EU Judgments on the Real Seat Approach to the Domicile of Companies

How Far Have The Judgments Of The European Court Of Justice In The Cases Of C-212/97 Centros, C-208/00 Uberseering And C-167/01 Inspire Art And Later Cases Undermined The Power Of Member States To Apply The “Real Seat” Approach To The Domicile Of Companies?

Introduction

It has been widely accepted that the real seat doctrine has become a very controversial topic, and the fact that the French based doctrine has been losing its importance day by day after a few current decisions made by the European Court of Justice (ECJ). These decisions play a significantly important role for the issue of whether the real seat doctrine is compatible with the free choice of companies. With the most famous and recent judgements of the ECJ on such as “Centros”, “Inspire Art” and “Uberseering” the conflict between national company law applications and the law of European Union (EU) has come into view, and also raises the questions of whether “the recent decisions of the ECJ for determining the domicile of companies have overruled the real seat doctrine” and “to what extent this doctrine is inconsistent with the freedom of establishment approach under the Articles 43 and 48 of the European Community (EC) treaty.”

After these decisions of the EJC, the hands of companies formed in a member stated has been strengthened since to be recognised by a member state where the company wants to move its administration without considering the real seat of the company. Additionally, this judgement has brought some important problems to the agenda. As Baelz and Baldwin argue that this decision ignites some academic debates for the issue of whether the extent to which the works for identification of a legal entity within the EU single market will be reflected to the different areas of company law.

It has been accepted that the approach of the real seat doctrine is distinguished among different states. While in some legal systems it is free to choose the state in which the promoters intend to establish their companies, in others such as German law, a company is not recognised unless its effective seat of management is in Germany. Thus, the real seat doctrine seems to be in a conflict with the “incorporation theory” which allows companies to choose their places.

The aim of this paper is to examine the effects of the decisions of the ECJ on the power of member states to apply “real seat” doctrine to the domicile of companies by drawing the attention particularly to the judgements in “Uberseering”, “Centros” and “Inspire Art”. A brief definition of background of the real seat doctrine will be given in the first section. Then, the essay will focus on the implications of the real seat theory on the EU company law’s approaches and the perspective of applicability and sustainability of the doctrine in Member States.

The Real Seat Theory

A. The Definition And The Use Of The Doctrine In The Eu Law

Although there has been some doubt about a precise definition of the real seat doctrine, one can be given from the framework made by the European Commission in September 2001:

“The validity of incorporation and legal status of a company are recognised by reference to the law of claimed formation only if it maintains its “real seat” within that jurisdiction. The meaning of “real seat” varies; generally, if there is no substantial connection between the “central”, or “controlling” operations (particularly the place where the governing organs meet) and the jurisdiction of formation, then recognition by reference to that law is denied. Thus if a company is formed under the law of one Member State and moves its undertaking or central functions to another (which applies the real seat doctrine) without re-incorporation within that other, its legal security will be undermined”.

Majority of European countries subscribe to the system of real seat and they insist that companies seeking to move to a country where the real seat doctrine is effective can only be legally recognized when they bring their headquarters with them as well. As an alternative to “real seat”, there is another doctrine so-called “Incorporation Doctrine” used by several Member States such as the UK, Ireland, Denmark, Spain, and Netherlands, to allow corporations to relocate their administrators without incurring legal damages. According to incorporation theory companies are free to choose the state of incorporation in those countries that adhere to this theory and only the law of incorporation state is implemented in case of any conflict.

After having given these definitions it can be said that these two leading approaches have been causing an unsolved conflict in the EU corporate law. As Danmann says one of the well known and most important obstacles to free choice in the EC seems to have been the real seat doctrine.For a long time it has been a controversial topic that the legitimacy of the real seat doctrine has been in a debate over the question whether the principles of this doctrine is compatible with freedom of establishment of companies. While some scholars argue that the Article 43 and 48 of the EC treaty give the right to promoters to choose the state of incorporation and the law which they want to be implemented for their companies. However, some scholars claim that the power has to be given to Member states to force their law on corporations established in another member state if the companies have less relationship with their state of incorporation than the former.

B. The Conflict Between “Freedom Of Establishment” And “Real Seat” Doctrine

For the determination of the correct law to apply to the “legal capacity and the internal structure of a corporation”, the conflict between the doctrines and the Article 43 and 48 of the EC treaty should be solved in the light of the decisions of the ECJ as there is not a certain regulation for this dilemma. Application of domestic law to a foreign company does certainly require recognition by the host state. However, the problem arises when central administration of a company is being transferred because of the possibility of refusal to accept this company’s request. As Drury points this issue may cause that the host state may treat the company as a simple partnership. Therefore, this restricted company will be unable to enter into contracts and legal activities.

