposes of this Regulation, a company or other legal person or association of natural or legal persons is domiciled at the place where it has its: (a) statutory seat; (b) central administration; or (c) principal place of business. […]’.

  59. Lehmann (2015), at pp 268–269.

  60. Benedettelli (2015), at p 33.

  61. See Tucker (2013–2014).

  62. See, e.g., Jacobs (2015). The provision is now § 115 of Del. GCL:

    ‘Forum selection provisions. The certificate of incorporation or the bylaws may require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in this State, and no provision of the certificate of incorporation or the bylaws may prohibit bringing such claims in the courts of this State. “Internal corporate claims” means claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancer’.

  63. See, e.g., Ventoruzzo (2016).

  64. Armour et al. (2012).

  65. The situation referred to in the text could, until around the late nineties, be seen in Italy, in lawsuits brought by trustees in bankruptcy against directors for damages caused by late filing for bankruptcy or for continuing trading despite the loss of capital: the trustee could seek damages equal to the entire amount of debt not covered by the estate. Later, this view was overturned in favour of a more causal-oriented approach to the determination of damages but the previous approach still resurfaces in some circumstances (see Court of Cassation, en banc, 15 May 2015, No. 9100, for a comprehensive reconstruction of the issue).

  66. See supra Sect. 2.

  67. Dammann (2004), at p 523; Deakin (2001), at pp 205–206.

  68. See Kahan and Kamar (2002–2003), at pp 696–697, who, however, note that Delaware lawyers can count on some additional revenue from companies incorporated in their state, in the range of $ 165–227 million in 2001.

  69. Daines (2002); Broughman and Ibrahim (2015).

  70. Enriques (2004a), at p 1264.

  71. Dammann (2004), at p 506.

  72. Ibid.

  73. See also Barzuza (2015), for the claim that the main determinant of choosing Nevada is managers’ preference for legal protection when their home state (which is the preferred option) is not a viable venue. The argument could be adapted to small companies in Europe, mutatis mutandis: owners and controlling shareholders, rather than managers, would be seeking legal protection.

  74. In Italy, for example, any case in company law worth more than €520,000 requires payment of a court fee of 3,372, plus another 1,686 if seizure or injunctive relief is sought as well. Any director liability case will induce defendants to file third-party claims against their insurers, hence each will have to pay another court fee of the same amount. In case an action is brought to void or annul a company decision, the plaintiff should be prepared to pay the same amount several times, because the company may re-issue the same decision, thus forcing multiple cases to be filed. In England, court fees are in the region of 5% of the claim, capped at £10,000 when the claim is worth £200,000 or more: see HM Courts & Tribunals Service, Civil and Family Court Fees of 6 March 2017 EX50 (03.17), available at hmctsformfinder.justice.gov.uk. Accessed 6 April 2017. See also https://e-justice.europa.eu/content_costs_of_proceedings-37-en.do (Accessed 6 April 2017) for reference to court fees of other European countries (which, however, are usually difficult to ascertain for a layman).

  75. Gelter (2012), at p 869, downplays court fees as a factor hindering derivative actions but recognises that they may be a ‘plausible’ factor in some cases. Suffice to say here that court fees may be yet another factor making it more burdensome for plaintiffs to attack the company or its directors and officers.

  76. Court inefficiency could lead to fewer cases only if the courts are so inefficient that it becomes completely pointless to file a lawsuit, which is not a likely scenario in any EU Member State. Court inefficiency could actually lead to more cases to be filed if the plaintiff seeks alternative venues for relief given the delay in obtaining a judgment.

  77. See Enriques (2004b), at pp 80–81.

  78. See, for example, the Doing Business Report Series of the World Bank (http://www.doingbusiness.org/reports), classifying and ranking countries on their ease of doing business, which also factors in the efficiency of civil justice; or see Palumbo et al. (2013).

  79. One could argue that, once a state holds itself out as a low-enforcement jurisdiction, it will have to stand by this reputation and avoid embracing any reform that may speed up justice, otherwise companies will not believe in its commitment and will ultimately not incorporate there. It is indeed true that, if the race to attract incorporations is actually successful, legislators may have a dilemma as to whether to reform justice or stick to what they have and hold on to the corporations. However, as long as justice is slow and inefficient, companies will still have an interest in incorporating in that state: it is very unlikely for any reform to have an immediate effect, and companies will have time to react to any improvement in efficiency by reincorporating in another state.

