Business and Company Law (Malberti, Papadopoulos) - CEILS, Appunti di Diritto Commerciale

Scarica Business and Company Law (Malberti, Papadopoulos) - CEILS e più Appunti in PDF di Diritto Commerciale solo su Docsity! 1 Business and Company Law (C. Malberti - T. Papadopoulos) 1 Introduction ........................................................................................................................ 2 1.1 Sources of Law ............................................................................................................ 4 1.2 Classification legal entities.......................................................................................... 7 2 Freedom of Establishment ................................................................................................ 14 2.2 Companies and Liability Issues in EU Company Law ............................................. 24 3 Mergers and acquisitions .................................................................................................. 33 3.1 Types of Mergers ...................................................................................................... 35 3.2 Reasons for mergers and acquisitions ....................................................................... 35 3.3 Procedure ................................................................................................................... 37 3.4 Private equity and venture capital ............................................................................. 38 3.5 Takeover Bids ........................................................................................................... 41 3.6 Legal Analysis on Mergers and Acquisitions ........................................................... 55 3.7 Cross-border Mergers ................................................................................................ 59 3.8 Cross-border demergers and divisions ...................................................................... 62 4 First and Eleventh Company Law Directives ................................................................... 64 4.1 1st Company Law Directive....................................................................................... 64 4.2 11th Company Law Directive .................................................................................... 67 5 2nd Company Law Directive ............................................................................................. 69 5.1 Capital Reductions .................................................................................................... 84 5.2 Formation and Financing – Management and Control.............................................. 89 2 1 INTRODUCTION General overview of the European Union. The integration process started in the 50s: - European Coal and Steel Community in 1951 - EEC with the Treaty of Rome in 1958. - European Atomic Energy Community. - The Single European Act (1986) opened the community to more members, which strengthened the operations. - Maastricht Treaty in 1992, foundation of EU - Nice Treaty (2000) - Lisbon Treaty (2007). The goals of the European Union are again (1) to establish a common (then internal) market; (2) free movement of goods, persons, services and capital. Companies are considered as per- sons, and to go around they enjoy the secondary or primary right of establishment; the sec- ondary right of establishment is a right to open an office in another member state, as a second establishment, whilst primary establishment means moving the company to another EU coun- try. Primary sources of EU Law are treaties and convetions: - Art.49 TFEU1 right of establishment - Art.54 TFEU2 definition of company. Legal person incorporated according to the laws of one of the MSs that has its legal office or centre of business within the Union. How to understand which is the applicable law, e.g. if the registered office is in Italy whilst the offices are set in Austria (Italy considers a company as such if it has a registered office there, Austria considers a company as such if it carries out activities in the country). So first, it would be an Italian company as Italy was the first one to recog- nise it and would be enjoying the freedom of establishment in the European Union, thus Austria cannot impose its legislation. If however the company was an English one, it would not enjoy the freedom of establishment, therefore Austria can enforce its legislation, e.g., capital requirements, … 1 Art.49 TFEU: Within the framework of the provisions set out below, restrictions on the freedom of establishment of nationals of a Member State in the territory of another Member State shall be prohibited. Such prohibition shall also apply to restrictions on the setting-up of agencies, branches or subsidiaries by nationals of any Member State established in the territory of any Member State. Freedom of establishment shall include the right to take up and pursue activities as self-employed persons and to set up and manage undertakings, in particular companies or firms within the meaning of the second paragraph of Article 54, under the conditions laid down for its own nationals by the law of the country where such establishment is effected, subject to the provisions of the Chapter relating to capital. 2 Art.54 TFEU: Companies or firms formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the Union shall, for the purposes of this Chapter, be treated in the same way as natural persons who are nationals of Member States. ‘Companies or firms’ means companies or firms constituted under civil or commercial law, including cooperative societies, and other legal persons governed by public or private law, save for those which are non-profit-making. 5 pany, European cooperative, and European interest grouping, normally the companies rele- vant for company law are those governed by the national law of the MS. For this reason it's also important that the European harmonization of company law is reflected in national law. although a particular business organisation may carry out its activities across national bor- ders, it is governed by the national law of one country. It should be borne in mind that, unlike natural persons, companies are crea- tures of the law and, in the present state of EU law, creatures of national law. they exist only by virtue of the varying national legislation which determines their incorporation and functioning3 Famous quotation by decision in Daily Mail case, involving an English company willing to transfer to the Netherlands; essentially English authorities didn't want to give the company the right to transfer abroad. Question: do companies enjoy the right to transfer themselves to other MS of the EU? Fol- lowing Directive 2121/19 this is now possible; but in the 80s the CJEU claimed it wasn't pos- sible, because companies are creatures of national law, so the UK company can exist only as long as the English legal system recognizes the existence of that company. If it doesn’t rec- ognize the existence of a company based abroad, then that company doesn’t exist anymore. So a company cannot transfer abroad if its national law doesn’t recognize its right to transfer. At that time it was decided that the Daily mail couldn’t transfer abroad because it would have been in violation of UK law and therefore it wouldn’t have been considered anymore an Eng- lish company. From this idea, inferred that companies didn't enjoy freedom of establishment as much as natural persons did, because companies are basically just an invention of the law of each MS. Legal persons only exist as long as you have a national law recognizing the ex- istence of that legal person. E.g., a German company wishes to transfer to the Netherlands. What happens to the legal personality of the company when the company doesn’t conform itself to the rules provided by national law. So if the vast majority of companies are in the end national companies we ought to ask ourselves if EU entities (for example the SE or the EEIG) are an exception to this rule, and to some extent they are: but these European legal entities are not just subject to EU law, because the regulations adopted by the EU that govern their func- tioning, make reference frequently to the national law of the place where the company is lo- cated, and more importantly a legal entity comes into existence in the vast majority of EU MS only when its registered in a national business register (authority recording all existing companies). Essentially, one rule that’s in force almost everywhere in the EU (but in the Netherlands and in Luxembourg) is that companies exist as long as they’re enrolled in the business register. Before the enrolment the company doesn’t exist. Problem: for European le- gal entities there is no European business register. European legal entities are still registered in national business registers; so in the end the legal personality also of European legal enti- ties depends upon the national rules governing the business register. So the EU has created, and continues to create, business organisation forms that are primarily governed by EU law, with respect to their form and function. But also European legal entities (SE, EEIG, …), even if more European in nature, are closely related to the national law of the place where they are located. 3 K v. The Treasury and Commissioners of Inland Revenue, ex parte Daily Mail and General Trust plc (1989) I All E.R., 328 (hereinafter “Daily Mail”) 6 The strategies the EU tries to promote to make company law adverse: (1) Harmonization strategy through directives, so that a business can operate freely in the internal market relying on legal forms that exist in the different states. need to lev- el the playing field, (2) Unification, the creation of unified legal entities is more recent (discussion started in the 60s, but the European company was approved only in 2001, and the European co- operative just in 2003). They tried to create another unified European legal entity, the European private company, the Societa Privata Europea, but it was never adopted, bc in order to adopt an act for a European legal entity they need to have unanimous agreement of MS. They frequently try to promote these European legal entities: for no-profit associations etc. The EU Commission is not so happy with these proposals, because it is extremely difficult to get a unanimous agreement for the statute. They very often fail. There is a partial unification because regulations are still not clear enough. (3) More recently the regulatory competition strategy. a. Min capital requirement b. Multiple voting shares Regulatory competition. In recent times (20 y ago) dating back to the Centros case4 (which immediately followed the Daily Mail case). The idea behind this approach is to say that we don't need to actively harmonize EU law; we don't need to create a unified European company law, but to let companies free to operate easily on a cross border basis and leave MS free to design their own company law, so that if specific rules and approaches will prove to be particularly efficient and valuable in a MS they will also be used by other MS. The ar- chetypal example of the regulatory competition strategy may be found in the minimum capi- tal requirement for private limited liability companies, i.e., to start a company minimum in- vestment. For public limited liability companies (PBLL) minimum amount is 25k euros (some MS have even more; different amounts), but there is not harmonization on minimum capital requirement for private limited liability companies (PRLL). Of course there are quite different approaches (in Italy 10k, in Germany 25k… but in some MS no need for this much money, e.g., UK and Ireland: w/ 1 unit of local currency you can create a legal entity). many small entrepreneurs started thinking why pay 25k euros when I can pay 1? At the beginning of the EU company law, in accordance with the Daily Mail case it was not really clear this was possible, as there was not this mutual recognition of companies yet; after the Centros case it became clear it was actually possible; started seeing many English limited companies incorporated by Germans with these companies operating exclusively in Germany. German government was not happy with this: many companies created in UK, less in Germany; strange structures coming from the UK that were not so compatible with German ones. So, Germany created a new legal entity, the UG (Unternehmensgesellschaft) which essentially is a private limited liability company with a minimum capital of 1€ but then after the establish- ment of the legal entity you need to respect some rules that are different from the rules that would be applicable in case of a GMBH, a German private company. 4 Centros Ltd v Erhvervs- og Selskabsstyrelsen (C-212/97) 7 By allowing companies to move around the EU you put pressure on the national legislative. Nowadays the minimum capital requirement for the creation of a PRLL is almost everywhere 1€, and this is the result of this regulatory competition. Because in the UK the minimum capi- tal requirement was 1€ and many persons had started created companies in the UK this put pressure on other MS to compete with the English approach and to lower the minimum capi- tal requirement. Another effect of the regulatory competition strategy is the multiple voting shares. in Nether- lands and northern countries multiple voting shares, not used in other MS of the EU. General principle: one vote for each share you own. Need to have proportionality btw capital invested and the votes in the general meeting. In the Netherlands 1 share 10 votes. Stellantis: Dutch company now; change in nationality because in Italy we didn’t have multiple voting shares (now we do), something that is allowed on the other hand in Netherlands. Now Italy has changed the law to allow them, by putting pressure on other MS by adopting some legal form abroad you push MS that are more reluctant to reform to adopt a common approach. Howev- er, the problem with this approach is that while harmonization tries to achieve a homogenous legal framework, and unification achieves by definition a homogeneous legal framework, the regulatory competition achieves an equal framework but only on the substance and not on le- gal terms → even if you know you can make an PRLL with 1€ rules in Germany are different from France’s. This regulatory competition does not achieve a real harmonization in the merit; doesn't make legal systems more similar to each other, and to some extent even complicates things. 1.2 CLASSIFICATION LEGAL ENTITIES Business entities can be classified according to different factors. Carrying out of business activities. Activities may be conducted by: - By sole proprietor: o A natural person o No distinction between personal and business assets o Bears all entrepreneurial risk Company law is concerned with companies, but business activities can also be carried out by natural persons alone. The sole proprietor is essentially a natural person; you have no distinc- tion/separation btw assets that the person uses to carry out the business and personal assets. The person may also create a single member company, but then the sole proprietor will create another legal entity that’s separate from him. The sole proprietor personally faces all losses, and personal assets will be at risk. But also inefficient way of carrying out business activities from a general POV, bc creditors of the business activity will have to control all activities you carry out. For this reason normally said that the creation of a legal entity is more in the interest of creditors than the entrepreneur’s, bc by insulating some assets devoted just to carry out business activities, creditors may know whether your activity is worth crediting or not. - By a business organisation (or company) o Two or more natural or legal persons o Incorporated or unincorporated (incorporation by registration or by notarial in- strument) 10 nerships are personal companies). Each country, however, does allow certain specific forms under which joint economic activities may be carried out, and these are generally divided into partnerships and companies. The essential, but not universal, distinction between these two generic forms is that partnerships are based on individual agreements between the partners, whereas companies are organisations that exist independently of its members and depend on capital resources. Some jurisdictions introduced private liability companies quite recently or not at all. In EU company law capital is the measure of the rights, whilst in personal compa- nies what matters is the person, e.g., count votes by persons and not by economical status – how much money you put in the company. Distinction on governing law (civil or commercial law). Companies based on civil code v companies with commercial nature. In common law countries there is no distinction between civil and commercial codes. Derives from old medieval times. In continental Europe the influence of Roman law which didn’t make a distinction between civil and commercial companies. As there are some legal entities that cannot be qualified as merchants, not created for carrying out economic activities in a strict sense, e.g., societees civiles French companies that manage buildings, not with the purpose of making money but managing apartments. In many MS we have difference btw what you find in civil code and what you find in commer- cial code. And companies are ruled by both rules in the civil and the commercial codes. In some countries nowadays we have a unification of civil and commercial codes (Italy, Nether- lands…). In common law countries there was never this distinction btw civil and commercial law; traditionally commercial code was basically the law of merchants, kind of special law used just by entrepreneurs and merchants in carrying out their business activities, which re- mained in force in many countries such as Germany and France. Even in civil law countries where you have a unification of civil and commercial law you still have companies that don’t carry out commercial activities and companies that can. Those that can’t carry out business activities are nor very useful for business purposes; however, they can be used as vehicles for possessing shares of other companies, like societe civile or società semplice, but they’re not commercial entities themselves, they’re more addressed towards shareholding. Legal personality (full, modified, or non-existent). There are some companies with full legal personality, others that do not have legal personality. Legal personality cannot be really categorised, need to know the legislation in each legal system. usually in a public lia- bility, the company enjoys full legal personality, personal companies exist only to the person of their shareholders. But it very much depends on the legislation. E.g., there is a long debate on Italian partnership, as they are not fully legal person, but have legal subjectivity. Tension between full legal personality and no personality at all. After the regulatory competition some MS started offering new types of legal entities for startuppers or small businesses. In addition to the private companies now we have sth like su- per private companies (startups). There is a trend, but rules are different from MS to MS, as they’re the result of regulatory competition, which doesn’t lead to real harmonization. Essen- tial features of these legal entities: low or non-existent capital requirements. Fewer mandato- ry requirements; standardisation; there is this debate in the EU today regarding the possibility for shareholders to incorporate a legal entity or creating an entity by using templates → so by urding modern bylaws, so statutes, governing instruments of companies. These templates are nowadays mandatory, because the EU recently approved a directive, Directive 1151, which says that all MS should provide for a template for the incorporation of a PRLL company. 11 Typical types of companies. List of business forms, normally there cannot be an atypical legal structure. (a) general partnerships, (b) limited partnership (c) private companies (d) public or stock companies (e) hybrids. Partnerships in general can be civil or commercial; general or limited. In this type what mat- ters is the person and not the contribution in pecuniary terms by the members5. In partner- ships the members do not enjoy limited liability, i.e., they are responsible in the obligations taken by the company. Normally, unlimited liability comes only after the creditor tries to re- ceive the credit from the partnership itself – it is a form of second liability, if the partnership cannot pay, the members do. That is why there is the debate on legal personality/subjectivity. Partnership laws provide default rules, that can be ruled out by specific arrangements, whilst the rules in public liability rules tend to be mandatory. - Personal relationship based on agreement - Typically unlimited liability for general partners - Partnership law provides default rules in absence of specific agreements o Decision making mechanisms o Ability to bind other parties General partnership, archetype of partnership agreement – equal voting rights, same contribution to the activities, no majority principle but for management decisions. no clear distinction between shareholders and directors (investors and managers), as they are the same. Separate representation or joint representation depends on the legal system. partner- ships are governed by default rules, but with exceptions e.g., rule on unlimited liability is mandatory. As they are personal legal entities, there is the possibility to expel a partner or withdraw from the partnership (e.g., bankruptcy). Decisions are taken according to the prin- ciple “one person, one vote” → in partnerships decisions are not taken according to the amount of capital invested in the company unless this is clearly stated in the partnership agreement. Normally each partner has the right to manage the partnership. And this also in countries like Germany where normally the management of legal entities is always carried out jointly. A distinguishing feature of German company law is that the board of directors should act jointly. Each partner can bind the company, each partner can take decisions → principle that is also applicable in Germany. This universal principle comes from the MA. This partnership can be used for commercial activities, but you can also have civil partner- ships for the carrying out of non-commercial activities; these are more vehicles that are used to loan assets. - Belgium: vennootschap onder firma (VOF) and société en nom collectif (SNC) - France: société en nom collectif (SNC) - Germany: Offene Handelsgesellschaft (OHG) - Luxembourg: société en nom collectif (SNC) - Netherlands: vennootschap onder firma (VOF) - Poland: spólka jawna (sp.j.) - Spain: sociedad regular colectiva (SC) - UK: general partnership (GP) 5 In public liability companies “shareholders” 12 Limited partnership. They can be considered as a sort of modified general partner- ship. There are two different classes of members, one made of members that are the same as the general partner in general partnerships and the other made of members who are just inves- tors. The general partners have unlimited liability and enjoy managerial rights, whilst the lim- ited partners are there just to invest some money and get a return, therefore have no manage- rial rights, doesn’t manage the company on a daily basis, has limited liability (loss is limited to the contribution). They are similar to the shareholders of a public company, they provide a contribution and if the business goes well they get some profits. Excessive management par- ticipation may lead to loss of limited liability, e.g., use of personal name for the company, ac- tive with third parties, … In many cases the position of the limited partners is abused, as what many persons do is appointed as general partner someone that doesn’t own any asset becom- ing the limited partner of the company and then manage the company as if he was the general partner, as if the limited partner was the general partner. Obviously, this is an abuse on part of the limited