As above mentioned in order to solve the issue of determining the law system to regulate foreign corporations’ relationships with the host state, most of Member States have adhered to the real seat doctrine. It should be, however, noted that the current situation has started to change to adhere to incorporation theory. England law can be taken as an example for better understanding the incorporation theory as it is the default system in England. A duly established company under the law where the company was incorporated must be recognised as if it was also incorporated in England. Although this theory can be an alternative to the real seat doctrine, the dilemma still seems to be unsolved. As a result of this the judgements of the ECJ should be taken into account to see different approaches throughout the Europe.

3. The European Court Of Justice’s Decisions And Their Implications On The “Real Seat” Doctrine.

A. The “Centros” Decision Of The Ecj

It is accepted that in the Centros case, the Court of Justice created its first elemental decision on freedom of establishment in the EU area. In this case a private limited Danish company, Centros Ltd. was incorporated under the UK law with the purpose of avoiding the costly and difficult setting up formalities existed in Denmark. According to the claim of Denmark, Centros should not be allowed to get round Danish incorporation requirements by only forming the company in another Member state. On the other hand, Centros claimed that the company was incorporated lawfully in the United Kingdom and it is their right to establish a branch in Denmark under the Articles 42 (former Article 52) and 48 (ex 58) of the EC treaty.

The ECJ held that a request of registration of a limited company formed under English law from Danish authorities could not be refused even though the real seat of the company is in Denmark. The registrar of Denmark had also claimed that a company whose almost whole businesses were done in Denmark had to be established in accordance with the Danish law. The reason underlying this claim was that Denmark partly accepted the incorporation theory. It should be stated that judgement of the Court of Justice seems to be appropriate. Although this approach of the Court of Justice conflicts with the real seat doctrine, it supports the incorporation doctrine. For example, Germany subscribes to the real seat doctrine. If Centros case had happened in Germany instead of Denmark, which adheres to the incorporation theory, it could have been said that Germany had the right to argue that the companies had to either transfer their real seat to the second Member state or re-incorporate in Germany in accordance with German law. This example shows that Denmark as a subscriber of the incorporate theory was mistaken in its claim.

After Centros decision of the ECJ there were still quite a few questions to be answered. However, it is the fact that one of the most remarkable questions is whether the freedom of establishment pursuant to article 43 and 48 of the EC treaty has enabled the companies to avoid national incorporation requirements such as taxation, minimum amount of capital. From this aspect it is said that as Kieninger points out, freedom of establishment has been used as limiting the real seat theory by several Member states’ courts even if they are supporters of this theory.

B. Daily Mail Case In The Light Of Centros

In Daily Mail case, a UK based company wanted to transfer its central administration from the UK to Netherlands to benefit from Dutch tax regulations. Under the UK law, companies that want to move their headquarters to another Member States but still wish to retain their legal personalities in the UK need to first attain the permission of British tax authorities. The company, Daily Mail, believed that this requirement constituted an obstacle to the right of freedom of establishment under Article 43 of the EC treaty. The EJC held that the Article 52 (as it was) and 58(now 48) of the EC treaty do not allow companies to move their headquarters to another Member states while retaining their legal status in the first member state. In this judgement, the Court of Justice also pointed that these articles are only valid for the institutions of “agencies, branches or subsidiaries by the nationals of any Member state. It is worth emphasising that the Daily Mail decision of the ECJ is important due to the fact that this case can be regarded as a leading judgement for the other cases concerned with freedom of establishment.

Another important point in Daily Mail case is that, the Court stated that diversities in different jurisdictions should be taken into account in order to determine the scope of freedom of establishment in Article 58 (now 48).

Having evaluated these two cases, it becomes clear that in terms of the decisions of the ECJ, there are slight but noteworthy differences between Centros and Daily Mail. First, Daily Mail case was about transferring the centre of management of a company whereas Centros was concerning with the secondary foundation. Another significant difference between these two cases, which is perhaps regarded as the main reason of the other differences, is that in Centros case, transfer of central administration was made into the territory of regulating state while the moving process was made from the state of incorporation in Daily mail. It has also been argued that Centros has overruled Daily Mail because in the judgement of Centros, the Court has stated that it is an obligation of a Member state to recognise o foreign company founded in accordance with the criteria of the Article 48 of the EC treaty. However, it should be mentioned that the mandatory recognition of a company by a Member state does not solve the problem of which law will be applied to. In other words, the Centros judgement does not offer “a rule of preference” related to the connecting factors conferred in Article 48 of EC treaty.