  80. See Ringe (2013), at p 260 (reputation costs of the use of a foreign entity; in the case in the text, the reputation effect would be vice versa, for local entrepreneurs using their ‘home’ low-liability company type).

  81. Bebchuk (1992); Enriques and Gelter (2006); Mucciarelli (2011–2012), at pp 458–467.

  82. Directive 2005/56/EC of the European Parliament and of the Council of 26 October 2005 on cross-border mergers of limited liability companies.

  83. See, e.g., Means (2011).

  84. Bebchuk (1992); Roe (2003); and, recently, the case of fee-shifting bylaws: Fisch (2015); Brown (2015).

  85. Dealing with the issue of possible reincorporation of insolvent companies and its relationship with COMI-shifting is beyond the scope of this article, which does not intend to discuss insolvent companies. On this, see Eidenmüller (2009); De Weijs and Breeman (2014); Latella (2014); see, now, Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings. The recast Regulation explicitly states that there is no presumption that the COMI is where the registered office is located if the transfer of the office has occurred less than three months before the filing for insolvency (Art. 3(1), second para.: ‘In the case of a company or legal person, the place of the registered office shall be presumed to be the centre of its main interests in the absence of proof to the contrary. That presumption shall only apply if the registered office has not been moved to another Member State within the 3-month period prior to the request for the opening of insolvency proceedings’).

  86. See National Grid Indus in connection with Daily Mail, supra n. 11.

  87. See the (now withdrawn) Proposal for a Council Regulation on the statute for a European Private Company (COM/2008/0396 final), which had a similar take on the transfer of the seat of insolvent companies. After stating that ‘[t]he registered office of an SPE may be transferred to another Member State in accordance with this Chapter’ (Art. 35(1)), it clarified that ‘[p]aragraph 1 shall not apply to SPEs against which proceedings for winding-up, liquidation, insolvency or suspension of payments have been brought, or in respect of which preventive measures have been taken by the competent authorities to avoid the opening of such proceedings’ (Art. 35(2)).

  88. See Directive 2005/56/EC, supra n. 82, Art. 4(1)(a): ‘[C]ross-border mergers shall only be possible between types of companies which may merge under the national law of the relevant Member States.

  89. Italian courts are very liberal in construing which acts can be of prejudice to creditors, and so – for example – deem ‘fraudulent’ the sale of real estate even at a fair price, on the assumption that a ‘qualitative’ modification of the debtor’s estate is relevant for creditors as well (i.e., money is easier to hide and to make unavailable to creditors) (the doctrine is well settled; see, e.g., Court of Cassation, 12 December 2012, No. 26151). Courts also allow actions when assets are contributed in kind to a partnership or company and thus ‘transformed’ into a partnership interest or into shares of a company (see, e.g., Court of Cassation, 22 October 2013, No. 23891). However, the case in the text is different, because it would imply ‘deconstructing’, albeit in a fashion limited to the claiming creditor, the reincorporation: the company should be regarded as the ‘old’ company in order to allow foreclosure on the shares under the law applicable before reincorporation.

  90. Enriques and Gelter (2006), at pp 449–452.

  91. Ibid.; as stated above, however, the developments regarding the Kornhaas decision (supra n. 13) could undermine this assumption.

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Authors and Affiliations

  1. Assistant Professor of Business Law, Department of Economics and Management, University of Florence, Florence, Italy

    Andrea Zorzi

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Correspondence to Andrea Zorzi.

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I would like to thank Luca Enriques, Lorenzo Stanghellini and Simon J. Little for their helpful comments, as well as Andrea Perrone, discussant at the VII Conference of the Italian Association of Professors of Business Law ‘Orizzonti del diritto commerciale’, 26–27 February 2016, Rome. Many thanks to Assaf Elrom, Tuire Kuronen, Roland Fischer and Lynne Wilkins for their help. Thanks also to Diletta Lenzi for assistance, to Sergio Gilotta for an initial suggestion and to Suzanne Habraken for her helpful revision.

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Zorzi, A. A European Nevada? Bad Enforcement as an Edge in State Competition for Incorporations. Eur Bus Org Law Rev 18, 251–272 (2017). https://doi.org/10.1007/s40804-017-0071-5

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