partners who in reality couldn’t act as general partners. Also in Germany we have this structure, where there is this limited partnership where the unlimited partner is a private limited liability company, so the famous GMBH und KG; this structure is interesting bc in practice you have a natural person who’s the limited partner, so no facing any liability; the general partner is a company with limited liability owned by the same person that is the lim- ited partner. And by having this structure the limited partner will not incur in any type of lia- bility, bc the general partner is not per se a natural person but a GMBH; the limited partner is a natural person, and he achieves the goal of having limited liability even by having a part- nership. This type of structure is common in Germany and not any other MS of the EU. There are some tax advantages in structuring your business in this way → discussion in Italy about adopting such a structure too, prohibited until 2003. In the end no one really adopted it prob- ably bc it was less advantageous than having a simple limited liability company. • Belgium: gewone commanditaire vennootschap (Comm. V) and société en commandite simple (SCS) • France: société en commandite simple (SCS) • Germany: Kommanditgesellschaft (KG) • Luxembourg: société en commandite simple (SCS) • Netherlands: commanditaire vennootschap (CV) and commanditaire ven- nootschap rechtspersoonlijkheid (CVR) • Poland: spólka komandytowa (sp.k) • Spain: sociedad en comandita (SEC) • UK: limited partnership (LP) Companies distinguish between public or private, or hybrids. Private companies. Good for SMEs (small and medium-sized enterprises); they’re almost everywhere incorporated and have full legal personality. Today the capital require- ments are quite low (of course this depends on each MS as e.g., the new legal form for SMEs may have been introduced as an alternative legal entity like the UG for Germany). The latter goes to the advantage of contractual creditor (that can contract out), namely banks to the det- riment of tort creditors. They normally have few shareholders, but in some MS there are even limitations to the number of shareholders bc they traditionally can’t go public. But in some MS there are even limitations about the number of shareholders for these companies. in some 15 tural societies). Private and public companies are included and etc. with the only exclusion of non-profit companies. The treaty provisions concern the application of the right of establishment to companies that are profit-making. Articles 49(2) and 54(1) TFEU provide that companies established in the EU may create sec- ondary establishments in other Member States and thus set up agencies, branches or subsidi- aries there. There is a considerable body of decisions of the ECJ in which the non- discriminatory exercise of this right of secondary establishment has been emphasized and elaborated. Discriminatory restrictions are those that discriminate against foreign companies, mainly because of the different nationality, e.g., a domestic provision that puts in a better po- sition domestic companies. Non-discriminatory provisions are those restrictions that are in- distinctly applicable to nationals and foreigners, that in practice treat more badly foreign companies; they may also breach Art.49 by obstructing or making less attractive the exercise of this fundamental freedom. Justification for restrictions: - Discriminatory restrictions → Art.51 exercise of official authority; Art.52 public secu- rity - Non-discriminatory restrictions → four requirements for justification (ref. Gebhard and Centros): national measures liable to hinder the exercise of fundamental freedoms granted by the treaty must be o Non-discriminatory o Justified by imperative requirements in the general interest o Suitable for obtaining the objective they pursue o Not beyond necessity Freedom of establishment applies only to cross-border situations. We are talking about a company that expands its activity to other MSs, either by branch, agency or subsidiary. We are not talking about domestic situations. In the cross-border mobility by companies it is important to analyse the position of the CJEU. Positive integration is achieved via directives, whilst negative integration is achieved by the EU court, by declaring some provisions incompatible with EU law, with a series of powerful and ground breaking rulings. Although negative integration suffers from a number of weak- nesses (e.g., reactive nature and the risks for legal certainty), it serves an important function in driving cross-border mobility for companies forward where political difficulties obstruct the legislative program. of course less efficient than the former, as linked to peculiar cases. What’s the importance of freedom of establishment of companies? The freedom to establish guarantee is of particular importance for companies as it provides the basis, in the absence of harmonizing secondary legislation, for companies to establish subsidiaries and branches across the EU. What does freedom of establishment of companies provide? Article 49 TFEU guarantee applies to companies. 1) It expressly includes the right to set up and manage companies and requires the abolition of restrictions on the setting up of agencies, branches, and subsidiaries by nationals of any Member State in the territory of another Mem- ber State. 2) Under Article 54 TFEU the Treaty rules apply equally to legal persons. Article 16 54 TFEU provides that companies and firms formed in accordance with the law of a Member State, and having a recognized office or principal place of business in the EU, are to be treat- ed the same way as natural persons. Freedom of establishment of companies is related to private international law. difficulties de- rive from diverging approaches across the EU to the notion of, and consequences of, incorpo- ration and the MS of a company’s seat. The rules of legal recognition of companies can differ among the MSs. There are two theories towards the recognition of a company as having valid legal personality. Company law gives legal personality to a company, thus creates its exist- ence, there are two main theories that recognise a company as such: (1) real seat theory and (2) incorporation theory. National approaches differ in the recognition of a company, accord- ing to which its legal personality and the national rules concerning to it change. 1. Real seat theory requires that a company be subject to the laws of the country in which its actual centre of administration is situated. Only one state should have the authority to regulate a corporation’s internal affairs and that this authority belongs to the state in which the corporation has its real seat (siege reel). Hence, this theory determines the applicable company law by reference to the country in which the company has its actual real seat (head office). The connecting factor is the actual corporate seat. The advantages are that most of the company’s shareholders, directors, officers and holders of debt securities will reside in the country whare the actual head office is situated. Accordingly, shareholders, customers, and creditors will be better protected if the company is subject to the law of the country in which its headquarters are located. The criticism is that this theory is a bit outdates, as the infor- mation technology and the cross-border business operations have changed and the directors don’t necessary have to be in the same place, as meetings can happen online. Moreover, ac- cording to this theory it is not possible to separate the central administration from the regis- tered office. 2. Incorporation theory affirms that a company receives recognition if it is incorporated in any of the MSs. The crucial point is not the actual centre of administration, but the place of incorporation and registration, i.e., where all formalities took place. the existence of a com- pany, as well as its subsequent dissolution, are governed by the law of the State of incorpora- tion. The connecting factor is the country of incorporation, which is easy to identify both by looking at the registry and at the company’s documents. It is easy to determine the jurisdic- tion to which a company is subject, and it is argued that this theory is the most in tune with the requirements of freedom of establishment, as it gives companies the freedom to select the law that will apply to them. The only criticism is that there is a danger of forum shopping, i.e., the company chooses the most convenient jurisdiction to its needs. Segers v Bestuur van de Bedrijfsvereniging voor Bank (Case C-79/85). Primary estab- lishment. The Court found in that case that where a company does not conduct business in the Member State of its registration or primary establishment but operates in practice through branches, or other forms of secondary establishment, in other Member States, it will still be seen as having its primary establishment in the Member State of registration. The core re- quirement for activating the Article 49 TFEU rights conferred on companies is that the host Member State rule in question amounts to a ‘restriction’, whether discriminatory or otherwise restrictive, on the freedom to establish. This restriction may then be justified by the Member 17 State. But this first step demands that a ‘restriction’ is found before Article 49 TFEU acti- vates. The nature of a ‘restriction’ on the freedom to establish has been addressed in the con- text of companies in a series of Court rulings. Most case law in this field concerns companies with, or setting up, secondary establishments in other Member States which seek to challenge illegal host Member State ‘restrictions’ on the freedom to establish these secondary establishments. Transfers of primary establishments are rare and forbidden by some Member States. A primary establishment could, however, be achieved through the acquisition of a shareholding in a company established in another Member State. The major current controversy concerns restrictions on registering a branch or other second- ary establishment in a host Member State where it is clear that the branch structure is being used to evade the full company formation and incorporation rules of the host Member States and, to all intents and purposes, the company operates from the host Member State. Nonethe- less, there are numerous examples from the Court’s case law of restrictions in other forms. There may be restrictions on the freedom of establishment: - Taxation - Social security - Forms of establishment - Benefits - Registration and formalities - Primary establishment The host MS may impose a tax reduction only to branches or agencies established in France by French companies. In Commission v France a French law indeed discriminated in tax law against branches or agencies of foreign companies. In Marks and Spencer a UK tax rule al- lowed companies in a group to offset profit and losses intra-group. Offsetting was not permit- ted, however, where losses were incurred by group subsidiaries which did not have and estab- lishment in the UK. This rule was not allowing Marks and Spencer to exercise the freedom of establishment, as it was available in the UK but not outside the UK. In Sergers letterbox company (a company that only exists in a specific jurisdiction that does not perform any real specific activity in the country). The social security system in Belgium excluded the company director from its national sickness insurance scheme because the company was formed in ac- cordance with the law of another MS where it maintained its registered office and did not car- ry on its business in that other State (indirect discrimination). Data processing ruling (Commission v Italy). Italian law required all security dealers to be established in the form of SIM (Italian limited liability company) with a registered office in Italy. But this requirement prevented dealers from using secondary establishments, such as branches or agencies, and imposed the additional cost of setting up a subsidiary in Italy. SEVIC ruling. The Court addressed cross-border mobility through the merger by acquisition device and found that a failure by Germany to register a cross-border merger breached the freedom of establishment. The Court emphasized that Article 49 TFEU and Article 54 TFEU included in particular the formation and management of companies under the conditions set out in law by the State of establishment for its own companies. The right of establishment al- 20 Uberseering, as a company incorporated in the Netherlands, but administered in Germany, did not have legal capacity in Germany as it was not incorporated formally there although its main operations were carried out in Germany. Uberseering was required to reincorporate in Germany in order to have legal capacity, and, in particular, to be able to sue, in Germany. In effect, Germany did not recognize the personality of the company in the Netherlands Ruling. The Court ruled that this amounted to a denial of legal capacity and was, in practice, equivalent to a requirement to reincorporate = this was a restriction on the freedom to estab- lish. The Court found that where a company was validly formed in accordance with the laws of a Member State where it had its registered office, and was deemed, under the laws of the second/host Member State, to have moved its centre of administration to that second Member State, that second Member State could not deny the company legal capacity and the ability to bring legal proceedings ECJ underlines the fact that national authorities cannot deny the ex- istence of a company which was lawfully formed in another MSs so as long the company was legal under Dutch law its legal capacity had to be recognized Inspire Art. an attempt was made to justify the restrictions on the grounds of preven- tion of fraud, protection of creditors, the effectiveness of tax inspections, and the need to en- sure fairness in business dealings. These grounds were similarly rejected by the Court given that there was no evidence that the proportionality, effectiveness, and non-discrimination re- quirements were met. Factual background. The case concerned a UK company with its primary establish- ment/incorporation in the UK which sought registration as a branch in the Dutch commercial register, it carried out most of its business in the Netherlands. Dutch law imposed rules which required designation as a ‘formally foreign company’ on letter box companies which, as in this case, were deliberately formed under the law of one Member State (the UK) but carried out activities (almost) exclusively in the Netherlands (via a branch) and had no real connec- tion back to the Member State of incorporation. Once this formal designation was imposed, particular requirements applied covering, inter alia, disclosure as to company status, mini- mum capital, and directors’ liability. Ruling. The Court determined that these Dutch rules unjustifiably impeded the exercise of the freedom to establish. The mandatory application of the Dutch rules on minimum capital and directors’ liability to foreign companies, where they carried on their activities exclusive- ly, or almost exclusively, in the Netherlands, with the result that a branch was subject to cer- tain rules which applied in the Netherlands to the formation of a company, had the effect of impeding the freedom of establishment. It was immaterial for the freedom to establish that a company was incorporated in one Member State with a view to establishing in a second. In the absence of evidence of fraud, the reasons for incorporation were irrelevant. The fact that the parent establishment was formed for the purpose of circumventing company law in the Netherlands, and the fact that the company carried on its activities exclusively in the Nether- lands, did not deprive it of the right to rely on the Treaty freedom. It was not an abuse of EU rights to seek the benefit of a more favourable regime: abuse had to be established on a case- by-case basis Cartesio. The freedom of establishment permits cross-border conversions 21 Factual background. Cartesio was a company governed by Hungarian law and filed an ap- plication with the Hungarian authorities to the transfer of its seat to Italy and, in consequence, for amendment of the reference to its company seat in the commercial register. That applica- tion was rejected on the ground that the Hungarian law in force did not allow a company in- corporated in Hungary to transfer its seat abroad while continuing to be subject to Hungarian law as its personal law. According to the Hungarian authorities, such a transfer would re- quire, first, that the company cease to exist and then, that the company reincorporate itself in compliance with the law of the country where it wishes to establish its new seat. Cartesio had legal personality under Hungarian law but was interested in being subjected to Italian law, according to Hungary this could happen only if the company was liquidated and incorporated in Italy as a completely new company. Ruling. As EU law now stands, the freedom of establishment of companies is to be interpret- ed as not precluding legislation of a Member State under which a company incorporated un- der the law of that Member State may not transfer its seat to another Member State whilst re- taining its status as a company governed by the law of the Member State of incorporation. The situation where the seat of a company incorporated under the law of one Member State is transferred to another Member State with no change as regards the law which governs that company falls to be distinguished from the situation where a company governed by the law of one Member State moves to another Member State with an attendant change as regards the national law applicable, since in the latter situation the company is converted into a form of company which is governed by the law of the Member State to which it has moved Conversions of companies fall within the scope of the fundamental freedom of establishment. Although the legislation of the home Member State concerning the incorporation and wind- ing-up of companies is not affected by the freedom of establishment, the home Member State cannot prevent that company, by means of requirements that it wind up or be liquidated, from converting itself into a company governed by the law of the other Member State, to the extent that it is permitted under that law to do so. Such a barrier to the actual conversion of such a company, without prior winding-up or liquidation, into a company governed by the law of the Member State to which it wishes to relocate constitutes a restriction on the freedom of estab- lishment of the company concerned, which, unless it serves overriding requirements in the public interest, is prohibited under Art 49 TFEU (ex Art. 43 EC Treaty). Apart from corpo- rate conversions, other methods of corporate restructuring might benefit from the freedom of establishment as interpreted in Cartesio. For example, inbound and outbound mergers, divi- sions and merger into a company established in third (new) Member States could also consti- tute an exercise of the freedom of establishment that could not be restricted by the legislation of the home Member State on the incorporation and winding-up of companies. Quite often, conversions are constituent parts of mergers and divisions of companies. This analogy re- quires, of course, interruption of the effects of the law of the home Member State and sub- mission to the law of the host Member State. Once a restriction has been found, it may be maintained by the MS, as long as it is justified: a. By Art.53 TFEU b. Where the restriction is not discriminatory, under an objective justification, accepted by the Court (Gebhard). 22 In Sevic the Court noted the existence of imperative reasons in the public interest, however, it found that while EU harmonization was useful for facilitating cross-border mergers, the ex- istence of harmonization could not be made a precondition for the implementation of the freedom of establishment. In particular, any restrictive measure would have to meet propor- tionality requirements. Vale. Concerned a cross-border conversion and examined the position of the MS of destination of the conversion. Factual background. This case concerned a company incorporated and registered in Italy which decided to be removed from the Italian register and requested a Hungarian commercial court to register the company in the Hungarian commercial register. However, that applica- tion was rejected by the commercial court on the ground that a company which was incorpo- rated and registered in Italy could not transfer its seat to Hungary and could not be registered in the Hungarian commercial register as the predecessor in law of a Hungarian company. Hungarian law authorizes Hungarian companies to convert but does not allow a company governed by the law of another Member State to convert to a Hungarian company Ruling. Freedom of establishment of companies must be interpreted as precluding national legislation which enables companies established under national law to convert, but does not allow, in a general manner, companies governed by the law of another Member State to con- vert to companies governed by national law by incorporating such a company. The Court considers that, in so far as the national legislation at issue provides only for conversion of companies which already have their seat in the Member State concerned, that legislation treats companies differently according to whether the conversion is domestic or of a cross- border nature, which is likely to deter companies which have their seat in another Member State from exercising the freedom of establishment laid down by the Treaty and, therefore, amounts to a restriction of freedom of establishment. Polbud case. Polish company (real seat theory) that wanted to transfer its registered office to Luxemburg (incorporation theory) but to keep its management centre in Poland. Ac- cording to the ECJ this is possible under freedom of establishment. Articles 49 and 54 TFEU must be interpreted as meaning that freedom of establishment is applicable to the transfer of the registered office of a company formed in accordance with the law of one Member State to the territory of another Member State, for the purposes of its conversion, in accordance with the conditions imposed by the legislation of the other Member State, into a company incorpo- rated under the law of the latter Member State, when there is no change in the location of the real head office of that company. Moreover, they must be interpreted as precluding legisla- tion of a Member State which provides that the transfer of the registered office of a company incorporated under the law of one Member State to the territory of another Member State, for the purposes of its conversion into a company incorporated under the law of the latter Mem- ber State, in accordance with the conditions imposed by the legislation of that Member State, is subject to the liquidation of the first company. In conclusion, in 2019 the ECJ called legis- lators to adopt harmonization of this issue because negative integration was not able to solve the problem of corporate mobility. After many efforts the EU adopted directive 2019/2121 harmonizing cross border conversions (among other things) as a result of political compro- mise, deadline for implementation is summer 2023 25 European Company Law provides for rules preventing the company – once registered in the public register – to challenge the validity of certain obligations entered into before registra- tion, on the grounds that the company was not in a condition to conclude binding contracts or, otherwise, to engage in obligations, for not enjoying a legal personality yet. A problem is with pre-incorporation contract. In order to set up a company, a lawyer is to proceed with all the necessary formalities, pay a registration fee to the relevant authority, rent an office, etc. Who is going to bear the cost at the pre-incorporation phase, as the company has not yet been incorporated, so it doesn’t have legal personality yet. The first company law directive tried to solve this problem. Art.7 Directive 2017/11328 on general provisions and joint and several liability. The article is somewhat ambiguous, as considering that not all MSs accept the pre-company doctrine, this rule grants that in cases where the company does not acquire legal personality, creditors have an action vis-à-vis the natural persons acting in its name and on its behalf. For MSs accepting the pre-company doctrine, on the other hand, since the pre-company exists regardless of whether it acquires legal personality, joint and several liability of the natural persons shall be interpreted as an addition al guarantee. The same article, refers also to cases where the com- pany has acquired legal personality; in such cases it is not clear why the legal person shall be permitted not to assume the obligations arising from previous actions and why shall natural persons continue to bear joint and several liability. As ECL aims at protecting the interests of creditors, Art.7 should be interpreted as precluding MSs from permitting companies to not as- sume obligations entered into by directors. Also, as the joint and several liability of natural persons is a guarantee which creditors may withdraw, the article should be interpreted as re- quiring that in all cases where natural persons pay a company’s debt, the former shall have a right of recourse regardless of whether the company has assumed the obligation or not. The second company law directive considered that, despite the registration in the public reg- ister, some companies operating in certain business sectors, such as baking and insurance, may not commence business without authorisation of the relevant authority. For instance, one may question what happens if a company whose object is to carry on banking activity com- mences the business in absence of the authorisation of the banking authority. The significance of pre-incorporation contracts is fundamental, as although not mandatory, they are needed to solve some practical issues. Art.5 Directive 2017/11329 on authorisation to commence business. It concerns specific ac- tivities that need a licence to be performed (e.g., insurance, banking, …) In general, once the company has registered with the public register, obligations entered into by the company, and on its behalf by the persons who, as an organ of the company, are au- 8 Art.7 Directive 2017/1132: The coordination measures prescribed by this Section shall apply to the laws, regu- lations and administrative provisions of the MSs relating to the types of company listed in Annex II. If, before a company being formed has acquired legal personality, action has been carried out in its name and the company does not assume the obligations arising from such action, the persons who acted shall without limit, be jointly and severally liable therefore, unless otherwise agreed. 