Meaningful regulatory competition in corporate law requires companies to be able to effectively choose the legal rules governing them without this choice necessitating other changes to the company’s operations. In this sense, regulatory competition in corporate law relies on a fiction: the election of the applicable corporate law based on a connecting factor that can easily be manipulated and must, therefore, largely be fictitious or meaningless, as opposed to being grounded in an economic and social reality. The paradigmatically meaningless connecting factor is, of course, the registered office, at least where it merely indicates the jurisdiction of incorporation and thus determines the applicable law according to the incorporation theory, which in its purest form simply provides that a company is governed by the company law of the country where it is incorporated. In all matters falling within the remit of corporate law (for purposes of private international law), the forum accordingly applies its own law if a company is, or seeks to be, incorporated under the forum’s law, and it recognises a company as a legal entity governed exclusively by foreign corporate law if it has been validly incorporated under the law of a foreign country, without imposing aspects of its internal corporate law on that company.Footnote 9
In this pure form, the incorporation theory cannot be found in any jurisdiction,Footnote 10 including the UK, which is often referred to as a quintessential incorporation theory country. All jurisdictions apply certain aspects of their internal corporate law to foreign companies, for example in order to protect third parties in their dealings with the company. In the UK, examples of such rules include transparency obligations imposed on foreign companies and the extension of the directors’ disqualification regime to companies with a ‘sufficient connection’ with the UK.Footnote 11 These rules concern questions that are typically addressed by a jurisdiction’s company law, namely the information that must be disclosed about a company that trades with third parties and the eligibility requirements of persons who serve on corporate boards.
Ultimately, the regulation of a question as a part of company law or another legal area is a function of somewhat arbitrary policy decisions. While there is widespread consensus across legal systems that the body of rules regarded as ‘company law’ regulates core aspects of a company’s existence, notably its formation and internal governance structure,Footnote 12 other aspects, in particular concerning a company’s dealings with third parties, are governed by company law in some, and by adjacent legal areas in other jurisdictions, or, more typically, they are governed by a combination of interrelated company-law and non-company-law institutions in one and the same legal system. If characterisation for purposes of private international law mirrors these conceptual distinctions, the domain of the incorporation theory may be limited, and it will certainly not represent a comprehensive set of rules regulating a company’s existence and business activities.Footnote 13
Consequently, the relevance of the registered office as a connecting factor is subject to a twofold qualification. First, it is not applicable where a legal question is not characterised as falling within company law for purposes of private international law. Secondly, even where it falls within the scope of the lex societatis (from the perspective of the lex fori or from a comparative perspective, depending on how characterisation is performed),Footnote 14 the forum (or host state) which seeks to regulate the activities of a company incorporated elsewhere may elect to apply individual rules or sets of rules belonging to its company law or to another legal area that would not be applicable by virtue of general, in the EU often uniform, conflicts rules to the foreign company. We term this latter avenue to an application of host state law regulation by means of ‘outreach statutes’. In the next two sections, we will first discuss two uniform conflict rules that have the effect of limiting the scope of the lex societatis, before we come to outreach statutes in Sect. 2.3.
Corporate mobility and regulatory competition are thus impeded to the extent that subject matters relevant to companies and their dealings with third parties are removed from the lex societatis or, in spite of belonging to the lex societatis, are governed cumulatively by the lex causae and certain outreach statutes of the lex fori, and the connecting factor that applies in lieu of or in addition to the registered office is ‘grounded in reality’, that is, it cannot be manipulated as easily as a fictitious connecting factor such as the registered office.Footnote 15 The relevant connection with the territory of a host state will vary in intensity depending on the Member State and the type of legal mechanism in question and may range from the domicile of parties to an agreement or the location of assets or business activities of some significance in the host state to a real seat equivalent (COMI). We will now turn to the question whether, outside of the lex societatis, such connecting factors ‘grounded in reality’ apply, and what the remaining reach of the incorporation law is where they exist.
Real Seat Equivalent: Insolvency Regulation
The closest connection of a company’s actual activities with a particular territory recognised in private international law for the purpose of determining the applicable law is represented by the location of the real seat or, similar but not identical, the company’s centre of main interest (COMI). What constitutes the ‘real seat’ of a company is not defined uniformly across jurisdictions, but usually it is the place of central decision-making, that is, the place where the board of directors regularly meets.Footnote 16 The Insolvency Regulation defines COMI as ‘the place where the debtor conducts the administration of its interests on a regular basis’, which must be ‘ascertainable by third parties’.Footnote 17 These two connecting factors, of course, will not necessarily lead to an application of the law at the place that is most affected by the company’s business activities, since the place of central decision-making may be different from the place where the company trades, has production facilities, or raises financing. However, they are a proxy that, it is presumed, will generally ensure that the law of the country in which the centre of a company’s activities is situated applies. At least historically, before the advent of modern communication technology and fast travelling, the real seat will have been a fairly effective proxy of the country most closely connected to a company’s activities.
The application of that state’s law, it is further argued, is justified, because by deciding to pursue business activities predominantly in a particular state, the incorporators have accepted the policy choices made by the domestic legislator, as expressed in binding laws regulating, for example, the company’s capacity, internal organisation, the liability of the corporate organs, and the protection of creditors,Footnote 18 who expect an application of the local law.Footnote 19 The fact that the real seat theory relies on the place of central decision-making, rather than the centre of a company’s business activities, and the existence of a rebuttable presumption of identity between the registered office and the centre of main interest in the Insolvency Regulation,Footnote 20 do not warrant a different assessment of the policy rationale underpinning the real seat theory and the Insolvency Regulation, but simply serve to facilitate the identification of the ‘most affected state’Footnote 21 with a view to increasing legal certainty and reducing transaction costs.Footnote 22
Whether it is convincing to justify an application of the law at the real seat with the hypothetical will of the incorporators who ‘opt into’ that law by locating the company’s main activities thereFootnote 23 is questionable, especially after Centros and the Court’s acknowledgement that the Treaty grants a right to choose the law by which a company is governed.Footnote 24 Reliance on the ‘perceptions of creditors’Footnote 25 as part of the definition of COMI also sits uneasily with the general approach of the Court to creditor protection in the context of corporate mobility, which is based on the premise that creditors do not require protection going beyond another Member State’s company law, provided they are ‘on notice’ that a company has been incorporated under foreign law.Footnote 26 Nevertheless, the conflict rules of the Insolvency Regulation introduce a clear element of a ‘real’ connection between a company and the applicable law into the European framework on corporate mobility.
