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Summary European Company Law I masterfase compleet UvA
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European Company Law I masterfase compleet UvA
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European Company Law Imasterfase compleet
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Week 1 – introduction in the real of EU company law
Anatomy of corporate law H1-H2
What are companies for?
Stakeholder versus shareholder approach: The goal of corporate law in the
Rheinland (stakeholder) model is to facilitate economic activity and to advance
the aggregate welfare of all who are affected by the firm’s activities, such as
shareholders, employees, creditors, suppliers, customers as well as third parties
such as local communities and beneficiaries of the natural environment. It is the
duty of the board to find a balance in these interests, for example with co-
determination. The views on how to achieve this differ.
Others argue that corporate law should only focus on shareholders interests, as
the rest of the stakeholders, such as employees or creditors, are protected by
contracts. Furthermore, company law should focus on maximizing shareholders
returns, as they are residual claimants and get paid last. The shareholder is
therefore the only one that needs additional protection in company law.
Some argue that the shareholder approach may lead to short-term decision
making, endangering the long term solidity of the firm. Others argue that it
doesn’t make a difference since shareholders are or should be driven by long-
term interests for their own sake.
Instrumental versus institutional approach: The instrumental (societas)
approach allows the company to be used and organized at will. The corporate
law is used to facilitate entrepreneurship and taking risks to generate profit,
therefore the corporate form should be completely flexible even after the
partnership has evolved in a large share ownership company. The institutional
approach sees the company as an institution with its own rights, which are not
identical to those of the shareholders. The society has its own rights and is
entitled to mandatory protection, even against its owner-shareholders
(universitas); for example by full autonomy of the board with no influence from
its shareholders.
The dominant approach depends on the nature of the company. Single
shareholder companies and joint venture agreements are seen as predominantly
instrumental. Closed companies require flexibility as well, but are in some ways
restricted from instrumental approaches. In listed companies with controlling
shareholders and listed companies with dispersed ownership, the company may
need the most protection from the anonymous body of shareholders.
Company law constitutes companies, and then organizes companies and it’s legal
representation. The common structure of the law of business corporations has
five easily recognizable characteristics:
- legal personality: This construction of law permits a firm to become a nexus
for contracts, by permitting a firm to serve as a single contracting party that
is distinct from the various individuals who own or manage the firm. In doing
so, it enhances the ability of individuals (owners, managers and employees)
to engage together in joint projects. This includes separate patrimony,
which entails a separation of a pool of assets that are distinct from other
assets owned by the shareholders. The law views the firm as being the owner
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and the firm therefore has the right to use and sell the assets and make it
available for attachment. These assets are, however, unavailable for
attachment to the personal creditors of the firm’s owners, which is called (i)
entity shielding. This entails two relatively distinct rules of law, the first of
which grants to creditors of the firm a claim on firm’s assets that is prior to
claims of personal creditors of the owners of the firm (this is called the
priority rule). The second rule, which is called liquidation protection
provides that the shareholders of a firm cannot withdraw their share of the
firm at any given time and by doing so force liquidation. This rule protects
the going concern value of the firm against destruction by shareholders or
individual creditors. Partnership often only have the first of rules, making it a
‘weak form’ of entity shielding. Legal forms furthermore need rules
specifying to third parties which individuals have (ii) authority to act on
behalf of the firm and enter into contract, and rules on the mere appearance
of having this authority (see delegated management). Finally, there need to
be (iii) procedure rules regulating law suits when dealing with separate
legal entities.
- limited liability: Creditors are limited to making claims against assets that
are held in the name of the firm itself, and have no claim against assets that
the firm’s shareholders hold in their own names. Shareholders can only lose
their investment and are not liable for debts of the company. This is
considered to be a strong contracting tool and financing device for
development and risk-bearing endeavors. By incorporating separate
subsidiaries, limited liability also permits firms to isolate different lines of
business for obtaining credit. The creditor will be able to asses the firm’s
value better because of partitions, and it will give the creditors incentive to
monitor the firm, which they are in a better position to do compared to
widely dispersed share ownership. Finally, limited liability allows for
simplified administration of bankruptcy. On the other side, as human
behavior is involved, limited liability may create moral hazard.
- transferable shares: This permits the firm to conduct business
uninterruptedly as the identity of the owners changes (which in turn
facilitates acquisition of companies), thus avoiding the complications of
member withdrawal that are common among e.g. partnerships. The
company’s assets need not be transferred. Free tradability maximizes the
liquidity of shareholdings and the ability of shareholders to diversify their
investment. It also provides for maximal flexibility in raising capital. On the
flipside, free tradability makes it difficult to maintain negotiated
arrangements for sharing control and participating in management.
Therefore, fully transferable does not necessarily mean freely tradable, as
laws provide that the shares might be restricted to public markets. Rather
they might only be transferable with permission of current shareholders or
the corporation, or only transferable to limited groups of individuals.