9 Art.5 Directive 2017/1132: 1. Where the laws of a Member State prescribe that a company may not commence business without authorization, they shall also make provision for responsibility for liabilities incurred by or on behalf of the company during the period before such authorization is granted or refused 2. Paragraph 1 shall not apply to liabilities under contracts concluded by the company conditionally upon being granted authorization to commence business 26 thorised to represent it, shall be binding for the company. Registration, indeed, shall consti- tute a bar to any irregularity in appointment of these representatives being relied upon as against third parties unless the company proves that such third parties had knowledge of it (ref. Art.8). What if the director of the company is not properly elected (by general meeting of shareholders) but their name is included in the registry and performs as the director; some- one could argue that the contracts are not valid as the representative is not appointed proper- ly, but despite any deficiencies in their appointment as long as the director is included in the registry, the contracts are valid. This is to protect creditors. Art.8 Directive 2017/113210 on effects of disclosure with respect to third parties. This provi- sion only protects creditors in good faith (that do not know the person is not properly ap- pointed and cannot bind the company). Some Courts of the EU and outside the EU adopt the ultra-vires doctrine, by which acts attempted by a company that are beyond the scope of pow- ers granted by the company’s objects clause (that specify the purpose of the company), in- cluded in the statutes or similar founding documents, are void or voidable. ECL however, re- jects the ultra vires doctrine. Art.9 Directive 2017/113211 on acts of the organs of a company and its representation. 2.2.2 Nullity of companies As companies are created based on a legal process starting from an act of private persons, generally a contract for the constitution of a company, what are the consequences in case these acts are deemed invalid? Does it lead to the nullity of the company itself or not? Ac- cording to ECL, it does whilst it (a) limits the cases in which a declaration of nullity may oc- cur and (b) determines which effects this declaration shall entail. Art.11 Directive 2017/113212 on conditions for nullity of a company. The nullity of compa- nies is regulated exhaustively by the Directive. Exhaustive harmonisation = matter dealt with completely by the directive. 10 Art.8 Directive 2017/1132: Completion of formalities of disclosure of the particulars concerning the persons who, as an organ of the company, are authorized to represent it, shall constitute a bar to any irregularity in their appointment being relied upon as against third parties, unless the company proves that such third parties had knowledge thereof 11 Art.9 Directive 2017/1132: 1. Acts done by the organs of the company shall be binding upon it even if those acts are not within the objects of the company, unless such acts exceed the powers that the law confers or allows to be conferred on those or- gans. However, Member States may provide that the company shall not be bound where such acts are outside the objects of the company, if it proves that the third party knew that the act was outside those objects or could not in view of the circumstances have been unaware of it. Disclosure of the statutes shall not of itself be suffi- cient proof thereof. 2. The limits on the powers of the organs of the company, arising under the statutes or from a decision of the competent organs, may not be relied on as against third parties, even if they have been disclosed. 3. If national law provides that authority to represent a company may, in derogation from the legal rules govern- ing the subject, be conferred by the statutes on a single person or on several persons acting jointly, that law may provide that such a provision in the statutes may be relied on as against third parties on condition that it relates to the general power of representation; the question whether such a provision in the statutes can be relied on as against third parties shall be governed by Article 16. 12 Art.11 Directive 2017/1132: The laws of the Member States may not provide for the nullity of companies oth- erwise than in accordance with the following provisions: (a) nullity must be ordered by decision of a court of law; (b) nullity may be ordered only on the grounds: 27 Public companies must have a minimum capital, and a minimum of two shareholders, in a very special case there can be only one founder member. Ubbink Isolatie BV. Direct effect of directive. Reference made to the ECJ by the su- preme court of Ned for a preliminary ruling on the interpretation of the rules on nullity laid down by the First Directive. Factual background. The questions referred to the CJEU arose in proceedings concerning the performance of a contract between Daken Wandtechniek BV and the company calling it- self Ubbink Isolatie BV. At the time of the contested contract, a partnership was registered in the commercial register under the name Ubbink Isolatie BV i.o. (Ubbink Isolatie, a private limited company in the course of formation), listing as partners Ubbink Nederland BV and Isetco BV, both private limited companies, and as general representative, with the title of di- rector, a certain Mr Juraske. However, there was no private limited company registered in the commercial register under the name Ubbink Isolatie BV. The national court found that as there had been no notarial instrument establishing a private limited company under the name Ubbink Isolatie BV, the company had not been duly formed Partnership = different from company, another category of legal person. Natural person form- ing the partnership bears liability for various debts of the partnership, joint liability Company: shareholders do not get liability for debts of company This ‘pre-company’ concluded the contested contract with Daken Wandtechniek under the name Ubbink Isolatie BV without the addition of the expression ‘in the course of formation’ and proceedings were brought against it under that name by Daken Wandtechniek before the Arrondissementsrechtbank (District Court), Arnhem for the termination of that contract and to establish liability thereunder; the appellant also initially submitted its defense under that name No expression “in the course of formation”!!! During the proceedings before that court, the appellant contended that Daken Wandtechniek was wrong to bring its action against Ubbink Isolatie BV. The summons issued upon the ap- plication of Daken Wandtechniek was void and the application could not be granted because Ubbink Isolatie BV did not exist. (i) that no instrument of constitution was executed or that the rules of preventive control or the requi- site legal formalities were not complied with; (ii) that the objects of the company are unlawful or contrary to public policy; (iii) that the instrument of constitution or the statutes do not state the name of the company, the amount of the individual subscriptions of capital, the total amount of the capital subscribed or the objects of the company; (iv) of failure to comply with provisions of national law concerning the minimum amount of capital to be paid up; (v) of the incapacity of all the founder members; (vi) that, contrary to the national law governing the company, the number of founder members is less than two. Apart from the grounds of nullity referred to in the first paragraph, a company shall not be subject to any cause of nonexistence, absolute nullity, relative nullity or declaration of nullity 30 - Is Article 11 of Council Directive 68/151/EEC of 9 March 1968, which has not been implemented in national law, directly applicable so as to preclude a declaration of nul- lity of a public limited company on a ground other than those set out in the said arti- cle? The court replied that the requirement that national law must be interpreted in conformity with Article 11 of Directive 68/151 precludes the interpretation of provisions of national law relating to public limited companies in such a manner that the nullity of a public limited company may be ordered on grounds other than those exhaustively listed in Article 11 of the directive in question. According to the Commission, the expression "objects of the company" must be interpreted as referring exclusively to the objects of the company as described in the instrument of incor- poration or the articles of association. It follows, in the Commission' s view, that a declara- tion of nullity of a company cannot be made on the basis of the activity actually pursued by it, for instance defrauding the founders' creditors. As is clear from the preamble, the purpose of the directive was to limit the cases in which nullity can arise and the retroactive effect of a declaration of nullity in order to ensure "cer- tainty in the law as regards relations between the company and third parties, and also between members" (sixth recital). Furthermore, the protection of third parties "must be ensured by provisions which restrict to the greatest possible extent the grounds on which obligations en- tered into in the name of the company are not valid". It follows, therefore, that each ground of nullity provided for in Article 11 of the directive must be interpreted strictly . In those cir- cumstances the words "objects of the company" must be understood as referring to the ob- jects of the company as described in the instrument of incorporation or the articles of associa- tion. The answer to the question must therefore be that a national court hearing a case which falls within the scope of the 1st CLD is required to interpret its national law in the light of the wording and the purpose of that directive, in order to preclude a declaration of nullity of a PBLL company on a ground other than those listed in Art.11. To sum up: Spanish legislation had an additional ground of nullity = lack of cause (not in- cluded in the first company law directive) + the directive was yet to be brought into effect Is art. 11 of council directive, not being implemented, directly applicable? Directive is binding although MSs have not implemented yet due to the direct effect of direc- tives and National law must be interpreted in conformity with the directive that has direct ef- fect. Prohibition to MS to add grounds of nullity other than those exhaustively listed In the di- rective, ECJ interpreted ii) ground of nullity on objects of the company = Defrauding found- ers’ creditors is not a ground for nullity. Objects of company as described in the documents of the company = articles of association or memorandum 31 2.2.3 Liability of directors (Art.3313 Directive 2013/34 on). Statutes for European companies stipulates that all members of the organs of an European company shall be liable for loss or damage sustained by the company following any breach of the legal, statutory or other obligations inherent in their duties. Although it does not cover the field of civil liability. ECL only requires the MSs to cover the civil liability of members of the administrative, management and supervisory organs for drawing up and publishing the fi- nancial statements and the management report. Statutory audits are specific independent officers with high qualifications that evaluate the fi- nancial condition of the company. They are not only related to annual and consolidated fi- nancial statements, but rather have a much broader relevance in the corporate governance of companies. In addition to the audit report, a document where auditors express their opinions, they are entrusted with other functions contributing to better corporate governance. After the financial scandals of 2008, where one of the so-called bug five auditing firms had to dismiss the licence and in response to the US Sarbanes-Oxley Act of 2002, the EU institu- tions adopted a new, more comprehensive Directive on statutory audits of annual accounts and consolidated accounts. Directive 2006/43/EC (new Eighth Directive), last amended by Directive 2014/56/EU, also lays down the rules on independence, objectivity and professional ethics applying to those persons, and the framework for their public oversight; in addition to the conditions for the approval and registration of the auditors. Under the new Eighth Di- rective, only qualified auditors, having an adequate knowledge of matters such as a company law, fiscal law and social law, shall carry on statutory audits (Recital 7 Directive 2006/43/EC). Auditors shall be independent professionals, subject to professional ethics, and keeping strict confidentiality on the information acquired by their clients (Recitals 9-11 Di- rective 2006/43/EC). The statutory auditor or audit firm should be appointed by the general meeting of shareholders or members of the audited entity; however, in order to protect the in- dependence of the auditor, a dismissal should be possible only where there are proper grounds (Recital 22 Directive 2006/EC) o In addition, the new Eighth Directive provides stricter rules applicable to the statutory audit of public-interest entities, such as listed compa- nies, banks, insurance companies, undertakings for the collective investment in transferable securities (UCITS), and so on: auditors for these entities shall meet higher standards and, to reinforce their independence, the key audit partner auditing such entities shall rotate over time (Recitals 23-27 Directive 2006/43/EC). As for the consolidated accounts of listed com- panies, also with regards to auditing, the EC Commission shall adopt international standards 13 Art.33 Directive 2013/34 on responsibility and liability for drawing up and publishing the financial statements and the management report: 1. Member States shall ensure that the members of the administrative, management and supervisory bodies of an undertaking, acting within the competences assigned to them by national law, have collective responsibility for ensuring that: a) the annual financial statements, the management report, the corporate governance statement when pro- vided separately and the report referred to in Article 19a(4); and b) the consolidated financial statements, the consolidated management reports, the consolidated corporate governance statement when provided separately and the report referred to in Article 29a(4), are drawn up and published in accordance with the requirements of this Directive and, where applicable, with the international accounting standards adopted in accordance with Regulation (EC) No 1606/2002. 2. Member States shall ensure that their laws, regulations and administrative provisions on liability, at least to- wards the undertaking, apply to the members of the administrative, management and supervisory bodies of the undertakings for breach of the duties referred to in paragraph 1. 32 and issue recommendations on the auditors’ civil liability (Recitals 13-15, 19 Directive 2006/43/EC). In 2014, the EU institutions approved a broad amendment to the new Eight Di- rective. In brief, public oversight authorities should be vested with sufficient powers to fulfil their tasks in an effective manner, including the power to bring a claim before a national court for the dismissal of the statutory auditor. Furthermore, public authorities shall be empowered to issue administrative pecuniary sanctions in case of identified infringements of the rules. 2.2.4 Auditors’ (director) civil liability 8th CLD expresses the opportunity for the EU Commission to issue recommendations on au- ditors’ civil liability. in its Recommendation of 2008, the Commission has proposed the limi- tation of the civil liability of statutory auditors and audit firms commission. Recitals 3-6, Commission Recommendation of June 2008 concerning the limitation of the civil liability of statutory auditors and audit firms14. What if the director presents the financial situation of the company better than it really is, and someone suffers a damage. The liability of statutory au- ditors is not unlimited, as it would make them too cautious, therefore the EU Commission proposes various methods as a means to limit the civil liability of auditors, among which the MS may choose: a) Establishment of a maximum financial amount or a formula allowing for the calcula- tion of such an amount b) Establishment of a set of principles by virtue of which a statutory auditor or an audit firm is not liable beyond its actual contribution to the loss suffered by a claimant and is accordingly not jointly and severally liable with other wrongdoers c) Provisions allowing any company to be audited and the statutory auditor or audit firm to determine a limitation of liability in an agreement. The limitation of auditors’ liability has raised an intense debate among legal scholars, some of whom do not support the idea that auditing firms should benefit from a limitation of liabil- ity. Where liability is limited, a judicial review of such agreement is required. 14 2008 Commission Recommendation: (3) Since unlimited joint and several liability may deter audit firms and networks from entering the international audit market for listed companies in the Community, there is little prospect of new audit networks emerging which are in position to conduct statutory audits of such companies; (4) As a consequence, the liability of auditors and audit firms, including group auditors, carrying out statutory audits of listed companies should be limited. However, any limitations on liability is not justified in cases of international breach of professional duties on the part of an auditor and should not apply in such cases. Nor should such a limitation prejudice the right of any injured party to be fairly compensated; (5) In view of the considerable variations between civil liability systems in the Member States, it is appropriate at this stage that each Member State be able to choose the method of limitation which it considers to be most suitable for its civil liability system. (6) Member States should accordingly be able to determine under national law a cap in respect of audi- tors’ liability. Alternatively, Member States should be able to establish under national law a system of propor- tionate liability according to which statutory auditors and audit firms are liable with other parties. In the Mem- ber States where any claims against statutory auditors might be brought only by the audited company and not by individuals or shareholders or any other third parties, Member States should also be able to allow the company, its shareholders and the auditor to determine the limitation of the auditors’ liability, subject to appropriate safe- guards for investors of the company audited. 35 ownership of the target’s intangible assets, or at least acquires the appropriate license to use this intellectual property. 3.1 TYPES OF MERGERS Horizontal vertical or conglomerate. A horizontal merger occurs when two competitors combine. Mergers and acquisitions are also regulated in other areas of law, e.g., tax law, employment law, competition law etc. In fact, a merger might result in a monopoly as a horizontal merger may cause the combined firm to experience an increase in market power that will have anticompetitive effects, the merger may be opposed on antitrust grounds. For example, in 1998, two petroleum compa- nies, Exxon and Mobil, combined in a $78.9 billion megamerger. Another example was the 2009 megamerger that occurred when Pfizer acquired Wyeth for $68 billion. A vertical merger is a combination of companies that have a buyer-seller relationship. E.g., in 1993 Merck, one of the world’s largest drug companies, acquired Medco Contain- ment Services INC., the larger marketer of discount prescription medicines. The transaction allowed Merck to become the largest integrated producer and distributor of pharmaceutical, apart from being the largest pharmaceutical company. A conglomerate merger occurs when the companies are not competitors and do not have a buyer-seller relationship, e.g., Philip Morris, a tobacco company, acquiring General Foods, Kraft and Nabisco; this company has done what many others have not been able to do suc- cessfully, i.e., manage a diverse portfolio of companies in a way that creates shareholder wealth. Mergers of PBLL companies. the 3rd CLD regulates mergers between PBLL companies to ensure that the safeguards required of companies are equivalent in all MSs, to protect the in- terests of members and third parties. MSs need not apply this directive to: - Cooperatives - Companies which are being acquired or will cease to exist and are the subject of bankruptcy proceedings, or relating to the winding-up of insolvent companies, … Merger by acquisition: the operation whereby one or more companies are wound up without going into liquidation and transfer to another all their assets and liabilities in exchange for the issue to the shareholders of the company or companies being acquired of shares in the acquir- ing company and a cash payment, if any, not exceeding 10% of the nominal value of the shares so issued or, where they have no nominal value, of their accounting par value. Merger by formation of a new company: the operation whereby several companies are wound up without going into liquidation and transfer all their assets and liabilities to a com- pany that they form, in exchange for the issue to their shareholders of shares in the new com- pany and a cash payment, if any, not exceeding 10 % of the nominal value of the shares so issued or, where they have no nominal value, of their accounting par value. 