The scope of the lex concursus is set out in a non-exhaustive list in the Insolvency Regulation. It provides that the lex concursus shall determine the conditions for the opening of insolvency proceedings, their conduct and closure, and further enumerates a number of issues falling within the scope of international insolvency law.Footnote 27 These questions are mostly concerned with the operation and effects of the insolvency proceedings themselves, so that the problem of an encroachment on matters that may be regarded as ‘belonging’ to company law does not arise. However, the demarcation between company law and insolvency law is less clear with regard to legal mechanisms intended to protect creditors before a company is actually insolvent, in particular where it concerns acts in the vicinity of insolvency that jeopardise the creditors’ interests or aggravate a company’s insolvency. The most important of such mechanisms are a shift of directors’ duties to creditors in the vicinity of insolvency; the duty to recapitalise (or liquidate while still solvent) a company; the liability of directors for a failure to protect the assets of a company when the company nears insolvency or after cash-flow insolvency or over-indebtedness, such as wrongful trading, a failure to file for the opening of insolvency proceedings, and action en responsabilité pour insufissance d’actif (liability for insufficiency of assets); the liability of directors or shareholders for causing the company’s insolvency or frustrating claims of creditors; the re-characterization of shareholder loans given, or not called in, when the company nears insolvency; and avoidance actions.Footnote 28 Some of these mechanisms are structurally designed and internally classified as company law, for example a shift of directors’ duties or the duty to recapitalise, and others as insolvency law, for example liability for insufficiency of assets. However, they seek to address the same economic problems: asymmetric information between creditors and the company and the misalignment of incentives, which result in a mispricing of the risk of asset substitution and the misallocation of resources, because directors and shareholders pursue non-value-maximizing investment projects in the vicinity of insolvency.Footnote 29 If these mechanisms are characterized functionally for purposes of private international law, they should accordingly all fall within the scope of either the lex societatis or the lex concursus. However, since characterization is governed by the lex fori and the dividing line between insolvency law and company law is difficult to define without reference to the boundaries drawn by the internal laws of a jurisdiction, it is not surprising that Member States have developed mutually incompatible and inconsistent solutions and legal uncertainty has until recently been high.Footnote 30
The situation has somewhat improved following a line of preliminary ruling requests that have given the Court of Justice an opportunity to decide on the characterisation of several of the above legal mechanisms and develop general criteria that can guide the delimitation of international company law and insolvency law. The rulings centre on an interpretation of what is now Article 6(1) Insolvency Regulation, which provides that the courts of the Member State where insolvency proceedings have been opened also have jurisdiction ‘for any action which derives directly from the insolvency proceedings and is closely linked with them’.Footnote 31 The Court’s interpretation of ‘closely connected action’ within the meaning of the Insolvency Regulation mirrors its approach to construing the bankruptcy exception in the EU Judgments Regulation (now the Recast Brussels Regulation), which excludes ‘proceedings relating to the winding-up of insolvent companies […] and analogous proceedings’ from the scope of the Regulation.Footnote 32 In Gourdain v. Nadler,Footnote 33 the Court of Justice held that the exception applied to actions that ‘derive[d] directly from the bankruptcy or winding-up and [were] closely connected with [insolvency] proceedings’.Footnote 34 In the case at hand, which concerned the French action en comblement de passif (the liability of a director or de facto director who committed a ‘management fault’ that contributed to a shortfall in the company’s assets),Footnote 35 the Court ascribed importance to the fact that the action was brought ‘on behalf of and in the interest of the general body of creditors […] [in derogation] from the general rules of the law of liability [of directors]’ and the application to the court could only be made by the liquidator.Footnote 36
These three factors—a derogation from the common rules of civil and commercial law, the protection of the interests of the general body of creditors, and an action brought by the liquidator—have been reiterated and amplified by the Court in more recent decisions arising under the Insolvency Regulation. They seem to be the guiding principles that determine the scope of the insolvency court’s international jurisdiction and, as will be discussed presently, also the scope of the lex concursus, which is the law of the Member State where insolvency proceedings are opened.Footnote 37 Before we come to the applicable law, however, we will offer some comments on the three conditions that must be met for an action to be regarded as ‘closely connected’.
