Dr. Christian Berger

ECJ puts pressure on German corporate law
Since the European Court of Justice (ECJ) delivered its judgments on the use of legal entities within the European Union in November 2002 and September 2003, there is a lively debate on the consequences for German corporate law and the German lawmakers. The essence of the Überseering and the Inspire Art Ltd cases is that an Entrepreneur wishing to operate a business within the EU will in future be able to choose from the full range of corporate forms available in the member states. Accordingly, the relatively strict German corporate law will now have to compete with the corporate legal forms of other European Union member states.

In the Überseering case, the judges held that under European law every member state must accept the legal capacity of companies established under the legal system of any other member state regardless of the company?s actual place of business (ECJ judgment delivered on 5 November 2002 - preliminary ruling on a referral from German Federal Court of Justice in the proceedings Überseering NV and Nordic Contstruction Company Baumanagement GmbH, Case C-208/00). Thus, German courts are forced to accept the legal capacity of companies established under the laws of another EU member state, even if they are managed and run in Germany.

In the recent Inspire Art Ltd. case , the ECJ decided the Dutch government could not impose capital and publicity requirements on a limited company with headquarters in the Netherlands (ECJ judgment delivered on 30 September 2003 - preliminary ruling on a referral from the Kantongerecht te Amsterdam - Netherlands in the proceedings Kamer van Koophandel en Fabrieken voor Amsterdam and Inspire Art Ltd., Case C-167/01). The ECJ found that the Dutch corporate registrar is obliged to register an English limited company even though this company does not comply with the Dutch regulations regarding the initial contribution and maintenance of share capital.

Prior to these judgment, German courts referred to the so called seat principle (Sitztheorie). Under this principle German courts did not accept the legal capacity of companies registered under foreign legislation if the companies? actual place of business was located in Germany.

The consequence of the seat principle was, for example, that such companies were not granted legal standing in a German court, therefore lacking the ability of enforcing contractual rights before German courts. Foreign companies moving their seat to Germany were required to reincorporate under German law in order to enjoy legal personality and limited liability status in Germany. Also, the application of the seat principle led to the result that a company registered in Germany was deemed to be liquidated if the company was moved to another member state with the consequence that the company's hidden reserves were taxed.

The main objective for the application of the seat principle was to assure the compliance of companies operating in Germany with German corporate law. The provisions of German corporate law protecting creditors are fairly strict by international standards. German courts have developed considerable case law, in particular relating to the corporate form of the limited liability company (GmbH, short for Gesellschaft mit beschränkter Haftung) and the contribution and maintenance of the minimum share capital. Further, German courts have consistently been proponents of stronger rights of minority shareholders. In addition, Germany?s rather unique system of co-determination provides for employees? participation in the management of German companies.

According to the two decisions of the ECJ, German courts may not apply the seat principle any longer, for doing so would violate EC law. Entrepreneurs can now chose any form of legal entity from any member state and operate and register their company under the laws of any other member state.

For example, a German entrepreneur can now set up an English limited company and run it in Germany, without having to comply with the German regulations on minimum share capital or employees? rights to co-determination. Other consequences are that the German employees? rights to co-determination will not apply, since foreign businesses are exempt from corporate co-determination. Also, the personal liability of the management of a foreign company cannot be judged by the laws of the member state which the company is effectively managed from or registered in, but by the jurisdiction of the country of origin of the corporate form used. Compared to these far reaching consequences the advantages of a cheaper and faster registration process when deciding to set up an English limited rather than the German equivalent seem to be negligible.

From the perspective of the M&A community, the judgment might increase flexibility when structuring cross-border transactions. There could be legal mergers (Verschmelzungen) pursuant to the German Transformation of Companies Act (Umwandlungsgesetz) between a German and a foreign incorporated company.

Also, practically, it might be more attractive for German entrepreneurs to use the English Ltd. Label, which is well known around the world, whereas the German ?GmbH? is not this familiar to the international community. Some entrepreneurs might think they enjoy greater confidence by international clients when operating their business under the corporate form of a limited company. On the other hand, there are also warnings about disadvantages, such as stigma attached to the Ltd label in certain regions and businesses.

The Überseering and the Inspire Art Ltd. cases will certainly stimulate the competition among corporate regimes in Europe and might lead to a concentration of corporations in favourable jurisdictions. This might even be accompanied by a general erosion of standards in corporate law. Such a race to laxity is known from the U.S. where a large number of companies is registered under the laws of Delaware since the state?s corporate law is more liberal than the regulations of other states.

The European adjudication put pressure on the German lawmakers to modernize German corporate law. Otherwise, the German statutory framework will not remain competitive vis-á -vis its EU counterparts.