Centros@20 Series - The Legacy of Centros and the Future of Regulatory Arbitrage in Business Law: Cross-border Conversions

In April 2018 the European Commission presented a proposed directive on cross-border mobility which includes a new legal process for cross-border conversion. The JURI committee of the European parliament tabled its report in January 2019. A compromise text was provisionally agreed in March 2019 and the European parliament approved the text in April. The text is now subject to the Corrigendum Procedure and it is expected the Council will approve it once that has happened.

Both the originally proposed directive and the amendments proposed owe a great deal to the Centros decision, reflect the limitations of that decision and throw some light on the conflicting views about the future of regulatory arbitrage in business law.

The Centros case decided that a UK company formed by Danish nationals only for the purpose of establishing itself in Denmark was entitled to establish a branch in Denmark and this was an exercise of the freedom of establishment under the Treaty. The court recognised that member states can take measures to prevent nationals improperly or fraudulently taking advantage of Community law provisions. However, the court held that choosing to form a company in another member state and to set up branches in other member states could not, of itself, be an abuse. The fact that a company does not conduct business in the member state where it has its registered office and has activities only in another member state is not enough to prove abuse or fraudulent conduct.

In the Polbud case in 2017 the shareholders of a Polish company resolved to transfer its registered office to Luxembourg with a view to becoming a Luxembourg company. The ECJ held that freedom of establishment applied, even if the real head office of the company was not moved, provided the conditions laid down by the legislation of the new member state were satisfied. The court followed Centros in saying that the fact the registered office or real head office was established in another member state to benefit from more favourable legislation did not, of itself, constitute abuse. It found that the Polish requirement to liquidate the company in Poland was a restriction on the freedom of establishment which was unjustified, as it went beyond what was needed to protect creditors, minority shareholders and employee interests. Whilst recognising Poland’s right to prevent abusive practices the court decided that there was no evidence of abuse and that requiring a liquidation procedure was disproportionate as it amounted to a general presumption that abuse existed.

Whilst the Centros and Polbud cases (and others) clearly enunciated the principle of freedom of establishment for companies, they also demonstrated that court proceedings are a slow, and therefore unattractive, way for companies to exercise their fundamental freedom. Centros had to wait almost seven years after applying to register a branch for the ECJ ruling, while Polbud waited over seven years from its shareholders’ decision to transfer the registered office. A letter from Companies House in the UK in 2017 demonstrates that case law does not necessarily translate into change. It said Companies House knew of the ECJ cases but the UK did not have procedures in place to allow transfers of companies out of England and Wales without the company dissolving and so could not act on a request (presumably to allow the company to transfer to another member state).

The European Commission was well aware of the practical difficulties of exercising the freedom of establishment when it presented the proposed Directive. The Explanatory Memorandum notes that ‘in practice the exercise of the Freedom of Establishment by companies remains difficult.’ It says  that company law ‘does not offer companies optimal conditions in terms  of a clear predictable and suitable legal framework’. It also notes that mobility has consequences for stakeholders, particularly employees, creditors and shareholders but that ‘legal uncertainty, partial inadequacy and also the lack of rules governing certain cross-border operations of companies means that there is no clear framework to ensure effective protection of these stakeholders’.

The proposed Directive puts forward a process for companies to follow to ‘convert’ ie to move their legal form to that of another member state without being dissolved, wound-up or going into liquidation, transferring at least their registered office to the new member state. The company must meet the requirements in the new member state to become the relevant company. Competent authorities must check the requirements have been followed. These include protections for creditors, employees and shareholders. A conversion is prevented if the company is in liquidation and has begun to distribute assets and may be prevented in other insolvency-related cases. Competent authorities must refuse a conversion if it is ‘set up for abusive or fraudulent purposes’ to evade or circumvent national or EU law or for criminal purposes.

Some amendments in the JURI report reflected continuing unease about a company’s ability to move to another member state. A proposed new recital stated that the freedom to move the registered office to another member state was based on an undesirable system of competition between member states fuelled by an unlevel playing field with different national provisions in social and fiscal policies. It said that the possibility to move the registered office without moving core activities had contributed to incomprehension and anti-European sentiments on the part of employees and other stakeholders. A substantive proposed amendment required the company to demonstrate the actual establishment and pursuit of economic activity in the destination member state for an indefinite period.

The agreed text does not include these amendments but the recitals do say it is important to counteract ‘shell’ or ‘front’ companies set up to evade, circumvent or infringe national or EU law. The recitals also list many factors which should be taken into account if the authority has serious doubts the operation is abusive or fraudulent, including where assets are located, where employees work and social contributions are due. Effective management or economic activity in the new member state can indicate an absence of abuse or fraud. The authority can obtain relevant information from the company, extend the assessment period from three to six months and have recourse to an independent expert in assessing the application.

It will be interesting to see how different member states use their powers to scrutinise conversions in future.

Vanessa Knapp is Professor of Law at Brunel University, London.