Comparative Corporate Governance: Shareholders as a Rule-maker

Comparative Corporate Governance Shareholders as a Rule-maker Petri Måntysaari Comparative Corporate Governance Shar...

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Comparative Corporate Governance Shareholders as a Rule-maker

Petri Måntysaari

Comparative Corporate Governance Shareholders as a Rule-maker

12

Professor Petri Måntysaari HANKEN Swedish School of Economics and Business Administration Kauppapuistikko 2 65100 Vaasa Finland [email protected]

Cataloging-in-Publication Data Library of Congress Control Number: 2005925157

ISBN 3-540-25380-7 Springer Berlin Heidelberg New York This work is subject to copyright. All rights are reserved, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilm or in any other way, and storage in data banks. Duplication of this publication or parts thereof is permitted only under the provisions of the German Copyright Law of September 9, 1965, in its current version, and permission for use must always be obtained from Springer-Verlag. Violations are liable for prosecution under the German Copyright Law. Springer is a part of Springer Science+Business Media springeronline.com ° Springer Berlin ´ Heidelberg 2005 Printed in Germany The use of general descriptive names, registered names, trademarks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. Softcover-Design: Erich Kirchner, Heidelberg SPIN 11408284

64/3153-5 4 3 2 1 0 ± Printed on acid-free paper

Foreword

It is fairly easy for a Finnish Jurist to understand German Company law. On the other hand, UK Company law seems very confusing. What is even more confusing is that the UK corporate govemance model is often regarded as one of the best in the World. Clearly German law cannot be as bad as it is often said to be. This books results from these kinds of thoughts and an interest in comparative law, Company law and securities markets law. I wanted to find out whether the functional method would give anything new to say about the regulation of corporate govemance in Germany and the UK. As I have been lecturing on Company law and corporate govemance myself, I also wanted to write a book that I could use as a textbook in my courses. For this reason, I focused on one of the key questions in corporate govemance: the regulation of shareholder activism. Petri Mäntysaari HANKEN Swedish School of Economics and Business Administration Vaasa, Finland 2 March 2005

Table of Contents

1 Introduction

1

2 Comparative Law and Corporate Governance 9 2.1 Introduction 9 2.2 The Comparative Legal Method in General 10 2.3 Comparative Corporate Governance inParticular 15 2.3.1 Introduction 15 2.3.2 The Objectives of Corporate Governance 16 2.3.3 The Choice of a Social Need 16 2.3.4 The Choice ofa Social Need and the Amount of Rules 18 2.3.5 The Choice of a Narrow Social Need 19 2.3.6 Rules on Governance and Rules on Constraints on Governance 21 2.3.7 The Legal Nature of Companies and the Organisation of Firms....... 22 2.3.8 The Sources and Natureof Rules 34 3 The Law of the European Union 3.1 The Legal Basis 3.2 The Harmonisation of Corporate Governance Rules 3.2.1. The General Approach in the Fast 3.2.2 Reasons for Harmonisation in the Future 3.2.3 The Effect of the Sarbanes-Oxley Act 3.2.4 The Present Approach to Harmonisation 3.3 Freedom to Choose the Company Form in the EU 3.4. The European Company 3.4.1 Introduction 3.4.2. The Applicable Rules in General 3.4.3 Party Autonomy under the SE Regulation 3.4.4 The Basic Governance Structure under the SE Regulation 3.5 Conclusion

35 35 37 37 38 44 47 53 58 58 60 64 66 77

4 The United Kingdom 4.1 General Remarks 4.1.1 Introduction 4.1.2 The Most Important Legal Forms of Business Organisation 4.1.3 Sources 4.1.4TheExtentof Party Autonomy in Rule-making 4.2 Basic Governance Structure

79 79 79 81 82 86 93

VIII

Table of Contents

4.2.1Introduction 4.2.2 General Meeting of Shareholders 4.2.3 Board ofDirectors 4.2.4 Managing Director 4.2.5 Company Secretary 4.2.6 The Location of Management 4.3 The Importance of Articles of Association 4.3.1Introduction 4.3.2 Parties Bound by the Memorandum and Articles 4.3.3 Enforcement by Shareholders 4.4 The General Meeting and Internal Management 4.4.1 Introduction 4.4.2 Division of Powers: General Remarks 4.4.3 Procedure of Decision-making 4.4.4 The Memorandum and Articles of Association 4.4.5 Decisions on Management Matters 4.4.6 The Appointment, Remuneration and Removal of Managers 4.5 Agreements and Internal Management 4.5.1 Introduction 4.5.2 Unanimous Consent 4.5.3 Shareholders' Agreements 4.5.4 Shareholders' Agreements with the Company 4.6 Disclosure, Remedies and Management Duties 4.6.1 Introduction 4.6.2 Disclosure of Information 4.6.3 Shareholder Remedies 4.6.4 Right to Sue: General Remarks 4.6.5 Proceedings Brought by Shareholders for Breach of Duty 4.6.6 Other Shareholder Remedies 4.6.7 The Duties of Board Members 4.6.8 The Duties of Sub-board Managers 4.6.9 The Duties of Company Secretary 4.6.10 Auditors'Duties 4.6.11 Shareholders'Duties 4.7 Shareholders and Dealings with Third Parties 4.7.1 Introduction 4.7.2 Representation of the Company: General Remarks 4.7.3 Company Acting through its Board ofDirectors 4.7.4 Company Acting through Other Representatives 4.7.5 Shareholders as a Rule-maker 4.8 The Govemance of Groups in the UK 4.8.1 Introduction 4.8.2 Legislation on Groups 4.8.3 The Effect of the Group Structure on the Scope of Rules 4.8.4 The Parent Company as a Rule-maker in the Subsidiary 4.8.5 Duties of the Board of the Subsidiary Company

93 94 95 100 101 104 105 105 105 112 114 114 114 116 120 122 135 143 143 143 146 149 151 151 152 159 166 169 179 181 191 196 198 202 202 202 203 204 206 210 216 216 217 218 221 222

Table of Contents

IX

4.8.6 Duties of the Board of the Parent Company 4.8.7 Duty of Board Members to Supervise Outsourced Activities 4.8.8 Duties of Outside Managers 4.9 Constraints on the Exercise of Shareholders' Powers 4.9.1 Introduction 4.9.2 Constraints on Voting 4.9.3 Enforcement of the Constitution of the Company 4.9.4 Constraints on Other Acts 4.9.5 Fraud on the Minority 4.9.6 Croups 4.9.7 Sanctions Against Shareholders

224 225 226 226 226 228 233 233 234 234 237

SGermany 5.1 General Remarks 5.1.1Introduction 5.1.2 The Most Important Legal Forms of Business Organisation 5.1.3 Sources 5.1.4 The Extent of Party Autonomy in Rule-making 5.2 Basic Govemance Structure 5.2.1 Introduction 5.2.2 The General Meeting 5.2.3 The Two-tier System 5.2.4 The Management Board 5.2.5 The Supervisory Board 5.2.6 Prokurist 5.2.7 TheLocation of Management 5.3 The Importance of Statutory Rules..... 5.3.1 Introduction 5.3.2 Effect on Board Members and the Statutory Auditor 5.3.3 Effect on Sub-board Managers and Employees 5.3.4 Derogation from the Aktiengesetz 5.4 The General Meeting and Internal Management 5.4.1 Introduction 5.4.2 General Remarks on the Division of Powers 5.4.3 Procedure of Decision-making 5.4.4 Articles of Association 5.4.5 Decisions on Management Matters 5.4.6 The Appointment, Removal and Remuneration of Managers 5.5 Agreements and Internal Management 5.6 Disclosure, Remedies and Management Duties 5.6.1 Introduction 5.6.2 The Rights of Shareholders to Disclosure of Information 5.6.3 Shareholder Remedies 5.6.4 Renal Sanctions 5.6.5 The Duties of Management Bodies 5.6.6 The Liability and Management Duties of Sub-board Managers

239 239 239 242 243 246 250 250 250 252 253 261 271 271 272 272 273 276 276 277 277 278 279 284 287 296 305 306 306 307 316 336 339 348

X

Table of Contents 5.6.7 The Liability and Duties of Statutory Auditors 5.7TheRoleofIndividualShareholders 5.8 Shareholders and Dealings with Third Parties 5.8.1 Introduction 5.8.2 Representation of the Company by its Shareholders 5.8.3 Representation of the Company by Other Representatives 5.8.4 Shareholders as a Rule-maker 5.8.5 Statutory Provisions on the Representation of the Company 5.9 The Govemance of Croups in Germany 5.9.1 Introduction 5.9.2 Fiduciary Duties of Group Members 5.9.3 The GmbH 5.9.4 Co-determination in Groups 5.9.5 Konzemrecht 5.9.6 Shareholders' Rights to Disclosure of Information in Company Groups 5.9.7 Shareholder Remedies in Company Groups 5.10 Constraints on the Exercise of Shareholders' Powers 5.10.1 Introduction 5.10.2 DutyofLoyalty 5.10.3 The Right to Contest Resolutions of the General Meeting 5.10.4 Capped Voting, Restrictions on the Use of Proxy Votes 5.10.5 Liability

6 Comparison 6.1 General Remarks 6.2 Convergence 6.3 Fundamental differences 6.4 Conflicts between models 6.5 Basic Govemance Structure 6.5.1 Germany 6.5.2 The United Kingdom 6.5.3 Two-tier Boards and Board Structures 6.5.4 The Fundamental Problems of UK Company Law 6.5.5 Commission Recommendation on the Role of Directors 6.5.6 The SE Company 6.6 Shareholders and Internal Management 6.6.1 Articles of Association 6.6.2 Appointment of Managers 6.6.3 Decisions on Management Matters in General 6.6.4 Shareholder Remedies 6.6.5 Legal Costs 6.6.6 Management Duties 6.6.7 Stakeholders' Interests 6.6.8 Voting 6.7 Proximity and Objectivity in Monitoring

352 353 354 354 355 355 358 360 362 362 363 364 365 366 373 374 379 379 380 380 384 385 389 389 393 394 395 397 397 398 399 401 404 406 407 407 408 409 410 412 413 413 414 415

Table of Contents 6.7.1 Approximation of Laws 6.7.2 Geraiany 6.7.3 The United Kingdom 6.7.4 Authorities as Objective Monitors 6.8 Consensus 6.9 Which Monitoring Model is Better? 6.10 Constraints on the Exercise of Shareholders' Powers 6.11Groups 6.12 Government Policy on Enforcement 6.12.1 Private Enforcement 6.12.2 Self-enforcement 6.12.3 Self-govemance of the Business Organisation 6.12.4 Public Enforcement References

XI 416 416 418 419 419 421 423 423 426 426 426 427 428 431

1 Introduction

As suppliers of capital, shareholders are expected to want corporate efficiency, honesty, productivity, and profitability. It is in their interests to restrict expropriation by managers and waste. If all goes well, managers will effectively represent these basic shareholder interests. But this is not always the case. When things go wrong, shareholders must do something. Shareholders are normally assumed to have the power to demand change at companies whose shares they hold. But small investors are oflen apathetic, and many institutional investors prefer not to demand change. They either vote with management or do not vote at all.^ There are many reasons for shareholders to remain only passive investors. For example, it costs money to be active; the benefits of improved corporate govemance are spread among all shareholders; institutions that merely track indices are not strong activists; and asset-management firms that are part of a bank are especially at risk from conflicts of interest. Sometimes shareholders are activists. Shareholder activism tends to increase in direct proportion to ownership concentration. Shareholder activism is often regarded as a good thing. Both the Commission of the European Communities and the US Securities and Exchange Commission (SEC) would prefer institutional investors to become more active, and involvement of institutional investors in the govemance of companies is encouraged by mies or proposed rules on the disclosure of their voting records and policies.^ Shareholder activism is not always regarded as necessary. It is thought that most shareholders lack the expertise and incentive to decide how to vote.^ Eisenberg MA, Corporate Law and Social Norms, Colum L Rev 99 (1999) pp 1283: "Twenty or thirty years ago, the basic norm that govemed institutional participation in corporate govemance was a passivity norm, reflected in part in the Wall Street Rule: If you don't like management, seil; if you don't seil, support management. Under the passivity norm, taking sides against management - voting against management proposals, supporting shareholder proposals, selling into tender offers, and so forth - 'was not done'." In January 2003, the SEC adopted rules that require mutual flinds to disclose their proxy voting records. These rules enable fund shareholders to monitor their funds' involvement in the govemance activities of portfolio companies. See also Communication from the Commission, Modemising Company Law and Enhancing Corporate Govemance in the European Union - A Plan to Move Forward. See Easterbrook FH, Fischel DR, The Economic Stmcture of Corporate Law (1991) pp 83 and 88.