3.2 REASONS FOR MERGERS AND ACQUISITIONS There are several possible motives that firms might engage in mergers or acquisitions, one of the most common is 36 (1) expansion. Acquiring a company in a line of business or geographic area into which the company may want to expand can be quicker than internal expansion. An acquisi- tion of a particular company may provide certain synergistic benefits for the acquirer, such as when two lines of business complement one another. However, an acquisition may be part of a diversification program that allows the company to move into other lines of business. In the pursuit of expansion, firms engaging in M&As cite potential synergistic gains as one of the reasons for the transaction. Synergy occurs when the sum of the parts is more productive and valuable than the individual components. (2) financial factors motivate some M&As, an acquirer’s financial analysis may re- veal that the target is undervalued. Certain types of buyers, such as private equity firms, may acquire an undervalued target and seek to sell it shortly thereafter for a higher value while possibly extracting dividends from it before it is resold. (3) Other motives, such as tax motives, may also play a role in an acquisition deci- sion. Corporate restructuring usually refers to asset selloffs such as divestitures. Companies that have acquired other firms or have developed other divisions through activities such as prod- uct extensions may decide that these decisions no longer fit into the company’s plans. The desire to sell parts of a company may come from poor performance of a division, financial exigency, or a change in the strategy orientation of the company. For example, the company may decide to refocus on its core business and sell off noncore subsidiaries. This type of ac- tivity increased after the end of the third merger wave as many companies that engaged in di- verse acquisition campaigns to build conglomerates began to question the advisability of these combinations. There are several forms of corporate selloffs, e.g., divestitures, spin and equity carve-outs. Mergers negotiations are often negotiated in a friendly environment. The process begins when the management of one firm contracts the target company’s management, often through the investment bankers of each firm. Mergers are the product of a negotiation process between the managements of the merging companies. The bidding firm typically initiates the negotiations when it contacts the target manager to inquire whether the company is for sale and to express its interest. Most mergers include the material adverse change clause (MAG clause), which allows each parties to withdraw from the agreement in case of major change of circumstances or extraordinary events, e.g., pandemic, recession, financial crisis. Confidenti- ality agreements allow the companies to exchange confidential information that may enable the parties to better understand the value of what they’re exchanging. A reverse merger is a merger in which a private company may go public15 by merging with an already public company that often is inactive or a corporate shell. The combined company may choose to issue securities and may not have to incur all of the costs and scrutiny that normally would be associated with the IPO (i.e., initial public offering), a process by which a private-turned-public company is inserted in the stock exchange for the first time. When a public company absorbs a private one, the latter doesn’t have to go through the IPO process (which is quite expensive), as it is associated with the public one. 15 Public company = the shares are open to the public and will be listed in the capital market and stock exchange 37 Special Purchase Acquisition Vehicles (SPACs) are companies that raise capital in an IPO where the funds are earmarked for acquisitions. They are sometimes also referred to as blank check or cash-shells. Holding companies refers to when rather than a merger or an acquisition, the acquiring company may choose to purchase only a portion of the target’s stock and act as a holding company, which is a company that owns sufficient stock to have a controlling interest in the target. If an acquirer busy the 100% of the target, the company is known as a wholly owned subsidiary; however, it is not necessary to own all of a company’s stock to exert control over it. In fact, even a 51% interest may not be necessary to allow a buyer to control a target. For companies with a widely distributed equity base, effective working control can be established with as little as 10 to 20% of the outstanding common stock. M&As are regulated at multiple levels, with company law, competition law, tax law, em- ployment law, capital markets law, comparative law, capital markets law, etc. The evolution of Merger and Acquisition activity: - First wave: turn of the last century (1893-1907) - Second wave: between the end of World War I and the 1929 stock market crash (1919 to 1929) - Third wave: end of World War II until the early 1970s (1945 to 1973) - Fourth wave: 1980s - Fifth wave: 1993 to the present 3.3 PROCEDURE Where the administrative or management bodies of companies decide to carry out a merger, they must draw up draft terms of merger in writing which include, in particular: - the type, name and registered office of the companies - the share exchange ratio - terms relating to the allotment of shares - the rights conferred by the acquiring company The administrative or management bodies of the companies must make the draft terms of merger public at least one month before the date fixed for the general meeting, pursuant to the conditions laid down in the Directive on protecting the interests of members and third parties. They shall be exempt from this requirement if the draft terms are made available on the company website for that period. In order to be valid, the merger must be approved by the general meeting of each of the merging companies. Member States need not make the merger subject to approval by the general meeting if: - publication of the merger takes place at least one month before the date fixed for the general meeting - all shareholders of the acquiring company are entitled to inspect certain documents (draft terms of merger, annual accounts, for example) at least one month before the date fixed for the general meeting - one or more shareholders of the acquiring company holding a minimum percentage of the subscribed capital (no more than 5%) is/are entitled to require that a general meet- ing be called to decide whether to approve the merger 40 - Syndicated loans (senior lenders-junior lenders). pharmaceutical start-up companies and technology companies. 3.4.1 Leveraged Buyout A leveraged buyout (or LBO, or highly-leveraged transaction (HLT), or "bootstrap" transac- tion) occurs when an investor, typically financial sponsor, acquires a controlling interest in a company's equity and where a significant percentage of the purchase price is financed through leverage (borrowing). The assets of the acquired company are used as collateral for the borrowed capital, sometimes with assets of the acquiring company. Typically, leveraged buyout uses a combination of various debt instruments from bank and debt capital markets. While every leveraged buyout is unique with respect to its specific capital structure, the one common element of a leveraged buyout is the use of financial leverage to complete the acqui- sition of a target company. In an LBO, the private equity firm acquiring the target company will finance the acquisition with a combination of debt and equity, much like an individual buying a house with a mortgage. Just as a mortgage is secured by the value of the house be- ing purchased, some portion of the debt incurred in an LBO is secured by the assets of the acquired business. Unlike a house, however, the bought-out business generates cash flows which are used to service the debt incurred in its buyout – in essence, the acquired company helps pay for itself (hence the term “bootstrap” acquisition). Leveraged buyouts involve an investor, financial sponsors or private equity firms making large acquisitions without com- mitting all the capital required for the acquisition. To do this, a financial sponsor will raise acquisition debt which is ultimately secured upon the acquisition target and also looks to the cash flows of the acquisition target to make interest and principal payments. Acquisition debt in an LBO is therefore usually non-recourse to the financial sponsor and to the equity fund that the financial sponsor manages. Furthermore, unlike in a hedge fund, where debt raised to purchase certain securities is also collateralized by the fund's other securities, the acquisition debt in an LBO is recourse only to the company purchased in a particular LBO transaction. Therefore, an LBO transaction's financial structure is particularly attractive to a fund's limited partners, allowing them the benefits of leverage but greatly limiting the degree of recourse of that leverage. Leveraged buyouts and the private equity market. In a leveraged buyout (LBO), a buyer uses debt to finance the acquisition of a company. The term is usually reserved, how- ever, for acquisition of public companies where the acquired company becomes private. This is referred to as going private because all of the public equity is purchased, usually by a small group or a single buyer, and the company’s shares are no longer traded in securities markets. One version of an LBO is a management buyout. In a management buyout, the buyer of a company, or a division of a company, is the manager of the entity. Most LBOs are buyouts of small and medium-sized companies or divisions of large companies. However, in what was then the largest transaction of all time, the 1989 $25.1 billion LBO of RJR Nabisco by Kohl- berg Kravis & Roberts shook the financial world. The use of significant amounts of debt to finance the acquisition of a company has a number of advantages, as well as risks. The most obvious risk associated with a leveraged buyout is that of financial distress. Unforeseen events such as recession, litigation, or changes in the regulatory environment can lead to difficulties meeting scheduled interest payments, tech- nical default (the violation of the terms of a debt covenant) or outright liquidation. Weak 41 management at the target company or misalignment of incentives between management and shareholders can also pose threats to the ultimate success of an LBO. There are a number of advantages to the use of leverage in acquisitions. Large interest and principal payments can force management to improve performance and operating efficiency. This “discipline of debt” can force management to focus on certain initiatives such as divesting non-core busi- nesses, downsizing, cost cutting or investing in technological upgrades that might otherwise be postponed or rejected outright. In this manner, the use of debt serves not just as a financ- ing technique, but also as a tool to force changes in managerial behaviour. 3.5 TAKEOVER BIDS A takeover may be defined as a transaction or series of transactions whereby a natural or le- gal person or group of persons acquires control over the assets of a company, either directly by becoming the owner of those assets or indirectly by obtaining control of the management of the company. (1) Where shares are closely held (i.e. by a small number of persons), a takeover will generally be effected by agreement with the holders of the majority of the share capital of the company being acquired. (2) Where the shares are held by the public generally, the takeover may be effected: a. by agreement between the acquirer and the controllers of the acquired company, b. by purchases of shares on the stock exchange, c. by means of a takeover bid, i.e., an offer to buy all the shares of the company in a takeover bid, one company (offeror/bidder/acquiring company) buys either all or at least a voting majority of the shares of another company (offeree/target company), by cash or shares or other securities in exchange for the shares it acquires. After the takeover, the two companies remain in existence, and the offeree company becomes a subsidiary of the other, and is controlled by the acquiring company through its majority shareholding and its ability to remove the existing directors and appoint its own nominees in their place. A takeover bid is a method for achieving a merger, the distinction between a takeover and a merger is that in the former the direct or indirect control over the assets of the acquired com- pany passes to the acquirer; in a merger the shareholding in the combined enterprise will be spread between the shareholders of the two companies. in a takeover, the bid is frequently against the wishes of the management of the offeree company, in a merger the bid is by con- sent of the management of both companies. In an unconditional bid, the bidder will pay the offered price irrespective of the number of shares acquired, while the bidder of a conditional bid will only pay the price offered if sufficient shares are acquired to provide a controlling in- terest. There may be bids from other sources, that include: - “white knights”, a person or firm that makes a welcome takeover bid for a company on improved terms to replace an unacceptable and unwelcome bid from a “black knight”; in fact, if a company is the target of a takeover bid from a source which it does not approve or on terms that it does not find attractive, it will seek of a more suitable owner, i.e., white knight. - “grey knights”, a counter bidder whose ultimate intentions are undeclared, it is an ambiguous intervener whose appearance is unwelcome to all 42 It is necessary that the applicable company law allows for anyone holding the majority of voting shares of a company to remove the existing board and appoint new directors to take over its management. In the case of a company whose shares are listed on the Stock Ex- change, there are no large blocks of shares held in private hands and not generally traded, and if the shares are held in registered form and lists of the current shareholders and their ad- dresses are publicly available. Takeovers are an important external corporate governance mechanism that facilitates effec- tive corporate restructuring. An aggressive market in corporate control serves as a discipli- nary device for management boards of potential target companies, who would be afraid of losing their posts at the hands of a new acquirer if their company were taken over, thus pro- moting efficient asset structures. However, the separation of ownership and control of the public corporation gives rise to a classical principal-agent problem, which can result in the sub-optimal use of capital and a failure to return excess capital to shareholders. This problem creates different approaches to corporate control transactions. There are two models of regulation depicting the relevant approaches: 1. Directors must not frustrate a public offer → the board of the company is not permit- ted to frustrate the efforts of the bid and to intervene in any other way in the decision – making process of the shareholders, who are the ultimate adjudicators. According to the philosophy of the free enterprise economy the owners of each party to a takeover or merger are the best judges of their own interests. This first model is implemented in the UK. This model constituted the basis for the proposal and the harmonization ef- forts of the European Commission, which led ultimately to the Directive 2004/25/EC on Takeover Bids. 2. Directors control access to the shareholders → model the board of the company has the right (under the corporate statute or because authorized by the general meeting of the shareholders) to frustrate a bid with various defensive measures. This model is en- countered in Continental Europe and the U.S.. However, in the U.S., the shareholders can protect their rights by court action if the board of the company frustrates a poten- tial value-enhancing public offer, or if the target company suffers serious and other- wise unjustified loss as a result of the defensive action of the board (let us to say, for serious infringements of the business judgment rule). Hostile takeover bids in Conti- nental Europe are quite rare (only 67 hostile bids in the 15 Member States in the 1990’s), due to the historically more permissive attitude towards technical barriers, such as pre- and post-bid defences, and to structural barriers, related to the way in which companies are owned and financed (e.g. concentrated shareholdings, and dis- tortion of the distribution of voting rights). Defensive measures. defensive measures which could be deployed by the board of a compa- ny resulting in the frustration of the bid are: - poison pill: a tactic used by a company that fears an unwanted takeover by ensuring that a successful takeover bid will trigger some event that substantially reduces the value of the company. It is generally a right plan that entitles existing shareholders to securities or cash if a hostile bidder takes control, while at the same time being re- deemable at the option of the board if the acquirer is friendly. Other - Sale of crown jewels (or Spin-offs): selling valuable assets of the company 45 prompted to adopt further safeguards for minority shareholder protection but is given the pos- sibility to evade the minimum protection standards of the Directive. Law and economics debate on the mandatory bid rule versus the market rule. There are two directions in the regulation of a private sale-of-control transactions. 1) Deregulatory rule (market rule/private negotiation rule). According to the market rule, corporate control transactions can be treated like most other sales of private property, with the seller keeping all of the consideration paid by the acquirer, and the acquirer remaining free to decide whether or not to buy any additional shares from the remain- ing shareholders of the target. 2) Sharing rule that falls within the scope of the mandatory bid rule. The law may im- pose some form of a sharing rule or equal opportunity rule, requiring the buyer or the seller of a controlling block to let outside shareholders participate in the bargain. If a mandatory bid rule is triggered, the bidder must offer the same price to all shareholders. The mandatory bid rule was criticized in the light of law & economics because it prevents some desirable (i.e. efficient) transactions, and therefore creates inefficiency costs, as it could incur high costs. In other words, Member States may allow their supervisory authorities to decide, case-by-case, that the Mandatory Bid Price should be adjusted or it does not apply at all in certain special circumstances, whether specified by the national rules or not. Unjustified or over-ample use of this power may constitute a breach of Art.3 (protection of minority shareholders in case of control transfer), unless some equivalent protection is granted. Although the directive provides for one category of derogation (ref. Art.5(2) – where control has been acquired following a 100% voluntary bid to all the holders of securities for all their holdings), there can be other categories of derogations granted by MSs at the implementation stage or by the supervisory authorities and the legislature at the bid stage. These derogations should be interpreted narrowly. This narrow discretion of the Member States and national su- pervisory authorities to the possible exemption is not only due to the determination of the price by “circumstances and in accordance to criteria clearly determined” and the relevant na- tional “list of circumstances” (Art.5(4)). The directive does not specify exactly what shares of the capital and voting rights is need- ed for control, which is left to MSs to decide. The lack of harmonised control threshold and a price definition does not contribute towards a unified system of minority shareholder protec- tion in the EU. The mandatory bid rule is not fully comprehensive, this makes it implementation and its protective function more difficult. It is possible that the mandatory bid rule’s scope will not include some cases of minority shareholder protection, e.g., there is no reference to the treat- ment of acquisitions of control of companies controlling a listed company. The minority shareholders of the listed company need protection from the new acquirers of the controlling company, who are also able to control the listed company. Unfortunately, the Directive does not regulate these situations, not even with a general provision. It leaves their regulation to the discretion of each Member State. The omission of partial bids from the Directive is another negative factor as regards minori- ty shareholder protection. A bidder may seek a stake below the mandatory bid threshold, pos- 46 sible because all he wants is working control, or he may want a larger stake. No mandatory bid requirement will of course follow a bid for a stake below the relevant threshold. So, a po- tential bidder could design the shares acquisition just below the mandatory bid threshold in a way that he fulfills his plans without having to finance a mandatory bid. While the mandatory bid rule declares minority shareholder protection as its primary aim, there is a huge debate about the possibility of succeeding in such an aim. There is a broad consensus in the literature that, while obviously ex post (i.e. after a control acquisition mate- rializes) minority shareholders are better off with a mandatory bid rule in place, ex ante, the rule inevitably reduces the number of value increasing control acquisitions. This is because a mandatory bid rule is discouraging to a potential investor/bidder as a result of the potential cost of making a mandatory offer. The minority shareholder protection rationale of the rule is closely related to the equal treatment rationale. Art.3 states as a general principle that all the holders of the securities of an offeree company of the same class must be afforded equal treatment. The equal treatment in question relates mainly to the premium paid for the shares acquired. If the bidder is not obliged to launch a mandatory bid when he reaches the mandatory bid threshold of control, then only the shareholders who sold their shares to the new controller benefit from the premi- um. Concerned parties problem. The definition of “concerned parties” in the Takeover Bid Directive is another issue which diminishes even more the contribution of the mandatory bid rule to minority shareholder protection and freedom of establishment. Form Art.2(1)(d) they are defined as natural or legal persons who cooperate with the offeror or the offeree on the basis of an agreement , either express or tacit , either oral or written aimed ei- ther of acquiring control of the offeree company or at frustrating the success- ful outcome of a bid. The percentage of voting rights which confers control is defined by the MSs, and it defines the acquisition of control according to Art.5(1). The vagueness of the relevant provision of the Directive and the wide discretion conferred upon Member States could harm the interests of minority shareholders. 