Kornhaas and the Limits of Corporate Establishment

Sometimes, the Court of Justice of the European Union (CJEU) appears to be in a state of mental blackout. This must have been the situation responsible for the recent Kornhaas decision, delivered (to be fair) only by a three-judge chamber, and without an opinion by an Advocate General. It is to be hoped that this is one of those decisions, as characterized by Weatherill, which is ‘so downright odd that it deserves to be locked into a secure container, plunged into the icy waters of a deep lake and forgotten about’.

Kornhaas is the most recent of many cases outlining and interpreting the corporate right of establishment in the EU. It partly reverses a liberal approach to establishment, initiated by the legendary Centros case from 1999, which arguably opened up a (limited) market for incorporations in the EU. As a consequence of that case, entrepreneurs from Germany and other EU Member States of continental Europe had availed themselves in large numbers of the possibility to set up English companies which, although registered in England, were exclusively economically active in the founders’ respective countries. Kornhaas concerned the problem to what extent the host Member State’s insolvency law can be applied to such an English company operating exclusively in Germany.

The CJEU held that German rules requiring reimbursement of payments which a director made after insolvency, but before the opening of the insolvency proceedings (§ 64 GmbHG) were to be characterised as “insolvency law”, and thus applied to a foreign firm operating in Germany by virtue of Article 4 of the EU Insolvency Regulation. The Court also clarified that such application of the German standard to the director of a foreign company does not infringe the European freedom of establishment.

The implication of this distinction between company law (country of origin) and insolvency law (host country) is the seemingly more general exception from the scope of establishment for such rules of the host Member State that relate to the conduct of the company’s business (as opposed to rules that affect the process of setting up the establishment itself). In substance, this distinction very much resembles an application of the well-known Keck doctrine which was originally developed in the context of free movement of goods.

The Kornhaas decision is flawed for several reasons. First, liability rules for violating insolvency filing requirements ought to be interpreted as company law in substance. The former High Level Group of Company Law Experts convincingly argued that “[t]he responsibility of directors when the company becomes insolvent has its most important effect prior to insolvency and is a key element of an appropriate corporate governance system”.

Secondly, the entire setup of distinguishing between two sets of legal rules risks creating frictions, inconsistencies and unnecessary costs of doing business in Europe. The combination of company law from the country of incorporation and insolvency law of the country where the “Centre of Main Interests” is located presents a formidable source of future litigation over legal uncertainties. The only solution to this dilemma would be to re-interpret the CoMI as the company’s registered office, an argument I have made here.

Finally, Kornhaas also encounters a number of doctrinal criticisms from an EU law perspective. The CJEU has long refused to apply the Keck concept to other fundamental freedoms, and for good reasons. The differentiation between product-related rules and selling arrangements itself is not overly helpful at times, and rather frequently raises new questions of delimitation. Further, the logic of the test does not sit easily with establishment situations: the scope of Article 49 TFEU (unlike Article 34 TFEU) does not differentiate but rather applies broadly to ‘the right to take up and pursue activities as self-employed persons and to set up and manage undertakings’ without there being any room for a differentiated interpretation. In addition, the establishment process is more complex than the importation of goods, as it is not limited to market access for certain products into the importing Member State, and thus defies any attempt to distinguish between production and marketing stages.

In any case, the classification of the German liability rule in Kornhaas as a ‘business-related arrangement’ is not convincing. In my view, the application of foreign liability standards on another jurisdiction’s company represents a significant impediment to its establishment and can by no means be dismissed as a formality. This was, by the way, also the Court’s view in the earlier Inspire Art decision. In that decision, Dutch rules imposing substantial liability rules, minimum capital and name requirements on “pseudo-foreign” firms were found to be contrary to freedom of establishment. The Court at the time even said that “The argument that freedom of establishment is not in any way infringed by the [Dutch rules] inasmuch as foreign companies are fully recognised in the Netherlands and are not refused registration in that Member State’s business register, that law having the effect simply of laying down a number of additional obligations […], cannot be accepted”. The same should have been true for Kornhaas.

Wolf-Georg Ringe is Professor of International Commercial Law at Copenhagen Business School. At Oxford, he is a Visiting Research Fellow at the Institute of European and Comparative Law and an associate member of the Oxford-Man Institute of Quantitative Finance.