Implementation of alternative dispute resolution mechanisms in cross border mergers: International legal study

Parg2: Necessity to coordinate between national company Laws

The necessary coordination between national company laws is expressed regarding the conflict of Laws level (A) and regarding the substantive Law level (B)

A-Towards harmoni2ation of national conflict of Laws rules

During an international merger, the applicability of national or foreign conflict of Laws rules is at stake.

If many civil law countries tend to have a favourable attitude towards the recognition of a company as it exists in its country of origin which will facilitates the cross border merger transactions, it doesn't mean that this approach is the end of the "real seat" doctrine, as the latter will remain applicable in the domestic context. Its importance will be, however, considerably reduced. From EU perspectives, the application of national conflict of Laws rules was limited in the famous "Centro's" ¹²¹ case based on the freedom of Establishment principle of Articles 52 and 58 of the Treaty of the European Union.

In Centro's the ECJ dealt with an EU member State^,s refuse to register a branch of a company incorporated in another member State where that company^,s intent was to conduct its principal business in the host state and to escape the host state^,s minimum capital regulations¹²².

¹²¹ Case C-212/97, Centro's Ltd. v. Erhvervs-og Selskabsstyrelsen, 1999 E.C.R

122 "....Centros Ltd. had its registered office in the United Kingdom and was seeking to establish a branch in Denmark to carry on its principal business there). Both owners of Centros Ltd. were Danish nationals whose company had never traded in the United Kingdom. When the Danish Trade and Companies Board refused to register a branch in Denmark, the company's owners filed an action claiming that they were entitled to establish a branch pursuant to the Treaty provisions on the freedom of establishment.." Id

Despite the company^,s obvious effort to circumvent more strict corporate rules, the ECJ held that "the host state^,s refuse to register the branch constituted an infringement on the right of establishment and thus violated the EC Treaty"¹²³ . There is no doubt that Centro's severely restricted the scope of the real seat doctrine.

According to Centro's it became possible to incorporate a company under the Laws of a member state which applies the incorporation state doctrine and then subsequently operates the company through a branch in any other member State. It also became irrelevant whether the company carries on any economic activity in the state of incorporation or whether the central administration is located in the state where the branch is established.

From American perspectives, the incorporation theory has been well established in corporate Laws, particularly in the State of California and New York¹²⁴.the given example is the "Western Airlines case"¹²⁵.

Last, there is however no doubt that forum shopping¹²⁶ can occur between the member states which apply the incorporation state doctrine. As it was remarkably quoted by Walker and Castels, with respect to the exercise of jurisdiction, forum shopping may contribute to facilitate "the manipulation of the outcome of disputes through the opportunistic

selection of forum that had little connection with the disputes but that had conflicts of Laws rules or procedural rules that would provide the parties

¹²³ Rothe, N., "Freedom of Establishment of Legal Persons Within The European Union: An Analysis of the European Court of Justice Decision In The ÜBERSEERING case, American University Law Review, June, 2004

¹²⁴ Blackburn, T., and Mason, G. , "The Unification of Corporate Laws: The United States, The European Community and the Race to Laxity ", Independent Law Review, 1994 west law data base

125 Western Airlines v. Sobieski, 191 Cal. App. 2d 399, 719 (1961) (upholding the determination by the California Commissioner of Corporations that a Delaware corporation could not amend its certificate of incorporation to eliminate cumulative voting because California Law required the use of cumulative voting, and because the headquarters, seat of operations and 30% of the shareholders were located in California).

¹²⁶ "....The term "forum shopping" covers the practice of choosing a country for the incorporation or reincorporation of a company on the basis of which country's company Law is the most favourable.." , Walker and Castels, Choice of law rules, Private /nternational Law, Canadian Conflict of Laws, Op.cit note 5 page 5

with advantages that were not available in forum more closely connected with the disputes"¹²⁷.