3.5.2 Squeeze-out and Sell-out Rights (Art.15, Art.16) Art.15 states that MSs have to ensure that an offeror buy the remaining securities from the holders at a fair price. The rule is aimed at allowing a bidder to gain 100 percent of the equity to simplify accounting and administration by removing the need to deal with minority share- holders. The bidder already knows that if they reach the squeeze-out threshold, there will be the possibility to exercise the squeeze-out right in order to apply a more efficient manage- ment regime. this measure aims at the protection of investors, therefore freedom of estab- lishment could be promoted. Additionally, the protection of shareholders is also promoted because they will have a second chance after the first bid to sell their shares. These potential benefits of the squeeze-out rule are cancelled out by another deficiency of the directive. The provision in question makes no reference to statutory mergers or delistings, which can be used as de facto means of squeeze-out at higher costs, but lower valuations than 47 the tender offer (like in the Deutsche Telecom and T-Online case). Statutory mergers may operate to the detriment of the protection of shareholders. The statutory merger process al- lows the majority shareholders to acquire the shares of the minority shareholders at a lower price than applied to the public offer which was previously rejected by the minority share- holders. Sell-out rights based on fair pricing provisions similar to Art.15 on squeeze-out. The aim of the provision is to provide an exit to the remaining shareholders and as a consequence to pro- tect them. Otherwise, the remaining shareholders could very easily be abused by the new con- troller and the only exit would be to sell their depreciated shares at a low price on the market. Nevertheless, this protection is again diluted. The sell-out right is granted according to Art.15(1) only where a bid is made to all the holders of the offeree company’s securities for all of their securities. This can be either a voluntary bid or mandatory bid. As seen above, mandatory bids may turn out to be easily avoidable, depending on the choices made by Member States and national supervisory authorities. The exercise of the sell-out right de- pends on the prior launch of a mandatory bid. The mandatory bid depends on the discretion of the Member States and the national supervisory authorities. Hence, the exercise of the sell- out right depends on this discretion, which renders this right ineffective. The Directive tries to protect the shareholders by conferring this right but simultaneously it cancels this protection by making the mandatory bid rule and, as a consequence, the sell-out right, easily avoidable. 3.5.3 Takeover bid process The core regulation of the takeover bid process are: 1. The non-frustration rule (Art.9) 2. The breakthrough rule (Art.11) 3. The reciprocity rule (Art.12) The first two regulate the behaviour of the management of the target company during the pre- and post-bid period. The reciprocity rule is nothing more than simply another opportunity to opt out. NON-FRUSTRATION. The board neutrality or non-frustration rule envisages the UK model of the regulation of takeovers at EU level. Art.9(2) states that the prior authorisa- tion of the general meeting of shareholders is required before any action on behalf of the tar- get’s board, which could result in the frustration of the bid. The directive rests on the princi- ple that a takeover bid is made to the shareholders and consequently it is up to the sharehold- ers to decide on defensive measures. The non-frustration rule is a way of protecting the inter- ests of shareholders and fulfilling the aims of the legal basis of Art.50(2). The board of the Company is only permitted to seek for alternative bids in order to offer a wider and competi- tive range of choices to the shareholders of the company. However, there are strong argu- ments against the protective scope of the competitive bids. Additionally, paragraph 2 of Arti- cle 9 mentions as a particular way of inhibiting permanently a bid the issuance of new shares. This defensive measure is expressly stated by the EU legislature because it can result in a permanent and irreversible barrier to the attempts of the bidder. The new shares dilute the stake of the bidder and it would be impossible to ever reach the desired control level of the company’s equity. This restriction also includes securities that confer the pre-emption right to subscribe to such securities, like convertible bonds and warrants. 50 Multiple-vote securities shall carry only one vote each at the general meeting of shareholders which decides on any defensive measures in accordance with the Article 9 Restrictions on the transfer of securities or on voting rights and any extraordinary rights of shareholders concerning the appointment or removal of board members are prohibited, if the bidder obtains 75% or more of the voting capital of the target company (Art.11(4)). The one share – one vote principle is implemented and multiple voting rights are declared inactive at the first general meeting of shareholders following closure of the bid, called by the offeror in order to amend the articles of association or to remove or appoint board members. The bid- der has the right to convene a special post-breakthrough meeting in order to strengthen his controlling position in the target company. The rule does not apply to legal golden shares hold by MSs. After objections from the EP, there is a provision in the directive concerning equitable compensation. This compensation should be conferred when loss is suffered by the holders of special rights which are broken through (Art.11(5)). According to the proportionality principle, the degree of risk/reward which the shareholders take should determine the degree of control to be exercised by shareholders. Thus, the greater the shareholders’ stake in the company in terms of his exposure to the company’s success or failure, through his holding in the risk-capital or general cash-flow rights, the greater his voice should be in determining the manner of its control. The breakthrough rule aims at the facilitation of takeover activity and requires that where contractual and property rights are exercised in ways which inhibit legitimate bids, these rights should be broken through. Thus, the breakthrough provision embodies an enhanced, idealized, or paternalistically imposed, freedom of shareholders based on a defined optimal redistribution of rights. This could also be called a one share-one vote principle. The breakthrough rule is deficient in two respects: as regards the substance of the rule, and as regards the optional character of Art.11. The prohibition of restrictions on the transfer of securities provided for in the articles of asso- ciation of the offeree company is redundant. It is already a requirement of listing that shares should be freely negotiable. . Additionally, the prohibition of such restrictions contained in agreements between shareholders may be thought to be too wide, since it risks catching nor- mal market arrangements, such as pre-emption and option rights, sale agreements with de- ferred settlement, and indeed irrevocable undertakings to accept a takeover offer (which usu- ally incorporate a restriction on sale of the shares concerned to a third party). The text of the Directive in this point is quite wide and catches normal financial transactions which are pro or at least neutral to takeover activity. The breakthrough rule is called mini-breakthrough because it allows the breakthrough of some, but not all the restrictions infringing the proportionality principle. I think that it is nec- essary to examine which categories of securities survive the implementation of the break- through rule. It is obvious that there are many exceptions from the breakthrough rule due to its narrow scope. The categories of securities outside the scope of the breakthrough rule con- stitute obstacles for any potential bidder. 51 Shares which evade the application of the breakthrough rule: 1. Ceiling or time lapse voting securities 2. Non-voting shares 3. Cross-shareholdings Ceiling or time lapse voting securities. The first problem is created because of the text of the Directive itself. Art.2(1)(g) defines multiple-voting securities as securities included in a distinct and separate class and carrying more than one vote each. Ceiling or time lapse vot- ing securities are not caught by the breakthrough rule. These shares are fully enfranchised af- ter a specific holding period and are not caught because while the voting rights will vary from time to time, according to the contingency of the duration of a holding, they remain of the same class. This kind of share is very common in France. The defensive aim of this kind of share is to discourage any potential bidder by ensuring that the offeror acquiring such a share obtains a diluted control right unless he is able to wait for up to four years for the shares to be fully enfranchised. The requirement that shares comprise part of a distinct and separate class excludes an important category of shares from the scope of the breakthrough rule. The scope of the breakthrough rule should be determined by the aim of negating the potential of certain shares to inhibit the takeover process and not by formalities like the requirement for different classes of shares. Nevertheless, multiple voting shares in separate class are undoubtedly caught by the breakthrough rule. This kind of share is often found in Scandinavian Member States and sometimes in the UK. Thus, we have the side-effect that multiple voting shares, which have exactly the same result of obstructing the course of the bid, are treated differently only because they belong to different classes. Furthermore, this creates inequality and does not level the playing field among the EU countries. France managed to exclude this French structure from the breakthrough rule without even opting out of the relevant provision. Non-voting shares. If non-voting shares are to be in conformity with the proportion- ality principle, they should be appropriately enfranchised to carry their proper weight at both meetings, both in the hands of the offeror and in the hands of others, whether sympathetic to the offeror or not. However, the Directive does not support such an approach. It is hard to re- gard the absence of a vote as a restriction on voting to be overridden under Art.11(3). First, Art.2(1)(g) of the Directive defines as securities only those carrying voting rights in a com- pany. Hence, the breakthrough rule cannot be applied to non-voting shares due to the strict definition of Art.2(1)(g) of the Directive. Secondly, the breakthrough rule does not catch non- voting shares because there is no provision to indicate how many votes non-voting shares should get if of a different class from voting shares. Thus, non-voting securities are not en- franchised in the hands of the offeror in the post-breakthrough meeting, nor can the offeror, or others sympathetic to the offer, exercise votes in relation to such shares in the meeting called to authorize defensive measures. Furthermore, in the Member States where the issu- ance of non-voting shares will be prohibited, alternatives with the same effect are sought in- evitably. (1) One alternative technique having the same result as non-voting shares involves certifi- cates for shares or non-voting depository receipts for shares. The shares are transferred to an independent administration office, which manages the shares and exercises the voting rights in the interests of the company. The shareholders receive a certificate in return for their 52 shares and retain the proprietary rights arising from the shares. This financial technique is usual in the Netherlands, France and Belgium. (2) Another alternative to non-voting shares is securities that are not shares but carry equity risk, through a right to participate in profits (such ‘enjoyment rights’ are common in Germa- ny). The breakthrough rule undoubtedly does not catch these company instruments which are not even shares. Cross-shareholdings. Cross-shareholdings are defensive arrangements whereby two companies buy stakes in each other and senior managers/owners sit on each others boards and vote their shares together defensively. Double-headed companies constitute an advanced form of cross-shareholdings. These corporate associations adopt a double corporate form but ensure that takeovers must be of both companies. This may be done by linking shareholdings in one company to shareholdings in the other, or coordinated, and sometimes entrenched, control may be assured by conferring cross-rights of board nomination and special, often preference, share structures. I think that there should be a provision in the Directive stating that cross-shareholdings are covered by the breakthrough rule. Proxies at general meetings. Another issue that is related indirectly to the breakthrough rule and distortion of the proportionality principle is that of proxies at general meetings. The lack of interest on the part of small shareholders in attending general meetings has led to the growth of a tradition in a number of EU Member States whereby largely banks and financial institutions request proxies in order to be able to exercise a major influence at the general meeting. It is inevitable that conflicts of interest should arise: the banks are creditors, share- holders and agents at the same time. When giving a proxy, the question is whether the man- ner of casting it must be carefully defined or whether blank proxy votes are admissible. The Directive is silent on the issue of proxies, leaving it to national regulation. The diver- gence of proxy legislation is wide among the different jurisdictions (Roman-Germanic v. Common Law v. Napoleonic). It would be positive for the market in corporate control, if there were common safeguards for proxies at European level. Furthermore, proxies depend on the institutional role of banks in this Domain, which is more usual in the capital markets of some Member States (e.g. Germany), than in others. Optionality. The most important deficiency of the breakthrough rule is an external one and derives from Art.12. the potential beneficial effects of the breakthrough rule have been muted by the fact that MSs are allowed to opt out of the rule. RECIPROCITY RULE. Art.12(3) affirms that MS may, under the conditions deter- mined by national law, exempt companies which applyArt.9(2)(3) and/or Art.11 from apply- ing them if they become the subject of an offer launched by a company which does not apply the same articles as they do, or b a company controlled, directly or indirectly by the latter. Hence, the reciprocity rule is nothing more than a possibility granted to the companies by their Member States. Paragraph 5 of the same Article23 gives us the procedural conditions for the application of the reciprocity rule when it is granted by a Member State. 23 Art.12(5) Directive 2014/25 Any measure applied in accordance with paragraph 3 shall be subject to the authorization of the general meeting of shareholders of the offeree company, which must be granted no earlier than 18 months before the bid was made public in accordance with Article 6(1). 55 According to this report, most of the Member States decided to apply the board neutrali- ty/non-frustration rule: eighteen Member States in total now impose the board neutrality rule. However, the board neutrality obligation is not new in any of these Member States, except one. Five of these Member States have introduced the reciprocity exception, which may in- hibit the emergence of an active EU market in corporate control, contrary to the original ob- jective of the Directive. No Member State has decided to implement the board neutrality rule where it was not (fully) applied before implementation, except for Malta. Some Member States had no strict board neutrality obligation before the implementation of the Directive. All these Member States have decided to introduce the rule only on a voluntary basis, in con- formity with the optionality system of Article 12, again, except for Malta. The rules on board neutrality/non-frustration, compared to previous or existing rules, will therefore remain al- most the same. Although these Member States do not impose a strict board neutrality rule, the discretion of management as regards the use of post-bid defences is quite restricted. Most of the Member States have not adopted the breakthrough rule on a mandatory basis. They have made it optional for companies. Therefore, its impact on the EU market in corpo- rate control will be quite restricted. Only the Baltic countries (Estonia, Latvia and Lithuania) have implemented the breakthrough rule on an obligatory basis. None of the other countries oblige their companies to apply this provision in full. Consequently, a mere 1% of listed companies in the EU will apply this rule on a mandatory basis. The reciprocity rule of Article 12 has certainly been implemented by the majority of Member States. Most of the Member States have allowed companies to reciprocate against a bidder not subject to the board neutrality and/or breakthrough rules. Reciprocity in general does not contribute to the integration of the EU market in corporate control, however, and does not fa- cilitate the exercise of the freedom of establishment by the offeror company, because it al- lows the target company to opt out of the two key provisions of the Directive, Articles 9 and/or 11. This decision of the Member States to implement the reciprocity rule was taken due to certain level playing-field considerations. Those Member States which implemented the non-frustration and/or the breakthrough rule were afraid that, without reciprocity, there would be no level playing-field between themselves and those countries which do not apply these rules. It is not hard to grasp that Member States were afraid of regulatory competition and of seat transfers towards jurisdictions opting out of the non-frustration and/or the break- through rule. The European Commission’s Report also finds that reciprocity is considered to be an incentive for companies which have acquisition plans to apply the rules of the Directive voluntarily, in order to be able to benefit from the liberal regime abroad. However, the Report admits that this argument is undermined by the fact that any company's decision to apply vol- untarily the board neutrality or breakthrough rule remains reversible. 3.6 LEGAL ANALYSIS ON MERGERS AND ACQUISITIONS A merger is a combination of two corporations in which only one corporation survives and the merged corporation goes out of existence. In the merger, the buyer assumes the assets and liabilities of the merged company. Sometimes the term statutory merger is used to refer to this type of business transaction. With regard to mergers, there is a specific directive dealing with mergers: - Tenth Company Law Directive on cross border mergers (Directive 2005/56/EC) 56 - Third Company Law Directive concerning mergers of public limited liability compa- nies (Directive 2011/35/EU) Were both repealed by Directive 2017/1132 of the EP and of the Council of June 2017 relat- ing to certain aspects of company law.. This directive concentrated all Company Law direc- tives into a single one, incorporating around 8 previously separated directives. In 2019, the Commission wanted to modernise the cross-border mergers by providing an amendment to the Directive, as regards the use of digital tools and processes in company law. Nowadays the Company Law package is Directive 2019/2121 of the European Parliament and of the Coun- cil of 27 November 2019 amending Directive 2017/1132 as regards cross-border conversions, mergers and divisions. Cross-border conversions (one company transfers its central office from one state to another). Cross-border mergers are also regulated by: - The European Company Statute (Se Statute) - Caselaw of the CJEU, protective scope of the freedom of establishment (Sevic) Mergers and consolidations pool the assets and liabilities of two or more corporations into a single corporation, which is either one of the combining entities (surviving company), or an entirely new company (emerging company). - Domestic merger: takes place between two companies in the same MS, regulated by Third Company law directive - Cross-border merger: takes place between companies in different MSs. Most jurisdictions require supermajority shareholder authorisation for a merger or consolida- tion. In the EU, CL directive sets a minimum approval requirement of at least two-thirds of the votes at the shareholders meeting. Merger constitute a fundamental change for merging companies, as the relationships among the participants in the firm can be revolutionised by a merger, e.g., shareholder’s ownership diluted, no antitakeover protections, … What happens to the minority of shareholders which opposes to the merger? CL protections. Mergers can so fundamentally realign the relationship among the firm participants. They exhibit the functional characteristics of fundamental trans- formations, e.g., a cross-border merger shifts the debtor from one company in Italy to another in Portugal. The relationship between the various pieces of secondary Community legislation, such as the relationship between the SE Statute and the Cross-Border Mergers Directive. Regulating cross-border mergers at EU level. The Cross-Border Mergers Directive will re- duce the costs of corporate restructuring through cross-border mergers and, as a result, will facilitate the exercise of the freedom of establishment by companies registered in these Member States. This facilitation of the exercise of the freedom of establishment should take place through the harmonised procedural framework which was introduced by the Cross- border Mergers Directive. This harmonised procedural framework constitutes the basis of market integration. Market integration in the area of cross-border mergers could lead to an ef- fective and liberalised EU corporate restructuring. As a matter of fact, the internal market could accrue benefits from this multi-faceted interaction between the secondary Community legislation and the ECJ’s case law. 57 3.6.1 The management-shareholder conflict in mergers. There are two principal conflicts that potentially arise between managers and shareholders: 1. managements’ self-interested refusal to agree to a merger that shareholders support (managerial entrenchment), and 2. self-interested attempts by management to build empires or to negotiate their future job status or compensation with an acquiring company at the expense of their share- holders (managerial nest-feathering). A managerial entrenchment is when managers resist a merger proposal which shareholders would like to accept. It is to distinguish whether the refusal is sincere or self-interested. Different systems address such conflict: in a board-centred system (board has lots of pow- ers, shareholders do not play a major role), managerial entrenchment is addressed through a combination of a trusteeship strategy (boards dominated by independent directors), a rewards strategy (incentive compensation for managers triggered by a change in control) and a deci- sion rights strategy (although a poison pill allows boards to say no to a merger, shareholders can vote in a new slate of directors). In shareholder-centric systems, an acquirer can shift the form of the transaction to a straight share acquisition (takeover). A managerial nest-feathering is the second manager-shareholder agency problem that arises if managers, in negotiating a merger agreement, put their own interests in building an empire through acquisitions or in securing employment with the surviving firm ahead of sharehold- ers’ interests in maximizing share value. Executive directors are involved in day-to-day deci- sions, whilst independent directors are not involved in the day-to-day management but super- vise the work of the other directors. The strategies adopted are similar: a. the shareholder approval requirement gives shareholders a means of challenging a merger driven by managerialism. Large block shareholders or coalitions of block holders, including of late hedge funds and institutional investors, will sometimes have the voting power to block corporate actions, especially when there is a clearly better alternative transaction proposed. b. To increase the efficiency of shareholder voting, many jurisdictions require approval by gatekeepers of the terms of mergers (a gatekeeper is an independent expert that counsels the company if the merger is profitable or not), consolidations and other or- ganic changes (a trusteeship strategy). EU law requires public companies which merge to commission independent experts’ reports on the substativ terms of mergers prior to their shareholder meetings (ref. Art.10, 11, 12 3rd CLD). c. Third way is to provide shareholders who disagree with exit rights (exit strategy or appraisal remedy). ECL gives the possibility to disagreeing shareholders to sell their shares and exit the company. Many US States limit appraisal rights by introducing a so-called “stock market exception” to their availability in corporate mergers. Share- holders do not receive appraisal rights if the merger consideration consists of stock in a widely-traded company rather than cash.24 As a result, appraisal rights are of little use to shareholders who wish to challenge the price they receive in stock mergers be- 24 appraisal rights ought to protect the liquidity rather than the value of the minority shares or the valuation pro- vided by the market, while imperfect, is unlikely to be systematically less accurate than that provided by a court. 