An action derogates from the common rules of civil and commercial law if it ‘finds its source’ in rules that are ‘specific to insolvency proceedings’, and not in general civil or commercial law.Footnote 38 This formulation is ambivalent, but the Court’s case law on connected actions makes it clear that the Court does not have the ‘source’ of a rule in a Member State’s domestic law in mind, for example in the Member State’s company law or insolvency legislation, but the circumstances under which a rule applies.Footnote 39 The clearest cases are provisions that require that insolvency proceedings have been opened, such as the French action en responsabilité pour insufissance d’actif, discussed in Gourdain v. Nadler,Footnote 40 wrongful or fraudulent trading,Footnote 41 or actions to set aside a transaction detrimental to the interests of the creditors entered into during a certain number of years before the opening of insolvency proceedings (avoidance actions).Footnote 42 More widely, the Court held in H v. H.K. and Kornhaas that provisions that sanction the conduct of a director at a time when the company was insolvent, without insolvency proceedings having (yet) been opened, may be closely connected, including where the action can be pursued by creditors outside of insolvency proceedings.Footnote 43
Finally, while not decided by the Court in H v. H.K. and Kornhaas, it may be argued that conduct that does not occur while a company is insolvent, but in the vicinity of insolvency, may in appropriate circumstances give rise to a closely connected action. For example, under German law, directors are liable to a company if they make payments to shareholders that cause the insolvency of the company.Footnote 44 The proximity that must exist between the payment and the company’s insolvency according to the German provision is comparable to the requirements of some other legal mechanisms that impose liability on directors for acts in the vicinity of insolvency, such as wrongful trading, which is characterized as insolvency law by the UK courts.Footnote 45 Payments are made in violation of the German provision if the company will not be able to satisfy its debts as they fall due, unless the director, exercising the care of a prudent businessman, could not have known that this would be the consequence of the payment.Footnote 46 As with the liability provision at issue in H v. H.K. and Kornhaas, the company can claim compensation from the director, irrespective of whether or not insolvency proceedings have been opened, although the claim will typically be brought by the liquidator after the company has gone into insolvent liquidation. Given these similarities, it seems likely that the Court of Justice would qualify the claim as a closely connected action.Footnote 47
The second condition of Gourdain v. Nadler is satisfied if an action benefits all creditors, notably by increasing the funds available for distribution, for example, as a result of holding a director or shareholder personally liable.Footnote 48 Whether this condition has much independent relevance is questionable, since claims of an insolvent company will always benefit the creditors as a general body if they are enforced successfully. In order to determine whether or not a particular claim can, in principle, fall within the scope of the Insolvency Regulation, the first condition is a more useful screening mechanism, since claims that do not arise in derogation from the ‘common rules of civil and commercial law’, as defined above, will not be connected with the insolvency of a company.Footnote 49 If this first condition is satisfied, it only remains to be seen whether the claim is actually enforced in the context of insolvency proceedings (see the third condition, discussed in the next paragraph) in order to determine whether it falls within the scope of the Insolvency Regulation. Through this lens, the reference by the Court of Justice to ‘the interest of the general body of creditors’ can therefore be understood as a clarification of the other two conditions that is largely absorbed in them and illustrates how insolvency law may be differentiated from company law in functional terms.Footnote 50
Turning to the third condition, the involvement of a liquidator, the case law of the Court of Justice initially seemed to imply that an action was closely connected with insolvency proceedings if it could only be brought by the liquidator in the event of the insolvency of a company.Footnote 51 In later cases, the Court clarified that an action that is ‘actually brought in the context of insolvency proceedings’ is a closely connected action (provided the other two conditions are satisfied), even if it concerns a claim that does not require the opening of insolvency proceedings and can also be enforced outside of insolvency proceedings.Footnote 52 Conversely, if it is brought as an individual action and not in the context of insolvency proceedings, it falls within the scope of the Recast Brussels Regulation.Footnote 53 This is also the case if an action that can generally only be pursued by the liquidator has been assigned to a third party for a percentage of the proceeds obtained from the claim as consideration.Footnote 54 The consequence of this distinction is that many legal mechanisms have a dual nature. They are characterized as insolvency law for purposes of international jurisdiction and private international law if they are enforced by the liquidator, and as company law (or indeed another legal area, for example tort law) if enforced by a third party. This approach may be criticised for rendering the applicable law a function of somewhat arbitrary differences in a Member State’s internal laws, which may pursue very similar policy goals with or without the involvement of a liquidator.Footnote 55 Nevertheless, it is now firmly embedded in the Court’s case law.
Case law furthermore shows that the three conditions apply cumulatively. An action to enforce a claim for payment of services rendered by an insolvent company was held not to be a closely connected action, even though the action of course benefited the general body of creditors by improving the asset position of the company and was, in the case at hand, brought by the liquidator after the opening of insolvency proceedings. The court explained that ‘[t]he fact that, after the opening of insolvency proceedings against a service provider, the action for payment is taken by the insolvency administrator appointed in the course of those proceedings […] does not substantially amend the nature of the debt relied on which continues to be subject, in terms of the substance of the matter, to the rules of [general commercial] law which remain unchanged.’Footnote 56 Conversely, avoidance actions derogate from the rules of general civil and commercial law, but if they are not enforced by the liquidator and instead assigned to a third party, they are no longer ‘closely connected with […] insolvency proceedings’.Footnote 57
All cases mentioned so far, with the exception of Kornhaas,Footnote 58 concerned the scope of the insolvency court’s international jurisdiction pursuant to Articles 3 and 6 Insolvency Regulation. Until Kornhaas was decided in December 2015, it was therefore unclear whether the Gourdain v. Nadler criteria also determined the scope of the lex concursus, the applicable law pursuant to Article 7 Insolvency Regulation.Footnote 59 In Kornhaas, the Court answered the question in the affirmative. Kornhaas dealt with a reference from the German Federal Court of Justice regarding the characterization of a provision imposing liability on managers of a private limited company incorporated under the laws of England and Wales for payments made after the company had become insolvent. The Court referred to its prior holding in H v. H.K.,Footnote 60 a case concerning the same provision of German law, where it had held that a national court that has international jurisdiction to open insolvency proceedings pursuant to Article 3 Insolvency Regulation has jurisdiction to rule on such an action. The Court concluded from H v. H.K. that the German provision had to be qualified as insolvency law not only for the purpose of determining the international jurisdiction of the insolvency court, but that it was also ‘covered by the law applicable to insolvency proceedings and their effects, within the meaning of Article [7(1)]’ of the Insolvency Regulation.Footnote 61 The Court added that the German provision fell within the scope of the lex concursus by virtue of Article 7(2) Insolvency Regulation, which provides, inter alia, that the lex concursus shall determine the conditions for the opening of insolvency proceedings. In order to ensure the effectiveness of provisions of national law requiring that insolvency proceedings be opened, the Court argued that Article 7(2) Insolvency Regulation ‘must be interpreted as meaning that, first, the preconditions for the opening of insolvency proceedings, second, the rules which designate the persons who are obliged to request the opening of those proceedings and, third, the consequences of an infringement of that obligation fall within its scope.’Footnote 62
We will now apply the Court’s criteria to those of the above legal mechanisms potentially belonging to either the lex societatis or the lex concursusFootnote 63 that have not yet been the subject matter of a decision by the Court (a shift of directors’ duties to creditors in the vicinity of insolvency; duty to recapitalise a company; wrongful trading; liability for failure to file for the opening of insolvency proceedings; the liability of directors or shareholders for causing the company’s insolvency or frustrating claims of creditors; and the re-characterization of shareholder loans).