1 Introduction In any case, one of the main differences between shareholders and other stakeholders is that shareholders alone have voting rights. The most commonly stated reason is that shareholders are the residual claimants to the firm's income.'^ The purpose of this book. This book has three purposes. Firstly, it examines whether legal rules allow shareholders to act as a rule-maker in a public limitedliability Company. Can activist shareholders run a public limited-liability Company or decide how it should be run by its managers? Secondly, this book examines some aspects of comparative corporate govemance as a legal discipline. Which things should one compare when one compares the regulation of corporate govemance under the laws of one country with that of another country? Thirdly, this book is intended as a text for university or business school students who take a course in comparative corporate govemance. One of the objectives of this book therefore is to also offer an introduction to two major European corporate govemance Systems. The book focuses on UK law and German law. The importance ofUK law and German law. One of the first questions to ask is to what extent the govemance of companies has been harmonised by provisions of EU Company law and whether UK and German law have played any role in this. The laws of these two countries have been quite important in the EU. The origins of much of EU Company law can be traced to German and UK law. While EU Company law is the main source of convergence of Company laws in Europe, EU Company law has also been influenced by Member States' laws and will probably continue to do so in the future.^ The beginning of the European process of Company law harmonisation was marked particularly by the influence of German ideas. While French law had been used as a model for the Third and Sixth Directives (merger and Splitting up), German law had prevailed in all other matters. The German point of view used to be that stock exchange and banking harmonisation are clearly separable from Company law harmonisation. The influence of Anglo-American ideas has been dominant for quite a considerable time. The Anglo-American view is that the regulation of stock exchange activity and banking on the one hand and Company law on the other are strongly interdependent.^ The change from the German model to the Anglo-American one happens at the same time as the move towards a Single securities market in the EU, the growth of European securities markets and a change in how large European companies raise finance. The main principle of UK Company and securities markets laws is that of disclosure. In addition to EU legislation, this principle has played an important role in some of the key Company law judgements of the European Court of Justice Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) pp 63 and 67; Easterbrook FH, Fischel DR, Voting in Corporate Law, J L & Econ 26 (1983) pp 395-396. See for example Lenaerts K, Interlocking Legal Orders in the European Union and Comparative Law, ICLQ 52 (2003) pp 873-906. Hopt KJ, Company Law in the European Union: Harmonization or Subsidiarity, 31 Saggi, conferenze e seminari del Centro di studi e ricerche di diritto comparato e straniero di Unidroit (1998) pp 6-8.

1 Introduction (ECJ) interpreting the EC Treaty.-^ Furthermore, the new regime of International Accounting Standards (lAS/IFRS) concems far more disclosure than before. German law and UK law can influence the Company laws of other Member States even in other ways. The Company laws of different Member States have been influenced not only by EU Company law but also by the Company laws of other Member States and other countries. For example, courts may look for guidance in the judgments of courts in other jurisdictions, the laws of one country can be used as a model in another by tradition, or there may be competition between Company law legislators.^ Even rules that do not directly originate from the State are influenced by rules applied in other countries; this is quite clear in the context of corporate govemance guidelines. German law is seemingly insignificant in the Company law books published in the UK, and vice versa. In the UK, it seems to be normal to discuss the German two-tier board stmcture, the role of employee representatives in the supervisory boards of large German companies and the relatively small number of hostile takeovers, but not much eise. In German Company law books, US law seems to be more important than UK law as a benchmark. Public limited-liability companies. Only listed companies, companies whose equity can be traded on a stock exchange, are discussed in this book. From a corporate govemance perspective, private limited companies, that is, companies whose equity cannot be traded on a stock exchange, are not less important. There are by far more private limited companies than listed companies in all member states of the European Union, and not all public-limited liability companies are listed on a stock exchange. Concentrated, not dispersed, ownership is the dominant worldwide pattem. At the moment, public limited-liabihty companies are nevertheless more interesting as regards future harmonisation and convergence of Company laws in Europe. There are economic and political pressures pushing European corporate govemance Systems towards convergence. But while the needs of European capital markets favour the convergence of national corporate govemance regimes that apply to public limited-liability companies, there are no such acute needs as regards private companies. Regulation andparty autonomy. The scope of party autonomy is one of the underlying questions in this book. The amount of statutory regulation and its compulsory nature vary, and so does the scope of party autonomy. Again there is a difference between Anglo-American laws and German law. There are roughly speaking two main models for the regulation of the govemance of public limited-liability companies.^ In both cases companies are regulated C-212/97 Centros [1999] ECR 1-1459; C-208/00 Überseering [2002] ECR 1-9919; C167/01 Inspire Art [2003] ECR 1-10155. See for example Centros, paragraph 36. See also Merkt H, Die Pluralisierung des europäischen Gesellschaftsrechts, RIW 1/2004 p 6. Hopt KJ, Company Law in the European Union: Harmonization or Subsidiarity, 31 Saggi, conferenze e seminari del Centro di studi e ricerche di diritto comparato e straniero di Unidroit (1998) pp 12-16. Merkt H, Untemehmenspublizität (2001) p 129; Merkt H, Zum Verhältnis von Kapitalmarktrecht und Gesellschaftsrecht in der Diskussion um die Corporate Govemance, AG

1 Introduction by a mix of, firstly, securities markets rules and traditional Company law rules and, secondly, mandatory rules and rules which are not compulsory. The Contents of this mix depend on the default form of raising finance chosen by the legislator. While this choice is probably influenced by path dependency and the economic climate, in particular by the prevailing ownership and control structure of firms and the way they raise finance,^^ the latter are also influenced by path dependency, in particular by existing and previous laws.^^ Regulation and business are in other words developed in tandem. According to the US model, it is assumed that companies raise equity in the capital markets. In order to protect investors and the functioning of effective capital markets, capital market transactions are regulated in the USA by federal laws that lay down mandatory rules.^^ These rules are complemented by Standards issued by securities exchanges. As regards traditional Company law matters, State Company laws set out only the most fundamental rules. Mandatory rules are necessary where disclosure requirements would not prevent expropriation by the management. Party autonomy can cover many traditional Company law matters. According to the Continental European model, companies are primarily assumed to raise finance privately. In order to protect minority shareholders and creditors, companies are to a large extent regulated by mandatory provisions of Company law.^^ The choice of one model instead of the other does not say anything about the quality of investor protection. For example, one of the fundamental purposes of Company law in Europe is to protect creditors. Law, not contract, protects creditors according to the European model. In the USA, the reverse is true. Creditors who wish to protect themselves from shareholders or managers behaving opportunistically must do so by contract.^"* Regardless of the model, the quality of investor protection depends on the quality of legal rules and the quality of acts done by market participants within this legal framework.

2003 p 127. See also Hopt KJ, Gestaltungsfreiheit im Gesellschaftsrecht in Europa Generalbericht. ZGR Sonderheft 13 (1998) pp 123-147. See Black BS, Kraakman R, A Self-enforcing Model of Corporate Law, Harv. L. Rev. 109 (1996) p 1913. Compare La Porta R, Löpez-de-Silanes F, Shleifer A, Corporate ownership around the World, J. Finance 54 (1999) pp 471-517. The authors found that, except in economies with very good shareholder protection, relatively few firms are widely held. See also Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Govemance and Its ImpHcations, Nw. U. Law Review 93 (1999) pp 644 and 661. 15 USC Section 77n (the Securities Act of 1933, Section 14); 15 USC Section 78cc(a) (the Securities Exchange Act of 1934, section 29(a)). See for example Hopt KJ, Gesellschaftsrecht im Wandel. In: Festschrift für Herbert Wiedemann (2002) pp 1015-1016. For the history of investor protection in Germany see also Cheffins BR, Mergers and Corporate Ownership Structure: The United States and Germany at the Tum of the 20th Century, AJCL 51 (2003) pp 499-500. Enriques L, Macey JR, Creditors Versus Capital Formation: The Case Against the European Legal Capital Rules, Comell L. Rev. 86 (2001) p 1173; Merkt H, Der Kapitalschutz in Europa - ein rocher de bronze? ZGR 2004 p 318.

1 Introduction Furthermore, dispersed share ownership is not necessarily caused by laws that deal with problems related to it. It is possible that these laws are caused by dispersed ownership. ^^ The choice of the US regulatory model thus does not necessarily lead to a US type of capitalism. Management. This book seeks to consider the relationship between shareholders and the "industrial bureaucrats" who actually run a public limited-liability Company. It is possible that the Company is run by managers who are recognised as organ members, managers who have broad authority over corporate affairs without being members of Company organs, or both. The Company may to some extent be run by its employees. The employees of the Company are not only affected by the govemance structure, they are representatives of the Company and part of the govemance structure themselves. How can shareholders teil these persons how to run the Company? There must be an examination of how each of the govemance mechanisms available to shareholders acts as a constraint at the relevant levels of the Company hierarchy, e.g. at the level of organ members, senior managers and employees. Shareholders, When discussing how a shareholder can run the Company or decide how it should be run, it is necessary to distinguish between active shareholders and passive shareholders. Active shareholders are actively involved in the business of the Company. Active shareholders will operate the business or at least be vocal, influence Company decisions and use their voting and other rights. Passive shareholders are merely investors. Passive shareholders rely on the rules that govem management and the fact that active shareholders can at least sometimes represent the interests of passive shareholders. Since the interests of active and passive shareholders can clash, there may be rules designed to prevent active shareholders from making gains at the expense of passive shareholders or from doing things that passive shareholders might not do, and rules setting out fiduciary-like duties owed by active shareholders to passive shareholders. Rules. It is also necessary to distinguish between legal rules that govem rulemaking and rules made by different rule-makers. Different rule-makers can make different kinds of rules ranging from enforceable legal rules to social norms.^^ The purpose of this book is to study legal rules that govem mle-making by shareholders and the type of mies that can be made by shareholders. For the purpose of this book it is sufficient to focus on those legal mies that affect management (that is, the intemal decision-making of the Company; the representation of the Company in its dealings with third parties; and the supervision of ^^ See Cheffins BR, Mergers and Corporate Ownership Structure: The United States and Germany at the Tum of the 20th Century, AJCL 51 (2003) pp 474, 489 and 499-501; Coffee JC, The Rise of Dispersed Ownership: The Roles of Law and the State in the Separation of Ownership and Control, Yale L J 111 (2001) p 44. ^^ See Eisenberg MA, Corporate Law and Social Norms, Colum L Rev 99 (1999) pp 1253-1255.

1 Introduction its activities) and rules that govem either the management procedure (for example the allocation of power in a Company) or the material constraints that apply to management generally (for example the duty of care and sanctions for the breach of rules). Many legal rules do not fall within these categories. For example, it is not necessary to focus on the vast amount of sector-specific legal rules protecting the workforce, the environment and so forth. These rules can be regarded as general constraints on the govemance of companies, and they do not govem the govemance as such (see Chap. 2.3.6 below). However, labour law rules do govem the govemance of companies where they provide that the workforce shall participate in management. About the structure of the book. The book consists of a brief introduction to comparative corporate govemance as a legal discipline, a chapter on the harmonisation of corporate govemance in the EU, two country surveys and an examination of major differences between these two jurisdictions. In the two country surveys, the legal regime and basic corporate govemance stmcture that apply to companies are described first. Next, four fundamental problem areas are examined: (a) shareholders acting as a mle-maker directly (for example, questions relating to articles of association and decisions on matters of management); (b) shareholders limiting the discretion of managers by monitoring them (in particular, questions relating to shareholders' rights to information, to the duties of members of the management of the Company, and to remedies available to shareholders for breach of duty or otherwise); (c) the Situation in a Company group; and (d) general constraints on shareholders' decision-making. The two country surveys are followed by a chapter where some aspects of UK and German law are compared. This chapter will not attempt to answer whether Germany's consensus-based model of capitalism is better than the market-oriented British model of capitalism. Rather, it deals with the legal framework of shareholder activism, in particular, the mle-making powers of shareholders or measures that are being used as an altemative to vesting these powers in the shareholders. About the results, One of the results of this study is that mies on govemance make it very difficult for shareholders to make managers mn a public limitedliability Company in a certain way. Where each shareholder has a small stake only, shareholders are relatively powerless.^'' However, a powerful shareholder can in real life influence management regardless of the formal mies. There are both similarities and differences between German and UK law. There is not only convergence of German law towards the UK model but also convergence of UK law towards the German model. As ownership diminishes in its ability to control management, the Organisation of the firm becomes more important; at the same time, extemal and intemal mies that govem Organisation become more important. This has happened in both countries. Mandatory mies play an important role in both countries. Company insiders and Outsiders know how a Company should be mn where the persons who actually ^"^ Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) p 1.