60 Protection of creditors Employee information and consultation Pre-merger certificate Transmission of the pre-merger certificate Scrutiny of the legality of the cross-border merger Date on the effect of the merger Registration Consequences Simplified formalities Employee participation Independent experts Validity The new harmonised protection of shareholders in cross-border merger has three dimen- sions: 1. Art.126a(1) introduces the right of shareholders of the merging companies, who voted against the approval of the common draft-terms of the cross-border merger, to dispose of their shares for adequate cash compensation. This latter right is an exit right aim- ing at the protection of shareholders, who do not agree with the cross-border merger and want to exit the merging company. 2. According to Art.126a(4), dissenting shareholders who exercised the exit right of Art.126a(1), but who believe that the cash compensation offered to them by the merg- ing company is inadequate, are granted a right to claim for additional cash compen- sation. 3. Art.126a(6) empowers shareholders of the merging companies, who did not have or did not exercise the exit right of Art.126a(1), but who consider that the share ex- change ratio set out in the common draft terms of the cross-border merger is inade- quate, to challenge that share exchange ratio and to ask for a cash payment. All these three categories of rights adopted for the protection of shareholders are analysed in the section of the report of the administrative or management body for shareholders. The im- portance of these three rights is heightened by the fact that shareholders are not entitled to protect their interests by challenging the approval of the cross-border merger by the general meeting on the basis that the share exchange ratio or the cash compensation have been inade- quately set. This possibility to protect the interests of shareholders through such challenge of the decision of the general meeting approving the cross-border merger on the ground of inad- equate share exchange ratio or cash compensation is prohibited by Art.126(4)(a)-(b). A com- mon characteristic of these three dimensions of shareholders’ protection is that all of them re- sult in a form of monetary compensation. Protection of creditors in cross-border mergers. The old regime of Art.121 was established by the CJEU in KA Finanz, where the court held that the article is a reference to the relevant provisions on creditor protection in domestic mergers, which were harmonised for PBLL companies by Artt. 99-101 Directive 2017/1132. The introductory general provision of first subparagraph of Art.126b(1) obliging Member States to set up an adequate system of creditor protection is followed by more specific provi- sions of Art.126b on creditor provision. 61 These more specific provisions include: a) a solvency declaration of the administrative or management body of each of the merg- ing companies that accurately reflects its current financial status (Art.126b(2)) and b) an application for adequate safeguards by dissatisfied creditors (second subparagraph of Art.126b(1)). In parallel with these details of the common draft terms of cross-border merger, Member States have the possibility to ask the publication of a solvency declaration prepared by the administrative or management body of each of the merging companies, which “accurately re- flects its current financial status at a date no earlier than one month before the disclosure of that declaration. The declaration shall state that, on the basis of the information available to the administrative or management body of the merging companies at the date of that declara- tion, and after having made reasonable enquiries, that administrative or management body is unaware of any reason why the company resulting from the merger would be unable to meet its liabilities when those liabilities fall due” (Art.126b(2)). This is a possibility for Member States, which may choose not to ask for this solvency decla- ration. Art.126b(2) seeks to protect creditors from the insolvency risk of the resulting compa- ny, to which their claims are transferred after the cross-border merger. Moreover, dissatisfied creditors may apply for adequate safeguards (Art.12226). This mecha- nism is triggered by creditor’s initiative, who must initiate the process by submitting the ap- plication, which could be successful if the creditor would manage to prove that the prediction over the debtor’s ability to repay the debt upon maturity is worse than before the cross-border merger. 3.7.1 Addressing abusive or fraudulent conduct in cross-border mergers Art.127 on pre-merger certificate. The article further requires that the national competent au- thority must not issue the pre-merger certificate where it is determined in compliance with national law that a cross-border merger is set up for abusive or fraudulent purposes leading to or aimed at the evasion or circumvention of Union or national law, or for criminal purposes. The rationale of this provision is to alleviate concerns that cross-border mergers could be used for abusive purposes violating provisions of national law as well. Art.131 on consequences of a cross-border merger. i.e., the assets and liabilities of the merg- ing companies shall be transferred to the acquiring company; the members of the merging companies shall become members of the acquiring company; the merging company shall cease to exist. Art.134 on validity. A cross-border merger occurred according to Art.129 may not be de- clared null and void. 3.7.2 Cross-border mergers: a method of corporate restructuring at EU level Cross-border mergers are clearly a means of corporate restructuring. It has been argued that the rights of owners and other participants in any firm to choose the most appropriate legal 26 Art.122: […] apply, within three months of the disclosure of the common draft terms of the cross-border mer- ger referred to in Article 123, to the appropriate administrative or judicial authority for adequate safeguards, provided that such creditors can credibly demonstrate that, due to the cross-border merger, the satisfaction of their claims is at stake and that they have not obtained adequate safeguards from the merging companies. 62 framework, to place their investments within the most effective organisational structure, and to monitor closely the flow of the firm’s tangible and intangible assets in the internal market, constitute some of the key elements of business organisation at EU level. Art 49 TFEU should cover not only the freedom of a company to expand and to pursue its business activities on a Community-wide basis, but also the freedom of founders to set up and manage (i.e. reorganise and restructure if necessary) companies as described by Art 49 TFEU27. From the ECJ caselaw, refer to SEVIC, where the court found that cross-border mergers are a corporate restructuring activity covered by the freedom of establishment. SEVIC dealt with the issue of prohibition of cross-border mergers by the MS of one of the participating compa- nies, the ECJ stressed the importance of mergers as a method of corporate restructuring and as an exercise of the freedom of establishment, declaring that a merger such as the one at is- sue constituted an effective means of transforming companies (formerly, complex and cost- intensive structures had to be selected in order to achieve an economically comparable re- sult). Such mergers make it possible, within the framework of a single operation, to pursue a particular activity in new forms and without interruption, reducing time and costs of other forms of company consolidation (e.g., dissolution via liquidation and formation of new com- pany with transfer of assets). 3.7.3 Restrictions and Justifications The ECJ did not distinguish between inbound and outbound mergers; both categories of merger are covered by the freedom of establishment, though SEVIC involved an inbound merger. On the one hand, an inbound merger pertains to the setting up of a foreign secondary establishment by the domestic company that acquires the foreign company. On the other hand, an outbound merger includes the setting up of a domestic secondary establishment by the foreign acquiring company. 3.8 CROSS-BORDER DEMERGERS AND DIVISIONS Cross-border divisions were first harmonised by Directive 2019/2121, amending Directive 2017/1132 with Artt.160(a)-160(u) – cross-border divisions of limited liability companies. There are three methods of cross-border division: 1) Full division 2) Partial division 3) Division by separation Division means an operation whereby (1) a company being divided, on being dissolved with- out going into liquidation, transfers all its assets and liabilities to two or more recipient com- panies, in exchange for the issue to the members of the company being divided of securities or shares in the recipient companies and, if applicable, a cash payment not exceeding 10 % of the nominal value, or, in the absence of a nominal value, a cash payment not exceeding 10 % of the accounting par value of those securities or shares (full division). (2) a company being divided transfers part of its assets and liabilities to one or more recipient companies, in ex- 27 Freedom of establishment shall include the right […] to set up and manage undertakings, in particular compa- nies or firms […] 65 Art.728 of the directive defines the scope of the directive on disclosure. The nullity of companies is the starting point of company law at EU level, with Art.10 Di- rective 113229, claiming certain procedures have to be followed in the creation of a company, and a preventive control to be established in order to avoid nullity of a company. This may be performed by either a judge or a notary. - Germany and Austria: judge - Ireland and Spain: administrative authority, the business register or Registradores - Belgium, Netherlands, Luxembourg, Italy: notary that does it Such control does not exist in the USA, they are right because this system of control makes the process very slow, they had control but it made the process too long, too much time to control. In some MS there is a two-step control, in Germany, Austria and Spain for instance there is not only judicial and administrative control but a notarial instrument beforehand (in the US there is no preventive control as controls in general can be useful but slow down the process of incorporation – in international ranking indeed depends also on the speediness a company can be created, the real goal is to be allowed to create the company online). This rule is im- portant as it was the only rule on incorporation. This has changed with Directive 1151/2019 as now all MS are required to allow companies to be incorporated fully online (Art.13g30). The key problem is understanding the authenticity of the person doing so, in some MS an identification of the incorporation is required, but not all, France just needs a copy of identity documents and that’s it and it’s not clear whether its con- trol is administrative or judicial as the “graphier” which has to do with these papers. This principle is made available for the incorporation of all LLC but MS can decide to limit the procedure only to the company indicated to annex IIA which are the private LLC. Art.1431 is about disclosure, still related to the 1st company law directive, in principle infor- mation should be published in the business register and list the documents that need to be 28 Art.7 Directive 2017/1132: The coordination measures prescribed by this Section shall apply to the laws, reg- ulations and administrative provisions of the Member States relating to the types of company listed in Annex II. [company forms listed by Member State] 29 Art.10 Directive 2017/1132: In all Member States whose laws do not provide for preventive, administrative or judicial control, at the time of formation of a company, the instrument of constitution, the company statutes and any amendments to those documents shall be drawn up and certified in due legal form. 30 Art.13(g) Directive 2017/1132: 1. Member States shall ensure that the online formation of companies may be carried out fully online without the necessity for the applicants to appear in person before any authority or per- son or body mandated under national law to deal with any aspect of the online formation of companies, includ- ing drawing up the instrument of constitution of a company. However, Member States may decide not to pro- vide for online formation procedures for types of companies other than those listed in Annex IIA. 31 Art.14 Directive 2017/1132: Member States shall take the measures required to ensure compulsory disclosure by companies of at least the following documents and particulars: (a) the instrument of constitution, and the statutes if they are contained in a separate instrument; (b) any amendments to the instruments referred to in point (a), including any extension of the duration of the company; (d) the appointment, termination of office and particulars of the persons who either as a body constitut- ed pursuant to law or as members of any such body: (i) are authorised to represent the company in dealings with third parties and in legal proceed- ings; it shall be apparent from the disclosure whether the persons authorised to represent the company may do so alone or are required to act jointly; 66 published. Us company instead make it more difficult to get information about companies from the bylaws, in fact this is a very European approach, by improving the quality of the register it is easier to assess its value. (The directive “instrument of the constitution” is statute or bylaws) - know the things that should be listed. The accounting documents (f) are a key problem since many MS such as Germany and Denmark did not want to allow the publication of accounts of companies. All this info gives a good insight for parties entering into contact with another company. This is not the case if one enters into contact with a US company, they would have to ask self pro- vided info to the company. Reliability of information may differ, in some MS the level of trustworthiness is really high (Germany, Austria) and to a lesser extent in others (France, Italy, Belgium etc..). In order to accommodate these situations, the value associated to the information depends on national law but some EU wide principles are indicated in Art.1632 which states that the documents and information to be published may be relied on by the company against third parties, mean- ing that by publishing info in the register one can use it against a party. This rule in reality does not apply in all EU MS, in the UK there used not to be a high level of correctness of da- ta, the opposite happened, the company doesn’t have the right to use the information against the party, the third parties instead could invoke information against the company. In countries where the register is checked there is a double effect, i.e., the right of the compa- ny to rely on the disclosed information vis-a-vis third parties and the right of the company to invoke information vis-a-vis third parties (positive and negative disclosure). The directive doesn’t capture all nuances and doesn’t say that the third party has the right to rely on the in- (ii) take part in the administration, supervision or control of the company; (e) at least once a year, the amount of the capital subscribed, where the instrument of constitution or the statutes mention an authorised capital, unless any increase in the capital subscribed necessitates an amendment of the statutes; (f) the accounting documents for each financial year which are required to be published (h) the winding-up of the company; (i) any declaration of nullity of the company by the courts; (j) the appointment of liquidators, particulars concerning them, and their respective powers …; (k) any termination of a liquidation and, in Member States where striking off the register entails legal consequences, the fact of any such striking off. 32 Art.16 Directive 2017/1132: 1. In each Member State, a file shall be opened in a central, commercial or com- panies register (‘the register’), for each of the companies registered therein. Member States shall ensure that companies have a European unique identifier (‘EUID’) … allowing them to be unequivocally identified in communications between registers through the system of interconnection of registers. 3. Member States shall ensure that the disclosure of the documents and information referred to in Article 14 is effected by making them publicly available in the register. In addition, Member States may also require that some or all of those documents and information are published in a national gazette designated for that purpose, or by equally effective means. 4. […] Member States that require the publication of documents and information in a national gazette or on a central electronic platform shall take the necessary measures to avoid any discrepancy between what is disclosed in accordance with paragraph 3 and what is published in the gazette or on the platform. In cases of any discrep- ancies under this Article, the documents and information made available in the register shall prevail. 5. The documents and information referred to in Article 14 may be relied on by the company as against third parties only after they have been disclosed in accordance with paragraph 3 of this Article, unless the company proves that the third parties had knowledge thereof. Third parties may always rely on any documents and infor- mation in respect of which the disclosure formalities have not yet been completed, save where non-disclosure causes such documents or information to have no effect. 67 formation in the register and this is not written in the directive anywhere although it usually is in Italy. In Germany is thought that the directive is right since in case of an error in the register the risk of liability of obligations contracted by the company due to their name published in the business register, therefore only the way around, so the contrary of the general perspective in all other MS. The directive sounds compatible with this perspective, which is a big part of German scholar thought, until the adoption of Directive 2019/1151, there was a paragraph stating the possibility to rely on third-party information due to the existence of the gazette33. This is the key problem of disclosure. The 2019 modified directive also provides some inter- esting provisions regarding the use of digital tools to get access to this business register in- formation. 34 A problem when dealing with foreign companies is impossibility or difficulty to get access to a foreign business register, the directive tried to solve this by using a new tool: the BRIS (business register interconnection system), a channel to exchange information. Each national register should have a link to this channel, this however presents the danger that to live in a very organized country could lead to the inaccurate assumption that the same relia- bility and correctness is found in another register. An Austrian judge challenged account dis- closure as being company secrets. Art.17 – MS shall ensure that up-to-date information is made available Art.18 – electronic copies of the documents. MSs shall provide for appropriate penalties in case of failure to disclose accounting documents, there are countries that are still against that (Germany). Ex. Austrian court asking to ECJ whether accounting documents could be con- sidered as trade secrets? In the US it works in this way. Art.2835 - penalties 4.2 11TH COMPANY LAW DIRECTIVE On branches disclosure. Art.28(a)36 also in directive 2019 saw the possibility of incorporation of branches of private LLC online, to open a secondary office in another MS on can do it online and files some documents to the business register of the state where the branch will be 33 Art.17 Directive 2017/1132: 1. Member States shall ensure that up-to-date information is made available ex- plaining the provisions of national law pursuant to which third parties may rely on information and each type of document referred to in Article 14, in accordance with Article 16(3), (4) and (5). 34 Art.18 Directive 2017/1132: 1. Electronic copies of the documents and information referred to in Article 14 shall also be made publicly available through the system of interconnection of registers. Member States may al- so make available documents and information referred to in Article 14 for types of companies other than those listed in Annex II. 35 Art.28 Directive 2017/1132: Member States shall provide for appropriate penalties at least in the case of: (a) failure to disclose accounting documents as required by Article 14(f); (b) omission from commercial documents or from any company website of the compulsory particulars provided for in Article 26. 