Centros and the cases following it had a profound transformational effect on European company law. While it has so far not resulted in fully-fledged regulatory competition for publicly traded companies, the case had at least two consequences. First, the discourse about EU Company Law and about national corporate law systems has become more international. While the Court of Justice of the European Union (CJEU) case law was not the only factor in this development, it likely contributed. Second, some member states have adjusted their laws to mitigate the effects of Centros. This article explores one reaction by some EU Member States, namely ‘defensive regulatory competition’, which refers to the attempt to stop the ‘flow’ of incorporations to other Member States by modifying the law.
Before Centros, many EU Member States used the ‘real seat theory’ to hinder regulatory arbitrage. Its purpose was not the protection of the creditors (or shareholders) of any particular company, but rather of a country’s authority to determine the law of business entities operating within its territory. Creditors might in fact be harmed if a court found that a debtor company lacked legal capacity. The real seat theory compelled founders to select the law of the real seat jurisdiction, thus protecting it from competition. All of this changed when the CJEU found its consequences to be incompatible with the freedom of establishment in Centros and Überseering, and when Inspire Art ruled that certain Dutch law statutory requirements for foreign companies with their real seat in the Netherlands were contrary to the EC/EU law.
While the debate on regulatory competition in the United States focuses on publicly traded firms (although not exclusively), in light of the practical impact of the case law the European debate soon turned to regulatory arbitrage opportunities for newly founded privately held firms. In the US, there is some debate on whether states have an incentive to attract closely held corporations and LLCs. But initiatives of this type may not always be easy to distinguish from the objective of creating a business-friendly environment. On the demand side, the empirical literature seems to be divided as to whether differences in legal doctrine drive corporation choices, or whether the general business environment, the role of the Delaware courts, or the prestige of the Delaware brand is the most important factor in driving firm formation choices.
In Europe, it seems quite clear that no jurisdiction is actively attempting to become the European Delaware, either for publicly traded business or for privately held firms. The UK became the destination of many Continental European founders in the mid-2000s but never actively sought to attract such incorporations and did not have the incentives to do so. However, founders began to cross borders to take advantage of more facile incorporation procedures and in particular of the absence of a minimum capital for private limited liability companies in a number of jurisdictions, including the UK. One can probably summarize the comparison with the US by saying that legal differences between Member States provided a ‘lower hanging fruit’ in Europe, presumably because of the absence of regulatory arbitrage opportunities in the past: Differences in minimum capital are far easier to make out than more subtle differences in doctrines (or even statutes) relating to directors’ and members’ liability risks. Moreover, the key issue are costs at the ex ante firm formation stage, as opposed to ex post liability risks. While the former affect every firm, the latter are hard to predict, and will likely only play a role in some firms.
In the past 15 years, Europe has seen a trend among Member States to facilitate firm formation and to reduce minimum capital requirements. Some reforms have been characterized as ‘defensive regulatory competition’. If Member States do not actively seek to attract firms, maybe they attempt to prevent an ‘outflow’ of newly founded firms. There are various possible motivations. First, policy makers in a Member State may truly think it is important for them to retain control over the large bulk of corporations operating in its territory. Second, there could be a rent-seeking explanation. Interest groups in the legal profession may be concerned about losing business to their peers in other Member States. Third, changes in the law have occurred for unrelated reasons. For example, minimum capital negatively affects a country’s ranking in the World Bank’s Doing Business index. Some countries may have changed their law to improve on the index.
All of this raises a number of empirical research questions, which I am seeking to explore in an ongoing research project. My forthcoming article in the European Business Organization Law Review looks at some of these issues. One question, for example, is whether cross-country incorporation is truly an important phenomenon from a quantitative perspective. Arguably, in most countries it remains a fringe issue. Only in a few countries and in a few years did the number of firm formations in the UK of this type exceed 5%. Second, has ‘defensive regulatory competition’ affected the number of Centros-type firm formations? The paper reports Difference-in-Differences regressions testing the impact of two reforms, namely Germany’s MoMiG of 2008, which included an entire package of reforms and created the UG (haftungsbeschränkt) variation of the German GmbH, as well as a Belgian law introducing the SPRL-starter in 2010 (which has recently been made redundant by Belgian’s abandonment of the legal capital system for the SPRL/BV). The German reform, whose effectiveness has been subject to some debate, appears to have had a modest impact. It likely contributed to a stronger existing trend among German founders away from the English private limited company.
Martin Gelter is a Professor of Law at Fordham University School of Law.