First, in obiter, Kornhaas makes it clear that provisions penalising directors for trading at a time when the company should have been put into insolvent liquidation—wrongful trading, liability for failure to file, and similar mechanisms—are principally caught by the lex concursus.Footnote 64 However, in spite of the fact that it is universally acknowledged that Articles 6 and 7 Insolvency Regulation have to be interpreted autonomously, Kornhaas does not ensure a consistent treatment of all functionally comparable mechanisms. ÖFAB v. Frank Koot illustrates the problem. The case concerned a provision pursuant to which directors are personally liable for the debts of a company that continues to trade in insolvency.Footnote 65 It is therefore functionally equivalent, for example, to wrongful trading under UK law.Footnote 66 However, importantly, the provision can be, and was in the case at hand, enforced by creditors individually. The third condition of Gourdain v. Nadler, accordingly, was not satisfied, and the Court of Justice concluded that the action did not fall within the scope of the Insolvency Regulation (however, this does not mean that the provision is to be characterized as company law, as we will see in Sect. 2.2.1 below).Footnote 67
Secondly, the liability of a director who does not act in the interest of creditors after duties have shifted from shareholders to creditors in the vicinity of insolvency is typically enforced by the liquidator in the insolvency of a company in the interest of ‘the company’s creditors as a whole’.Footnote 68 Thus, the operation of creditor-regarding duties conforms to the second and third conditions of Gourdain v. Nadler. This leaves the question whether they derogate from ordinary civil and commercial law. Arguably, this question needs to be answered in the affirmative, at least if directors’ duties are structured as in the UK Companies Act 2006, which have the interests of the shareholders at their centre,Footnote 69 since creditor-regarding duties then deviate from general directors’ duties at a particular point in time in a company’s life. On this view, liability claims against directors who disregard creditor interests in the vicinity of insolvency would, accordingly, have to be qualified as closely connected actions, provided the liquidator enforces the claims.
Thirdly, the characterisation of the duty to recapitalise a company and of the re-characterization of shareholder loans as equity capital are ambivalent in the Member States, which is not surprising, given the range of designs for these mechanisms in national laws. The duty to call a general meeting and either recapitalise or liquidate a company operates, at least potentially, in the vicinity of insolvency, but it relies on general mechanisms of corporate law to achieve its regulatory goal and, of course, does not involve a liquidator. This may be different, however, where the focus is on liability for the failure to comply with the duty. Here, claims may well be designed in a way resembling liability for a failure to file for the opening of insolvency proceedings or similar mechanisms.Footnote 70 The doctrine of equity-replacing shareholder loans can form part of a jurisdiction’s capital maintenance regime or be designed as an insolvency law mechanism and entail the subordination of shareholder loans in insolvency.Footnote 71 In the former case, where the usual consequences of a violation of capital maintenance rules apply if a shareholder loan that has been re-characterised as equity capital is repaid, the mechanism will typically not derogate from ordinary commercial law, whereas it falls outside the scope of the lex societatis in the latter case.Footnote 72
The situation outlined above can lead to significant inconsistencies in how the relevant rules are applied where companies exercise their right to choose the applicable company law by relying on Centros. Moreover, the complexity of the questions arising, as well as the large number of host state-home state combinations results in a high degree of legal uncertainty for both companies and their creditors. This is particularly true given that, in many Member States, directors’ duties are enforced virtually exclusively in the context of insolvency.Footnote 73 As the potential benefits of regulatory arbitrage tend to be modest to start with, it would be unsurprising if costs associated with legal uncertainty and complexity in themselves were sufficient to discourage corporate migration.
Additionally, several of the largest Member States, including Germany, France, Italy, and Spain, rely in important respects on insolvency law, and thus effectively real seat-based rules to regulate corporate behaviour.Footnote 74 This is somewhat comparable to the situation in the US, where the scope of company law, according to the internal affairs doctrine, is centred around the shareholder–director relationship, with creditors mainly being protected through insolvency law rules. However, while insolvency law is federal in the US, and thus uniform across all states, it differs significantly across EU Member States. Therefore, for companies primarily operating in a Member State that relies on company law in order to protect creditors, a change in the applicable company law away from this country may result in reduced protection standards, and for companies primarily operating in a Member State that relies on insolvency law to protect creditors, a change in the applicable company law will have a diminished effect on the rules they are subject to, even in circumstances where no duplication of legal requirements results.Footnote 75 In contrast, in the US, a disagreement about the scope of company law, and more generally the role that company law, insolvency law and other legal areas play in addressing the conflicts that the use of the corporate form gives rise to, is limited, given the common heritage of the 51 US jurisdictions. As a result, the few existing differences in corporate law, for example with regard to power allocation and board insulation, are more relevant when the decision is made where to incorporate, and at the same time it is less costly for firms to incorporate in another state than in the EU, because the problem of over- or underinclusive regulatory regimes, or simply lack of clarity about the applicable rules, does not exist to the same extent. On the other hand, effective protection of creditors based on a company’s COMI may render post-Centros opportunities for regulatory arbitrage politically more palatable in the EU.
