The Real Seat Theory vs. Incorporation Theory
Arguably, one of the most important aims of the European Union is to establish a common market. It is suggested that such an aim may be achieved only by allowing and facilitating the freedom of movement for workers, the freedom of establishment, the freedom to provide services and the freedom of movement of goods. This article will focus on the freedom of establishment by starting with a critical analysis of Article 48 of the Treaty of Amsterdam, to then critically evaluate the 'real seat' theory and the 'incorporation theory' so as to consider whether they facilitate or hinder the freedom of establishment.
Article 48 states:
'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 Community shall, for the purposes of this Chapter, be treated in the same way as natural persons who are nationals of Member States.'
The treaty clearly states that a legal person, such as a company or firm, must be treated in the same way as a natural person. Therefore a company must be able to move freely between member states without any restrictions. However, the freedom of establishment for a company may be considered to be more complicated than the free movement of individuals as a company may be at two different places simultaneously. Furthermore, as companies are creatures of law, the legal recognition of a company varies across member states. Generally, EU member states follow two approaches towards recognising a company as having a valid legal personality. Most of the member states follow the real seat theory, such as the United Kingdom, which recognises a company as a legal personality if it is incorporated in any of the member states. The incorporation theory therefore, allows a company freedom to choose the law applicable to them.
Other member states follow the real seat theory which requires a company to be subject to the law of the country in which its effective centre of administration is located. Supporters of the real seat theory state that:
'a dominant proportion of the promoters, directors, officers, share holders, and debt-security holders of a corporation is more likely to be concentrated in the country where the genuine head office is located than in any other single country.'
Therefore, in order to protect shareholders, creditors and customers, it is necessary for the company to be subject to the law of the country in which its headquarters are located. For example, if a company is incorporated in England, but the company's headquarters or central administration is in Germany, which follows the real seat theory, then France, another country which follows the real seat theory, would recognise this company as subject to German law, while the UK would consider it as subject to its own laws. However, as the company is not incorporated in Germany, German law does not recognise it as a legal personality, therefore nor would French law.
Such a situation may occur when the growth of a company's branch drives it to become the principal place of business. To achieve legal recognition, the company would have to be liquidated and reincorporated. It is therefore argued that such obstacle prevents the free movement of companies within member states. Therefore, the question arises as to whether the real seat theory is compatible with Act 43 and 48 of the EC Treaty on the freedom of establishment for companies.
The treaty states that the 'registered office, central administration or principal place of business' are connecting factors between a company and a member state so as take into account the different systems of company law within the EU. Furthermore, article 239 states that member states should enter into negotiations with each other so as to achieve a mutual recognition of companies, as far as it is necessary. Such negotiations have not been undertaken however, therefore the obstacles to the free movements of companies still remain. However, case law has to some extent clarified ECJ's position on the issue.
The first case to appear before the European Court of Justice is Commission v France. The EU commission brought proceedings against France on the bases that French law was contrary to Art 48 as it treated companies with their seat in another member state differently. As a company's seat is derived from their nationality, such different treatment amounted to a discrimination on the bases of nationality. The French Government tried to argue that the difference in treatment was based on distinction between 'residents' and 'non-residents' which was found and accepted in all legal systems. However, the ECJ rejected such argument and all other arguments put forward by the French government. It emphasised that national legislation are obliged to follow the principle of establishment as stated in Art 48 and 43 of the EC treaty and restriction or discrimination on the basis of nationality is a breach of the freedom of establishment.
Commission v France was the first case to illustrate the effect and importance of Article 43 and 48 of the EC Treaty. Another relevant ECJ decision to the freedom of establishment is known as the Daily Mail. The Daily Mail, an investment bank incorporated under English law, wanted to transfer its central management to Netherlands for the purpose of circumventing English tax law. The United Kingdom objected by arguing that the Daily Mail should at least sell some of its assets in order to fulfil tax requirements under UK law prior to moving. The ECJ concluded that UK tax law did not affect the freedom of establishment as it only restricted the transfer of the company's central management while maintaining its legal personality. It has been suggested that the reason for this decision was so as to prevent the circumvention of the law of member states. Such argument may be supported by the opinion of the Advocate General to the Court who states that:
'As a general rule it appears that the national court may assess whether, in a specific case and having regard to the circumstances, there is a suggestion of abuse of a right or circumvention of the law and whether it should decide not to apply Community law.'
The ECJ however did not explicitly state that a member state may refuse to apply EC law when there is an intention to circumvent national law, nor did it establish a principle against circumvention. Nonetheless, it appears that a member state can effectively prevent a company from moving its central administration without breaching article 48 of the EC Treaty as: 'It should be borne in mind that, unlike natural persons, companies are creatures of law and, in the present state of Community law, creatures of national law.'
Centros is another important case which develops further the principle of establishment, in which a Danish couple incorporated a company in England in order to circumvent the Danish minimum capital requirements. The company never traded in England however, yet it tried to establish a branch in Denmark. Denmark refused to register Centros on the bases that it was not trying to establish a branch but a 'principal establishment' as it never traded in the UK. Furthermore, Denmark argued that such refusal was justified as the minimum requirements of capital were in order to protect creditors. The ECJ rejected these arguments on the bases that the requirements should not be discriminatory, and such policies cannot justify denial of legal capacity as it restricts the freedom of establishment. The court did stated however that Denmark may take measures to combat fraud or to intervene if the company was trying to avoid obligations towards public or private creditors in Denmark. The ECJ further distinguished the Daily Mail from Centros by suggesting that the Daily Mail was concerned with the transfer of the centre of administration to another Member State, not with a company whose seat of administration was transferred. The ECJ restated that companies are creatures of law therefore they have to fulfil their obligation under the law subject to them, however this dose not extent to the prevention of a company form setting up a branch.
Centros has caused much controversy amongst academics due to the contrasting decision with the Daily Mail. Following the Daily Mail, it was thought that the circumvention of national law was incompatible with the freedom of establishment, while the decision in Centros seems to refute such conclusion. Another point of controversy is the argument that the ruling in Centros signifies an end to the real seat theory. However the ECJ avoided stating explicitly that the real seat theory is incompatible with the EC Treaty. It is suggested that the judges were reluctant to make such a statement as they considered such a decision to be a matter for the legislature.
The final case to be analysed is that of Uberseering, in which a company incorporated in Netherlands, contracted a German company to do some work on its property which left the work unfinished. Uberseering sued the company, but as it was not recognised as a legal personality, the action was dismissed. The ECJ held that denying legal capacity to Uberseering is against the principle of the freedom of establishment. This decision seems to support the argument that the real seat theory is incompatible with EU law. However, it is suggest that the real seat theory is still compatible as the decision only affects a company's legal standing.
Based on the above analysis, it may be argued that the judiciary and legislature have not managed to harmonise the connecting factors of national companies within Europe. It seems that the Centros and Uberseering decisions have not directly addressed the compatibility or incompatibility of the real seat theory with the principle of the freedom of establishment. The ECJ however has clarified some aspects of the freedom of establishment such as a member's state compatibility with the freedom of establishment when restricting the establishment or movement of companies in certain circumstances. Nonetheless, it is yet to be clarified whether the freedom of establishment for companies is restricted by the manner in which they are legally recognised.
