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ECJ to Rule on Use of Foreign Companies for Domestic Activities - International Law Office

International Law Office

Company & Commercial - Germany

ECJ to Rule on Use of Foreign Companies for Domestic Activities

April 09 2001

In the case of companies formed under foreign law which subsequently move their central management to Germany, it is the established practice of the German Federal Supreme Court to deny them legal capacity, and hence the capacity to sue or be sued before a German court. According to the European Court of Justice's (ECJ) reasoning in the Centros Case (ECJ March 9 1999 Rs C-212/97), it is highly questionable whether this practice is compatible with the freedom of establishment guaranteed under Article 48 of the Treaty establishing the European Union. Therefore, by way of a resolution of March 3 2000, the Federal Supreme Court submitted this question to the ECJ for a preliminary ruling. Contrary to common law principles, conflicts of law are decided in favour of the law applicable at the company's actual domicile, and not according to its place of formation. Therefore, in order to become fully operational, a company formed under foreign law must establish a new company under German law if its central, controlling management is moved to Germany. If the ECJ rejects the Federal Supreme Court's established practice, this may lead to new possibilities with regard to the use of foreign companies for domestic activities.

The German Federal Supreme Court's reasoning is based on the ECJ's decision in the Daily Mail Case (ECJ September 27 1988 RS 81/87). In this case the ECJ held that companies can make use of the freedom of establishment by opening a branch or forming a new company under the law of an EU member state and transferring their assets to the new company. However, in the Centros Case Danish investors established a private limited company in the United Kingdom to do business in Denmark in order to circumvent the Danish provisions on the minimum share capital of limited companies. Although the company's registered office was in the United Kingdom, the ECJ held that the Danish local authorities were obliged to enter the company's branch office in the Commercial Register. The circumvention of national provisions concerning the minimum share capital of limited liability companies had to be accepted due to a lack of harmonization in this area.

It is thus expected that the ECJ will hold that the rulings of the Federal Supreme Court infringe the freedom of establishment laid down in Article 48 of the EC Treaty. A decision of this kind could provide plenty of scope for the use of companies formed under foreign law for business activities in Germany. In relation to the use of limited liability companies, in particular, investors would be free to exploit the different company law systems of the member states as there is no harmonization to speak of in this area. As German provisions concerning the provision and safeguarding of share capital and shareholder loans are rather severe in comparison with the laws of other member states, the use of foreign companies could be an attractive alternative. This also applies to the rules governing workers' co-determination in management. Further, the formation of a foreign company could prevent strict consumer protection regulations from applying, as a cross-border jurisdictional basis would be established thereby, which would trigger the application of the prohibitions on restrictions and discrimination of the EC Treaty.

However, even if the ECJ rejects the Federal Supreme Court's established practice in this matter, only the question of whether companies formed under foreign law which have subsequently moved their registered offices to Germany should be denied legal capacity will be clarified. It remains to be seen whether the German Federal Supreme Court will uphold its present practice in other relevant areas of company law, as there is already a widespread debate about the analogous application of co-determination provisions for foreign companies.

For further information on this topic please contact Roman Bärwaldt at Clifford Chance Pünder by telephone (+49 30 254 65 800) or by fax (+49 30 254 66 900) or by e-mail (roman.baerwaldt@cliffordchance.com).

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