European Private Company (Societas Privata Europaea)
by Rainer Kulms
1. Modernizing company law and private companies
Choosing a business organization from a statutory menu of corporate law options requires a careful cost-benefit analysis. The enabling character of a national corporate law system is as important as agency costs that may arise under certain corporate law settings. Within the European corporate governance community, the private company is a latecomer. Private companies (ie companies with shares neither listed on the stock exchange nor otherwise traded on the capital market) are also latecomers in attracting the regulatory attention of the European Commission. At late as 2003, the Commission’s Action Plan (Modernising Company Law and Enhancing Corporate Governance in the European Union: A Plan to Move Forward) declared that the focus of company law policy was on listed companies and those that had publicly raised capital. Conversely, other companies (ie private companies) had demonstrated a need for private ordering and for flexible rules appropriate for small and medium-sized enterprises (SMEs). The High Level Group of Company Law Experts, appointed by the European Commission, acknowledged that the statute for the European Company (Societas Europaea) was ill-equipped to accommodate the business interests of SMEs. Though recognizing the importance of private ordering, the group of experts did not feel private company law reform was a top priority for EU regulatory action. The experts’ report cautioned against introducing a new corporate entity which would be exposed to an unfortunate overlap between Union and mandatory national law rules.
The European Parliament has been sympathetic towards creating a uniform private company form for the Union. In defining their policy approach members of the European Parliament have been inspired by a private initiative of business, supported by academics in some Member States, predominantly from continental European countries. A need for EU regulatory intervention was declared, having its origins in the ECJ’s jurisprudence on the freedom of establishment and in the intricacies of Member State legislation on private companies. The Commission’s June 2008 plan for a ‘Small Business Act for Europe’ includes a draft Council Regulation on a Statute for a European Private Company. The draft has been received favourably by the European Parliament, which emphasized the need for harmonized rules on employee participation and on an insolvency certificate, eventually to be supplemented by a minimum capital requirement well beyond the Commission’s threshold.
2. Member States’ policies and regulatory competition
It is the purpose of the ECJ’s jurisprudence to eliminate negative externalities generated by national company law systems. The Member States are bound to recognize companies from other Member States without qualification. Nonetheless, path dependence of national company law orders and tax law have effectively foreclosed any meaningful regulatory competition. Regulatory competition between the various national orders will occur as soon as private ordering is allowed to flourish, not stymied by a comprehensive set of mandatory rules. Within the Union, this is especially the case for private companies and partnerships. The margin of costs for creating a private company or a Gesellschaft mit beschränkter Haftung (GmbH) fluctuates greatly in Member States’ jurisdictions. English law dispenses entirely with a statutory minimum requirement for private limited companies. Some Member States impose a token requirement of €1, whereas German scholars have been at pains to defend a legal capital requirement of €25,000 for many decades.
English private limited companies have been instrumental in triggering regulatory competition for the least burdensome statutory scheme for private companies. In recent years, new private limited companies created by Dutch and German nationals have come to occupy a top position among ‘foreign’ private entities to be registered with the competent UK authorities (ie private limited companies with non-English directors). These developments were the leitmotif for legislative action in Germany and the Netherlands to amend the respective statutes on the GmbH and the Besloten Vennootschap (BV). During the legislative process in these Member States policy issues were unearthed that will shape the EU’s future regulatory debate on private companies. In abolishing a statutory minimum capital, the relationship between private contracting in company law, legal capital and creditor protection in the vicinity of insolvency (insolvency (corporate)) will have to be re-assessed.
a) Private limited company—corporate governance and insolvency
English company law on private limited companies, as amended by the Companies Act 2006, does not make the commencement of business activities conditional on a statutory duty to pay in the full amount of authorized capital. Business activities of a newly established private limited company may be undertaken once shareholders have paid in the first instalment of their contribution and the total amount of individual contributions can be ascertained. If a private limited company is limited by guarantee, the commencement of business activities does not depend on shareholders making an immediate contribution. The director of a private limited company may be subject to duties of care less demanding than those applicable to a board of directors of a listed company. Traditional standards do apply, but the company’s constitution may specify certain exemptions. Thus conflicts of interest can be tolerated which would otherwise constitute a breach of duty. In renouncing a rigid approach towards legal capital, English law on private limited companies imposes management duties in the vicinity of insolvency that are at variance with traditional German law on the GmbH. The Insolvency Act proscribes an ex post regime, which relies on director liability for wrongful trading to control management action in the vicinity of insolvency. Company directors are encouraged to undertake rescue attempts and only to put their company into liquidation proceedings when there is no reasonable hope of saving it.