- Delegated management; centralized management under a board structure;
or separation of management and ownership – Standard legal forms differ in
allocating authority to bind the firm, to exercise powers granted to firm by its
contracts and to direct the uses made of assets owned by the firm. In
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corporate law this is generally done by vesting principal authority in a board
of directors that is periodically elected by the firm’s shareholders, which
decides in all but the most fundamental decisions. The board usually has 4
basic features. The board (as monitoring and ratifying decisions as well as
hiring officers) is (i) separate from the operational managers (initiation and
execution) of the corporation. The board is (ii) elected – at least a
substantial part – by the firm’s shareholders who are seen as bearing the
costs and benefits of the decisions. Thirdly, the board is formally (iii)
distinct from the shareholders of the firm. Fourth, the board normally has
(iv) multiple members.
- investor ownership; shared ownership by contributors of capital arranged
by law– this generally entails both the right to control the firm (usually by
way of voting in the election of directors and voting to approve major
transactions) and the right to receive the firm’s residual earnings or profits
(usually in proportion to the amount of capital contributed to the firm). This
form of ownership gives a clear signal to all interested parties of what type of
firm they are dealing with. Also, an advantage could be that investors are
very difficult to protect contractually and that investors have homogeneous
interests among themselves hence reducing chances of costly conflict.
The corporate form is less flexible since it all depends on the capital brought
into the firm, and not on e.g. labour (compare partnership). The latest trend
however is that the corporate form by law and by contractual arrangements
can become more and more flexible.
The law sometimes appoints others than owners to participation in the firm,
for example by codetermination of employees.
Hybrid forms such as LLP, trusts and closed corporations are existent across
different member states. Corporations are continuously influenced by other
bodies of law e.g. Konzernrecht, codetermination rules, insolvency and tax law,
securities laws (including disclosure obligations) and self regulation.
The relationship between the participants in a company is mostly contractual
and based primarily on the articles of association. The defining elements of the
corporate form (except for legal personality) could in theory be established by
contract. This leaves us with the question on the necessity of law, which
depends mostly on the question on mandatory versus default rules. Default rules
provide convenient standard forms that cut company costs, encourage revelation
of information and facilitates choice of the most efficient rules. Furthermore, it
supplements in cases where (over time) the articles of association contract no
longer foresees certain complex situations or becomes obsolete, for example
when the company has become much larger. The court is more flexible in
interpreting standard charters which are common and widely used, thus creating
precedence.
Abovementioned options in corporate forms, the distinction between default and
mandatory rules and the differences in different jurisdictions may lead to the
question of choice of jurisdictions in which to incorporate.
Place of incorporation rule: This rule, which applies for example in the
US, permits a business corporation to be incorporated under the law of
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any individual state, regardless of where the firm’s principle place of
business, or other assets and activities are located. Mandatory rules
among states may then be a signal of enhancing corporate form (and
cutting costs).
Real seat doctrine: Firms under this rule are formally required to
incorporate under the law of the state where the firm had its principal
place of business.
The choice of jurisdiction may very well lead to regulatory competition, as
jurisdictions might take the opportunity to induce firms to incorporate under its
law. There’s debate on whether this phenomenon leads to a ‘race to the bottom’
(as jurisdictions that strip away most of their protection rules for constituencies
who do not control the reincorporation decision) or a ‘race to the top’ (due to
capital market price’s effect on shareholders welfare, the state that protects the
rights of shareholders and other corporate constituencies effectively will win).
By making its legal form widely available, corporate law enables entrepreneurs
to transact easily through the medium of the corporate entity, and thus lower the
cost of conducting business. Secondly, corporate law has an important function
of reducing the ongoing costs of organizing business through the corporate form.
It does so by responding to and consequently reducing the value-reducing forms
of three principal sources of opportunism: Conflicts between managers and
shareholders, conflicts among shareholders and conflicts between shareholders
and the corporation’s other constituencies (including creditors and employees).
These are also called agency problems: The welfare of one party ‘the principal’
depends upon the actions taken by another party ‘the agent’.
There are three generic types of agency problems:
i. Conflicts between the owners (principals) and managers (agents), in
which the managers need to be responsive to the owners’ interests
rather than pursuing their own interests.
ii. Conflicts between the minority shareholders (principals) and the
majority shareholders (agents), in which the latter can control
decisions that affect all. Similar problems may occur when minority
shareholders have a veto, or when there’s a distinction between
normal and preferred shareholders or senior/junior creditors in
bankruptcy (effectively becoming the owners).
iii. Conflicts between third parties such as creditors, employees and
customers (principals) and the firm itself (agent), in which the firm
may have the incentive to behave opportunistically.
In all situations, principals need to engage in costly monitoring of the agent. The
law plays an important role in reducing agency costs by a variety of strategies,
which depend on the ability to coordinate between principals. If coordination is
difficult, a top-bottom approach of regulation is more suitable than governance,
since it’ll be harder for principals to monitor and decide on whether action is
needed.