Let's consider a hypothetical merger between two large companies in different member states that have divergent company Laws. Suppose Rolls Royce, a public limited company incorporated under British Law, enters into a merger agreement with BMW, a German company¹²⁸. The resulting merged entity could take several forms: (1) a legal merger creating a British company incorporated under either British or German Law (RollsBMW UK or Deutsche Rolls); (2) a European company incorporated under the proposed European Community Statute ¹²⁹ (Euro company-RollsBMW); or (3) a group arrangement, under which a holding company incorporated in either the United Kingdom, Germany, or a third country (such as Luxembourg) would own the shares of separately existing Rolls Royce and BMW subsidiaries. The salient aspect of this supposed transaction is that management generally has had little flexibility in selecting the Law applicable to the internal affairs of the corporation. The new availability of the legal merger within Europe, however, gives management discretion to choose the Law applicable to internal corporate affairs, that is, the ability to migrate to a foreign jurisdiction and enter the "race to the bottom."

¹²⁷ Walker, Op.cit note 5 page 5 Id

¹²⁸ In Germany, ("stock society") is the most Common form of business organization for large, publicly traded companies.

¹²⁹ Proposal for a Council Regulation on the Statute for a European Community, Official .Journal. European. Community (1989) [hereinafter ECS]

Many scholars start to talk about this race to the bottom what is known as the «Delaware effect" or the "Delaware syndrome.¹³⁰" These terms have been widely used in the European debate to refer to an undesirable situation in the development in the US where, throughout the twentieth century, U.S. Corporation Law was competitively deregulated by states attempting to attract corporations to their own jurisdictions.

The reason why European legal scholars refer to developments in the US is that the European Union and the US seem to have a lot in common with regard to the regulation of companies.

Firstly, the regulation of corporations in the US is conducted at the state level, so that each state has its own corporate Laws. This is very similar to the situation in the European Union where, in the absence of harmonisation, the power to regulate companies is vested in the member states. The European Union may be compared with the US to some extent, as the harmonisation may be compared with the federal regulation in the US. Whereas there is some harmonisation of company Law in the European Union there are no federal Laws on this subject.

Secondly, In the US, the problems created by the lack of uniformity with respect to company Laws and relating to conflicts in the substantive Laws that may apply to companies that conduct interstate business have been dealt with in part by the adoption of the internal affairs doctrine¹³¹. U.S states apply the internal affairs doctrine, whereby a corporation is

governed by the Law of the state in which it is incorporated; it is immaterial whether the corporation conducts any economic activity there or where it's central administration is located.

¹³⁰ Birkemose, H., "The Fear of the Delaware-Effect--The American Demon, in The Internationalisation of Companies and Company Law, Corporate Migration in the European Union: An Analysis of the Proposed 14th EC Company Law Directive on the Transfer of the Registered Office of a Company from One Member State to Another with a Change of Applicable Law", Columbia Journal Of European Law. Page 181, 186 (2000) West Law

¹³¹ "...the "internal affair doctrine" came to assure that for most issues of corporate procedures , governance and relationships among officers , directors and shareholders , a corporation needs to be concerned only with the Law of its state of incorporation and can ignore the corporation Laws of the other states. Firms choose as their state of incorporation a statutory domicile which is independent of physical presence and can be changed with shareholder approval...." FORSTINGER, Ch.M, Take over Law in the EU and the US, A comparative analysis, Op.cit note page 12

This doctrine adopts a choice of Law system that specifies that the internal affairs of a corporation shall be governed by the Law of the place of incorporation of the company being regulated¹³². According to the Restatement Second of US Conflict of Laws, a corporation's internal affairs are involved "whenever the issue concerns the relations inter se of the corporation, its stockholders, directors, officers or agents..."¹³³ The use of the internal affairs rule will give companies the certainty that in most situations, they will know in advance the standards to which they will be held, and that differing Laws of other states will not be unexpectedly applied to their actions.