36 Art.28(a) Directive 2017/1132: 1. Member States shall ensure that the registration in a Member State of a branch of a company that is governed by the law of another Member State may be fully carried out online with- out the necessity for the applicants to appear in person before any authority or any person or body mandated un- der national law to deal with any aspect of the application for registration of branches 70 1) protection for creditors although the fact that a company has high share capital requirements doesn’t tell a lot about the financial status of the company, don’t know if the contribution is still there, as a general principle it is better to deal with a company with high share capital that one with low ones, but cannot be sure as you have to look at the accounts. The capital was considered a tool to protect creditors and to some extent this is something that we have already said when refer- ring to the second function of capitals (indirectly), but back then it was believed that the capi- tal was a real guarantee the company provided to creditors. when you see a company has a capital of 1’000000€, you may think that this company should own at least the same amount in assets (common mistake). This was the way of thinking in the fifties because until the en- actment of the 1st company law directive you did not have access to the balance sheet. Parties did not know what was written in the balance sheet, they could only rely on what was written in the bylaws. After the enactment of the 1st company law directive such function became ob- solete, as you finally had the chance to look at the financial situation of companies directly in the account of the company, discovering that the capital was just a number put in the balance sheet, worth less than nothing if the company has more debts than assets. There is however an exception to this rule, in some states with relevant losses it is necessary to recapitalise the company or to liquidate it (Italy and Greece, loss has to be higher than 30% of the capital; France and Spain, loss has to be higher than 50% of the capital). In some countries like Ger- many or Luxemburg, there is not a duty to recapitalise the company; in countries with strict rules, legal capital still plays a value, as in countries with capital of 100€ in Spain or in France, the net worth (equity) is at least 50€ (difference between assets and real liability of the company). The equity is divided in share capital and reserves (liabilities). Duty to recapitalise or liquidate the company when - Italy: loss is higher than 1/3 of the capital - France and Spain: loss higher than 50% of the share capital - Germany and Luxemburg: no duty to recapitalise the company, you can have a com- pany having more losses than assets continuing to operate To keep the accounts in balance, put 100 under A. In order to have balance need to add sth to the L side. You want all your assets to be considered as part of the capital. So you put 100€ of capital. But this arrangement is not strictly mandated. You may want to have just part of the capitals, say 10€. The 90€ in excess in this case represent a share premium, or if they’re the result of money that was earned during the life of the company they’re a reserve available for distribution. Difference btw this situation and the one with 100€ of capital? In principle, if you don’t put all the assets in the capital and create a separate item can distribute the 90€ but not the 10€ of capital. With 100€ cannot distribute anything. Say we distribute 40€ out of the 90€, the company will be poorer by 40€ —> less reserves for 40€. The capital in the end is the limit to the distribution of assets. The 10€ of capital in reality don’t exist, it’s just a num- ber. Assets Liabilities 100€ 10€ capital 90€ share premium/reserve for distribution 2) limitation of the companies to distribute dividends to shareholders 71 The limit being the liabilities. Moreover the company binds itself with the share capital, i.e., will not distribute those dividends to keep the value of the company. After a company is cre- ated with a capital of 10€ by contributing 10€, there won’t be the possibility of any distribu- tion of assets; after some years, you make 5€ thus the assets become 15€, the capital remains 10€ and in the liabilities there is a reserve of 5€. If these are the accounts, even if the value of the company is 15€, you can only distribute up to 5€, because the capital is the limit to the ability the company has to distribute dividends to shareholders. It creates a buffer in the inter- ests of creditors normally which limits the possibility of shareholders to take assets from the company itself. Items on the liability sides are fictitious elements, the duty and obligation that I have to give back 10€ is just fictitious, when the company will be liquidated they will have to be given back. If we create a company with 100€ the capital is 100€. Say you need to pay a lawyer who wants 5€. Need to put +5€ in the losses, so we have 105€ liabilities and 100€ of assets. Need to add an element as the company is losing money so far as L>A. Let’s say we have a good business. We make 20€ in the first year +20€ → 115€A. We delete the 5€ loss and in fact we’ll have 15€ that can be distributed to the shareholders. We can in this scenario give just up to 15€ to the shareholders while the company’s capital is now 115€ and 0 debt. Assets Liabilities 100€ 100€ +5€ = 15€ +5€ (available for distribution) 3) tool used to organise the voting of the company Rights are proportional to the capital (or to the shares which are proportional to the capital), e.g., holding 20% of the capital of a company implies holding 20% of the voting rights. Pro- portional ownership in the capital is the measure of the voting rights each person has in the company. The share capital is a limit that companies have to make distributions to the share- holders. Cannot distribute dividends if you have no positive net worth and if there are more assets than the capital. The second company law directive deals with the legal capital, mainly with: - Equal treatment - Scope, narrower than the 1st company law directive as limited to public limited liabil- ity companies - Disclosure - Minimum number of shareholders, a single member of a public limited liability com- pany does not imply the company does not exist - Capital and contributions (Centros case) - Distributions - Own shares, if a company buys own shares, it is giving back the contribution to the shareholders without actually buying anything - Capital increases/reductions, rules regarding distribution of dividends Scope. More limited than the 1st CLD, as it addresses only PBLL companies, as there couldn’t be found an agreement for the requirements of PRLL companies 72 Equal treatment of shareholders. There is a principle in the 2nd CLD that regards the fact that shareholders should be treated on equal terms. The laws of MSs shall ensure equal treatment of the shareholders who are in the same position of another, although there are al- ways differences, for time place nationality shares etc. the question is if the provision is to be interpreted narrowly or broadly? In Audiolux the ECJ gave a narrow interpretation, affirming that majority and minority shareholders are not in the same position. Disclosure. Rules regarding the disclosure are available already in the 1st CL Directive, the 2nd CL Directive requires companies to provide additional information, incorporated in the statutes or other instruments (Art.338). The rules regard the harmonisation of the contents of bylaws, of memorandums of association or the articles of incorporation of the statutes that according to the 1st CLD need to be published and made available in the public register. The information to be disclosed, i.e., to be put in the incorporation instrument and statutes of the PBLL companies are: - Type, there are fixed legal forms of companies, NL being the only exception with some atypical forms; - Name, to avoid the ground of nullity of a company - Object of the company, activity that the company agrees to undertake when being in- corporated, in some MSs have to be very specific, a change may result in big conse- quences, in UK the definition can be broader (e.g., “any legal activities”, unrestricted object clause is possible). - Subscribed capital of the company, when a company is created, contributions are made which are turned into capital, need to understand how the balance sheet is struc- tured. - Rules governing corporate bodies or who may represent the companies 38 Art.3 2nd CLD: The following information at least must appear in either the statutes or the instrument of in- corporation or a separate document published in accordance with the procedure laid down in the laws of each Member State in accordance with Article 3 of Directive 2009/101/EC: (a) the registered office; (b) the nominal value of the shares subscribed and, at least once a year, the number thereof; (c) the number of shares subscribed without stating the nominal value, where such shares may be issued under national law; (d) the special conditions, if any, limiting the transfer of shares; (e) where there are several classes of shares, the information referred to in points (b), (c) and (d) for each class and the rights attaching to the shares of each class; (f) whether the shares are registered or bearer, where national law provides for both types, and any provisions relating to the conversion of such shares unless the procedure is laid down by law; (g) the amount of the subscribed capital paid up at the time the company is incorporated or is authorised to commence business; (h) the nominal value of the shares or, where there is no nominal value, the number of shares issued for a con- sideration other than in cash, together with the nature of the consideration and the name of the person providing that consideration; (i) the identity of the natural or legal persons or companies or firms by whom or in whose name the statutes or the instrument of incorporation, or where the company was not formed at the same time, the drafts of those doc- uments, have been signed; (j) the total amount, or at least an estimate, of all the costs payable by the company or chargeable to it by reason of its formation and, where appropriate, before the company is authorised to commence business; and (k) any special advantage granted, at the time the company is formed or up to the time it receives authorisation to commence business, to anyone who has taken part in the formation of the company or in transactions leading to the grant of such authorisation. 75 Capital and contributions. The minimum capital requirement in the EU for public limited liability company is 25000€ (Art.4540), whilst for private ones there is no minimum requirement. It is a minimum standard, which MSs can increase, e.g., Italy is 50000, although some countries are not that compliant, e.g., Romania and Poland. Art.4641 – assets that can contribute in the company What assets can we contribute in the company? All those capable of economic assessment, i.e., according to a set of accounting principles: IFRS (International Financial Reporting Standard), GAAPs (General Accepted Accounting Practices, these are national). Some assets are considered assets according the IFRS but not according to the GAAPs of a national sys- tem. There may be assets whose nature is disputed, e.g., knowhows, goodwill = refers to all the in- tangible elements that can be gotten from the life of a company. IFRS more lenient than na- tional GAAPs that tend to be more conservative. In any case, work or supply services may not form part of the assets, i.e., cannot work for the PBLL companies and receive shares. Art.4742 – shares may not be issued at a price lower than their nominal value. In some MSs, the accountable par is considered a synonym of the nominal value, and to issue shares with a nominal value or with an accountable par doesn’t make much difference. Art.4843 – paid-up capital States that when you make a contribution into the company it should be paid at least for 25% of the nominal value of shares you’re receiving. The only exception being that if a contribu- tion is made not in cash, it must be paid in its entirety either immediately or within 5 years; the cash being the currency that has legal tender where the contribution has been signed. for a contribution in kind, an expert evaluation is needed, as normally contribution in kind are property assets, cars, object etc but a single person cannot evaluate the value. Art.4944 – consideration other than in cash 40 Art.45 1. The laws of the Member States shall require that, in order that a company may be incorporated or obtain au- thorisation to commence business, a minimum capital shall be subscribed the amount of which shall be not less than EUR 25 000. 41 Art.46 Subscribed capital may be formed only of assets capable of economic assessment. However, an undertaking to perform work or supply services may not form part of those assets. 42 Art.47 Shares may not be issued at a price lower than their nominal value, or, where there is no nominal value, their accountable par 43 Art.48 Shares issued for a consideration must be paid up at the time the company is incorporated or is authorised to commence business at not less than 25 % of their nominal value or, in the absence of a nominal value, their accountable par. However, where shares are issued for a consideration other than in cash at the time the com- pany is incorporated or is authorised to commence business, the consideration must be transferred in full within five years of that time. 44 Art.49 1. A report on any consideration other than in cash shall be drawn up before the company is incorporated or is authorised to commence business, by one or more independent experts appointed or approved by an administrative or judicial authority. Such experts may be natural persons as well as legal persons and compa- nies or firms under the laws of each Member State. 76 to avoid overvaluation of assets, you need to prepare an official evaluation of the asset you’re contributing, in the interest of avoiding an over evaluation of the assets but also for the bene- fit of the creditors. When making a contribution other than in cash need to prepare a report, made by an independent expert appointed or approved by an administrative or judicial au- thority. This expert evaluation comprises consideration of the methods of valuation used and certifies that the value of the contribution is equal at least to the value of the capital plus eventually the share premium (extra value of a share in relation to its value when it was is- sued) attached to the contribution itself. Art.5045 – exception How to make rules on capital softer? Introduction of rules that make easier the evaluation of assets if the assets have a market value that does not require the intervention of an expert. Art.5246 – time limit of 2 years To avoid evaluation of contribution in kind: make contribution in cash, then company buys from you some assets and pays it a lot of money, so that receive money back and the compa- ny gets the asset. In order to avoid this easy circumvention of the rules, during transactions there are the same procedures as those to make a contribution in kind. Shareholders may not be released from the obligation to pay up their contributions. Art.53 – obligation to pay up contributions subject to the provisions relating to the reduction of subscribed capital, the shareholders may not be released from the obligation to pay up their contributions. Art.5447 – same safeguards in case of a conversion into a PBLL company rules on the evaluation of assets in kind are also applicable when making a conversion into public liability company, as only those are subject to the Second Directive which requires an expert evaluation on capital. This rule is generally applied in the EU, but in Italy if a conver- sion of a company from private to public there is no need of an expert report, as traditionally in Italy those were subject to the same rules on capital. The legality of this practice is due use and in the majority of MSs the expert evaluation is needed every time. Distributions. When are distributions allowed in PBLL companies? The EU adopts the enhanced balance sheet test, which allows the distribution of dividends if the balance sheet would make them possible, i.e., when there are more assets than liabilities. Governed by the provision of Art.5648 Directive 1132/2017, : if I have a balance sheet, 100€ assets and 45 Art.50 1. Member States may decide not to apply Article 49(1), (2) and (3) [of this Directive] 46 Art.52 1. If, before the expiry of a time limit laid down by national law of at least two years from the time the company is incorporated or is authorised to commence business, the company acquires any asset belonging to a person or company or firm referred to in point (i) of Article 4 for a consideration of not less than one-tenth of the subscribed capital, the acquisition shall be examined and details of it published in the manner provided for in Article 49(1), (2) and (3) and it shall be submitted for the approval of the general meeting […] 47 Art.54 Pending coordination of national laws at a subsequent date, Member States shall adopt the measures necessary to require provision of at least the same safeguards as are laid down in Articles 3 to 6 and in Articles 45 to 53 in the event of the conversion of another type of company into a public limited liability company. 48 Art.56 - General rules on distribution. 77 50€ liabilities, the sheet is unbalanced, need at least another item under liabilities as you should be able to cover the legal capital, which could be a reserve available for distribution (thus may be an amount of profits made over the years during the activities of the company). 50€ of available reserve. If this rule applies we can arrange distribution only if after distrib- uting the amount we want to distribute there is a loss in the account. If we distribute our available reserve of 50€ and give money to the shareholders, we end up with 50€ assets and 50€ liabilities. If we distributed 1 more the result would have been 49€ A and 51€L, the loss of 1€ is because this is due to the company’s aim of distributing available reserves among shareholders. This approach is traditionally similar to common law countries, solvency test, which tries to predict if the company would go in insolvency a specific timeframe (12 months) after a specific distribution, i.e., directors can make distributions if are sure they wont go in insolvency in an year. Art. 56(3) The amount of a distribution to shareholders may not exceed the amount of the profits at the end of the last financial year plus any profits brought forward and sums drawn from reserves available for this purpose, less any losses brough forward and sums placed to reserve in accordance with the law or the statutes. What if a reserve is not available for distribution? When this happens need to create a specific reserve (own’s share reserve). If we have 110 assets and 50+50+10 liabilities it’d be possi- ble to distribute up to 10€ for the company because this is the amount of reserve that is avail- able for distribution. Another question: what is a loss? To what extent should a distribution take into account the losses of a company? Different approaches in civil law and common law countries. Take for example a start-up with 50 assets and 50 liabilities, it tends to incur in losses at the beginning of its activities, e.g., after 1 year of operation loss of 5€ of capital (45 assets and 50 -5 liabilities). After the 2nd year it keeps on losing money, but investors trust the project and there is a loss of 10 (40 assets and 50 - 10 liabilities). Now our company starts making money, and it makes on the 3rd year of activity a profit of 5€ (45€ assets and 50 -5 li- abilities – profit reflected in liabilities). It may be a profit available for distribution or not, de- pending on the country. Looking at Art.56 Directive 17/1132 this profit is not available for distribution, as it takes a civil law approach. Need to take into account all the previous losses, all the previous profits, and calculate the potential surplus taking into account all the account- ing periods. This rule, named asset balanced sheet test (Assets > liabilities + legal capital), comes from the German tradition, affirming that dividends can be distributed only as long as there are more assets than liabilities. How much is the worth of the company with 45€ assets and 50-5€ liabilities? 45€ w/out capability of distributing shares. Need to take into account the share capital and the all the other reserves that can’t be distributed to the shareholders that may exist in the balance sheet. A legal reserve is the archetype of non-distributable assets, it is a buffer created in accounts by setting aside a small portion of the profits made. Say we’ve made 100€ of profit: 150€ assets and 50 + 100 liabilities, 5% will be set aside into the legal reserve that is not available for distribution; it is a buffer to prevent future losses that (1) Except for cases of reductions of subscribed capital, no distribution to shareholders may be made when on the closing date of the last financial year the net assets as set out in the company's annual accounts are or, following such a distribution, would become, lower than the amount of the subscribed capital plus those reserves which may not be distributed under the law or the statutes of the company […] 80 It is difficult for a company to subscribe shares when the company is created in the incorpora- tion phase. This subscription of shares is a problem that is more relevant when there is a capi- tal increase. E.g., issuing an equal amount of shares to increase capital, A 100€ and L 100€, for 100 new shares of the value of 1€, the capital doubles. We offer the shares not to share- holders, but to the company itself, A 100€ and L 200€; the company subscribes these shares, pays 100€ to itself, and in addition it has 100 shares and the value of the company is 100€ still. We double the capital and give the impression of increasing the value of the company, but no increase in value actually because shares are pieces of paper. Thus, 2nd CLD prohibits this practice of subscription of own shares to prevent scams. Are other transactions with own shares possible? Even if the subscription of own shares is prohibited, other transactions are allowed: acquisition of own shares of the company not by the company itself but by share- holders. Here reference to the principle of equal treatment. Should offer the same possibilities to all investors. In order to do this since it creates issues both for governance and integrity of share capital need to follow some rules. Capital increases. Transactions whereby new shares (thus voting rights) are created in order to get new assets. If there are no pre-emption rights (as in the USA), the sharehold- ers' participation could be diluted. Capital increases may be: - new contributions = real increases – assets entering into the company (actual contri- bution in cash); - nominal increase of the shared capital = it takes place without making the company richer after the transaction, possibly through the reserves the company owns if it has some; reorganization in the liability side of the balance sheet from the reserve to the capital, which of course cannot be distributed to the shareholders. When dealing with these transactions, some reserves are not available for nominal capital in- creases. The available ones are those that can be used for distribution of dividends after mak- ing profits, while the reserves that cannot be distributed are of three kinds: 1. legal reserve = small part of the profit part set outside for bad times (usually a 5% of profit that could help overcome losses in bad accounting times) – formed ac- cording to national rules (usually until the reserve reaches 10/20% of the capital) – since it’s not available for distribution, in some MSs (e.g., Italy) it cannot be used to increase capital 2. share premium, which in many MSs is not a reserve in strict sense, because it’s there to tell if the business is generating money or not, and therefore whether it can be distributed or not – the possibility to use it for capital increase depends on the MS 3. own shares reserve = reorganisation in the liability side of the balance sheet when there are own shares – recorded it in a traditional way according to the di- rective – generally it cannot be used as capital increase since it represents a num- ber that doesn’t have value for the company 52 Art.64 1. where MSs permit a company to, either directly or indirectly, advance funds or make loans or provide se- curity, with a view to the acquisition of its shares by a third party, they shall make such transactions subject to the conditions set out in paragraphs 2 to 5 81 The capital increase is, in the end, a fixed number found in the bylaw and accounts. It can be changed by taking a decision to modify the bylaws, which is competence of the general meet- ing. According to Art.6853, the general meeting may empower the board of directors to in- crease the capital in their own. This can be done for a maximum period of 5 years (renewa- ble). This power is important for big companies since in order to get more resources, it is far easier to have the board of directors to decide the capital increase, as it takes a lot to organise a general meeting. The directive seems more focused on new contributions, but nothing pro- hibits nominal capital increase. The general meeting does not lose power to make the capital increase, but it has concurrent power with the board of directors. Usually in companies with few shareholders capital increases are quick transactions, with the subscription of new shares done at the same time the increase is decided. When there are many shareholders this procedure requires several days or weeks due to the slow process of decisions, made of: - decision of the capital increase - offer of the shares - possible withdrawals of subscriptions - … In the directive Art.7154 (default rule) states that when in capital increases a new contribution is subscribed only in part, the company doesn’t have an interest in getting just that part of the contribution as, unless decided otherwise by the general meeting, a partial subscription would leave the increase without effect. These contributions may be recorded in a reserve so-called future capital increase, that will be turned into capital once it gains full effect (otherwise it will go back to the subscribers). Lately they have invented ways to increase capital with subscriptions progressing day by day, in order to push subscribers to get the shares earlier. Art. 7255 – pre-emption rights 53 Art. 68 1. Any increase in capital must be decided upon by the general meeting. Both that decision and the increase in the subscribed capital shall be published in the manner laid down by the laws of each Member State, in ac- cordance with Article 16. 