Effects of Business Activity: Rome II
Conflict rules determining the law applicable to non-contractual obligations generally require a less intense connection with the applicable law than the Insolvency Regulation. In the EU, they are governed by the Rome II Regulation.Footnote 76 Company law may overlap in particular with two types of non-contractual obligations, tort law and culpa in contrahendo, in situations where misconduct by a corporate insider gives rise to claims of either the company or third parties against the corporate insider.Footnote 77 The connecting factor in tort law is the place where the damage occurs, thus leading to the application of the lex damni,Footnote 78 unless the parties involved in the tort have their habitual residence in the same country or the tort is ‘manifestly more closely connected’ with another country.Footnote 79Culpa in contrahendo is defined as ‘a non-contractual obligation arising out of dealings prior to the conclusion of a contract’ and is governed by the law that applies, or would have applied, to the contract.Footnote 80 Alternatively, if that law cannot be determined, the connecting factors of tort law apply.Footnote 81
The lex damni that is applicable pursuant to Article 4(1) Rome II Regulation will, in the present context, generally be the law of the country where shareholders, creditors, or other stakeholders reside who have suffered a loss as a result of the challenged conduct.Footnote 82 Misconduct of corporate insiders that amounts to a tortious act within the meaning of Rome II will typically also constitute a breach of directors’ duties under company law. Therefore, where claimants are resident in countries other than the incorporation state, the challenged conduct will be subject to at least two simultaneously applying sets of behavioural constraints and sanctioning regimes. This accumulation of legal regimes could be avoided if the law applicable to the tortious act was determined pursuant to Article 4(3) Rome II Regulation instead of Article 4(1), and it could be argued that a manifestly closer connection existed with the country where the registered office of a defendant director’s company was located. However, Article 4(3) is described as an ‘escape clause’,Footnote 83 and a general disapplication of the rules of Article 4(1) and (2) in favour of the lex societatis if the defendant is a director or manager of a company is difficult to reconcile with the decision of the drafters of the Rome II Regulation to define the habitual residence of a company as the place of central administration or, when the damage arises in the course of the operation of a branch or other establishment, the place where the branch or establishment is located.Footnote 84
The Rome II Regulation defines the term ‘non-contractual obligations’ negatively by excluding several matters from the scope of the Regulation, in the context of business activities of a company in particular ‘non-contractual obligations arising out of the law of companies […] regarding matters such as the creation, by registration or otherwise, legal capacity, internal organisation or winding-up of companies […] [and] the personal liability of officers and members as such for the obligations of the company or body’.Footnote 85 The Rome II Regulation therefore confirms that certain questions of core company law, including liability for a breach of directors’ duties, are governed by the lex societatis.Footnote 86 However, the situation is less clear where the legal mechanism is not directly related to a company’s internal governance structure or the position of a defendant as a director or member. In such cases, it is often necessary to determine when legal mechanisms give rise to the personal liability of officers and members as such, and when they impose liability on tortfeasors irrespective of their position as an officer or member. The relevant legal mechanisms can be found in diverse legal areas in the Member States, ranging from company law to tort, quasi-contract, and securities regulation. The situation is further complicated by the use of broadly phrased, open-ended tort law provisions in many Member States that are susceptible to being utilised in a variety of situations closely related to processes within corporations and affecting corporate stakeholders.Footnote 87 To give a few examples from national case law, tort law has been relied upon to impose liability on directors for incorrect corporate disclosuresFootnote 88 or acts that harm creditors.Footnote 89 In other situations, the dissemination of incorrect information to investors and shareholders has been held to constitute a breach of pre-contractual duties (culpa in contrahendo),Footnote 90 and in still others a breach of directors’ duties under company law.Footnote 91 The case law of the Court of Justice offers very limited guidance on the characterisation of the different legal mechanisms, and a common approach to determining the demarcation between the lex societatis and the law applicable to non-contractual obligations has not yet emerged in the EU.
In the following paragraphs, we will discuss the views held in the Member States on this question, focussing on provisions of national law at the intersection of company law and tort law that impose liability on directors, and provisions holding shareholders liable for the debts of a company (piercing the corporate veil). Considering available guidance from the Court of Justice, we argue that liability claims other than those based on a core set of company law duties, for example the liability of directors for a breach of information obligations towards investors or entering into obligations that a director knows the company will not be able to perform, and the liability of shareholders for entering into a transaction that is detrimental to the interests of the creditors and leading to the insolvency of the company, are removed from the scope of the lex societatis.
Liability of Directors
The approaches pursued by Member States in order to distinguish between acts committed by a director that lead to liability under company law and acts that are governed by the law applicable to non-contractual obligations, especially tort law, can be roughly divided into three groups. First, several Member States draw a distinction along the lines of substantive law: liability questions that arise from a breach of directors’ duties, the articles of association, or more generally from a breach of company law, are characterised as company law for purposes of private international law, and situations where liability arises from a wrongful act that is not grounded in company law—and that does not consist of a breach of contract or trust either—are characterised as non-contractual in nature and thus subject to the Rome II Regulation.Footnote 92 Secondly, in some Member States, conflict of laws characterisation is based on the type of harmful act. If an act involves the exercise of corporate power, it falls within the scope of the lex societatis; otherwise, conflict rules from tort law or another legal area apply. A final approach distinguishes according to the type of injured party: the lex societatis governs any mechanism that gives rise to liability if a loss is caused to the company (and only so-called reflective loss to the shareholders), and the lex loci delicti commissi governs damages claims of third parties that suffer a direct (i.e. not only reflectiveFootnote 93) loss. Third parties may include shareholders, if they suffer a loss in an individual capacity, rather than in their capacity as a shareholder because of a reduction in the value of their shareholding,Footnote 94 as well as company outsiders, such as creditors or customers.