This "incorporation state" doctrine is applied in a number of the member states in the European Union, and it has been debated whether the other main doctrine, the real seat doctrine, is incompatible with the Treaty of Rome. If it is, would this mean that the incorporation state doctrine would prevail in the European Union? Even after Centro's, the use of the real seat doctrine continued to impose an actual restriction on competition between legal orders in the European Union. More than anything, the European jurisprudence has increased the pressure on EU member states to harmonize legislation in the area of company Law¹³⁴.

¹³² Approximately twenty states have adopted statutes based on Section 106 of the former draft of the Model Business Corporations Act, which states that the Act does not authorize states to regulate "the organization or internal affairs" of a foreign corporation. Restatement (Second) of Conflict of Laws S 302 and S 302 (1971) The Revised Model Business Corporations Act has essentially carried forward the same concept. Model Business Corp. Act. S 15.05(c) (1993). Id

133 Restatement (Second) of Conflict of Laws S 313 (1971)

¹³⁴ the EU Directive preamble states: "None of the provisions and formalities of national Law, to which reference is made in this Directive, should introduce restrictions on freedom of establishment or on the free movement of capital save where these can be justified in accordance with the case-Law of the Court of Justice and in particular by requirements of the general interest and are both necessary for, and proportionate to, the attainment of such overriding requirements". EU directive on cross border mergers. note 3 p 11

After the Centro's case in 1999, the Europe Court of Justice has again delivered a significant case dealing with the legal situation of EU companies establishing themselves in other member states. Recently, in the Überseering case¹³⁵ dated November 5^th, 2002, the European Court of Justice has considered incompatible with the Treaty freedoms, the German rule, based on the real seat doctrine, whereby foreign companies with a seat on the German territory were refused to appear in German courts unless they proceeded to re-incorporation. This was considered a complete negation of the freedom of establishment. Likewise, foreign companies with a seat in the Tunisia territory must re incorporate in accordance with the legislation in force in the country in order to merge with Tunisian companies! Member states should allow companies that have been incorporated in other member states to freely enter their territory, according to the rules under which they have been formed in their state of origin. The Überseering case constitutes another landmark on the road towards the more free circulation of companies in Europe.

Whether it introduces the incorporation theory as the European rule, is open to doubt, as the Court has exclusively relied on the Treaty rules on free establishment. It seems that the Court has rather developed a new approach that could allow bridging the differences between incorporation and real seat techniques¹³⁶. Member states should agree to a set of minimum standards that companies must follow when doing business in any EU member State and establish those in EU Law.

This harmonization would diminish the roles of the real seat doctrine and incorporation theory as alternative approaches to conflict-of-Laws problems, because the Law of the seat country and the Law of the state of incorporation would be largely equivalent. With the achievement of legal harmonization in the area of company Law, the European Union should devise strategies to control abuses of the freedom of establishment

¹³⁵ ECJ Überseering BV and Nordic Constriction Company Baumanagement (NCC), case 208/00, Judgement of 5 November 2002

¹³⁶ Blackburn, T., and George Mason , "The Unification of Corporate Laws: The United States, The European Community and the Race to Laxity ", op cited note 3 page 45

provisions to circumvent national regulations for the formation of a company. Moreover, member states should ratify convention about the mutual recognition of business forms and negotiate an approach to conflict-of-Laws problems. In order to facilitate cross-border merger operations, each company taking part in a cross-border merger remains subject to the provisions and formalities of the national Law which would be applicable in the case of a national merger. In other words each firm involved in a cross-border merger transaction would generally be governed by its own national Law with respect to the corporate formalities to be observed.

It appears from all these considerations that the relationship between conflict of Laws and cross-border mergers is not limited to the debate about the general differences between the "statutory seat" and the "real seat" doctrine. Additional controversial question may arise regards the substantive Laws governing the cross-border transaction

B-towards coordination of national substantive Laws

There can be no doubt that each company participating in a merger transaction will be governed by its national company Law. In order to understand which Law need to be applied in a merger involving companies from different countries it is first of all necessary to analyze the concept of the Law governing the legal status of each company, generally called "lex societatis" or "statute personnel de la société".