1 Introduction manage the Company must comply with clear and enforceable extemal rules. These rules are clearer in Germany, and it is easier for shareholders to enforce them in a German Company. Shareholders benefit from mandatory rules provided that they are effectively enforced against wrongdoers or not breached in the first place. Effective monitoring would make it more difficult to breach mandatory rules. There is interaction between monitoring and compliance, but from the shareholders' perspective, the main control mechanism is voluntary compliance by managers due to cultural or other reasons. On the other hand, it is difficult for non-controlling shareholders to monitor management unless there are mandatory rules that can be enforced by them. The amount of mandatory rules, the right of minority shareholders to sue and their right to be indemnified by the Company against legal costs influence their chances to monitor management. ^^ There are differences between the UK and Germany in this respect. In practice, it is difficult for non-controlling shareholders to enforce mandatory rules even when these rules exist. If shareholders cannot enforce the rules that protect them, these rules will not be enforced unless: (a) there is an effective extemal or internal monitoring body that has an Obligation to punish management for breach of rules; or (b) managers comply with these rules voluntarily. It is nowadays clear that there are two-tier board structures in both countries with an "independent" body or "independent" persons acting as an internal monitoring body. Although public enforcement has been relatively unimportant in the past, it is becoming increasingly important in both countries. It is interesting that in Germany, the legislator has encouraged voluntary compliance by a relatively wide network of mechanisms that complement one another. Irene Lynch Fannon wrote recently: "The division of shareholders and Controllers has become the established reality in large publicly held firms. The consequent rise in managerial power and prerogative raises issues of accountability. How should the lack of management accountability to shareholders be remedied? Giving non-controlling shareholders more voice would not be sufficient in the light of the fact most shareholders do not want more voice and prefer the passive role."^^ "[T]he Operation of capital markets is a very incomplete reflection of the entire function of management."^^ "Since the division of ownership and control allows managers of the Company to attain a position of control and most shareholders prefer a passive role, mandatory Company law should support the idea of a monitoring organ - such as the German Aufsichtsrat without Mitbestimmung which acts independently from both shareholders and management."^^ "If there are meaningful mandatory rules and an independent monitoring organ acting under a ^^ See Ulmer P, Die Aktionärsklage als Instrument zur Kontrolle des Vorstands- und Aufsichtsratshandelns, ZHR 163 (1999) pp 306-307 on US law. ^^ See Lynch Fannon I, Working Within Two Kinds of Capitalism. Corporate Govemance and Employee Stakeholding: US and EC Perspectives (2003) p 19. ^^ Lynch Fannon I, op cit p 21. ^^ Lynch Fannon I, op cit p 19.

8

1 Introduction

duty to penalise any breach of these rules, the debate on the constituencies to whom management should be accountable could become less important."^^ One can only agree.^^ One of the findings of this book is that although there is some convergence towards the German model in the UK, the recent reforms of UK Company law do not go far enough. In a group of companies, both German and UK corporate govemance rules make it relatively easy for the parent Company to teil the managers of a subsidiary how to run the subsidiary. In Germany, there are effective statutory rules on the govemance of controlled companies and the duties of Controlling companies (Konzemrecht), but the choice of the GmbH as the main Company form for subsidiaries is in practice more important than the Konzemrecht.

^^ Lynch Fannon I, op cit p 21. ^^ See Roth GH, Die (Ohn-)Macht der Hauptversammlung. Oder: Unlautere Werbung für Aktienrecht, ZIP 2003 pp 376-377; Hommelhoff P, Die OECD-Principles on Corporate Govemance - ihre Chancen und Risiken aus dem Blickwinkel der deutschen corporate govemance-Bewegung, ZGR 2001 pp 242-243; Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Govemance and Its Implications, Nw U Law Rev 93 (1999) p 691: "dispersed ownership requires special legal mies if it is to persist". See also Säle HA, Delaware's good faith, Comell L Rev 89 (2004) pp 461-462; Rashkover BW, Reforming corporations through prosecution: perspectives from an SEC enforcement lawyer, Comell L Rev 89 (2004) pp 537-538.

2 Comparative Law and Corporate Governance

2.1 Introduction Corporate governance mechanisms are very complex, and national models of corporate governance are often described at a high level of generality. But a high level of generality here can mean that the study does not add anything new. What should comparative corporate governance be in order to add something new? To begin with, comparative corporate governance is understood here as a legal discipline. Comparative law has its own methods and traditions. The starting point is not with any particular definition of corporate governance. Corporate governance is a flexible term covering a vast number of questions related to Systems by which the activities of companies, Company representatives and Company stakeholders are directed and controlled.' For example, the OECD Principles of Corporate Governance 2004 State that: "Corporate governance involves a set of relationships between a Company's management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the Company are set, and the means of attaining those objectives and monitoring Performance are determined." The starting point should be the choice of a purpose, method and audience. (a) In any discipline, each serious study should have a purpose. (b) Depending on the purpose of the study, the writer will choose one of many alternative methods. These methods can sometimes lead to the same result and at other times to very different results. Sometimes the writer finds the comparative legal method appropriate. (c) In addition to a purpose and a method, the writer must choose an audience. The audience's prior knowledge of the matter (Vorverständnis), information needs and language determine how the study must be carried out.^ For example, a judge of the European Court of Justice (ECJ) might, in order to Interpret EU law in a way acceptable to his colleagues and most Member States (purpose), compare existing national laws of Member States (method). In this For questions relating to the regulation of corporate governance generally see Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) The Anatomy of Corporate Law. A Comparative and Functional Approach (2004). See for example Coester M, Markesinis B, Liability of Financial Experts in German and American Law: An Exercise in Comparative Methodology, AJCL 51 (2003) p 277. The authors compared German and American law for American readers.

10

2 Comparative Law and Corporate Govemance

case, he will try to convince highly knowledgeable jurists specialised in EU law (audience).^ Let US assume that the writer chooses the comparative legal method. What are the characteristics of comparative corporate govemance as a legal discipline?

2.2 The Comparative Legal Method in General Comparative law is about comparing things. It is therefore not sufficient to describe just one national model of corporate govemance. A comparative lawyer must choose at least two jurisdictions. An article on, say, co-determination in Germany and nothing eise is not a comparative study. A State. Comparative law is always linked to one or more states. Each Jurisdiction has its own mies. As different jurisdictions have different mies, it is not meaningful to write about corporate govemance without choosing the laws of one or several jurisdictions first. There is no such thing as universally applicable legal mies on corporate govemance common to all states, and corporate govemance ideas developed in one State do not necessarily work in another. Choice of jurisdictions. The purpose of the comparative study will determine the choice of jurisdictions. Sometimes it is meaningful to choose jurisdictions closely related to one another, at other times jurisdictions that belong to markedly different cultures. It is technically possible to compare any two things with each other, but the work of the comparative lawyer is not meaningful unless the choice of jurisdictions is meaningful. For example, the extent of differences between the laws of the USA and Finland can make the choice of US law unhelpful if the purpose of the study is to help interpret existing Finnish law; this purpose would often be better served by the choice of German law or Swedish law or the law of any other Member State of the EU. The purpose of the study also determines whether the comparative lawyer should concentrate on the differences or similarities between different legal Systems."* For example, an advocate may sometimes need to concentrate on differences between Systems within the same cultural sphere in order to win his case; an academic may want to concentrate on similarities between culturally remote Systems in Order to find characteristics common to many Systems; or a judge of the ECJ may need to concentrate on both in order to find a Solution which best suits

See for example Lenaerts K, Interlocking Legal Orders in the European Union and Comparative Law, ICLQ 52 (2003) p 873: "For the Court of Justice [of the European Communities] and the [Court of First Instance], it is one method amongst other methods of interpretation of the law (such as literal, exegetic, historical, systematic interpretation) and it constitutes a tool for establishing the law." The writer refers to Fennelly N, Legal interpretation at the European Court of Justice, Fordham Int'l LJ (1997) pp 656-679. Compare Husa J, Farewell to Functionalism or Methodological Tolerance? RabelsZ 67 (2003)p 425.

2.2 The Comparative Legal Method in General

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the objectives of the Community and is acceptable for the different national legal Orders responsible for implementing Community law.^ The functional method, The main method used by modern comparative law is the functional method.^ It is more useflil in micro-comparison than in macrocomparison (the comparison of legal families, mentalities or legal cultures)7 The functional method is based on the idea that it does not make any sense to compare things unless they are comparable. The functional method is a value-neutral technique, but a comparative lawyer neither can be nor has to be value-neutral. The comparative lawyer is not valueneutral when deciding why he should write about something in the first place, when defining the topic of the study and choosing the purpose of the study and the point he wants to make. The fact that the functional method is a value-neutral technique means the following: (a) When using the functional method, it is first assumed that societies try to deal with perceived social needs in many ways, one of which is to address them by legal rules. In comparative law, it is necessary to identify both a social need that can be solved by legal means and the legal rules applied in different jurisdictions to deal with this need. The question will normally be subdivided into separate subquestions, because the main question is normally far too general in light of the purpose of the study and the information needs of the audience. (b) The comparative lawyer finds out what the Solution would be in each Jurisdiction according to the views of persons trained in law in the Jurisdiction in question. The comparative lawyer then tries to give a sufficiently accurate view - one could call it a "true and fair view" - of the Solution in each Jurisdiction to the extent necessary in light of the purpose of the study and the information needs of the audience. Different jurisdictions sometimes deal with the perceived social need in similar ways and at other times in very different ways. (c) An important task is to identify these similarities and differences. To what extent the comparative lawyer is expected to identify them and to explain why they exist depends again on the purpose of the study. For example, a judge of the ECJ would, due to the teleology of the comparative method used by him,^ probably not need very detailed information on the causes of similarities and differences. In comparative studies with an academic Status, the comparative lawyer is often expected by the audience (that is, by his colleagues and law professors) to provide an explanation of similarities and differences. It is probably impossible to find exact causal explanations for the existence of individual rules. However, this does not exclude efforts to give rational explaLenaerts K, Interlocking Legal Orders in the European Union and Comparative Law, ICLQ 52 (2003) pp 879, 884-887, 893. See generally Zweigert K, Kötz H, Einführung in die Rechtsvergleichung (1996) § 3 II. See Husa J, Farewell to FunctionaHsm or Methodological Tolerance? RabelsZ 67 (2003) pp 421-422. For example, the functional method as it is known in comparative law would not be the optimal method for a work like Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) The Anatomy of Corporate Law. A Comparative and Functional Approach (2004). See for example Lenaerts K, Interlocking Legal Orders in the European Union and Comparative Law, ICLQ 52 (2003) p 879.

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nations for similarities and differences.^ The similarities and differences can be caused by many reasons and the comparative lawyer must have an open mind. For example, a legal System will probably choose the rule that, among the various alternatives, appears to be the most acceptable to the rule-maker at the time, but this rule does not necessarily have to be efficient or fair or provide the greatest net social benefit - even communist countries and brutal dictatorships have laws. It is also clear that law is not exclusively concemed with economic factors; some goals are thought worthy of public pursuit although they are not necessarily cost effective. One of the reasons why important differences persist is path dependency (laws and corporate structures that an economy has at any point in time depend in part on those that it had at earlier times).^^ Harmonisation, legal transplants (copying the rule from another legal System),^^ and economic factors belong to the reasons that promote convergence. (d) What the comparative lawyer does at the end is teil the reader what the result of the study is in Hght of its purpose. For example, will the Solutions adopted in Germany or the UK help draft a new Statute in Sweden, and if so, how? Can the Solutions adopted in continental Europe help interpret existing British law, and if so, how? Can govemance principles adopted by institutional investors in the USA be enforced in Germany with different equity markets, legal norms, business culture and traditions?^^ The functional method thus means the comparison of how a social need has been dealt with by legal means. A comparative lawyer does not compare individual rules as such. Neither does he compare legal concepts; legal terms like the "board" or "good faith" are not comparable because they can mean basically anything and different things in different jurisdictions. For example, the comparative lawyer should not compare rules that apply to whatever is meant by the "board" in different jurisdictions, because "boards" can mean different things in different countries and the rules that apply to them do not necessarily share the same function.^^ The concept "board of a UK Company" is not directly comparable with the concept "supervisory board (Aufsichtsrat) of a German AG", but the rules of UK law and the rules of German law are comparable to the extent that they deal with the same social need. Comparability and complementarity. The functional method is about comparing reasonably comparable things. Much depends on what is compared. Which See Husa J, Farewell to Functionalism or Methodological Tolerance? RabelsZ 67 (2003) p433. See especially Bebchuk LA, Roe M, A Theory of Path Dependence in Corporate Ownership and Govemance, Stan L Rev 52 (1999) p 127. See especially Watson A, Legal Transplants: An Approach to Comparative Law, Second Edition (1992). See Andre TJ, Cultural Hegemony: The Exportation of Anglo-Saxon Corporate Govemance Ideologies to Germany, Tul L Rev 73 (1998) pp 69-171. See for example Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) Comparative Corporate Govemance - The State of the Art and Emerging Research (1998) pp 234-250; Davies PL, Stmktur der Untemehmensfuhmng in Großbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 pp 270 and 283.