Of the three approaches, the first one best conforms—with one important caveat that will be discussed presently—to the existing system of European conflict rules as set out in the Rome IFootnote 95 and Rome II Regulations.Footnote 96 Liability for a breach of directors’ duties, giving rise to a claim of the company or against a director, can be interpreted as being a matter of the internal organisation of the company within the meaning of Article 1(2)(d) Rome II Regulation, which is accordingly excluded from the scope of the Rome II Regulation. This view has been confirmed implicitly by the Court of Justice, which decided in Holterman Ferho Exploitatie BV v. Spies von BüllesheimFootnote 97 that liability claims based on a breach of directors’ duties did not fall within the special tort jurisdiction of the Brussels Regulation. The Court held that where ‘a company sues its former manager on the basis of allegedly wrongful conduct, Article 5(3) of Regulation No 44/2001 [dealing with jurisdiction for tort claimsFootnote 98] must be interpreted as meaning that that action is a matter relating to tort or delict where the conduct complained of may not be considered to be a breach of the manager’s obligations under company law’.Footnote 99 Since the Brussels and Rome II Regulations have to be interpreted consistently,Footnote 100 the Court’s holding is also relevant to a characterisation of liability claims for a breach of directors’ duties under Rome II and international company law.
The caveat is that the interpretation of what constitutes a tort/delict cannot be guided by the demarcation between company law and tort law pursuant to a Member State’s internal laws, which differ in how they design legal institutions sanctioning misconduct by company directors, but must be based on an autonomous understanding of ‘the law of companies’ within the meaning of Article 1(2)(d) Rome II Regulation.Footnote 101 For example, disclosure obligations that arise when a company accesses public financial markets or is involved in a takeover may be set out in a Member State’s internal company law, but it is now widely accepted that liability for incorrect disclosures would nevertheless need to be characterised as falling outside the scope of the lex societatis.Footnote 102 The Court of Justice has also held in Harald Kolassa v. Barclays BankFootnote 103 that for purposes of interpreting the Brussels Regulation and determining international jurisdiction, prospectus liability claims as well as damages claims for ‘breaches of other legal information obligations towards investors’Footnote 104 concern ‘matters relating to tort, delict or quasi-delict’.Footnote 105 While the connecting factor for jurisdiction (‘place where the harmful event occurred’)Footnote 106 is different from the connecting factor to determine the applicable law pursuant to the Rome II Regulation,Footnote 107 the underlying policy objectives of both provisions are similar, namely (here) to strengthen the protection of investors in all markets that have been targeted by the issuer of the incorrect statement.Footnote 108
Likewise, there are good reasons to conclude that liability for entering into obligations that a director knows the company will not be able to perform is governed by the lex loci delicti.Footnote 109 The Court of Justice has not addressed the question directly, but in ÖFAB v. Frank Koot,Footnote 110 a case concerning the demarcation between the Insolvency Regulation and the Brussels Regulation,Footnote 111 the Court held that ‘matters relating to tort, delict or quasi delict’ in Article 7(2) of the Recast Brussels Regulation ‘must be interpreted as [covering] actions such as those at issue in the main proceedings brought by a creditor of a limited company seeking to hold liable a member of the board of directors of that company and one of its shareholders for the debts of that company, because they allowed that company to continue to carry on business even though it was undercapitalised and was forced to go into liquidation.’Footnote 112 The fact that the liability provision at issue was laid down in Swedish company law was irrelevant to the Court’s finding that special jurisdiction in matters regarding tort existed. Conversely, where a Member State relies on provisions of general tort law for the regulation of directors’ duties, these rules would nevertheless need to be characterised as company law.
