The Commission's Company Law Package: overview and critical view of the proposal for cross border transactions

The much awaited Company Law Package was finally published by the European Commission on April 25. It aims to establish “simpler and less burdensome rules for companies”  regarding incorporation and cross border transactions and consists of two proposals.

Proposal 2018/0113  intends to promote the use of digital tools and procedures in company law. Member States will need to allow a fully online procedure for the registration of new companies and of branches of other companies, that permits the incorporation without the physical presence of the members before any public authority. To avoid fraud and abuse the proposal “sets safeguards against fraud and abuse such as mandatory identification control, rules on disqualified directors and a possibility for Member States to require the involvement of a person or body in the process, such as notaries or lawyers”. The proposal also establishes the need to offer free access to the most relevant information of companies in the Companies Registers. This proposal will require important changes in national legislations and its implementation will be a technological challenge for the Member States that want to preserve the present level of control in the incorporation of companies. The question of online identification will undoubtedly be of special interest and complexity.

This first proposal certainly deserves more detailed examination. However, to keep this post short, I will concentrate here on the second proposal (2018/0114) regarding cross-border conversions, mergers and divisions.

Directive 1132/2017 already includes rules for internal mergers and divisions and also for cross border mergers. The proposal introduces minor changes in the existing regulation of cross border mergers: among others, it requires a new report for the information of employees and gives non-conforming shareholders the right to exit the company. But the real novelty is the introduction of common procedures for cross border divisions and conversions (also known as cross border transfers of seat)and divisions. Cross border conversions had been expressly admitted by the Court of Justice of the EU,  (cases C-210/06 – Cartesio, C-378/10 - VALE Építési and C-106/16 – POLBUD) and divisions implicitly admitted in the case C-411/03 - SEVIC Systems. However, the lack of a harmonized regulation in all member states created uncertainties. The proposal creates a uniform procedure to facilitate these transactions while at the same time protecting the rights of minority shareholders, creditors and employees.

The procedure for both cross border conversions and divisions follows closely the existing one for cross border mergers. In summary, the steps would be the drawing up of the draft terms and the administrator´s and expert´s reports, disclosure of these documents, shareholder approval, examination by the competent authority of the home member state and registration in the host member state.

The most important -and controversial- difference is a new requirement aimed at avoiding the abusive use of these transactions. In conversions and divisions, an independent expert must express an opinion on  “the accuracy of the reports and information submitted by the company” (article 86.g. page 49-50). The purpose of this opinion is to enable  the authority of the country of origin to control not only the formalities of the operation –as it does in mergers- but also whether the transfer or division is “an artificial arrangement aimed at obtaining undue tax advantages or at unduly prejudicing the legal or contractual rights of employees, creditors or minority members_” (Article 86c(3) page 47).  To that effect, the report must refer at least to ”the characteristics of the establishment in the destination Member State, including the intent, the sector, the investment, the net turnover and profit or loss, number of employees, the composition of the balance sheet, the tax residence, the assets and their location, the habitual place of work of the employees and of specific groups of employees, the place where social contributions are due and the commercial risks assumed by the converted company in the destination Member State and the departure Member State”(article 86-g)._

It is debatable if this ex ante control by the expert and the authority is an efficient way of preventing the abusive use of these transactions.

Firstly, because the expert report´s content is complex, so it will take time and money to complete. Once it has been obtained, the competent authority designated in each Member State has to determine, based on the report, if the operation “constitutes an artificial arrangement” that unduly avoids tax or harms stakeholders. This implies further delays. The authority has one month to decide on this matter (Articles 86.m.7 ad 160.o), but in case of serious doubts (Articles 86.n and 160.p) an in-depth investigation can take two additional months. In addition, if the authority is not a judge, there is a right to judicial review of the decision (Articles 86.o and 160.q). All this means that the timeline of the operation becomes absolutely unpredictable and potentially very long.

Secondly, it is doubtful that the system can fulfill its objective, because the concept of “artificial arrangement” is far from clear and because it is extremely difficult to determine the intention to defraud tax or other stakeholders before the transaction is effective (ex ante). For example, the tax consequences of a cross border division or conversion are impossible to assess without full knowledge of the entire corporate structure of the group and of the tax legislation of each jurisdiction where the group has subsidiaries or branches. This seems impossible to do accurately by the expert or by the competent authority in the brief delay the proposal establishes.

Although the report is not necessary for small and micro companies (86.g.6), the uncertainty regarding the outcome of the transaction remains, as the competent authority must in any case make the judgment about the abusive nature of the operation. In this case, it will be even more difficult for this authority to give an opinion as it will not be able to rely on the expert´s report.

A further concern is that this procedure might lead to arbitrary decisions, as judging ex ante the intentions of the company is so difficult. Some States might be tempted to pressure the national authority to be strict, to prevent the flight of companies to other member states.

The procedure also implies risks for stakeholders because it establishes that the operations that have _“taken effect in compliance with the procedures transposing this Directive may not be declared null and void_” (Article 86.u and 160.w). The reason behind this is that the ex ante control should offer a total guarantee that the operation complies with the law and is not fraudulent, and therefore should not be challenged. But this can amount to a blessing of fraud if the company has been able to hide its real intentions from the expert and the competent authority.

The conclusion is that the new Directive -with a procedure that is essentially common to cross border mergers, conversions and divisions- would reduce uncertainties and facilitate these operations. However, it seems that the ex ante control of abusive operations by the competent authority creates costs and uncertainties while not ensuring the absence of fraud.

It is true that the ex post control of the transaction can create an even greater uncertainty if could lead to the nullity of the whole operation. But it might be a better option if in the case of fraud the consequence is not the undoing of the conversion or division. Other remedies can be established: for example, the right of the prejudiced parties to claim compensation or to opt for the lex societatis  and forum that would have been applied before de conversion or division -in relation to rights born before these cross-border operations-. In Delaware, for example, in the case of cross border conversions third parties “may be served with process in the State of Delaware in any action, suit or proceeding for enforcement of any obligation of the corporation arising while it was a corporation of this State” (§ 266.c.5 Delaware General Corporation Law). In the forthcoming discussion of the proposal in Parliament, these alternatives should be considered.