According to AUDIT, B., the "lex societatis" is considered the Law that governs the incorporation, the organization and the dissolution or liquidation of the company¹³⁷.

137 Audit. (B), Droit International Privé, Economica, 4^e ed, 2006, paragraph n°1128

Although consecrated by many legal systems particularly in France by the jurisprudence¹³⁸ , many legal systems disagreed regards the choice of the Law to be applicable. During an international merger , the main conditions required are the necessity of a preliminary documents to negotiate the negotiations, the necessity of a balance sheet assessed and approved by the company' s accountants, the approval by shareholders and boards of directors of the merger contract, the registration and the publication of the contract. Normally these conditions are governed by their own "lex societatis". One can ask a question : what if the absorbed company' lex societatis doesn't consider for example a "letter of intent" necessary and the contrary for the absorbed company? More, what if the lex societatis of the absorbed company doesn't require a balance sheet adjusted to evaluate the worth of the company while it is required under the lex societatis of the absorbing company ? Equally , which "lex societatis" will govern the "transfer of universality"- in other words , the transfer of the assets and liabilities and the transfer of all creditors of the shareholders of the absorbed company to the absorbing company?

According to the doctrine of universal succession the acquiring company is considered the universal successor¹³⁹ of the merged company. In other words all the assets and liabilities of the absorbed company will be transferred automatically upon merger to the acquiring company¹⁴⁰.The universal succession can take place provided that the "lex societatis" of the absorbing company will govern the responsibility generated by the succession, the transfer of shares and the increase capital and the absorbed company' lex societatis will govern the dissolution without winding up. The "lex societatis" of each company may, however, have serious shortcomings. What if the lex societatis of the absorbing company

¹³⁸ Case Royal-Dutch Shell, Cass. Civ 1st , 25 January , 1966, note by Y. Loussouarn

¹³⁹ "...Universal successor is the one who acquire the universality of the patrimony of his author". Dahl's Law
Dictionary , compiled by Henry Saint Dahl, William S.Hein & Co ,Inc. Buffalo , New York , Dalloz , Paris 1995

140 The court held that ... "the doctrine of universal succession provided that assets and liabilities were transferred automatically upon mergermall matters governing the status of a foreign corporation should be determined by reference to the domestic Law of that foreign corporation" Sweet & Maxwell Limited Eurosteel Ltd v Stinnes AG, (QBD (Comm))Queen^,s Bench Division (Commercial Court), 8 December 1999, [2000] 1 All E.R. (Comm) 964, [2000] C.L.C. 470,

disregard the Law of the company that disappears, whereas the lex societatis of the absorbed company disregards the fact that the deal cannot be justified without taking into account the Law of the acquiring company?

The idea proposed and that could be the most appropriate is a
mixed approach . The details of this solution, however, are problematic.

Since the laws of two countries are affected, a comprehensive combination of both national substantive laws might be preferable. However, this can lead to inconsistencies. For that reason, it could be said that the more demanding of the two laws should be applicable. Yet, determining which law is more demanding can be a difficult task. Consequently, it could be argued that the problem is to be solved by a harmonization of the rules on conflict of laws, rather then by the substantive provisions of the corporate law on cross-border mergers. The law on cross-border mergers is closely linked to other fields of corporate law.