In some of the cases outlined in the preceding paragraphs, a characterisation as tort law can have severe consequences. Since the applicable law pursuant to the Rome II Regulation is the lex loci damni and not the lex loci delicti commissi (unless the escape clause of Article 4(3) Rome II can be invoked), directors potentially face liability pursuant to a multitude of ill-aligned legal systems. For example, where the directors continue to trade in violation of legal obligations and creditors enter into contracts with the company, the damage occurs in all countries from which goods are delivered or funds are transferred to the company.Footnote 113 This seems to run counter to the goal of the Rome II Regulation to ‘ensure a reasonable balance between the interests of the person claimed to be liable and the person who has sustained damage’.Footnote 114
The second approach, which defines the lex societatis by asking whether an act involves the exercise of corporate power, will in many cases lead to the same result as the first approach. Again, the boundaries between the lex societatis and the lex loci delicti commissi may shift from one Member State to another, since the test depends on how the scope of corporate power is defined in the Member States’ company laws. Developing an autonomous definition of ‘exercise of corporate power’ will be difficult because of the inherent ambivalence of the term and the fact that the extent of corporate power is a function of unharmonised aspects of internal company law. Furthermore, if the criterion was interpreted as implying that directors must have acted within the scope of actual powers conferred on them, it would fall short of capturing some situations that are part of core company law, for example a breach of the duty to act within powers.Footnote 115
The third approach encroaches furthest on the rule-making authority of the home state. While a distinction according to the type of injured party (and presumably also according to the type of loss suffered)Footnote 116 has the advantage of presenting a relatively clear criterion that allows a functional demarcation between the lex societatis and the lex loci delicti commissi independent of the internal delineation of company law and tort law,Footnote 117 it would allow Member States to bring a provision designed to regulate the behaviour of company directors relatively easily within the reach of host state law (where injured parties are located)Footnote 118 by formulating directors’ duties broadly and stipulating that the duties are owed not only to the company and shareholders, but also to third parties. The host state could accordingly impose part of its liability regime on the directors of foreign companies operating within its territory in order to protect company outsiders. For example, a formulation of directors’ duties as in the French Code de commerce, which provides that directors shall be liable ‘to the company or third parties either for infringements of the laws or regulations applicable to public limited companies, or for breaches of the memorandum and articles of association, or for management mistakes’Footnote 119 would presumably need to be characterised as tort law according to the third approach in cases where the claimant is a third party.Footnote 120 To what extent such a characterisation leads to overreaching host state law depends crucially on the conditions that give rise to liability under national law. Pursuant to the current situation in France, liability towards third parties (understood as not including the shareholders) requires a so-called faute séparable des fonctions (a fault separable from the functions of the defendant director). Faute séparable was described by the Cour de Cassation as ‘an intentional fault of a particular gravity that is incompatible with the normal exercise of the director’s corporate functions’.Footnote 121 This can arguably be equated with a tortious act and may, therefore, be held to justify a characterisation as tort law. However, hypothetically, a Member State may design a liability provision more widely and grant third parties the right to claim compensation for any loss suffered as a result, for example, of negligent management mistakes. Thus, it is clear that this approach to characterisation leads to a potentially broad scope of application of host state law, including in matters that fall within core areas of managerial activity, such as the approval of the company’s accounts.Footnote 122 In addition, if a third party sues, two or more liability regimes may apply cumulatively, namely the incorporation state’s company law and the tort laws of all countries where the damage occurs, thus possibly resulting in overregulation and overdeterrence.
Liability of Shareholders for Obligations of the Company
In most Member States, the liability of the shareholders for the obligations of the company (piercing the corporate veil) is characterised as part of the lex societatis.Footnote 123 However, conceptually, it is not evident why a classification as company law is always the most appropriate solution, and it is indeed possible to find differing views in some Member States and in the academic literature, which suggest a classification as tort law or insolvency law.Footnote 124
Considering the criteria established by the Court of Justice to delineate the lex societatis, lex concursus and neighbouring legal areas, it becomes clear that a uniform approach to characterising veil piercing is inadequate, but it is rather necessary to distinguish according to the precise structure, operation and function of individual veil piercing mechanisms that can be found in the Member States. For example, veil piercing according to English law generally applies only in the limited circumstances where ‘a person is under an existing legal obligation or liability or subject to an existing legal restriction which he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control’.Footnote 125 This formulation shows that the principle does not constitute a derogation from ordinary civil and commercial law within the meaning of Gourdain v. Nadler.Footnote 126 Rather, its aim is to provide a legal response to abuses of the principles of limited liability and separate legal personality generally.Footnote 127 However, applying the approaches to distinguishing between the lex societatis and the lex loci delicti described above when we discussed the liability of directors, a characterisation as company law is also by no means clear. Often, veil piercing cases do not involve a breach of company law or an exercise of corporate power, but the disregard or evasion of other applicable rules and regulations, which renders the above criteria ill-suited to identify the boundaries of the lex societatis and lex loci delicti.
In comparison, causing a company’s insolvency under German law (Existenzvernichtung),Footnote 128 which is commonly described as a case of veil piercing (Durchgriffshaftung),Footnote 129 applies to the specific case of shareholders entering into a transaction (or otherwise transferring assets out of the reach of the creditors) in order to benefit certain parties to the detriment of the creditors as a whole and in the knowledge that the action may lead to the company’s insolvency.Footnote 130 As a consequence, the shareholders are liable to the company for the loss caused by their actions. Given that the company is the claimant, the liability claim will generally be enforced by the liquidator after insolvency proceedings have been opened. Thus, the situation is similar to that of any other legal mechanism imposing liability on directors for acting in a manner that causes a loss to the company’s creditors at a time when the directors knew or should have known that their action would cause or aggravate the company’s insolvency. The German doctrine should accordingly be classified similarly for purposes of private international law, namely as insolvency law.Footnote 131
Where a jurisdiction applies so-called outreach statutes, it does not generally call into question, as a matter of private international law, the applicability of foreign company law rules to an entity incorporated abroad. Instead, outreach statutes can, first, apply specifically to (pseudo-)foreign companies, so as to prevent an unwanted regulatory outcome which would otherwise result from the acceptance of a foreign lex societatis for companies operating in, or interacting with, the economy of the host state. In the context of EU Company Law, the most famous example of such an outreach statute is, of course, the Dutch Law on Formally Foreign Companies, which was at the centre of the Inspire Art case and was held to constitute a restriction on the freedom of establishment that could not be justified.Footnote 132
Outreach statutes have also been discussed in the context of regulatory competition in the United States. As examined in another contribution to this special issue, California imposes a number of mandatory corporate law rules on foreign companies with significant economic ties with California, including rules on the election and removal of directors, directors’ liability, certain shareholder rights, and recently mandatory gender quotas for directors of public companies. The legality of these attempts to deviate from the internal affairs doctrine is hotly debated in the US literature, and some courts have rejected the applicability of California’s corporate law to companies not chartered there.Footnote 133
A second, wider category of rules that can be viewed as outreach statutes does not specifically apply to foreign companies, but rather to all entities operatingFootnote 134 in the host state. Such rules will typically have the same effect as host state rules targeted specifically at (pseudo-)foreign companies where they concern questions addressed at least in part by the company law of the host state, and will thus apply in addition to the lex societatis. Outreach statutes in this second, wider sense typically apply to foreign companies because the legal mechanism they promulgate is formally part of another legal area, for example administrative law in cases where enforcement is through a government agency, or capital markets regulation where the company’s securities are listed on a domestic stock exchange.Footnote 135 Unless the host state attempts to impose additional requirements only on foreign companies, going beyond the requirements set for companies formed under its own laws, the difference between the two types of outreach statutes is however merely one of legislative technique.Footnote 136
Outreach statutes of both types that restrict a company’s freedom of establishment may of course be justified under Gebhard, as is, presumably, the case in the fairly widespread practice among Member States of applying domestic director disqualification rules to foreign companies operating within their jurisdiction.Footnote 137 Moreover, KornhaasFootnote 138 raises the question whether justification is in fact necessary where the outreach statute in question does not directly affect a company’s ability to establish itself in the host state.Footnote 139 One may speculate whether the Court is more likely to reach this conclusion in case of the second, wider type of outreach statute. As in the other areas described above, the ability of Member States to impose additional requirements on foreign companies through the use of outreach statutes is likely to reduce the extent to which an exercise of the choice of lex societatis enabled by Centros effectively changes the legal requirements of a company compared to an incorporation in the real seat Member State.