Article 48 of the EC treaty has only enumerated the connecting factors as companies’ registered offices, central administrations or principal places of business within the Community, therefore; it was needed to issue some regulations to clarify “connecting factors “and to make a common rule of preference. Both Council Regulation (EC) No 2137/85 on the European Economic Interest Grouping of 1985.75 and the Council Regulation (EC) No 2157/2001 of 8 October 2001 provide a compromise between two different approaches the incorporation and the real seat doctrine.

C. The Uberseering

Until the Uberseering decision of the ECJ in Germany it was not possible to have a legal capacity of suing or to be sued for companies which were not established in accordance with the rules offered by German company law. Uberseering was a Dutch company and incorporated in Netherlands. After a transfer of all shares of the company to Germans the principal place of business of the company was moved to Germany. The company made a contract with a German firm, the German contractor sued Uberseering for some reasons which are beyond this essay. The court of first instance and the court of appeals held that the company had moved its real centre of administration to Germany, furthermore; shareholders of the company are German citizens. Therefore, the Dutch company was a subject to German law. On the other hand, it is true that as the company had not been incorporated in accordance with the German company law, as a result; it did not have the right to stand before a German court.

The German Supreme Court sent the case to the ECJ to take the answers of two questions:

1. Whether bringing a claim by a company that is formed in another Member State is against to the freedom of establishment of companies guaranteed by the Articles 43 and 48 of the EC treaty when the company loses its capacity to bring a claim.
2. Second question is concerned with the legal personality and the ability of carrying a case: the German Supreme Court asks whether Articles 43 and 48 of the EC treaty should be read in a way that these subjects are administrated by the law of state of incorporation.

Before showing the answers of the Court of Justice, it is imported to point out that Uberseering case does not deal with company law; it is a case which is based on freedom of establishment of companies. As to the questions, the ECJ repeated its decision given for Centros case which was that “companies are free to do their businesses in EU area as long as they are incorporated in an EU member state”. In respect to the first question the Court clearly stated that freedom of establishment could not be restricted by the state to which the company’s central administration was moved. As above mentioned the ECJ’s decision is on the ground of freedom of establishment of companies because the holding did not mentioned that German law is not valid.

In both Centros and Uberseering, it has been a controversial topic that the ECJ has put the real seat doctrine in reserve and made the incorporation theory compulsory. According to Wymeersch this statement of the Court is deceptive for the reason that in the absence of a valid rule in the EC Treaty. The ECJ has no rights to make a decision on company law matters except interpretation of company law directives. Although the decision of the Court is not neither on the ground of the company law nor conflicts of law, it definitely has an effect on them.

Finally, the judgment in Uberseering case has shown that the approach of the ECJ is far from the traditional incorporation theory; however, it creates a community law for interpretation of the connecting factors given in the Article 48 of the EC treaty. In addition to the stress on the incorporation doctrine it has been argued that Uberseering decision has put an end to the real seat theory.It is to some extent true that after Uberseering decision, a few Member States had to take up the incorporation doctrine seriously. For example, Germany, as a strong proponent of the real seat theory, has left behind the real seat doctrine. The reason for that is the decision of the ECJ taken for Uberseering . Indeed, Member States now have to recognise legal capacity of companies which are officially incorporated in another Member State. Moreover, Baldwin and Baelz argue that member states like Germany should also recognise these companies as a legal entity with limited liability.

D. Inspire Art Decision

After the landmark judgements evaluated by now (Centros, Daily Mail and Uberseering) the Court of Justice again made a decision in support of freedom of establishment, implicitly the incorporation doctrine, in Inspire Art decision.

It is obvious that the facts of this case are not very different from other cases. Briefly, Inspire Art Ltd. was a private limited company founded in the UK. After the formation, the company started to do business with Netherlands where there is the residence of the director and the only shareholder of the company. As it can be imagined that the main aim of the establishing the company in the UK was to benefit from several advantages that British company law offers. The company was registered in the Commercial register of the Chamber of Commerce without stating that it was a pseudo-foreign company.