For instance, mergers typically require approval at general meetings¹⁴¹ and address questions of creditor protection¹⁴², so all requirements that belong to these sub-areas of law would also have to be embraced. Furthermore, it is too necessary to unify everything that relates to cross-border mergers. To some extent, there is no need to harmonize the substantive law, because it does not create any problems if, for instance, the rules governing the set up of the shareholders^, meetings (at which the shareholders vote on the cross-border merger) stay different. As a result, a mixed theory that distinguishes between different types of rules would be the best solution. This would mean that, firstly, the requirements of a cross-border merger are dealt with by the

¹⁴¹ section 251 of Delaware General Corporation Law, and article 7 Third Council Directive dated October 9, 1978 concerning mergers of public limited liability companies, 1978 Official Journal

¹⁴² This is particularly important, if a legal system requires minimum capital, see, Second Council Directive 77/91/EEC of 13 December 1976 on coordination of safeguards which, for the protection of the interests of members and others, 1977 Official .Journal

law of each company, because it is for each legal system to decide if, and to what extent, cross-border mergers are allowed.

Secondly, the rules of the procedure of a cross-border merger, such as the approval of the shareholders are also based on the law of each company. This can sometimes lead to the application of both laws, because, for instance, the cross-border merger' contract has to fulfill the rules of both countries. Thirdly, the dissolution of one corporation and the transfer of all of its assets and liabilities are to be decided jointly by the law of the absorbed company. Further consequences might also have to be dealt with by the law of the surviving company, because only this company will do business in the future. Under the German private international Law, for example , the Laws applicable to all companies participating in a merger are cumulatively applicable (the so-called "unification theory")¹⁴³. In the Daimler Chrysler case, the German Law was the "governing Law" for the Daimler-Benz Merger (to the extent executed in Germany), for the Daimler-Benz Capital Increase, and for the Chrysler Capital Exchange. In all other respects, the Agreement was governed by the Delaware Law without regard to the principles of conflict of Laws thereof. With regard to the agreement and any of the transactions contemplated by it, the parties consented to submit themselves to any federal court located in the state of Delaware or any Delaware state court.

This question however merits closer examination.

The need for conflict of laws rules could be removed by unifying the substantive law of the various legal systems in which the world is divided in general but it is not the case regarding the substantive law on cross- border mergers. Moreover various institutions have been established to

¹⁴³ Beitzek, G. « les conflits de lois en matière de fusion des sociétés, droit communautaire et droit international privé, doctrine et chronique », Revue critique de droit international privé, librairie Sirey, Paris, 1967

promote the unification of private law. These include the Rome Institute for the Unification of Private Law (UNIDROIT)¹⁴⁴.

At private level, lawyers may avoid conflict of laws problems by resorting to various localization tools such as choice of law, choice of forum or dispute resolution clause.

At jurisdictional level, "forum shopping" and the doctrine of "forum non conveniens" are also very useful tools for avoiding the application of the law of a particular legal system. However, unified substantive laws in the field of cross-border mergers may be not necessary.

Following the adoption of the EU Directive on cross-border mergers the basic principle is that a cross-border merger shall be governed by the rules already applicable to domestic mergers¹⁴⁵. However this does not mean that coordination of domestic laws is not necessary at all. If there are no special provisions in the directive, the existing domestic rules have to step in. For example, it is for the member states to decide whether, for instance, shareholders should be granted an appraisal right because the merger will transform them into shareholders of a different and foreign corporation. It is preferable to coordinate national substantive laws regarding the types of companies that are legally permitted to carry out a cross border merger transaction, to require that the contract of merger must be duly drafted and require a minimum of collaboration between the authorities in charge of filling / registration of the merger contract. By contrast to a situation in which a particular national merger law is applicable to cross-border mergers, unified rules offer a release from complex conflict of laws questions in determining whether cross-border mergers should take place.

Special and clear rules on conflict of laws inserted in national substantive laws might be preferable, too.

¹⁴⁴ The International Institute for the Unification of Private Law (UNIDROIT) is an independent intergovernmental organization with its seat in Rome. Its purpose is to examine ways of harmonizing and coordinating the private Law of states and of group of states and to prepare gradually for the adoption by states of uniform rules of private Law. Further information's can be found on the website at www.unidroit.org

¹⁴⁵ Article 2 of the EU Directive on cross-border mergers See appendices 1