2. Nevertheless, the statutes or instrument of incorporation or the general meeting, the decision of which must be published in accordance with the rules referred to in paragraph 1, may authorise an increase in the sub- scribed capital up to a maximum amount which they shall fix with due regard for any maximum amount provided for by law. Where appropriate, the increase in the subscribed capital shall be decided on within the limits of the amount fixed by the company body empowered to do so. The power of such body in this respect shall be for a maximum period of five years and may be renewed one or more times by the general meeting, each time for a period not exceeding five years. 3. Where there are several classes of shares, the decision by the general meeting concerning the increase in capi- tal referred to in paragraph 1 or the authorisation to increase the capital referred to in paragraph 2 shall be sub- ject to a separate vote at least for each class of shareholder whose rights are affected by the transaction. 4. This Article shall apply to the issue of all securities which are convertible into shares or which carry the right to subscribe for shares, but not to the conversion of such securities, nor to the exercise of the right to subscribe. 54 Art.71 Where an increase in capital is not fully subscribed, the capital will be increased by the amount of the subscriptions received only if the conditions of the issue so provide. 55 Art.72 82 The pre-emptive right is applicable only once, meaning that the shares should be offered one time to the shareholders for a measure proportional to their share participation to the compa- ny. Many MSs (ex. Italy) provide for a second round for the shares which were not sold. In Lux- embourg this possibility is not mandated by law, but the second round can be decided by the general meeting. The directive doesn’t require the double round; in the states that use them the second round may be introduced in the bylaws or in the decisions of the general meeting. The pre-emption right is mandatory, but not completely unavoidable. In Delaware there are no pre-emption rights. In New York it as only a default rule. Even in Europe in some specific cases it can be excluded by the general meeting or board of directors (mostly in or- der to get profit). Occasional exemptions of the pre-emption rights. An important element of the pre- emption right is also the time given to the shareholder to exercise it. According to the Di- rective MSs should provide at least 14 days to the current shareholders to do it = minimum amount of time given so that they can acquire the resources. This is considered a quite long period of time especially considering that we are talking about companies listed in the stock exchange so in the different MS we have different ways to face this issue - In Germany and Italy to some extent companies may have a capital increase with the exemption of pre-emption rights if the shares are offered for a specific price, this is obviously a violation of the directive - In France we have a blatant violation of the directive, indeed only five days are given to the shareholders to exercise their right Initially in Italy this period was of 30 days, then reduced to 15 and finally to 14 in conformity with the Directive But what are the reasons for the exclusion of pre-emptive rights? 1. whenever the capital is increased by consideration in cash, shares must be offered on a pre-emptive ba- sis to shareholders in proportion to the capital represented by their shares 2. the laws of a Member State: (a) need not apply paragraph 1 to shares which carry a limited right to participate in distributions within the meaning of Article 56 and/or in the company's assets in the event of liquidation; or (b) may permit, where the subscribed capital of a company having several classes of shares carrying different rights with regard to voting, or participation in distributions within the meaning of Article 56 or in assets in the event of liquidation, is increased by issuing new shares in only one of these classes, the right of pre-emption of shareholders of the other classes to be exercised only after the exercise of that right by the shareholders of the class in which the new shares are being issued. 3. Any offer of subscription on a pre-emptive basis and the period within which that right must be exercised shall be published […] The right of pre-emption must be exercised within a period which shall not be less than 14 days from the date of publication of the offer or from the date of dispatch of the letters to the shareholders. 4. The right of pre-emption may not be restricted or withdrawn by the statutes or instrument of incorpo- ration. This may, however, be done by decision of the general meeting. The administrative or management body shall be required to present to such a meeting a written report indicating the reasons for restriction or withdrawal of the right of pre-emption, and justifying the proposed issue price. The general meeting shall act in accordance with the rules for a quorum and a majority laid down in Article 83. 5. The laws of a Member State may provide that the statutes, the instrument of incorporation or the general meeting, acting in accordance with the rules for a quorum, a majority and publication set out in paragraph 4, may give the power to restrict or withdraw the right of pre-emption to the company body which is em- powered to decide on an increase in subscribed capital within the limit of the authorised capital. That power may not be granted for a longer period than the power for which provision is made in Article 68(2). 85 tributed to the shareholders. Capital can also be reduced and the money deriving from the re- duction may not be distributed but go into the reserve. In both these situations the creditors may be damaged and put at a disadvantage because the company is poorer or the distribution of dividends becomes easier (in the second case), so some rules were issued in order to provide protection for creditors 2. Nominal Capital Reductions (Reductions in Cases of Losses) So, for example if a company has 180$ of cash, 200$ of capital and 20$ of losses, in this case can you use the capital to the loss reconcile the current situation? Yes, you can reduce the capital, so by reducing the capital from 200$ to 180$ you delete the loss. This is not very dangerous for creditors because the money is gone, the shareholders are not richer and alt- hough the possibility of distribution of dividends gets easier (which may be dangerous for creditors) it depends on how well will the company do the next accounting year. These types of transactions don’t make the shareholders richer therefore they are not considered harmful for the creditors so MSs are not obliged to apply the same safeguards that they must apply in the Real Capital Reductions. The Real Capital Reductions has some points in common with two other transactions we’ve already dealt with the Distribution of Dividends and the Acquisition of Own Shares = all three are ways to make the shareholders richer at the expenses of the company, although gov- erned by different provisions they all lead to the same practical result. Art.7356 – reductions in subscribed capital At EU level, need of a notice calling the general meeting to decide such reduction. Compe- tence is on the general meeting, as normally happens in case of modification of the bylaws, in reality this is not a general competence given to the general meeting. it is something that can implicitly derive from the provisions, but it is not a principle explicitly mentioned by the di- rective When proposing the decision to reduce the share capital, a notice must be prepared specifying the purpose of the reduction and the way in which the reduction should be carried out. In principle, specification should be made when making a reduction to the distribution of as- sets of the shareholders or in case of a reduction to offset losses. This procedure is required more in the case of the real reduction of capital (with distribution of dividends) Ex. Italian law requires specification only in the first case and not in the second one, so Ital- ian law not completely compliant with second company law directive which does not make difference on this point. 56 Art.73 Any reduction in the subscribed capital, except under a court order, shall be subject at least to a decision of the general meeting acting in accordance with the rules for a quorum and a majority laid down in Article 83 without prejudice to Articles 79 and 80. Such decision shall be published in the manner laid down by the laws of each Member State in accordance with Article 16. The notice convening the meeting must specify at least the purpose of the reduction and the way in which it is to be carried out. 86 Purpose of the reduction: if it is to offset losses, justification is in itself; if it is for the distri- bution of dividends you need to specify why the company doesn’t need the money anymore or why lowering the threshold etc. The method to carry out the reduction (must be indicated in the notice as well) The real capital reduction may be carried out in different ways: 1. Give back the money to the shareholders 2. Create a reserve that becomes available for distribution (but that is not immediately distributed) 3. When you make a contribution in cash you are required to pay just to 25% of the shares you receive and for the balance (75%) the company has a credit against the shareholders = decreasing the debt shareholders have towards the company There is a prohibition for the company to renounce to contribution that should be paid unless you carry out this procedure for the capital reduction. How are creditors protected? There are several ways depending on the MSs. A way to ensure protection of creditors may be found in Second Company Law Directive = archetype of pro- tection was articulated in this directive Art.7557 – protection of creditors in capital reduction What should the creditor prove in order to obtain security? They should demonstrate that due to the reduction the satisfaction of their claims is at risk + that they did not receive adequate guarantees for the satisfaction of their credits vis a vis the company Similar to EGI decision = there we have that antedate the publication of the merger draft (document starting the entire transactions). In divisions and mergers creditors that antedate the publication of the merger draft should be protected, not those that antedate the decision to approve the merger draft. Art. 75 on the other hand refers to the creditor antedating the publi- cation of the decision Shall at least have the right to obtain security for claims which have not fallen due by the date of that publication → different perspective in MSs, in some creditors can oppose the transaction and then transaction is blocked, in some other countries this is not possible and creditors have just the right to het some security. This is more evident in mergers and divi- sions, the new approach adopted for creditors’ protection in this case would not block the transaction, as is stipulated in the German law (adoption of German approach) For the capital reduction this is less clear 57 Art.75 1. In the event of a reduction in the subscribed capital, at least the creditors whose claims antedate the publication of the decision on the reduction shall at least have the right to obtain security for claims which have not fallen due by the date of that publication. Member States may not set aside such a right un- less the creditor has adequate safeguards, or unless such safeguards are not necessary having regard to the assets of the company. 2. The laws of the Member States shall also stipulate at least that the reduction shall be void, or that no payment may be made for the benefit of the shareholders, until the creditors have obtained satisfaction or a court has decided that their application should not be acceded to. 3. This Article shall apply where the reduction in the subscribed capital is brought about by the total or partial waiving of the payment of the balance of the shareholders' contributions. 87 Art. 75(2) → highlights that the approach we have in southern Europe is more consistent with the directive = laws of MSs shall provide that at least the reduction should be void or that no payment may be made until the creditor has received satisfaction or the court has decided that guarantees must be provided MSs should really have rules that in case of capital reductions, do not allow the actual distri- bution of assets to the shareholders until a judge had the opportunity to take a decision. Do creditors have real power to block transactions? Depends on how fact the judgement is going to be (in Italy for sure transaction will be blocked). Provisions should be interpreted for what they say and for how they have been evolving overtime. Now the idea is more that it is no completely true that there is possibility to completely block the transaction, what you’re entitled to is the right to obtain securities. Capital reduction in case of losses. Art.7658 – reduction in case of losses Art.7759 – minimum level of decrease It is not allowed to decrease the capital below the minimum legal requirement provided in a given MSs (at least 25.000 euros). It is possible, however, to reduce the share capital below the threshold if you immediately re-increase the capital (coup d’ accordion = mossa della fisarmonica). This is only circumstance in which public limited liability company would go below the threshold Ex. you have a company 100 euros of a real estate in Trento, if capital = 100 euro you cannot make a distribution of dividends. If there is a loss of 100 euro, the entire capital lost = use the coup of accordion: reduce capital to 0, loss goes to 0. Increase the capital again and with new contributions you bring back the capital to 100, now we have a company that can carry out new transactions. Why are we doing it? 100 euro we had before were not cash, they were a real estate in Trento (can be very costly), according to national accounting principles, you record assets at their historical value (= price you paid years ago to buy the property) = makes sense to recapitalize the company Luxemburg and Germany they have a plethora of companies with negative net-worth, be- cause they bought assets years ago, never re-evaluated = if you have a negative net-worth it does not matter because still you have assets allowing you to pay the debts you have Ex. Asset recorded at 100 euros and Debts at 200 euros 58 Art.76 1. Member States need not apply Article 75 to a reduction in the subscribed capital the purpose of which is to offset losses incurred or to include sums of money in a reserve provided that, following that operation, the amount of such reserve is not more than 10 % of the reduced subscribed capital. Except in the event of a reduc- tion in the subscribed capital, that reserve may not be distributed to shareholders; it may be used only for offset- ting losses incurred or for increasing the subscribed capital by the capitalisation of such reserve, in so far as the Member States permit such an operation. 59 Art.77 The subscribed capital may not be reduced to an amount less than the minimum capital laid down in ac- cordance with Article 45. However, Member States may permit such a reduction if they also provide that the decision to reduce the subscribed capital may take effect only when the subscribed capital is increased to an amount at least equal to the prescribed minimum. 90 is to protect share capital from the beginning (rule that derives from German tradition, there to protect the share capital). Moreover, any special advantages granted to anyone as part of the company’s formation costs. With regards to controls that need to be carried out in the formation of a company, there is a directive on the digitalisation of CL, i.e., can create companies online. The clause is that the instrument of incorporation, other company statutes, and any amendments, must be prepared and certified in due legal form (pursuant to the laws of the RO Member State) unless RO Member State’s laws provide for a preventative review at the time of formation/amendment. Once prepared and executed, an extract of the company’s instrument of incorporation and statutes must be filed in order to register the company in the RO Member State’s commercial register.Once the RO Member State has verified the filing as legally compliant, the compa- ny’s registration is frequently published in the national gazette. In the EU emphasis on business registers, thus in the vast majority of MSs PBLL companies acquire legal personality only when entered into legal resister (exception Luxemburg and NDL – sign before a notary). All companies may be searched in business registers. Rules on capital requirements. PRLL companies don’t have harmonisation of min capital requirement (e.g., Centros company formed for one pound and then operating in an- other state). The 2nd CLD requires 25,000€ in minimum subscribed capital at the time of incorporation, but some MSs require more. - Belgium: 61,500€ - France: 37,000€ - Germany: 50,000€ - Italy: 50,000€ - Luxembourg: 30,000€ - Netherlands: 45,000€ - Poland: zł100,000 (about 24,000€) - Spain: 60,000€ - UK £50,000 (about 60,000€) The fact that the capital is subscribed, doesn’t mean the company has received the money, as according to 2nd CLD, only 25% of the nominal value of the subscribed shares have to be paid up at incorporation. Shareholders may not be relieved of their obligation to pay up all subscribed shares, unless capital reduction rules are followed. The contribution in kind shall be fully paid in 5 years, and only “assets capable of economic assessment” can be used to ay up shares. An important aspect is the rules governing contribution in kind, as need an expert report to avoid an overevaluation of the assets. Pre-incorporation transactions/expenses. E.g., legal, notarial, and accounting ex- penses; registration fees; facility lease; supply chain arrangements; employment contracts. Must be assumed or ratified by the new company for it to be bound. If not assumed, persons acting on behalf of the to-be-incorporated company are jointly and severally liable, unless otherwise agreed. 91 PRLL companies. The formation procedure is substantially similar to PBLL companies be- cause 1st CLD applies even though 2nd CLD doesn’t. - Similar instruments of incorporation and statutes - Member State notarial act requirements apply - Registration is required, but rules on how and when formation and registration is ac- complished can vary by Member State - Pre-incorporation liability rules apply an important difference concerns the possibility to restrict formation of single member private companies. E.g., Single member company not allowed to form other single member compa- nies, or single member is directly liable for single member private company’s obligations (lifts limited liability protection). There is a specific directive on single member companies, nothing in EU law prevents MSs from requiring to have 2+ shareholders in PBLL companies; although require to have a form for single member PRLL companies. this possibility doesn’t mean the rules are the same for 2+ PRLL companies, e.g., for single members the states may require full contribution of the subscribed amount. There is no harmonisation for capital requirement, debate on regulatory competition for PRLL companies, or debate on multiple voting shares. The competition among MSs for com- pany registrations encourages “informal” harmonisation, although each MSs introduced its own simplified forms, with many policy in common and a success if the only goal was to make minimum capital requirement. - UK PRLL company registrations exploded after Centros - Germany revised its requirements for informal harmonisation With regard to contribution in kind, the rules for the expert evaluation are in the 2nd CLD, therefore not applicable. However, many MSs apply similar rules to PRLL companies (e.g., in Italy very similar, in Luxemburg very different). Management and Control. They tried many times to harmonize the structure of pub- lic and private limited liability companies but never succeeded. UK was not a member of the community at first, so the German system was adopted (two tier structure), when UK joined the EU, they tried to find compromise because they did not want that system = compromise in the 5th CLD never adopted. Main compromise: allowing companies to have either a German or UK approach (general meeting appointing the board of director and audit committee within the board of directors) Creation of the supranational legal entities (European company and European coopera- tive). Even if harmonization of management and control was a total failure, they had to invent something = idea of the 5th CLD was considered again, so with the European company and cooperative it is possible to adopt either German/UK method (one-tier/two-tier board struc- ture). Method in UK is more or less the one of France (general meeting appointing the board and the PDG = President Director General), same also in Italy where board of directors appointed by general meeting. In both we have a monitoring corporate body, different from UK where they are created inside the board of directors 92 - France Commercaire au conts = carrying out controls on accounts 60s France decision of allowing parties to decide whether they wanted a one-tier or two-tier structure, so now it is possible to pick one of the two - Italy Board of auditors = appointed by general meeting and charged with accounting controls (collegio sindacale, today it also has some other functions) Harmonization still has not occurred on governance of companies 9th Company Law Directive. Germany wanted to organize a directive for groups of compa- nies, idea was that in Germany and Brazil there is legislation on groups of companies (man- aging relations between companies belonging to the same group). They wanted to bring this at EU level with the 9th CLD. Main German idea was that in some cases the interest of the group may prevail over the interest of the company. In UK this does not make sense = each company is independent, and distinctions are not made for companies belonging to a group, with UK joining the EU this directive was not adopted At EU level it never materialized, no legislation on groups More recently expert groups of the commission where favourable in disclosing the structure of groups in business register, communicating internal relations and providing for a diagram, yet this would be impossible to implement without harmonization (some countries in com- mon law have no legislation dealing with groups!) No harmonized framework - Failed approach of the 5th CLD - Optional approach was adopted for EU business organizations in particular for the SE and SCE (choosing between UK and German structure) o Dualism one-tier/two-tier Idea that was later used also at national level (first was France in Italy there is the possibility to choose between 3 structures: English, Italian and German, Portugal, Netherlands). In some other no possibility to choose (UK before Brexit, Germany, where only possibility to adopt a different approach through establishing a European company). European legal entities used also to take advantage of board structures not allowed in national systems. Luxemburg is very flexible as well allowing for both the models. Board of Directors. Normally directors have 2 main duties 1. Duty of care = duty to behave correctly, trying to maximize the value of the shares, be a good manager 2. Duty of loyalty = not acting in conflict of interest Normally in order to see whether a director is liable courts are very lenient in checking whether there is a violation of duty of care and stricter in case of conflict of interest. Portfolio theory = I invest 1 euro in each of your companies, if 20% goes bankrupt, does not matter if the remaining 80% is going very well. It is far better to have such an outcome than to have the 100% going bad.