Professor Ferran’s recent article exploring the behaviour of companies that have decided to move their jurisdiction of incorporation reminds us that the ‘freedom to incorporate’ debate (with its ‘race to the bottom’ and ‘race to the top’ advocates) is not one that is confined to the United States. Despite some additional hurdles, there is, in fact, considerable freedom to choose in Europe and, therefore, ample scope for regulatory competition among jurisdictions. Professor Ferran welcomes this mobility as a discovery mechanism – arguing that greater choice offers the prospect of incremental improvements to company law, while minimising policy mistakes whose costs are borne disproportionately by less well-resourced companies. In their responses to corporate migration, Ferran urges policy-makers to think hard about including additional optionality in corporate law, so that a plurality of ownership models can thrive – an exercise which she argues (at page 834) could ‘help to change the corporate ecosystem for the benefit of society as a whole.’
But, although corporate migrations are possible in Europe and Professor Ferran is undoubtedly correct that we can learn much from them, she also acknowledges (for example, at page 815) that company-law driven foreign incorporations are rare. Unlike in the United States, where public and private companies are routinely incorporated in Delaware even though there is no tax or business reason to be there, in the UK most companies – and especially most private companies – are incorporated in their home territory. Where there is a foreign holding company, it is almost always used for tax related reasons: as Ferran points out (at page 831), regulation or political uncertainty are more likely to drive a European migration than a more attractive set of company law rules.
Indeed, this relative lack of mobility seems to exist even within the UK, where the adoption of a much more flexible corporate vehicle – the Limited Liability Partnership, or LLP – has been largely confined to professional partnerships and regulated asset management vehicles. When originally introduced (as a response to regulatory competition from the Channel Islands for accountancy firms who wanted the protection of limited liability within a partnership-like structure), it was anticipated by some that the LLP would be widely adopted by ordinary, unlisted trading businesses, who would find its contractual structure more attractive than the rigid confines of the UK’s mandatory corporate law rules. In fact, although adoption has been widespread in some sectors, it has been very limited outside of those well-resourced and sophisticated markets. And, even then, there is good reason to suppose that the adopters have been driven to the LLP for tax rather than company law reasons: its tax transparency and its treatment of ‘members’ as partners rather than as employees for fiscal purposes have undoubtedly been key factors driving LLP conversions, as recently acknowledged by the UK tax authority. It is noteworthy that the same reluctance to switch to a different corporate vehicle does not seem to be evident in the United States, where the LLC has been widely adopted as an alternative to the limited company, and where ‘check the box’ regulations (allowing incorporators to choose the tax treatment of the vehicle whatever its form) render the fiscal consequences nugatory.
This leads us to an interesting question: why don’t we see more corporate law-driven migrations (or LLP conversions) in the UK, and more regulatory competition for this potentially lucrative business?
That may be particularly puzzling given that regulatory competition outside of mainstream company law is more common. As already noted, the UK LLP itself was hurriedly introduced as a response to threats by large accounting firms to move to Jersey, whose regulators had drafted a law specifically to respond to their concerns with UK partnership law (and, in particular, its insistence on joint and several liability for partners). But perhaps even more striking has been competition for investment fund business, where the battleground has been limited partnership structures.
In Europe, the UK limited partnership (governed by a combination of the Partnership Act 1890 and the Limited Partnerships Act 1907) dominated private equity fund structures for decades, but fund promoters have taken advantage of the freedom to choose between the English and the Scottish versions: funds which want a partnership with legal personality (for example, because they want to be able to act as a limited partner in another fund limited partnership) register in Scotland, while others choose the (non-legal personality) English version. However, the desire of the Channel Islands to muscle in on that business has been evident in their successive attempts to fix some of the perceived problems with UK law, and with significant success: Jersey’s 1994 Limited Partnerships Law and Guernsey’s 1995 equivalent have both proved popular in recent years. It is true that indirect tax optimisation is an important consideration in deciding where to base the fund, but the vehicle’s company law attributes (including the protection from unlimited liability offered to investors) are equally important when selecting a suitable jurisdiction.
Aware of this competition for business, a number of other EU countries have also made a pitch for it, including France and Luxembourg, while recently announced plans to amend UK limited partnership law (together with two earlier adjustments) were explicitly based upon a desire for the UK to increase the competitiveness of its vehicle, and no doubt a response to the apparent willingness of incorporators to move abroad for a suitable set of rules. Cyprus also entered the fray with a recent re-vamp of its British-inspired limited partnership law.
Sophisticated and well-resourced business people in the UK and elsewhere in Europe do therefore use foreign vehicles for legal , rather than tax, reasons (although legal, tax and regulatory consequences are all important), and other jurisdictions compete for that business – but such mobility appears to be much less common where the legal form chosen is a limited company.