2.2 The Comparative Legal Method in General

13

rules deal with the same social need? Complementarity can sometimes be a helpful concept, because two distinct phenomena can be interdependent in different ways depending on the context. Two choice variables are complements when doing (more of) one of them increases the attractiveness of doing (more of) the other. In contrast, two choice variables are Substitutes if doing (more of) one reduces the attractiveness of doing (more of) the other. For example, direct monitoring of employees' behaviour and the use of performance-based incentive pay may be Substitutes.^"* Now, lawmakers like legislators and judges often try to do fairly reasonable things. As the impact of adopting one complement is oflen increased by adopting other complements as well, lawmakers often adopt rules that are complements. There can be a rieh web of complementary relationships between rules. When existing rules are complements, each of them may or may not be attractive on their own, but together they are more powerful. A comparative lawyer should thus compare these wholes of complementary ways to deal with a given social need by legal means in different jurisdictions. For example, a German rule providing for the board membership of employee representatives may not seem attractive when judged separately, but this rule should not be judged without taking into account complements such as the two-tier board structure, the existence of a large body of mandatory rules, and so forth. The soundness of a certain rule can thus be ensured by a Cluster of rules and practices, which are not always immediately apparent to a foreign lawyer. ^^ The interdependence between different rules and other phenomena can partly help to explain the existence of a certain rule. There can be a causal relationship between the simultaneous existence of two complements, and between the existence of one Substitute but not the other. Law. Comparative law is about the study of law. A comparative lawyer is basically not required to think like an economist or a sociologist. For example, a comparative lawyer would not study how companies are run in real life; companies are run and organised in an endless number of ways.^^ The comparative lawyer could though study how legal rules enable the Company to be run and how the running of the Company is constrained by them. Furthermore, it is not the task of the comparative lawyer to study different socio-economic or politically inspired views on which stakeholders should have a say in the internal decision-making of companies. Instead, the comparative lawyer might study how the internal decisionmaking of companies is regulated and controlled in some jurisdictions in order to find out which stakeholders should, in light of the findings of this comparative le^"^ These definitions cited from Roberts J, The Modem Firm (2004) pp 34-35; see also pp 46-51 and 232. For the use of complementarity as a tool in comparative law see Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Govemance and its Implications, Nw U L Rev 93 (1999) pp 659-660; Chodosh HE, Comparing Comparisons: In Search of Methodology, Iowa L Rev 84 (1999) pp 1121-1127. ^^ See Coester M, Markesinis B, Liability of Financial Experts in German and American Law: An Exercise in Comparative Methodology, AJCL 51 (2003) p 309. ^^ See for example Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) pp 13-14; Roberts J, The Modem Firm (2004) pp 19-20.

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gal study, have a say in the internal decision-making of companies in another Jurisdiction. The comparative lawyer's views on the contents of foreign law are based on things that lawyers in that foreign country find authoritative or otherwise relevant when answering a similar question. When studying foreign law the comparative lawyer reads texts like Statutes, judgments and professional literature because foreign lawyers usually find them authoritative. In addition to formal rules (laid down by Statute, developed by the courts, included in Standard contracts and so forth) found in authoritative texts he should even take into account other things that would be relevant in the opinion of foreign lawyers. ^^ What is relevant varies depending on the Jurisdiction and the question. It is generally accepted that law should not be viewed separately fi'om the legal culture in which it exists. It is also useful to study the question from different perspectives (preparatory works, judgments, the views of practitioners) and read materials written at different levels of generality (scholarly articles, Student textbooks, comparative studies). The comparative lawyer thus studies legal rules or related rules instead of merely social rules. Social rules, among other things, may nevertheless help explain the contents of legal rules. The functional method can require the study of many fields of law. The potential diversity of disciplines poses problems for would-be comparative lawyers. In addition to a ränge of expertise spanning several jurisdictions, the comparative lawyer may need a ränge of expertise spanning many fields of law, so that a "true and fair view" can be synthesised. The comparative lawyer does not assume that all lawyers understand existing law in the same way in the relevant Jurisdiction. It is possible that the content of existing law is unclear. It is possible that the sources used by the comparative lawyer show that the contents of law are understood in different ways by different groups of lawyers; it is not unusual in many countries that courts, practising lawyers and academics think differently.^^ The comparative lawyer should describe these different views to the extent that it is necessary in order to give a sufficiently "true and fair view" to his chosen audience. The audience. The work of a comparative lawyer is directed to the audience chosen by him. The comparative lawyer will try to do all this in a way that is meaningful to this audience.^^ Sometimes the readers know one language and not the other. Sometimes the readers know a lot about the field of law and the different jurisdictions in question, sometimes not. Sometimes the readers can take in information in very abstract form, whereas sometimes they lack this ability. Sometimes the readers, for example a professor supervising the work of a doctoral ^^ See generally Zweigert K, Kötz H, Einfiihrung in die Rechtsvergleichung (1996) § 3 III. Actually, the same should be said of domestic law when the comparative lawyer writes about the law of his own country. ^^ See for example Coester M, Markesinis B, Liabihty of Financial Experts in German and American Law: An Exercise in Comparative Methodology, AJCL 51 (2003) pp 301 and 306. ^^ See for example Cheffins BR, Using Theory to Study Law: A Company Law Perspective, CLJ 58(1) (1999) pp 199-200.

2.3 Comparative Corporate Govemance in Particular

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Student, expect the results to be presented in a certain form, at other times the comparative lawyer may be free to choose the way he presents his ideas. While the identity of readers and their Vorverständnis play a key role in comparative law, the person of the comparative lawyer and his prior knowledge of the matter are just factors that make research in practice easier or more difficult for him; it is as a rule more difficult to understand foreign law than domestic law and more difficult to write in a foreign language than in one's own language. For example, a Continental European lawyer does not think like a common law lawyer, but a comparative Continental European lawyer should try to understand how common law lawyers think. A true and fair view. Comparative law can only be pragmatic. The way the comparative lawyer presents the results of the study is dependent on the purpose of the study and the audience (that is, the prior knowledge and expectations of the intended readers). These two things will also determine what the comparative lawyer must do in order to be able to give a sufficiently accurate view - a "true and fair view" - of the relevant jurisdictions. Single authorship. These requirements seem at first to demand a multi-author work. But in a single author work, the simultaneous analysis of different legal Systems helps the author to look at the problem from unfamiliar perspectives, to ask new questions simultaneously relevant to many different jurisdictions and to develop a unified synthesis. These considerations favour single authorship, despite all the difficulties that it poses.^^

2.3 Comparative Corporate Governance in Particular 2.3.1 Introduction Now, let US think about the govemance of limited-liability companies. All comparative lawyers should, of course, use the comparative legal method. In addition, a comparative lawyer should take into account the special characteristics of the comparative legal study of corporate govemance. A comparative lawyer should at least take into account the following four things (as will be explained below): the special aspects relating to the choice of a social need in comparative corporate govemance; the distinction between mies on govemance and mies on constraints on govemance; the effects of the legal nature of companies; and the effects of the Organisation of firms. Before discussing any other special aspects of the comparative legal study of corporate govemance, it is necessary to deal with, firstly, the relevance of the general objectives of the regulation of corporate govemance and, secondly, the choice of a social need in comparative corporate govemance. ^^ For example, most surveys published in Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) Comparative Corporate Govemance - The State of the Art and Emerging Research (1998) can hardly be described as comparative.

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2.3.2 The Objectives of Corporate Governance As Said above, corporate govemance can mean many things. From the perspective of comparative law, the definition of corporate govemance is basically irrelevant. With the functional method being a value-neutral technique, it is probably unsurprising that comparative law is neutral as regards the objectives of mies relating to corporate govemance. For example, it is wrong for a comparative lawyer to blindly accept the view that the principal goal of mies related to corporate govemance is, say, to restrict the expropriation of investors by Company insiders and to maximise profits for shareholders; this could tum out to be the principal goal of some mies in a certain Jurisdiction but it does not have to be so and the comparative lawyer will know this only after studying the Jurisdiction and mies in question. The same can be said of the view that the goal of corporate govemance mies is the pursuit of overall social efficiency. Existing law does not always serve that goal.^^ This does not prevent the comparative lawyer from evaluating the Solutions adopted in different jurisdictions by analysing how well certain goals chosen by him are met. The comparative lawyer may have to do this because of the purpose of the study.

2.3.3 The Choice of a Social Need What is relevant is the choice of a social need. There is a vast amount of different social needs.22 For example, it is clear that comparative corporate govemance as a legal discipline is more than the study of different ways in which countries allocate power among participants in a Corporation. Which kinds of social needs are we dealing with then in the context of the govemance of companies? To begin with, at least some social needs arise out of the fact that a Company is an artificial person. The following basic questions are likely to be discussed in most comparative corporate govemance studies. To whom do assets linked to the Company belong? Some form of "asset partitioning" is necessary. It is necessary to designate a separate pool of assets that are associated with the Company, and that are distinct from the personal assets of the Company's owners and managers. The second component of asset partitioning is

Compare Hansmann H, Kraakman R, What is Corporate Law? In: Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) op cit p 19: "To say that the pursuit of aggregate social welfare is the appropriate goal of corporate law is not to say, of course, that the law always serves that goal." See also Leyens PC, Deutscher Aufsichtsrat und U.S.-Board: ein- oder zweistufiges Verwaltungssystem? Zum Stand der rechtsvergleichenden Corporate GovemanceDebatte, RabelsZ 67 (2003) p 60.


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the assignment of rights in this distinct pool of assets.^^ As a rule, the assets of a limited-liability Company do not belong to shareholders; only shares do. Who is to be regarded as acting as or on behalf of the Company? A Company cannot act on its own in the physical sense. Somebody must represent it by taking care of its internal decision-making, somebody must represent it in its dealings with Company Outsiders (such as customers, suppliers and persons providing finance) and Company insiders (such as organ members, directors, managers, employees and shareholders) and somebody must represent it by taking care of its internal supervision and control. A Company must have an Organisation if it is to carry out business. "The decisive power in modern industrial society is exercised not by capital but by Organisation, not by the capitalist but by the industrial bureaucrat."24 How should the persons acting as or on behalf of the Company act? It may be necessary to make these persons act in a certain way. For example, in some jurisdictions it may be necessary to prevent internal abuse and waste (abuse and waste in relation to the Company itself), derivative abuse and waste (internal abuse and waste which affect stakeholders and society as a whole), stakeholder abuse and waste (abuse and waste in relation to the various stakeholders), and general abuse and waste (abuse and waste in relation to the society as a whole). One can assume that there are rules telling these persons what to do and what not to do. In addition to clear rules or general Standards, one of the legislative strategies dealing with this Problem is to set out in whose interests these persons must act. For example, depending on the Jurisdiction, they could be expected to act: in an economically effective way; or for the benefit of the Company; or for the benefit of shareholders; or for the benefit of the workforce; or for the benefit of the society as a whole; or for the benefit of a certain political movement and so forth. How should the various stakeholders act? It may also be necessary to make stakeholders act in a certain way. For example, in some jurisdictions the personal rights of shareholders can be affected by rules protecting the Company or other stakeholders (the use of voting rights is subject to rules protecting minority shareholders, the sale of shares is subject to rules protecting the workforce or competition and so forth); the personal rights of creditors can be affected by insolvency rules protecting the Company, its workforce and other creditors; and the personal rights of employees can be affected by rules protecting the interests of the employer. How are these persons and stakeholders motivated? The self-interest of all these parties may not always lead them to act in ways that the rule-maker, Organisation or society in general would want. For example, investors do not fulfil their role in the Company if they either have not invested in the first place or have already exited the Company; investors usually invest in companies that generate value for them. From an Organisation design perspective, the motivation problem ^^ See Hansmann H, Kraakman R, The Essential Role of Organizational Law, Yale L J 110 (2000) pp 392-393; Fleischer H, Gesetz und Vertrag als alternative Problemlösungsmodelle im Gesellschaftsrecht, ZHR 168 (2004) p 679. 2^ Galbraith JK, The New Industrial State, Third Edition (1978) p xiv.

