11 Colum. J. Eur. L. 219 (2005)

Kubler, Friedrich.
Professor of Law, University of Pennsylvania Law School; Professor Emeritus, University of Frankfurt.


A. The Basic Model

Traditionally, company law on the European continent has been quite different from the structures which have evolved in the U.S. The various national systems differ in many ways, but there appears to exist a common pattern that shows its own distinct features. This pattern appears particularly obvious in Germany; thus I will use the German system as a starting point for my inquiry without always explaining how the rules and practices of countries like France, Italy, Spain, the Netherlands, Sweden, or Austria differ from German patterns. The basic model is characterized by three features.

1. The model follows a stakeholder philosophy.

The overall purpose of European corporate law is not maximization of shareholder wealth or return on equity investment, but the accommodation and reconciliation of conflicting interests, primarily among shareholders, creditors and employees. This basic approach is reflected on the individual firm level. First, employees are entitled to board representation; this generally implies a two-tier board structure, separating a managing or executive board from a supervisory board that serves as the organ implementing workers co-determination. The other distinct feature reflecting this philosophy is a comprehensive regime of legal capital, which is designed to serve as a “cushion” for the benefit of the creditors of the corporation. It imposes minimum amounts of capital for the formation of companies, excludes certain assets like future services from being used as shareholder contributions, requires cumbersome procedures for contributions in-kind and severely restricts the distribution of dividends and corporate stock repurchases. This burdens not only the formation of companies, but also the raising of capital through the issuance of new shares with significant costs.

2. The stakeholder approach affects the function and structure of the legal rules shaping the organization of the business enterprise.

These rules are designed to determine the relationship between shareholders, creditors, and employees. For this reason, their elaboration cannot be left to the shareholders; corporate law is generally mandatory in nature. This is true for the regulation of corporate finance, or the rules on legal capital, as well as for the organizational structure of the company, or the corporate governance regime. German law fixes the composition and the size of the supervisory board in every detail, and it strictly separates and defines the powers of the executive board, the supervisory board and the shareholders’ meeting. This imposes a heavy, rigid and inflexible regime upon business entities; the law allows very little freedom to adapt the organizational structures of the enterprise to the changing incentives provided by factor and product markets.

3. Such a regime will not be effective unless companies are prevented from avoiding undesirable laws by moving into another jurisdiction, as American corporations are free to do.

Most of the continental European countries have locked companies into their national legal systems by applying the real seat theory. Under this doctrine the company is not free to choose a state for incorporation; it must incorporate according to the laws of the state where its head office is located and where most of its activities take place. Moving into another jurisdiction generally requires the dissolution of the existing company and the formation of a new company at the chosen location. This burdens corporations not only with cumbersome and costly procedures, but also with adverse tax consequences, e.g. the realization and taxation of undisclosed (or hidden) reserves.

B. The European Approach

The European Community adopted this approach from the very beginning. The American model – based on free incorporation, legislative competition, and a predominance of enabling rules – was well-known and generally rejected. It allowed a “race of laxity,” resulting in “abuse and speculative excesses;” the objective of community legislation has been “avoidance of the Delaware effect, i.e. companies relocating in Member States with least regulations.”, Therefore, the original Treaty of the European Economic Community authorized and required legislation “coordinating to the necessary extent the safeguards, which, for the protection of the interests of members and others, are required by Member States of companies and firms…with a view to making such safeguards equivalent throughout the Community.”, At the same time, the Member States were invited “to enter into negotiations with each other” – that is, to form a convention – “with a view to securing for the benefit of their nationals:…the mutual recognition of companies or firms,…the retention of legal personality in the event of transfer of their seat from one country to another, and the possibility of mergers between companies or firms governed by the laws of different countries…. “. These provisions made it very clear that the right of establishment did not include the freedom  to move a company from one Member State to another by merely reincorporating within the desired country.

C. Reason for Review

The purpose of this article is to show that the institutions of the European Community (“EC”) have fully respected this concept for a long time; only recently could one observe its decline. This article will explain this decline in three steps. Part II describes the waning importance of harmonization of Part III deals with a rather dramatic change in the attitude of the European Court of Justice (ECJ). Part IV explores the impact of the recently enacted Regulation and Directive establishing a European Company, the Societas Europaea. Part V looks for an explanation of why all this happened. Part VI concludes with a few more general observations.