Employees and Defensive Company Law Harmonisation
At least for large companies and corporate groups, the area which would perhaps offer the greatest incentives to engage in regulatory arbitrage in Europe relates to board-level employee participation.Footnote 140 Whether affording employees the right to appoint board members (or otherwiseFootnote 141 influence board composition) creates value overall is of course hard to ascertain empirically.Footnote 142 Likewise, the distributional effects of employee participation arrangements for the providers of capital and labour are notoriously hard to measure.Footnote 143 Unsurprisingly, therefore, the social optimality of employee participation arrangements continues to be a contested question.Footnote 144
Irrespective of the overall ex ante value effects of employee participation, however, shareholders should be expected to potentially benefit significantly from a unilateral right to remove existing protections implicitly provided to employees through employee participation arrangements. As highlighted by Gelter,Footnote 145 the ability to disapply employee participation ex post introduces a significant scope for opportunistic behaviour by shareholders and firms. To the extent that employee participation arrangements can be regarded as akin to insurance schemes, with employees accepting lower wages in return for a higher degree of job security,Footnote 146 it is obvious that the potential for a unilateral withdrawal of the very mechanism creating the benefit for employees can result in a value transfer from employees to shareholders. From a more dynamic viewpoint, a firm’s ability to unilaterally change employee participation rights should in the longer term remove any potential benefits from having these arrangements in the first place, whether or not the firm actually engages in opportunistic behaviour.Footnote 147
Since the decision in Centros only concerned choice of law at the point of incorporation, it did not directly enable ex post choice of law—and thus opportunistic behaviour of firms vis-à-vis their employees. The decisions that followed, however, confirmed the right of companies to change the applicable law ex post.Footnote 148 The two main ways in which ex post choice can be exercised by companies is by way of cross-border mergers and by outright incorporations.
Both of these operations constitute exercises of the freedom of establishment according to the CJEU’s jurisprudence,Footnote 149 thereby limiting the ways in which the state of emigration can seek to preserve the continued application of its rules due to the strict justification requirements existing under EU law.Footnote 150 This may be of particular relevance in the context of employee participation: it is unclear and, it is submitted, doubtful, whether a legal requirement to preserve board-level employee participation, enacted on the Member State level, could pass the Gebhard test.Footnote 151 This is partly due to the uncertain nature of the benefits, and indeed the precise aims, of mandatory employee participation rules.Footnote 152 The fact that employee participation arrangements can often be sidestepped even within the jurisdictions mandating themFootnote 153 casts further doubts on the justifiability of an insistence by a host state on the continued application of its rules following a cross-border reorganisation. Consequently, the choice of law created by the CJEU’s case law could have created a significant incentive for regulatory arbitrage, and thus corporate movement, in the area of employee participation.
In reality, however, we observe only very limited regulatory arbitrage around the area of employee participation. There are two principal reasons for the lack of corporate movement away from Member States mandating employee participation.
First, in relation to cross-border mergers, the Member States agreed to ‘defensively’ harmonise the rules governing this type of transaction in a way that preserved existing employee participation arrangements in the vast majority of cases in which abandoning them could benefit firms or their shareholders. There does not necessarily exist a clear legal basis for concluding that restrictions of fundamental freedoms in secondary EU law can be justified in situations where the same restriction enacted by a Member State could not.Footnote 154 However, at least as a matter of fact, the rules protecting employee participation in cross-border mergers,Footnote 155 which are based on the SE Model,Footnote 156 have not been challenged, and are unlikely to be called into question by the Court. This defensive harmonisation, which had already been enacted by the time the decision in SEVIC SystemsFootnote 157 was delivered, precluded significant corporate movement motivated by employee participation arbitrage.Footnote 158
Second, in relation to cross-border reincorporations, the mere confirmation in VALE and National Grid Indus that such transactions generally fall within the scope of the freedom of establishment ultimately does little to facilitate corporate mobility. Reincorporations are complex transactions, and the CJEU did not, and could not, create a viable legal framework for their implementation.Footnote 159 In fact, despite the clear jurisprudence of the Court, several Member States still do not permit reincorporations at all,Footnote 160 and even the company at issue in VALE ultimately failed to reincorporate successfully.Footnote 161 We are thus likely to only see companies make use of the mobility afforded by these decisions once a directive on cross-border reincorporations—which has already been on and off the EU legislative agenda for decadesFootnote 162—is finally adopted by the Member States. Unsurprisingly, a draftFootnote 163 of this directive, which has now cleared most legislative hurdles, adopts essentially the same model for reincorporations as already applies to cross-border mergers and in relation to SE formations.