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is to shape the Organisation to bring closer alignment of interests between the Organisation and its members and thereby increase the efficiency of the choices they make.^^ Corporate govemance scholarship usually deals with agency problems at the top level of Company hierarchy.^^ However, from the perspective of a comparative lawyer, the main questions usually relate to the regulation of monetary retums, the regulation of duties, and the enforcement of sanctions. At another level, motivation is affected by rules that are necessary because of the Organisation of the firm (that is, by rules on the allocation of power, the allocation of risk, and the distribution of information; see Chap. 2.3.7 below).

2.3.4 The Choice of a Social Need and the Amount of Rules But there is a vast amount of rules goveming the questions listed above. Every Jurisdiction addresses these problems in a variety of contexts.^^ Some rules can be general and not limited to the activities of companies or persons acting as or on behalf of companies. Not only are there rules on agency and employment, there are even rules protecting the environment, the physical integrity of humans, and so forth.^^ Rules can also be special and intended to deal with problems arising out of the activities of companies. These special rules can be based on external sources. Relevant extemal sources may include, among others, mandatory legislation, dispositive legislation and legislation providing for recommendations. Extemal sources may also include industry self-regulation and generally applicable practices. Industry self-regulation - for example by corporate govemance codes and accounting Standards - plays an important role in the modern regulation of companies. The sources of extemal mies can be national or intemational. For example, there are intemational mies based on EU Company and securities markets law and intemational accounting Standards. There are also several intemational recom-

Roberts J, The Modem Firm (2004) pp 118-119. Compare Hansmann H, Kraakman R, Agency problems and Legal Strategies. In: Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) op cit pp 26-27. See for example La Porta R, Löpez-de-Silanes F, Shleifer A, Vishny RW, Investor Protection and Corporate Govemance, J Finan Econ 58 (2000) pp 5-7; Cheffins BR, Law as Bedrock: The Foundations of an Economy Dominated by Widely Held Public Companies, OJLS 23 (2003) pp 2-3. Economic reality requires Company representatives to take into account general constraints such as the interests of consumers of the Company's products, the activities of competitors, the pressures of intemational trade, the interests of the workforce, and trade Union negotiations. Since such general constraints are not legal rules, they do not show how different jurisdictions solve problems by legal means, but they can help explain why a certain Jurisdiction has chosen a certain mle.


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mendations for multinational enterprises,^^ such as the OECD Guidelines for Multinational Enterprises. These Guidelines are recommendations that provide principles and Standards of good practice. Like the OECD, the ILO has adopted several Standards for multinational enterprises. In addition to extemal sources, special rules can be based on internal sources such as articles of association, internal guidelines and ad-hoc decisions. One can therefore distinguish between internal control mechanisms (internal corporate govemance) and extemal control mechanisms (extemal corporate govemance). These extemal and intemal mies do not necessarily have to be linked directly to action on the part of the State. Even non-state institutions, Company bodies and individuals such as shareholders can perform the function of a mle-maker. In any case, the possibihty that they can act as a mle-maker is linked at least indirectly to action on the part of the State because the State may choose the scope and binding nature of both legislation and matters that may be regulated by non-state institutions or the parties themselves. In comparative corporate govemance, it is basically wrong to focus on special mies intended to deal with problems arising out of the activities of companies. This is so because a comparative lawyer does not compare mies as such but how a social need has been addressed by legal means. But what should the comparative lawyer focus on in corporate govemance in light of the fact that there is a vast amount of mies affecting corporate govemance at least indirectly?

2.3.5 The Choice of a Narrow Social Need For many reasons, a comparative lawyer should choose a very narrow social need for the comparative legal study of corporate govemance.^^ Taking into account the amount of mies goveming companies, it is not meaningful for the comparative lawyer to choose a very broad social need.^' (a) For example, the comparative lawyer should not choose the regulation of "matters related to the agency theory and the Separation of corporate management and ownership". This is because the management is normally expected to comply with most mies that govem the activities of companies generally and it would in practice be impossible for the comparative lawyer to study all such mies or even the most important ones. (b) For the same reason, the comparative lawyer should not choose the need to restrict "expropriation". According to one view, the principal goal of corporate govemance is to restrict expropriation by Company insiders (such as managers and Controlling shareholders) of the Company, Investors (such ^^ See Gordon K, Miyake M, Deciphering Codes of Corporate Conduct: A Review of their Contents. OECD, Working Papers on International Investment 1999/2. Last revised: March 2000. ^^ See also Coester M, Markesinis B, Liability of Financial Experts in German and American Law: An Exercise in Comparative Methodology, AJCL 51 (2003) p 309. ^^ For a different view see Davies PL, Hertig G, Hopt KJ, Beyond the Anatomy. In: Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) op cit pp 222-226 where the authors in effect suggest very wide research topics.

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as shareholders, minority shareholders and credit institutions) or creditors (such as suppliers and other contract parties).^^ However, the choice of this social need would make the comparative study impossible to be carried out. (c) It has been argued that Company law addresses three basic agency problems: the opportunism of managers vis-a-vis shareholders; the opportunism of Controlling shareholders visa-vis minority shareholders; and the opportunism of shareholders as a dass vis-avis other corporate constituencies, such as corporate creditors and employees. At least the first of these three basic agency problems looks too wide for a meaningful comparative legal study, (d) It is also üitile for the comparative lawyer to compare "background rules that supply Solutions to the unforeseen contingencies facing investors".^^ In comparative corporate govemance, the comparative lawyer should preferably define the relevant social need in a narrow way in order to be able to: minimise the relevance of rules which govem business activities in general; and focus on rules which are intended to deal with problems relating to companies in particular.^"^ This does not mean that the comparative lawyer should focus only on rules that belong to the latter group. (a) Companies are part of society. It is necessary to take into account rules that protect stakeholders outside the traditional field of Company law.^^ (b) Even traditional Company law matters may be regulated by rules which do not necessarily belong only to Company law; they can be regulated for example by the general principles of the law of agency, the law of obligations, and torts law. A related matter is that the comparative lawyer should not define the social need unless he already knows enough of the issues that may become relevant during the course of the study. This usually requires some prior research. For example, the comparative lawyer could find out that to focus on "extemal" control mechanisms only, "intemal-vertical" control mechanisms only, or "intemalhorizontal" control mechanisms only, would not give a true and fair view of law, because these control mechanisms can partly serve the same function and over32

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La Porta R, Löpez-de-Silanes F, Shleifer A, Vishny RW, Investor Protection and Corporate Govemance, J Finan Econ 58 (2000) p 4. Compare Boot AWA, Macey JR, The Role of Objectivity, Proximity and Adaptability in Corporate Govemance, Comell L Rev 89 (2004) p 364. Compare La Porta R, Löpez-de-Silanes F, Shleifer A, Vishny RW, Law and Finance, 106 J Polit Economy (1998) p 1120: "We look only at laws pertaining to investor protection, and specifically only at Company and bankruptcy / reorganization laws ... There are several conspicuous omissions from the data set. First, this paper says little about merger and takeover rules, except indirectly by looking at voting mechanisms ... Second, this paper also says little about disclosure rules ... Third, in this paper we do not use any information from regulations imposed by security exchanges ... Finally, a potentially important set of rules that we do not deal with here is banking and fmancial institution regulations ..." Such a study would not give a true and fair view of law. For a narrower view see Hansmann H, Kraakman R, What is Corporate Law? In: Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) op cit p 17. The authors focus on traditional corporate law.


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lap.^^ And the comparative lawyer should of course focus on the flinction, not the rules. 2.3.6 Rules on Governance and Rules on Constraints on Govemance In addition to choosing a narrow social need, the comparative lawyer could distinguish between rules that act as constraints on the govemance of companies and rules on the govemance of companies. Most sector-specific mies outside the fields of Company law and related areas, for example environmental legislation and mies protecting workers, are mere constraints that do not affect the govemance of companies as such. This distinction can be illustrated by mies on co-determination and worker participation. These mies can either be constraints on govemance or mies on govemance or both. In order to be regarded as rules on govemance, it is not enough that the mies on co-determination and worker participation affect the procedure of the Company's decision-making in some way. Examples of rules on governance. Rules on co-determination and worker participation affect the govemance of companies directiy and should be regarded as mies on the govemance of companies instead of mere constraints on govemance where they set out that the workforce should participate in the management of the Company. This is the case when, under these mies, the representatives of the workforce represent the Company by taking care of its intemal decision-making, or the representation of the Company in its dealings with Outsiders, or the supervision of its activities. For example, mies which set out that a number of representatives of the workforce must be appointed to the organs which take care of the Company's intemal decision-making (especially mies on worker participation on the board of directors^^) belong to this category. The same can be said of mies according to which the company's intemal decision-making is subject to the consent of the workforce or a neutral organ or a third party that protects the interests of the workforce; this may be the case, for example, where a trade union is empowered to deCompare Cunningham LA, Commonalities and Prescriptions in the Vertical Dimension of Global Corporate Govemance, Comell L Rev 84 (1999) p 1134: "Corporate govemance mechanisms can be divided into the following three categories: (1) intemal-vertical, (2) intemal-horizontal, and (3) extemal. Internal govemance mechanisms are classified as vertical when they address the relationship between those in control of the Corporation and all other constituents (including shareholders, workers, lenders, and communities). Intemal govemance mechanisms are considered horizontal when they directly regulate the relationships among these various constituencies inter se. Extemal govemance mechanisms are those mies and regulations imposed upon the corporate entity to address concems beyond the direct interests of the Corporation. They include mies about competition and antitmst, national trade, and public health and safety." See for example Lynch Fannon I, Working Within Two Kinds of Capitalism. Corporate Govemance and Employee Stakeholding: US and EC Perspectives (2003) p 48-49. See also Davies PL, Stmktur der Untemehmensfühmng in Großbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 p 289.

22


cide whom the Company may employ. Even the duty to negotiate with the workforce can belong to this category because increased disclosure and observability can lead to better monitoring and increase the management's motivation to act in the desired way. Example of constraints on governance. Rules on co-determination and worker participation could be regarded as mere constraints on the govemance of companies to the extent that they set forth that an employer is legally obUged to consider the effect of its decisions on the workforce or prohibited from taking certain decisions which are contrary to the interests of the workforce. Borderline cases, Sometimes it is not easy to draw the line between these two categories. Rules that apply to certain activities generally can affect the govemance of companies directly. They should then be regarded as mies on the govemance of the Company. For example, environmental laws could in principle affect the allocation of power in the Company by providing for corporate environmental management Systems or lay down the duties of the persons responsible for environmental management and provide for the civil or criminal liability of these persons (statutory board members or other managers). However, mies on the environmental liability of companies, the criminal liability for corporations or the extent of the liability of corporations for loss sustained by third parties can be classified as mere constraints on govemance.

2.3.7 The Legal Nature of Companies and the Organisation of Firms Two fundamental things should influence comparative corporate govemance: The effect of the legal nature of companies and the Organisation of firms. The effect of the legal nature of companies has been discussed above. A legal fiction, a Company cannot do anything on its own but must be represented by others. This leads to some general needs that will be taken into account in most comparative corporate govemance studies. In addition, a Company needs an Organisation. A comparative lawyer should focus on the stmcture and hierarchy of the Organisation of firms. The Organisation of a modem firm is flexible.^^ It is not defined by ownership. There is interaction between Organisation and strategy; strategy and Organisation should in practice be developed in tandem.^^ Not necessarily permanent, the organisational stmctures may exist on a project-by-project basis. What is characteristic of the Organisation of a modem firm is that: relatively small subunits are created within the Organisation; the managers of these subunits are given substantial decision rights; and outsourcing and networking are important."^^ As will be seen below, the legal nature of companies as well as the stmcture and hierarchy of the Organisation of firms give rise to phenomena such as the ^^ See also Collins H, Regulating the Employment Relation for Competitiveness, ILJ 30 (2001) p 20. 39 See Roberts J, The Modem Firm (2004) pp 281-282. ^0 See Roberts J, The Modem Firm (2004) pp 2, 180,182-190 and 231-232.


