When we speak about entrepreneurship, we all tend to focus on the fanciest of the adventure: growth, success, raising money. Yet, we all have to start at the same stage: incorporating a company. This requires some legal knowledge. Most of the time, a lawyer will be in charge of this part. But having general knowledge of what you can do is a valuable asset.
The following is a guest post by Jonas Habert. Jonas explains us how to avoid strict legislation when we have to set up a company.
[Enter Jonas Habert.]
Right of Establishment in the EU and the Subsidiary Companies
The nature of the right of establishment for companies within the European Union (EU), as set out in Article 54 of the Treaty for the Functioning of the European Union, and its interpretation by the European Court of Justice (ECJ), allows entrepreneurs to incorporate a holding company as an empty shell in the Member State with the least stringent requirements and to create a subsidiary, or “daughter”, in the Member State they truly want to do business in, evading its strict legislation.
Example: Nils wants to create a business in Denmark. Danish law requires a minimum capital, half of which must be paid during the first year of business. Nils cannot raise this capital within this period of time.
Instead, he can:
- Set up a private company limited by shares (PLC) in the United Kingdom which only requires £1 of paid-up capital.
- Then set up a daughter company in Denmark that will pursue the entirety of the Company’s business and will be the actual headquarters (including meetings of associates etc).
This astonishing possibility could seem, prima facie, to be a fraud. Nevertheless, this scheme has been approved by the ECJ in a series of cases that this paper will summarise and examine. No legal knowledge is required as we will explain the subtlety of the latest cases through clear and understandable analysis.
The Legal Basics
Differentiation between the “real seat” and the “registered office”
These two concepts are used to attach a legal system to a company. The doctrine of “registered office” applies the law of the EU Member State where the company has been incorporated, whereas the “real seat” doctrine applies the law where the registered company has the “centre of its interests”. In most EU countries, the “registered office” theory prevails (France, England etc.).
Therefore, if Nils incorporates his company in England and carries out its business in the Danish subsidiary, the law applicable to his company will be English law.
How can you benefit from the EU “freedom of establishment”?
The criteria is simple and flows from two articles of the TFEU:
Article 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”.
Article 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.”
Thus the requirements are:
- The company must qualify as a company according to the above EU definition (which only excludes non-profit-making companies).
- The company must either have its registered office, central administration or principal place of business within the Union.
- The company must comply with the regulations of the Member State to which the company is attached.
NB: There is an extra condition where the freedom of establishment is invoked for the benefit of an agency, branch or subsidiary: it will need an “effective and continuous economical link” with this Member State. Nonetheless, this requirement has grown to be less important.
Using the freedom of establishment to evade strict state legislation
In the “Centros” (212-97) case decided in 1999, the ECJ was asked to analyse the following situation
Mr Bryde, a Danish citizen, incorporated Centros, a PLC, in England, where the theory of incorporation applies. The company was thus duly formed and governed by English company law.
The members of Centros then wanted to open a branch in Denmark where all the business would be conducted and Mr Bryde’s intentions were made clear: avoidance of the minimum capital requirement for incorporation in Denmark.
The Danish state authorities refused to incorporate this branch (which would be the “real seat” of Centros) for the following reasons:
- Centros was not conducting any kind of activity in the United Kingdom.
- Its incorporation was only to avoid Danish legislation.
- The ECJ held that the freedom of establishment applied to a branch of a Company “duly formed in another Member State” and precluded Denmark from refusing the incorporation of the branch.
- Nevertheless the ECJ also held that a Member State can take any measure to avoid fraud in its territory by a company or its members.
This solution has been confirmed in two other cases, “Inspire Art” and “Überseering”, respectively in 2003 and 2002.
What is important to note from Centros is that the facts of the case are not sufficient to constitute a fraud!
In the “Cadbury Schweppes” case, the ECJ held “the fact that the company was established in a Member State for the purpose of benefiting from more favourable legislation does not in itself suffice to constitute abuse of that freedom or fraud”.
These cases therefore render the freedom of establishment for subsidiaries, branches and agencies as almost limitless!
Then, in 2008, the ECJ specified its solution in “Cartesio”
A company named Cartesio was created and incorporated in Hungary. In 2005, this company asked the Hungarian Companies’ Court to transfer its “real seat” (operational headquarters) to Italy. The court refused, in accordance with its own law, which forbids companies formed in Hungary to transfer their “real seat” to another country without transferring their statutory seat.
It was held that the situation differed depending on whether the company wanted to maintain the original attachment to the first Member State of incorporation or wanted the transfer to provoke a change to the applicable law (which would be the law of the Member State of transfer).
- If the original attachment is kept (usually because it was only the “real seat” that was transferred): the validity of the transfer depends on the law of the first Member State. This is our situation here: only this law will be able to rule whether the company could keep its legal personality.
- If the original attachment is broken (usually by a transfer of “statutory seat”): the original law loses its power upon the company to the new Member State of incorporation. Then, as we saw in the above cases: this second Member State will not be allowed to restrain this incorporation because of the freedom of establishment (Centros).
Recommendations to entrepreneurs wishing to avoid strict legislation in a particular Member State whilst still wanting to do business there
You will then have a positive dichotomy of seats that you would not have with a Member State recognising the “real seat” doctrine. If you apply “Cartesio” in a Member State which recognises the “real seat” doctrine, you will not be able to transfer your “real seat” without transferring your “statutory seat”. You will then have to comply with the law of the second state. Whereas if the original state recognises the “statutory seat theory” its law will still be applicable even though you have transferred all your “real business” to the Member State of your target business (to avoid its strict legislation).
2° Choose a Member state with flexible legislation (for example, UK legislation is commonly recognised as “business friendly”).
3° Open a branch or a subsidiary in the Member State of your target business.
*German law used to recognise the « real seat theory ». But because of the ECJ, to keep being attractive to entrepreneurs, they recently changed to the “statutory seat” theory.