With the request of the Chamber of Commerce to the Kantongerecht to change the status of Inspire art as a foreign company, the Kantongerecht held that Inspire art was a foreign company in accordance with the Article 1-5 of WFBV (Law on Formally Foreign Companies) and had to meet the requirement offered by national law. The case also referred to the ECJ in order to ask whether the Articles 43 and 48 of the EC are interpreted as preventing Netherlands from putting extra conditions such as those of which are defined in their statue (Article 2-5 of WFBV).

The Chamber of Commerce and a few Member States argued that the provisions in the national law of Netherlands are not against to Articles 43 and 48 of the EC treaty regulated freedom of establishment of companies. Moreover they pointed out that the Court should consider Inspire Art case in a way that is different from Centros because that case was about determining the governor state, whereas the matter in Inspire Art was only to attach additional connecting factors by national legislature.

In the end, the Netherlands government and Germany and Italy stated that the case law of the ECJ should recognise the right of the Member States to put into practice some necessary regulations to stop inappropriate and counterfeit applications made by hiding under the veil of the Community law. After all these claims, the ECJ held that it was not an abusive conduct to be incorporated under the UK law rather than the Dutch law as it was merely to circumvent the strict minimum capital rules of the Dutch company law.

This decision is important in terms of the issues that the Court of justice dealt with. In other words, in Uberseering, Centros and Daily Mail main issues were not concerned with company law while in Inspire art the ECJ tackle several company law issues. According to Lowry national laws of the Member States will be tested in respect to four conditions:

1. They must be non-discriminatory.
2. They must be necessary for protection of public interest objective.
3. They must be proportionate
4. They must be suitable for securing the attainment of the objective they are designed to address”.

It has been argued that Inspire Art decision has exclusively undermined the real seat theory. The major view, already construed from Überseering and Centros, is that a conversion of the foreign company into a domestic partnership was not allowed under European law. This argument is valid for inbound case, regarding with outbound cases domestic companies wish to move to another member state, as Christian and Philipp state, Inspire art decision does not bring any change.

4. Effects Of Decisions On The Real Seat Doctrine

As earlier mentioned, it is argued that the real seat doctrine has been relatively affected by the decisions of the ECJ. In the light of these decisions, it is said that Member states are now supposed to recognise the legal capacity of the foreign companies which their principal places of decisions in a Member State, without asking companies for any requests to change their company type.

A serious problem then arises that Member States especially those of which adhered to the real seat doctrine want to implement their legal system on companies. Arguments of the supporters of real seat doctrine have been based on the need for minority shareholders and creditors’ rights and Member states’ free choice of determining minimum capital. They argue that a company should be established under the legal discipline of only one country; therefore, problems of financing of the company, protection of shareholders and creditors rights caused by the conflict between different legal systems can be easily solved. However, Roth argues that protection of creditors cannot be a restriction of freedom of establishment.

The common point which the ECJ stressed out in its decisions is that companies established in a Member states should have freedom of establishment in accordance with the articles 43 and 48 of the EC treaty and restrictions to this freedom should not be allowed. Following these holdings drive us to the “incorporation theory”. Nonetheless, the Court has changed the structure of the incorporation theory by accepting several exceptional requirements which host states can apply. For example, in Centros it is stated that host stated can impose some extra requirements, such as asking for a higher minimum capital for protection of creditors.

After decisions of the ECJ, it can be interpreted that the current view of the EC company law shows us the real seat doctrine has lost its importance and it should be replaced by other approaches for removing the obstacle from freedom of establishment. Indeed, so called 14th Company Law Directive is one of the last exercises of the EC for transfer of companies within the EU area, and it will enable companies to transfer their principle place of businesses to another Member state with its former legal capacity and personality.

5. Conclusion

In this essay, implications and applicability of the decisions of the ECJ on real seat theory and in the EU area have been evaluated. As a result, it is said that national matters such as taxation, social issues thought for protection of shareholders and public interest and the need for a minimum capital are the arguments of the proponents of real seat doctrine.

On the other hand, the European Commission does not seem to make a concession to these proponents since the works for legislation of the draft of 14th Commission Directive has been carrying on. The reason for this is that the aim underlying the approach of freedom of establishment appears to make companies be able to race in a competitive market and to provide equal opportunities to all entities. The real seat doctrine seems to be an obstacle to the social and economical spirit of the EC company law which intends to create a single market to which everyone can easily access.

In the light of the current use of real seat doctrine and from a practical perspective, it can be said that although the power of the Member States to apply the real seat doctrine has implicitly been undermined by the ECJ decisions, the doctrine is still in force in several countries. It is deemed that for a permanent solution the national concerns and the EC’s policies seeking to provide mobility to companies should be reconciled.