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Penetration and dilution of rules. In addition, there are a number of social needs related to Organization. Hierarchy and the Location of Management in a Single Independent Company The traditional approach to corporate govemance is based on a single-company model. It is usual for Company law writers to focus on the relationship between shareholders and those in control of the Company. According to this view, a limited-liability Company is owned by its shareholders and its business activities are controlled by members of a board of some kind and/or Controlling shareholders. This approach fails to recognise the importance of Organisation."*^ Most decisions taken on behalf of the Company are clearly not taken by its shareholders or members of any statutory board but by professional managers and employees at relatively low levels of hierarchy. The same applies to most transactions carried out on behalf of the Company. It would indeed be cumbersome if a large number of issues had to be passed through several levels of management before a decision could be taken; a Company would not function effectively if minor issues had to be referred to senior management. The Company usually has divisional structures, and different management flinctions are organised along divisional lines. Divisionalisation involves structuring the Organisation on the basis of subunits defined by product, customers or geography.42 On the other hand, the management structure is not necessarily linear. In order to ensure that its Operations are well inter-coordinated, the Company may adopt a matrix management System whereby staff are accountable both to managers in business divisions and to those within their own particular specialism. The result can be a complex structure within which lines of decision-making and accountability are unclear."*^ For example, the Finnish telecommunications giant Nokia Corporation consisted of four vertical business groups in 2004: Mobile Phones; Multimedia; Networks; and Enterprise Solutions. In addition, the organisational structure included three horizontal groups that supported the business groups: Customer and Market Operations; Technology Platforms; and Research, Venturing and Business Infrastructure.'*'* According to the articles of association of Nokia Corporation, a non-statutory body called the Group Executive Board was responsible for managing the Operations of Nokia. The members of this large body included the chairman of the board of directors, the managing director and "Head of Customer and Market Operations", a "Chief Technology Officer", a "Technology Advisor", a "Senior Vice President, Human Resources", a "Chief Financial "^^ For a traditional view on corporate govemance and corporate law see, for example, Davies PL, Hertig G, Hopt KJ, Beyond the Anatomy. In: Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) op cit pp 222-226. "^^ See for example Roberts J, The Modem Firm (2004) pp 1 and 167-168. "^^ See also Roberts J, The Modem Firm (2004) p 183. Roberts describes the matrix Organisation of BP plc before the 1990s. "^"^ This horizontal group was dropped within a year.

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Officer", a "Senior Vice President, Corporate Relations and Responsibility of Nokia Corporation", a "Chief Strategy Officer", a "General Manager of Mobile Phones", a "General Manager of Multimedia", a "General Manager of Networks", a "General Manager, Business Units, Networks", and a "General Manager of Enterprise Solutions". In real life, a Company is probably managed at different levels of the Company hierarchy. A Company is not managed only by the body that has the largest powers or only by what could be described as its "centre of gravity" of management, that is, a point in the structure of a Company's management where all of the weight of the Company's management could be thought to be. A comparative lawyer should identify the most important levels for the purposes of the study. The most important levels of the Company structure can vary depending on the nature of the matter. For example, it may be necessary to distinguish between the Company's internal decision-making, representation of the Company in its dealings with third parties, the monitoring of management and the enforcement of sanctions for breach of duty. These functions are unlikely to coincide completely. Although hierarchies are reduced, discretion is increased and direct control and supervision are diminished in a modern Company, some levels of hierarchy will remain. Some managers will necessarily have an "agency role" on behalf of external suppliers of capital. Some managers must decide on the Organisation of the firm. Some managers must specify the work to be performed. Some managers will coordinate production by directing labour and some managers will monitor Output in Order to determine whether employees are performing their contracts of employment satisfactorily."^^

Company Groups It is not sufficient to study the govemance of Single independent companies. The Single independent Company model is a thing of the past. In corporate practice, a web of wholly or partly owned subsidiaries is for public companies the main form of doing business. Market forces have lead to the growth of a large number of large and small multinational firms."*^ In Company groups, the economic and legal units of business do not necessarily coincide; each legal unit of business operates to some extent in the interests of one or more other legal units or the corporate group as a whole. The structure of Company groups varies a lot, as has been recognised by the OECD Guidelines for Multinational Enterprises: "These usually comprise companies or other entities established in more than one country and so linked that they may co-ordinate their Operations in various ways. While one or more of these entities may be able to exercise a significant influence over the activities of others, ^^ See CoUins H, Regulating the employment relation for competitiveness, ILJ 30 (2001) pp 25-31. ^^ See also Blumberg PI, The Corporate Entity in an Era of Multinational Corporations, Del J Corp L 15 (1990) pp 326-327; Roberts J, The Modem Firm (2004) pp 180-181.


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their degree of autonomy within the enterprise may vary widely from one multinational enterprise to another.'"^'^ Group structures differ according to the type of firm and the kinds of markets in which it operates, and they will also evolve over time. The firm normally ends up with a multidivisional structure. In Company groups, divisionalisation means that the operating functions of many legally separate subsidiaries are performed within one subunit of the firm, and separate operating functions are organised within separate subunits of the firm/^ The roles of shareholders vary. While there may be passive investors in different companies belonging to the group, the parent Company is typically not a passive investor in its subsidiaries."^^ The degree of centralised control over subsidiaries and affiliates varies. For example, the ILO has stated that the "degree of autonomy of entities within multinational enterprises in relation to each other varies widely from one such enterprise to another, depending on the nature of the links between such entities and their fields of activity and having regard to the great diversity in the form of ownership, in the size, in the nature and location of the Operations of the enterprises concemed..."5o There is a trade-off between the integration of functions within the firm and the responsiveness of individual subunits of the firm to markets. Although divisional structures represent an effective Communications System between the decisionmaking centres of the firm and the markets in which it operates, the size and complexity of the managerial structure could itself become a hindrance to such communication in a large firm.^^ The following conclusions have been drawn. (a) A foreign subsidiär/ may have relatively little autonomy: if it belongs to a large multinational group established in many foreign countries; if it manufactures fairly standardised products; if the activities of the members are largely integrated; if it has been created to serve a market larger than the country in which it is established; or if the parent Company holds a large portion of the equity.^^ (b) A foreign subsidiary may enjoy more autonomy: if it was acquired to serve mainly the local market; if it belongs to a small group: if it has interchange of products with the rest of the group and is operating in an activity slightly different from that of other members; if an important part of its shares is held by local investors; and if the whole concem pursues

^'' The OECD Guidelines for Multinational Enterprises (2000), Concepts and Principles. "^^ See Muchlinski P, Multinational Enterprises and the Law (2004) p 58; Roberts J, The Modem Firm (2004) p 1. "^^ Blumberg PI, The Corporate Entity in an Era of Multinational Corporations, Del J Corp L 15 (1990) p 327. ^^ ILO, Tripartite Declaration of Principles conceming Multinational Enterprises and Social Policy (1977), Article 6. See also Roberts J, The Modem Firm (2004) pp 182-190. ^^ See Muchlinski P, Multinational Enterprises and the Law (2004) p 58; Roberts J, The Modem Firm (2004) pp 183-190. ^^ OECD, Stmcture and Organization of Multinational Enterprises (1987) p 35; cited from Muchlinski P, Multinational Enterprises and the Law (2004) p 60.

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2 Comparative Law and Corporate Goveraance

growth strategy.^^ (c) In addition: US firms tend to be relatively centralised; centralisation may decrease over time; a new establishment may be more closely controlled than an acquired local Company; some Industries will be more globally integrated and centralised than others; poor Performance increases central control; and geographically organised multinational enterprises tend to be less centralised than functional, product or matrix-organised firms.^"^ What is characteristic of modern firms is creating relatively small subunits within the Organisation in which significant decision rights are lodged and decreasing the number of layers of management and the extent of central staff.^^ In any case, group management structures require effective monitoring Systems. Divisionalisation can be complemented by a matrix management System. For example, a Company manufacturing large diesel engines could have three divisions Marine, Power Plants and Service - operating globally. Local companies could Support the Operations in their respective countries. This matrix Organisation would ensure that the business areas carry prime responsibility for their customers and also interact with them directly. Matrix management Systems can be complicated,^^ and they do not always work. For example, Baring Securities Limited operated a matrix management System from the end of 1992 onwards. Different functions were organised and managed "globally", meaning that a particular activity of subsidiary A might be managed by directors or executives actually employed by subsidiary (or parent) B. Therefore, responsibility for the trading aspect of the business of Baring Futures (Singapore) was split from that for the settlement side, and both were managed by executives nominally employed by, or directors of, other companies in the Barings group.^^ As is well known, Barings bank collapsed in spectacular fashion.

Networks Networks are an important part of the Organisation of modern firms. The OECD Guidelines for Multinational Enterprises recognise that "[mjultinational enterprises, like their domestic counterparts, have evolved to encompass a broader ränge of business arrangements and organisational forms. Strategie alliances and closer relations with suppliers and contractors tend to blur the boundaries of the enterprise."^^ Firms are thus evolving into co-ordination centres of outsourced Services and activities. Even management functions may to some extent be outsourced and occur in a network to which the Company belongs.

OECD, Structure and Organization of Multinational Enterprises (1987) p 35; cited from Muchlinski P, Multinational Enterprises and the Law (2004) p 60. Muchlinski P, Multinational Enterprises and the Law (2004) pp 60-61. Roberts J, The Modem Firm (2004) pp 180 and 232. 56 See Roberts J, The Modem Firm (2004) pp 109-110. ^"^ This management System of the Barings group was explained by Mr Justice EvansLombe in Barings Plc v Coopers & Lybrand (a firm) [2002] EWHC 461 (Ch). ^^ The OECD Guidelines for Multinational Enterprises (2000), Preface.


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For example, extemal auditors appointed by the Company report on the Company's accounts and management. Internal audits may be outsourced. In a group of companies, the parent normally monitors the business of its subsidiaries. But monitoring is not the only activity to be affected. As an increasing number of companies concentrate themselves on their core business, important parts of a Company's business may actually be carried out by other companies. For example, in a supplier partnership the buyer binds its management System to that of the seller in order to coordinate production and delivery times and to ensure sufficient attention on efficiency and quality; the parties also share knowledge, information and know-how in order to promote innovation, improve quality and reduce costs. Networking and outsourcing reduce hierarchies inside the Company. As work will be performed in networks that may extend over different legally independent Company structures, the internal Organisation of a modern Company becomes flatter and more lateral. At the same time, the rights and obligations of "extemal" persons participating in the govemance of the networked Company might not be the same as those of their counterparts within a Single independent Company.

Economic and Legal Theories ofttie Firm A comparative lawyer's opinion of what constitutes the business enterprise or the "firm" for the purpose of the comparative study of the govemance of companies does not have to coincide with economic and legal theories of the firm. Economics offers several distinct theories of the firm. Each theory explains a particular feature of the business enterprise but does not capture its whole.^^ The same is tme of the legal theory of the firm. There is no Single, dominant legal conception of the business enterprise, but rather a series of accounts that view it fi*om particular perspectives. For example, Company law is to a large extent concemed with a set of fmancial claims on the assets and income streams of the firm.^^ Even in the field of Company law there have been several competing schools of thought over the years.^^ 5^ Deakin S, 'Enterprise-Risk': The Juridical Nature of the Firm Revisited, ILJ 32 (2003) p 97: "Coase's account in *The Nature of the Firm' focused on the relations of production and the firm-market boundary, which he associated with the legal distinction between employees and independent contractors. The *Nexus of Contracts' theory widened the field of inquiry to include the firm's relations with suppliers of finance. The Troperty Rights' approach, in tum, built a theory of vertical integration and disintegration around aspects of the control of the firm's non-human assets." See also Ronald Coase, The Nature of the Firm, Economica 4 (1937) p 386, reprinted in Ronald Coase, The Firm, the Market and the Law (1988); Michael C. JensenAVilliam H. Meckling, A Theory of the Firm: Managerial Behaviour, Agency Costs and Financial Structure, J Finan Econ 3 (1976) pp 305-360; Oliver Hart, Firms, Contracts and Financial Structure (1995). 60 Deakin S, 'Enterprise-Risk': The Juridical Nature of the Firm Revisited, ILJ 32 (2003) pp 97-99. ^1 See Cheffms BR, The Trajectory of (Corporate Law) Scholarship, CLJ 63 (2004) pp 456-506; Skeel DA, Corporate Anatomy Lessons, Yale L J 113 (2004) pp 1519-1520.