The ubiquity of English private limited companies does not necessarily lend credence to the contention that the statutory scheme is bound to generate serious corporate governance problems or jeopardize creditors’ interests. Private limited companies operating as investment vehicles for venture capital funding are closely tied to a network of private contracts, specifically designed to avert opportunistic behaviour and to overcome potential statutory shortcomings. Banks supplying private limited companies with fresh liquidity will invariably require personal shareholder guarantees, thus augmenting the guarantees given by the corporate entity. From a business perspective, there is a significantly higher potential for risk from issues other than capital market problems. In the end, private contracting will have to address this aspect of creditor protection. It is a matter of debate to what extent liability for wrongful trading or management failure in the vicinity of insolvency should be predicated upon a distinction between adjusting and non-adjusting creditors.
b) The Dutch law reform of the BV
The Dutch company law reform of 2008/09 dispenses with a statutory minimum capital for BVs (ie private companies similar to the German GmbH). However, the Dutch legislature does not entirely part with the interface between capital maintenance and creditor protection, traditionally a vital feature of continental European corporate statutes. A combined net asset and solvency test is to ascertain whether distributions to shareholders are feasible. If a distribution is made in the vicinity of insolvency, board members shall be held liable to reimburse company funds if insolvency occurs as a consequence of such distribution. Personal liability is triggered whenever a director knew that the company would be unable to meet its financial obligations after a distribution. Individual members of the board of directors may exonerate themselves from liability if they did not bear any personal responsibility for the decision to distribute dividends. Moreover, shareholders will be required to return their dividends if the company becomes insolvent less than a year after distribution.
c) Germany—The 2008 reform of the Gesellschaft mit beschränkter Haftung (GmbH)
A 2008 German reform statute amending the law on the GmbH reaffirms in principle the regulatory policy decision in favour of a statutory minimum capital of €25,000. On the other hand, the reform statute adds a new corporate type to the menu of German companies. An Unternehmergesellschaft (literally a company for entrepreneurs) is introduced with a token statutory capital of €1. This Unternehmergesellschaft enjoys limited liability. It shall be required to allocate 25 per cent of its annual surplus (without prejudice to any loss carried forward) to building up a contingency reserve until a legal capital amount of €25,000 is attained. The advent of the Unternehmergesellschaft sheds new light on the genuine problems of traditional continental law concepts for the Gesellschaft mit beschränkter Haftung and other private companies. In the vicinity of insolvency, the focus on creditor protection will move from an ex ante to an ex post perspective. If insolvency proceedings are no longer a foregone conclusion once the capital falls below the statutory minimum, new management duties will have to evolve. The breach of these duties will be sanctioned ex post by damages and criminal law penalties. The amended German statute on the GmbH echoes scholarly debate on solvency tests: the director will have to reimburse distributions made to shareholders if such distributions were decisive in precipitating the GmbH’s illiquidity. The director is relieved of liability if a prudent businessman could not have foreseen the company’s illiquidity. The relevant German statute triggers a duty to file for insolvency irrespective of the statutory form of a corporate entity. The board of directors and, in the absence of an acting board of directors, the shareholders will have to commence insolvency proceedings no later than three weeks after the occurrence of the insolvency or illiquidity. In a tribute to the ECJ’s jurisprudence on company mobility, German law now accepts that the administrative office of a GmbH is not necessarily identical to its official address as stipulated in the articles of association.
3. Private companies—a need for regulatory intervention?
The amendments of Member State laws on the BV and the GmbH seem to indicate that those statutory types of private company most appreciated by investors will emerge victorious from regulatory competition. Regrettably, however, recent competitive races in private company law legislation also tend to confirm the assumption that a non-cooperative equilibrium between the Member States will occur once temporary competitive advantages have been offset. It should not be overlooked though, that a de facto harmonization (due to equilibrium strategies pursued by the Member States) does not place investors on a level playing field. Under German insolvency law, English private limited companies encounter obstacles to receiving fair treatment, lending support to calls for a new interaction between company law and insolvency rules. In the interest of the freedom of establishment for private companies, the insolvency implications of company law will have to be re-assessed in order to safeguard company mobility within the Union. Regulatory disparities between national company and insolvency laws generate costs that investors have to internalize as business strategies for foreign subsidiaries and private companies are implemented. These costs pose a challenge to both small and medium-sized undertakings and conglomerates consisting of a network of domestic and foreign subsidiaries. This finding has led the European Parliament and the Commission to conclude that predominantly small and mid-sized undertakings face inordinate disadvantages that regulatory intervention should seek to redress.