That is not to say that mainstream company law-driven relocations are unheard of. From 2002, following a series of decisions of the ECJ in favour of freedom of establishment, a number of German companies rejected the GmbH model, and opted instead to incorporate in the UK, while some European companies who have wanted to attract US investors, or list on the US public markets, have used a Delaware holding company. Luxembourg has recently amended its own company law in an effort to attract more foreign companies although, again, low corporate tax rates has been the main driver of business to Luxembourg, with suitable company law being a pre-requisite but not a motivator of mobility.
So, although private company law in the EU is not constrained by the EU’s Shareholder Rights and Company Law Directives, and the Channel Islands are not constrained by EU Directives at all, there is very little evidence of a race to anywhere, top or bottom, so far as UK companies are concerned.
Perhaps this lack of arbitrage suggests that there is no demand for an alternative to the UK corporate vehicle because users are generally happy with British company law rules; but that would be surprising given that, at least on the face of it, some of the UK’s mandatory rules are inconvenient for some types of company – see, for example, Professor Ferran’s argument (at page 828) that the rule allowing directors to be ousted by majority shareholder vote undermines the ‘independence’ of independent directors, and this author’s argument that the rules on conflicts of interests pose problems for non-executive directors. More likely, the problems with UK company law do generate inefficiency, but not enough to outweigh the costs of moving, and/or they are inefficiencies that can be mitigated by other means (such as through insurance, or using shareholders’ agreements). Note that such mitigations do not entirely eliminate the problems created by inconvenient laws, because the solutions are themselves costly – which means that there is a still a benefit to fine-tuning the rules, and policy-makers should not take the lack of migrations as a sign that improvements are not desirable.
In this regard, Professor Ferran also makes a very interesting contribution: she uses data from migrations to Jersey (not themselves driven by company law) to draw some conclusions about the market’s view on certain provisions in domestic corporate law. Ferran finds that many rights that are missing from Jersey law are replicated by contract in migrated companies, including, for example, pre-emption rights in new issues, the procedures for company meetings, and the 75 per cent threshold for a special resolution. This, Ferran argues (at page 820), ‘can be viewed, in effect, as an endorsement from the market’s dominant players of the UK position on these matters’. On the other hand, the fact that capital maintenance rules are not replicated may indicate that the market does not value them, and that managers find them inconvenient. A curious intermediate position is found in the ‘say on pay’ rules, recently introduced in the UK but missing from Jersey law: emigrating companies do not replicate these in their constitutions, but comply with them voluntarily. As Ferran points out (at page 822), whether such a fragile position will hold as investors become increasingly willing to challenge companies on remuneration will provide a helpful guide to the market’s attitude to that regulatory intervention.
Any such analysis, useful though it is, must also be treated with caution. While an emigrating company’s adoption or rejection of a mandatory rule might tell us something about the market’s attitude to it, it may be that many rules which are adopted are merely regarded as irrelevant by all parties, but managers – eager to present a ‘business as usual’ case to investors – leave the rule unchanged because they perceive that this will facilitate an easier transition. Only in cases where investors are likely to benefit financially (such as with less restrictive capital maintenance rules), or managers feel very strongly (perhaps more flexible ‘say on pay’ rules), will the provisions get tested, but rules which no-one values may survive just for the purposes of ‘window dressing’.
So, if policy-makers will find it hard to assess the market’s response to a rule even by studying emigrant behaviour, how are they supposed to react? Professor Ferran’s call for more optionality in UK company law is surely a sensible response (although she emphasises (at page 838) that ‘mass deregulation’ is not appropriate, and some mandatory rules remain essential). Such optionality allows different practices to be adopted by market participants, so long as boundaries are established in appropriate cases to cater for the fact that investors in widely-held companies are only very imperfectly able to price for the terms of the corporate constitution in their investment decisions.
Corporate opportunities law, at least in so far as it applies to non-executive directors, is one obvious candidate for optionality, as well as relaxations of other duties for directors specifically appointed to represent a particular constituency. For example, a board may wish to appoint an employee or customer representative, but such an appointee may have legitimate concerns about her clear obligation to pursue strategies whose objective is to maximise shareholder value, albeit in an ‘enlightened’ way. Similarly, a significant shareholder’s nominated director may want to represent the specific concerns of her appointor and, in some companies, that may indeed be a perfectly proper and helpful governance mechanism. Clearly and unequivocally allowing companies, with the informed consent of shareholders, to legitimise such practices seems highly desirable and may facilitate, for example, more widespread stakeholder representation or the ‘insider, controlling shareholder model’. The latter, as Ferran points out (at page 829) – and as private equity’s success may partially substantiate – has some significant advantages.