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Each comparative study of the govemance of companies explains a particular feature of the business enterprise. The boundaries of the "firm" depend on the purpose of the study and the chosen social need. But even if the boundaries of the firm were defined and re-defined on a case-by-case basis in each comparative study, these definitions would not necessarily be less accurate than those used in other theories of the firm.^^

The Penetration and Dilution ofRules The legal nature of companies and the Organisation of firms can have an effect on the scope of rules. It may be that the rules apply at a certain level of hierarchy in a certain Company. It is possible that the rules penetrate only some levels of hierarchy and that their effect is diluted by the existence of many levels of hierarchy. Furthermore, the fact that part of the Company's functions are carried out by other group companies or network members can dilute the effect of rules when the rules do not penetrate the separate legal personality of companies. How do rules penetrate the Organisation of the firm in the case of a Single independent Company? To what extent are rules diluted by the structure and hierarchy of the Organisation of the Company? (a) To begin with, it is possible that the relevance of different rules is dependent on the relevant level of hierarchy. For example, the duties of blue-collar employees are to a large extent govemed by rules that are found in labour law and contract law, but special rules applicable to limited-liability companies are probably more relevant as far as the duties of board members, chief executive officers, chief financial officers, and other persons at top levels of management are concemed. (b) Two of the most common things that prevent the penetration, and dilute the effect, of rules are the separate legal personality of companies and the limited liability of shareholders. For example, many rules that govem the contractual rights of employees do not penetrate the Company hierarchy "upwards" up to the level of Company owners because a Company as a contract party is deemed to be distinct from its shareholders and the limited liability of shareholders for obligations of the Company is regarded as one of the most fundamental principles of Company law. (c) It is possible that in addition to the level of management, the relevance of different rules is dependent on the nature of the act done on behalf of the Company. For example, a certain rule may affect the validity of the Company's internal decision-making in one way and the validity of contracts concluded on behalf of the Company in another way or not at all. (d) It is also possible that the relevance of the rule is dependent on which persons are party to the legal relationship. For example, the fiduciary duties of the board of directors could in principle encompass obligations to the Company, its shareholders, employees, stakeholders, or only some of them. (e) The question of penetration affects not only rules based on sources outside the Company (such as statutory law) but even rules based on the Company's internal decision-making (such as articles of association or ad-hoc decisions). For example, resolutions by shareholders are ^2 Deakin S, *Enterprise-Risk': The Juridical Nature of the Firm Revisited, ILJ 32 (2003) pp 97-113.


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not necessarily binding on blue-collar workers. It is of course possible that resolutions by shareholders are not binding on the management, either. For example, shareholders in Britain get to vote each year on their firm's executive-pay plans but these resolutions are not binding on management.^^ The workforce can play an important role in comparative corporate govemance. This is true regardless of the fact that it is not usual to recognise the workforce in the organic structure of companies. The traditional focus upon the relationship of Company organs and financial capital is often too narrow because it ignores the fact that the day-to-day management of large companies is dealt with at relatively low levels of hierarchy. A pubHc Company is hardly run by a handful of people who convene a few times a year; most of the work will be carried out by a large number of people who work at different levels of hierarchy every day. The role of the workforce is not limited to Cooperation on the shop floor, works Councils, collective bargaining, and worker representation on boards.^"^ The workforce is not only a stakeholder,^^ a constituency that needs to be protected against the opportunism of capitalists.^^ In practice most of the Company's internal decision-making and its representation in its dealings with third parties will be taken care of by its workforce: the company's managers, middle-management and shop floor employees.^*^ How do rules penetrate the Organisation of the firm in a group of companies? This is a case of the management of two or more companies. Some questions will be govemed by the general rules applicable to the management of the parent Company. For example, the parent Company will be able to control the subsidiary and manage its business through its own representatives whose powers to act on behalf ^^ The Commission has recommended a similar procedure; the vote may be either mandatory or advisory. Commission Recommendation on fostering an appropriate regime for the remuneration of directors of listed companies. ^^ For example, the European Works Council Directive (94/45/EEC) is focused on transnational issues within multinational companies. It covers topics such as keeping staff informed of how their firm is doing across the European Community and whether any pan-European redundancy programmes are planned. The Information and Consultation Directive (2002/14/EC) gives employees a right to be informed about the business's economic Situation, informed and consulted about employment prospects, and informed and consulted about decisions likely to lead to substantial changes in work Organisation or contractual relations, including redundancies and transfers. ^^ See Wedderbum A, Employees, Partnership and Company Law, ILJ 31 (2002) pp 99111. ^^ Compare Lynch Fannon I, Working Within Two Kinds of Capitalism. Corporate Govemance and Employee Stakeholding: US and EC Perspectives (2003) p 22: "The corporate govemance debate has reached a point where the only real question is whether we ought to abandon the legal structure of the corporation, which has existed more or less intact since the nineteenth Century, so that modem management (an unelected, careerist constituency with clear vested interests of its own) is legally obliged to consider its obligations to labour, suppliers, customers and others? This work focuses only on labour, as a deserving beneficiary." ^^ Compare CoUins H, Regulating the employment relation for competitiveness, ILJ 30 (2001) p 23.

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of the parent Company are determined in accordance with the rules applicable at the level of the parent Company. The scope of some rules that govem the management of the parent Company may be limited by the fact that the subsidiär/ is a legal person distinct from its shareholders. For example, a decision by the board of the parent Company may not be sufficient where the rules that govem the management of the subsidiary provide that the matter must be decided on by the board of the latter. The scope of general rules may be limited by the a distinct body of rules applicable to groups (like in German law). And most importantly, the scope of both general rules and special rules on groups may be limited by the fact that many subsidiaries are foreign companies regulated by foreign law designated by the applicable rules of international private law. How do rules penetrate the Organisation of the firm in a network Situation? Even this is a case of the management of two or more companies. The same kinds of questions arise as in the case of groups of companies. Relevant levels of hierarchy. A comparative lawyer should find out whether a rule penetrates the hierarchy and structure of the firm to the effect that it is valid in the relevant Company and at the right level of hierarchy. The comparative lawyer should identify the relevant rule in the context of the study. For example, if the comparative lawyer finds out that a Company is represented in its dealings with third parties primarily by its middle management, he should also find out whether a rule that govems the representation of the Company in its dealings with third parties applies to acts done by those representatives of the Company. This is not necessarily the case.^^ It is also possible that the largest part of corporate crime occurs at the level of lower to middle management and that a Company is not criminally liable for the acts or omissions of another Company within the group;^^ a rule that applies to only statutory board members of the parent Company would not necessarily be very effective in real life. Social Needs and Organisation There are quite a few social needs that arise out of the Organisation of limitedliability companies. The most fundamental of these needs relate to the allocation of power, allocation of risk and distribution of information. The following basic questions are likely to be discussed in many comparative corporate govemance studies. How is power allocated in a limited-liability Company? Many persons may act as or on behalf of the Company in some way but somebody must (a) actually mn the Company (formulate and decide on the Company's policy; decide on the Organisation of the firm; put the Company's policy into effect and carry it out; and enter into related contracts with third parties on behalf of the company);'^^ (b) appoint the persons who mn the Company; (c) monitor the persons who mn the com^^ For example, Article 9(1) of the First Company law Directive Covers only acts done by the "organs" of the Company but not acts done by other representatives. ^^ See Hill J, Corporate Criminal Liability in Australia, JBL 2000 pp 12 and 14. ^^ Davies PL, Gower's Principles of Modem Company Law, sixth edition (1997) p 178.


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pany; and (d) provide information to shareholders and stakeholders to enable them to act in a rational way. How is risk allocated in a limited-liability Company? The risk can be allocated in many ways between stakeholders and Company representatives acting as or on behalf of the Company. Power and risk do not necessarily coincide.^^ (a) For example, shareholders have some fundamental powers in the Company although the risk of losing the amount invested can be quite low. If the Company faces fmancial min, the amount invested by shareholders is wiped out first. However, shareholders are normally under no Obligation to make payments to the Company or its creditors after the shares have been paid up in füll (limited liability) and shareholders may be able to reduce the risk of losing the value of their shares by diversifying their holdings. (b) Members of a statutory body such as a board of directors can have wide powers in the Company, but even they can reduce their risk. The risk of liability for economic loss sustained by the Company or its stakeholders by reason of bad management is not necessarily high and can be further reduced by D&O insurance policies.*^^ The risk of loss of human capital invested in the Company can be decreased by multiple board memberships. Factors that can decrease the likehhood of such events occurring include, for example, the lack of effective Systems for the enforcement of sanctions against board members and the lack of effective Systems for the removal of ineffective board members. (c) The employees have generally very limited powers in the Company, but their risk of losing the human capital invested in the Company can be quite high. It can also be difficult for employees to reduce this risk by diversification. (d) The liability of creditors is limited to the amount invested in the Company. Creditors can decrease the risk of losing the amount invested by diversification. The powers that creditors have during the ordinary course of the Company's business depend usually on contract, but creditors can have wider powers in corporate crises. The allocation of risk is linked to the availability of remedies. Remedies against Company representatives and the duties of Company representatives go hand in hand. There are different kinds of remedies and they affect the duties of Company representatives in different ways. For example, some remedies available to shareholders are linked to a breach of duty, but other remedies do not require any such breach. Some remedies (for example the power to appoint and remove managers) can enable shareholders (at least Controlling shareholders) to force managers to run the Company in a certain way, but other remedies (for example disclosure and the following negative Publicity) act merely as a constraint discouraging the management from doing certain things. Some remedies exist in name only because they cannot be enforced in practice. How is information distributed and disclosed in a limited-liability Company? In a public Company, the flow of information is important in four respects. Firstly, it See for example Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) pp 29-30, 37 and 53; Ong DM, The Impact of Environmental Law on Corporate Govemance, EJIL 12 (2001) pp 702-707. See for example Black BS, Cheffins BR, Klausner M, Outside directors and lawsuits: What are the real risks? McKinsey Quarterly (2004) Issue 4 pp 70-77.

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is important for persons who act as or on behalf ofthe Company because it enables them to take decisions on a rational basis. Secondly, Investors and other stakeholders also need to make decisions on a rational basis. For example, the disclosure of information is necessary in order to facilitate extemal financing and the efficient allocation of resources through extemal capital markets. Thirdly, the flow of information is closely connected with how the govemance of companies is monitored and how effective different monitoring Systems are. There can be either proximity or objectivity in monitoring, but only well informed monitors perform well.'^^ Fourthly, the flow of information is connected with the observability of the actions of managers and employees. While limited observabiHty is a source of motivation problems, increased observability makes it possible to motivate them.^"* How are these problems solved in Company groups and networks? The same Problems exist in Company groups and networks7^ (a) The allocation of power plays a major role for groups. Since a Company group consists of many separate legal entities, mies on the allocation of power must be applied separately to each participating entity. These mies are not necessarily identical or compatible with each other. While some mies on the allocation of power apply to the parent Company, different mies can apply to the subsidiary, and even more so in multinational enterprises. The stmcture of the group makes it necessary to allocate power in two ways. Firstly, power must be allocated between different participating entities. Secondly, power must be allocated intemally within each entity. These mies are applied cumulatively. For example, the mies that govem the subsidiary can provide the parent Company with certain powers in the capacity of a Controlling shareholder. The mies that govem the parent set out to what extent the exercise of any of these powers is vested in its managers, statutory board members, or shareholders ("end-shareholders"). The mies that govem the subsidiary determine to what extent acts done by a Controlling shareholder are binding on the managers or statutory board members of the subsidiary, and can provide to what extent acts done by a Controlling shareholder's managers, statutory board members, or endshareholders are binding on the subsidiary itself. (b) The allocation of risk is gov-

Boot AWA, Macey JR, The Role of Objectivity, Proximity and Adaptability in Corporate Govemance, Comell L Rev 89 (2004) pp 357-358: "Monitors are crucial to effective corporate govemance and assume a variety of forms: directors, auditors, credit rating agencies, stock market analysts, takeover firms, arbitrageurs, large shareholders, and outside lenders. Even customers and suppliers act as monitors when they exercise their ability to observe management quality and to send effective Signals to the market about management's Performance." See Roberts J, The Modem Firm (2004) pp 123-128, 135-137 and 161. See the recommendations published by Fomm Europaeum, a network of university professors in the field of Company law and related subjects: Fomm Europaeum Konzemrecht, Konzemrecht für Europa, ZGR 1998 pp 672-772. In that article, the following topics were discussed: "Begriff der Gmppe" (the defmition ofthe group), "Gmppenpublizitäf (group disclosure), "Ordnungsgemäße Konzemgeschäftsfuhmng" (proper management of the group), "Sonderprüfung" (special audit), "Pflichtangebote" (mandatory bid), "Auskauf, Austritt" (squeeze-out, sell-out), "Konzem-Erklämng" (declaration of the existence ofthe group), "Geschäftsleiterpflichten in der Krise (wrongful trading)".