Regulatory strategies dictate substantive terms that govern the content of the
principal-agent relationship, tending to constrain the agent’s behavior directly.
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- Agent constraints: Rules for specific behavior (ex ante) for the protection of
creditors and public investors, such as minimum capital or dividend
restrictions, and standards (ex post determination), mostly focusing on
internal affairs, that command agents not to make decisions that would harm
the interest of their principals. Rules may be mechanically enforced whereas
standards require some sort of adjudicators (e.g. courts).
- Affiliation terms: These terms arrange for the affiliation of a principal with
his agent. The law may be formed by way of terms of entry (ex ante),
requiring obligations to the agent (e.g. disclosure in public capital markets)
before contracting with the principal. It may also entail exit opportunities (ex
post) for principles, divided in the right to withdrawal (e.g. when dissenting
from a merger) and the right of transfer
Governance strategies seek to facilitate the principals’ control over their
agent’s behavior.
- Appointment rights: The power to select (ex ante) and remove (ex post)
directors is a key element in controlling the enterprise.
- Decision rights: These rights provide that a principal is allowed to intervene
in the firm’s management by granting principals the power to initiate (ex
ante) or ratify (ex post) management decisions.
- Agent incentives: Incentives can be divided into reward strategies (ex post)
which reward agents for successfully advancing the interest of their
principals, formed by either a sharing rule (agent’s monetary returns are
directly tied to those of the principal) or a pay-for-performance regime
according to the agent’s success. The agent incentive scheme can be
discouraged by law. Secondly, an agent incentive can come by way of
trusteeship strategies (ex ante) which focus not on monetary incentives but
other incentives such as reputation or conscience (e.g. independent directors,
auditors, judge-commissionaires etc.).
Each strategy aims for compliance and depends on the existence of legal
institutions such as courts and regulators to secure enforcement. Governance
strategies depend mostly in the principals ability to coordinate and act at low
cost, requiring less sophistication and information on the part of courts than is
required to enforce agent’s compliance directly through regulatory strategies.
This is done by a) public enforcement – ex ante rights of approval and ex post
law suits – by organs of the state, b) private enforcement by formal and informal
sanctions (mostly ex post) and c) gatekeeper control (mostly ex ante) in
situations that require specific practices to accomplish a corporate transaction
(e.g. notaries, accountants and lawyers).
Disclosure plays a fundamental role in controlling corporate agency costs. Such
duties can consist of a prospectus, periodic financial disclosure or ad hoc
disclosure (e.g. to determine entry and exit). In regulatory strategies disclosure
helps to reveal the existence of challengeable transactions in court. In
governance strategies disclosure helps in a complementary way, to assess
intervention tactics and improve principal’s decisions. Finally disclosure ties
reputations of trustees to it’s duty to disclose.
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Week 2 – Harmonization, new developments
Creating an internal market in the EU
One of the foundations of the EU is the economic desire to have an internal
market (art. 26 TFEU). Optimizing a wealth generation under one large market
is a shared objective of all member states, regardless of social foundation and tax
systems. The internal market would benefit all member states and citizens. The
internal market includes the free movement of goods, service, employment and
investor’s capital, as well as a single currency (Euro).
National company laws may create barriers to the abovementioned freedoms,
therefore affecting the internal market, for example by way of making it difficult
to do business in a country. Company law generally tries to achieve the same
economic objectives, such as incorporating a business, basic rules on the
organization of the company (shareholders – board) and protection of
stakeholders such as creditors or employees. The firm may also reorganize,
merge or split, which can be financed by equity financing.
Although the basic principles are the same, company laws are not the same in
member states because of differences in politics, culture, social and legal
traditions. The shape of a jurisdictions corporate law is influenced by many
different forces, such as the general nature – for example hedge funds, banks,
pension funds – and the number – widely dispersed or controlling shareholder –
of corporate shareholders. These patterns can create ways in which certain
corporate players, such as directors, can obtain for large autonomy
(“distributional effect”). Consequently, this leads to reform of the share
ownership rebalancing the level playing field by imposing disclosure duties
(“efficiency effect”).
Due to these differences, company laws are not the same even though the basic
principles apply. The EU stepped in to remove certain local rules and
requirements of different member states to harmonize and facilitate cross
border business.
The EU Company law directives
For decades the EC has wanted to harmonize key areas in company law as a
result of the freedom of establishment. The diversity in company laws in
different member states was seen as frustrating the functioning of the internal
market, distorting competition and leading to a race to the bottom.
The grounds for harmonization of EU Company law is found in art. 50 TFEU:
The Commission, Council and Parliament are instructed to “coordinating to the
necessary extent the safeguards which, for the protection of the interests of
members [shareholders] and others [stakeholders], are required by Member States
of companies with a view to making such safeguards equivalent throughout the
Union” (art. 50 TFEU) Essentially this states that all stakeholders need to be
protected when conducting business in other member states in order to create
an internal market.
Directives in general are instruments that require a member state to adopt
national legislation that is in line with the provisions of the EU. There are two
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