4. Uniform rules through the Statute for a European Private Company
The Commission’s Proposal for a Regulation on the Statute for a European Private Company aims at providing small and mid-sized undertakings with a supranational corporate vehicle, which is intended to exist concurrently with national company forms. The draft regulation does not reserve the new supranational form for corporate entities exclusively active in cross-border business activities. In an attempt to avert misuse, the European Parliament has insisted on a cross-border component to be realized within two years of the company’s formation. On the merits, the Commission’s proposal strives for a compromise between the English private limited company and the rather convoluted set of German norms on the GmbH, as amended by the 2008 reform statute. The European Private Company is not intended to replicate governance structures of partnerships. It may be founded by a single or several shareholders, natural persons or undertakings, and shall have limited liability. The (token) statutory minimum capital is set at €1. The rules on distributions are predicated upon a net asset test: distributions to shareholders may be made only if, after the distributions, the assets of the European Private Company fully cover its liabilities. The articles of association may stipulate that the management of the European Private Company issue a ‘solvency certificate’ before a distribution is made, certifying that the company will be able to pay its debts within one year of its distribution. In the legislative process, the European Parliament has opted for a more restrictive approach towards solvency certificates. A private company shall generally be made to produce a solvency certificate. The failure to do so would trigger a statutory duty to make arrangements for a minimum capital of €8,000.
The company shall be managed by a management body. The decision-making structure of the company may be one-tier or two-tier. Shareholders have exclusive decision-making powers over the following matters: variation of rights attaching to shares, distributions, variation of the share capital, approval of the annual accounts, appointment and removal of a director and expulsion or withdrawal of a shareholder. The articles of association may vest shareholders with additional powers with respect to management affairs. The draft statute lays down general duties and liabilities of the directors (including a specific duty to avoid conflicts of interest). An individual director shall be liable to the company if he is in breach of his duties under the statute, the articles of association or a resolution of shareholders and thereby causes loss or damage to the company. Where more than one director has committed such a breach, joint and several liability is imposed on the directors concerned. Apart from these general principles, the draft statute decides that issues of director liability shall be governed by the applicable national law. With respect to employee participation the Commission’s proposal specifies that EU rules on employees’ rights in cross-border mergers of limited liability companies and the procedures envisaged by the Statute for the European Company (Societas Europaea) shall apply accordingly.
The draft statute for the European Private Company is guided by the regulatory policy decision to maintain shareholders’ freedom of contract to the greatest possible extent. It does not go beyond laying down statutory minimum standards. According to the European Commission, the draft statute honours the principle of subsidiarity. Nonetheless, as a matter of regulatory technique the draft statute is likely to test the interface between EU law and Member States’ laws on private companies. In confining itself to basic rules, the Commission entrusts the ECJ with the task of developing a viable body of EU law on private companies. Again, Member States’ powers to legislate on the liabilities of directors, management duties in the vicinity of insolvency, accounting standards and tax law aspects remain unaffected. Nor would a new statute for the European Private Company prevail over the conflict of law rules of Regulation 1346/2000 on Insolvency Proceedings (insolvency, cross-border). In spite of its regulatory thrust, the draft statute does not add much to resolving the intricate problems of interaction between national laws and EU rules. It shies away from the impetus of corresponding (scholarly) proposals in the United States, which would allow shareholders to opt out of state law in favour of subscribing to a federal set of rules. Under EU rules on private companies, it is as yet a matter of conjecture to what extent shareholders (by benefiting from a free choice of law, including rules on trading in the vicinity of insolvency) should be empowered to fabricate their optimal corporate form.
Lucian Arye Bebchuk, ‘Federalism and the Corporation: Desirable Limits on State Competition in Corporate Law’ (1992) 105 Harvard LR 1435; Jaap Winter and others (High Level Group of Company Law Experts), Report on A Modern Regulatory Framework for Company Law in Europe (2002); Joseph A McCahery, Theo Raaijmakers and Erik PM Vermeulen, The Governance of Close Corporations: US and European Perspectives (2004); Hylda Boschma, Loes Leannarts and Hanny Schutte-Veenstra, ‘The Reform of Dutch Private Company Law: New Rules for the Protection of Creditors’ (2007) 8 EBOR 567; Harm-Jan de Kluiver, ‘Private Ordering and Buy-Out Remedies: Towards a New Balance Between Fairness and Welfare?’ (2007) 8 EBOR 104; Commission of the European Communities, ‘Commission Staff Working Document accompanying the Proposal for a Council Regulation on the Statute for a European Private Company (SPE): Impact Assessment’ SEC(2008) 2098 (2008); Robert Drury, ‘The European Private Company’  EBOR 9; Mads Andenas and Frank Wooldridge, European Comparative Company Law (2009); Joseph A McCahery, Levinus Timmerman and Erik PM Vermeulen (eds), Private Company Law Reform: International and European Perspectives (2009); Larry E Ribstein, The Rise of the Uncorporation (2010).