The Race to the Bottom - A Study of the Consequences of ECJ Case Law and the Freedom of Establishment

Abstract: Nationals of Member States, including companies and firms that are formed in accordance with the laws of a Member State, are granted the right to freedom of establishment through Art 43 and 48 in the EC Treaty. However, as the legal situation appears today, this freedom of establishment is restricted. In accordance with the freedom of establishment, natural persons are entitled to incorporate companies in any Member State and legal persons can, almost without restrictions, set up secondary establishments, that is branches, agencies or subsidiaries in any Member State. The Member State of arrival cannot lawfully, with a few exceptions, none of which yet has been applied, hinder or place limitations on such an establishment. So far, nothing in the ECJ case law or in legal writing indicates what situations and measurements would qualify as exceptions and it is uncertain if there will ever be a case where the protective interests, such as for example public policy, will be considered as more important than the fundamental right to freedom of establishment. This means that on the one hand freedom of establishment is highly protected. However, would a company wish to move its registered seat, i.e. its registered office, central administration or principal place of business, problems occur. It has been ruled by the ECJ that, since companies only exist by virtue of the national law under which they were incorporated, Member States are free to hinder and place restrictions on the transfer of companies registered seats from their territory. This means that it is not possible for a company to transfer its seat from one Member State and keep its legal status, as long as it does not follow from the national law of the State of origin. In the USA it is both possible and occurs frequently that companies are established in one state and later transferred and re-incorporated in another. The possibility to re-incorporate has lead to a regulatory competition, often referred to as the race to the bottom and the Delaware-effect, which has had the consequence that states have created more lenient company laws, where the protection for minority shareholders and workers has been neglected. Legal scholars unanimously agree that the reason behind the regulatory competition between states in the USA is primarily fiscal, since the states are entitled to levy franchise tax on companies incorporated under their legislation. The franchise tax constitutes a significant part of the income of states in the USA. Over the last decades a ferocious debate regarding whether the EU is facing a future similar to that in the USA, where company laws have been undermined, has been going on. This thesis shows that even if the USA and the EU are similar to structure, the differences are prominent and thus the problems in the EU, would re-incorporation become possible, would not be the same as those present in the USA. The differences, such as the prohibition for Member States to levy franchise tax or incorporation fees on companies wishing to establish in their territory, differences in ownership structure, do weaken the incitements for Member States within the EU to enter into regulatory competition. The fact that the incitements for Member States to enter into regulatory competition are weak, in combination with numerous other factors, inter alia the harmonisation process taking place within Community company law, language and cultural differences and the traditional non-competition perspective within company law making in the EU points towards a future, if re-incorporation will become possible, where an effect similar to that in the USA is not likely to occur.