33

emed by similar principles. Risk will have to be allocated between different participating entities and within each participating entity. As regards the allocation of risk between different entities, one of the central questions is to what extent the legal consequences of the actions of any subsidiary or affiliated Company should extend to its parent.^^ In Company law, this problem has sometimes been dealt with by modifying the scope of the limited liability of shareholders (the doctrine of "Piercing the corporate veil" or "Durchgriff')7'^ An alternative way would be the use of identification rules to determine the acts or omissions attributable to the Company; the scope of rules originally designed for a separate legal entity can be extended to cover even other relevant entities, all relevant persons within these entities, and all relevant acts done by these persons. This regulatory practice can make the scope of rules that set out rights and duties depend on the extent of control by the parent, centralised management, functional integration or similar factors."^^ For example, in the Amoco Cadiz case the US District Court was faced with Claims of neghgence arising out of a major oil spillage off the coast of Northern France in 1978. The parent of the Company that owned the Amoco Cadiz was held to be liable on two grounds: by its own active involvement in the alleged negligence, and through its close control over the operating subsidiaries.^^ As regards the allocation of risk within each participating entity, one of the interesting questions is the liability of the shareholders, statutory board members, managers, auditors or lenders of the parent for acts or omissions relating to the business of subsidiaries or affiliates. (c) What has been said of the allocation of power and risk can also be said of the distribution of information. In a group, it is necessary to distribute information both between different participating entities and within each participating entity. Traditional recipients of corporate information may need information about other entities in the group, the group as a whole, transactions carried out by other entities in the group, or intra-group transactions.^^ (d) The rules on the allocation of power will determine the persons who may act in the name of an entity that belongs to a group. There can also be special rules on how the different entities and the persons within these should act. There is a trade-off between centralised management in the interests of the parent and the protection of stakeholders in the entities that belong to the group. In a group, this problem is often addressed with rules on the power to give binding directions and fiduciary duties.

79

Blumberg PI, The Corporate Entity in an Era of Multinational Corporations, Del J Corp L 15 (1990) pp 285-286. See Blumberg PI, The Corporate Entity in an Era of Multinational Corporations, Del J Corp L 15 (1990) pp 288 and 321. Blumberg PI, The Corporate Entity in an Era of Multinational Corporations, Del J Corp L 15 (1990) pp 288, 290-291 and 322; Forum Europaeum Konzemrecht, Konzemrecht für Europa, ZGR 1998 pp 679-680; Hofstetter K, Parent Responsibihty for Subsidiary Corporations, ICLQ 39 (1990) p 595; Hill J, Corporate Criminal Liability in Australia, JBL 2003 p 15. See Muchlinski P, Multinational Enterprises and the Law (2004) pp 323-333. See Muchlinski P, Multinational Enterprises and the Law (2004) pp 346-348.

34

2 Comparative Law and Corporate Goveraance

2.3.8 The Sources and Nature of Ruies As Said above, the relevant rules may be extemal or internal and they can be based on a variety of sources. Rules do not always have to be linked to action on the part of the State. Extemal rules include not only rules supplied by law, but can include even rules supplied by other extemal sources. Intemal mies can appear in the Company's Constitution, resolutions, contracts, decisions by individual persons and so forth. All these mies can be mandatory, dispositive or non-binding. Mandatory mies apply regardless of what the parties have decided. Dispositive mies apply to the extent that the parties have not decided otherwise. Unlike mandatory and dispositive mies, non-binding mies are not complemented by any legal sanctions for their breach.^^ A comparative lawyer should also distinguish between the nominal nature of these mies and their de facto nature. For example, the recommendations of a nongovemmental Organisation or Standards can in fact be mandatory where the failure to observe them can lead to liability for loss caused by negligence; nongovemmental codes of corporate govemance can in fact be mandatory where the failure to observe them can lead to the delisting of securities; and certain provisions of statutory law can in fact be non-binding where they are not complemented by sanctions enforced against persons who do not comply with them. The differences between the nominal nature of rules and their de facto nature can be quite important in corporate govemance practice. For example, the effective enforcement of sanctions against Company representatives for the breach of nominally mandatory statutory mies is a problem because many shareholders prefer not to be confrontational and the few activist shareholders often lack power to enforce sanctions. The lack of enforcement can make nominally mandatory mies de facto non-binding. On the other hand, some regulations in intemal guidelines can be de facto mandatory due to sanctions for their breach, but nominally nonbinding in some countries because they violate mandatory laws.^^

^^ In Company law, it is normal to distinguish between "soft law" and "hard law". However, this distinction does not seem sufficiently clear. See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 322-323: "We referred above to the Combined Code as 'soft law'. This is not because it is enforced via the Listing Rules. Non-compliance with the Listing Rules can have consequences for companies which are perhaps even more serious than those arisingfrombreaches of the Companies Act. Those consequences include financial penalties of an unlimited amount on both defaulting companies and defaulting directors, actions by the FSA to obtain an injunction or restitution, and, ultimately, de-listing of the Company. However, the Combined Code can be classified as *soft law' if regard is had to the nature of the Obligation placed on the Company by the Listing Rules with regard to the Combined Code. In effect, it is only a disclosure obHgation." ^^ See for example "The Spirit & the Letter of Our Commitment", the General Electric integrity policy.

3 The Law of the European Union

3.1 The Legal Basis EU institutions have taken a number of initiatives in the area of corporate govemance. The main aspects of the regulation of corporate govemance can be summarised as follows: (a) There is freedom to choose the Company form in the EU. This freedom is based on the freedom of establishment and the recent case law of the European Court of Justice (ECJ). Public limited-liability companies also have the Option to incorporate as a European Company under the SE Regulation, (b) There is extensive harmonisation of the regulation of securities markets and financial reporting in the EU. The disclosure of information to investors is largely govemed by derivative EU law. (c) EU Company law contains few binding rules on the subject of corporate govemance. However, measures relating to share capital, mergers or divisions are covered by EU law, and there are non-binding Commission recommendations on the role and remuneration of directors, minimum quality assurance Standards for statutory audits, and the independence of statutory auditors. Freedom of establishment is the principal basis of EU Company law. Article 43(1) of the EC Treaty provides that "restrictions on the freedom of establishment of nationals of a Member State in the territory of another Member State shall be prohibited" and Article 43(2) that freedom of establishment shall include "the right to ... set up and manage undertakings .., under the conditions laid down for its own nationals by the law of the country where such establishment is effected".^ The approximation of Member States' Company laws by means of directives is primarily based on Article 44 of the EC Treaty.^ Article 44(2)(g) provides that the protection of shareholders shall be coordinated by means of directives "to the necessary extent" with a view to making such safeguards equivalent throughout the Community. In addition, Article 44(2)(c) sets out that administrative procedures and practices the maintenance of which would form an obstacle to freedom of establishment shall be abolished by means of directives.

In the future, the Treaty establishing a Constitution for Europe will repeal the EC Treaty when it enters into force (Articles IV-437 and IV-447). The Constitution nevertheless contains similar provisions on freedom of establishment as the EC Treaty (Article III137). The approximation of securities markets and accounting legislation is based on Article 95(1) oftheEC Treaty.

36


Article 44(2)(g) has been interpreted to include two main grounds for the adoption of EU initiatives in the area of Company law: (a) facilitating freedom of establishment of companies (because the harmonisation of a number of minimum requirements makes it easier for companies to establish themselves in other Member States in which the regulatory framework is similar); and (b) ensuring legal certainty in intra-Community Operations (because the presence of a number of common safeguards creates trust in cross-border economic relationships). In practice, EU Company law pursues many objectives. The stated objectives of secondary Company legislation reflect the wording of Articles 2, 3 and 44 of the EC Treaty: (a) The completion of the internal market means that it is necessary to remove barriers to trade and adapt the structures of production to the Community dimension.^ While the activities of companies often extend beyond the frontiers of national territories,"^ the legal framework is still largely based on national laws.^ There are divergences between the laws of the Member States, and these divergences give rise to legal and psychological difficulties and tax problems.^ (b) It is necessary to ensure minimum equivalent protection for both shareholders and creditors of companies as well as other people doing business with companies^ (c) It is necessary to ensure that the principles of equal treatment of shareholders in the same position are observed and harmonised.^ (d) It is necessary to ensure that competition in the internal market is not distorted by divergences between Member States' laws. Furthermore, Community companies should be able to compete on an equal footing in world markets. (e) Legal obstacles to Company development on a European scale must be removed. The Single market implies the creation of Europe-wide companies, which must be able to act throughout the Community in the same way as in their own country. It is necessary to ensure as far as possible that the economic unit and the legal unit of business in the Community coincide.^ Furthermore, it is necessary to help Community companies to compete on an equal footing for financial resources available in the Community capital markets, as well as in world capital markets.^^ (f) It is necessary to ensure that the Community capital market functions in an efficient and cost-effective way. The protection of investors and the maintenance of confidence in the financial markets is an im-

^ See for example recital 1 of Regulation 2157/2001/EC on the Statute for a European Company (SE). 4 Recital 1 of the First Company Law Directive (68/151/EEC). ^ Recital 4 of Regulation 2157/2001/EC on the Statute for a European Company (SE). ^ Recital 3 of Regulation 2157/2001/EC on the Statute for a European Company (SE); recital 4 of the Twelfth Company Law Directive (89/667/EEC). •^ Recital 5 of the First Company Law Directive (68/151/EEC); recitals 2 and 3 of the Second Company Law Directive (77/91/EEC); recitals 3, 6 and 8 of Third Company Law Directive (78/855/EEC). ^ Recital 4 of the Second Company Law Directive (77/91/EEC). ^ Recital 6 of Regulation 2157/2001/EC on the Statute for a European Company (SE). ^^ Recital 4 of Regulation 1606/2002/EC on the application of international accounting Standards.

3.2 The Harmonisation of Corporate Govemance Rules

37

portant aspect of the completion of the internal market. ^^ (g) It is also necessary to ensure that the financial reporting Standards applied by Community companies participating in financial markets are accepted intemationally and become global Standards P

3.2 The Harmonisation of Corporate Governance Rules 3.2.1. The General Approach in the Past The development of EU Company law has been proceeding hand in hand with the general process of harmonisation of law within the EU.^^ The harmonisation of Company law has nevertheless long suffered from the lack of clear objectives and a clear programme. In the beginning, EC institutions neither set out clearly the goals to be achieved nor agreed on the rationale of Company law harmonisation.^'* The Commission aimed originally at full-scale harmonisation with regard to both public and private limited-liability companies, but this approach only led to the adoption of the First Directive in 1968 before the financial accounting directives. A piece-meal approach followed after the First Company Law Directive. Efforts were made to first harmonise the rules for public companies on a step-bystep basis. These efforts were not very successful.^^ A few more Directives were adopted but attempts to harmonise core issues of Company law - such as the institutional structure of the public Company, minority protection and directors' liability - failed. Instead of major initiatives, the efforts of the Commission were concentrated on getting the Statute for the European Company adopted. The piece-meal approach and the use of legal transplants based on Community law may have increased the number of internal conflicts within Member States' national Company law Systems. National Company laws are Systems of individual rules intended to complement one another in a reasonable way. They are also embedded in national bodies of private law. For example, Company law makes use of

Recital 4 of Regulation 1606/2002/EC on the application of international accounting Standards; recitals 1 and 2 of Directive 2003/6/EC on insider dealing and market manipulation (market abuse). Recitals 2 and 5 of Regulation 1606/2002/EC on the application of international accountting Standards. Hopt KJ, Company Law in the European Union: Harmonization or Subsidiarity, 31 Saggi, conferenze e seminari del Centro di studi e ricerche di diritto comparato e straniero di Unidroit (1998) p 1. Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) p 3. See for example Merkt H, Die Pluralisierung des europäischen Gesellschaftsrechts, RIW 1/2004 pp 2-3; Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Govemance and Its Implications, Nw U L Rev 93 (1999) pp 667671.

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private law concepts such as "legal acts", "good faith" and "power of attomey". Legal transplants based on Community law have sometimes become "legal irritants" within Member States' national Company law Systems.^^ Since the 1990s, the EU Company law legislative process has been characterised by more political deference to national law with a higher number of references to national rules in the legislative proposals. The legal basis of this approach is the principle of subsidiarity, inserted into the EC Treaty by the Maastricht Agreement.^^ This more flexible approach to harmonisation resulted in the adoption of the Regulation on the European Company Statute (Societas Europaea) in October 2001.^8

3.2.2 Reasons for Harmonisation in the Future Many factors may give a new impetus to the approximation of corporate govemance rules in the EU.^^ The prevention of a race to the bottom. In the past, there was no need to develop more uniform or harmonised rules in order to prevent a race to the bottom with investors choosing the Member State of incorporation for a Company according to the least demanding Company law System.^^ This was so despite the fact that fear of Delawarisation in Europe used to be one of the reasons why the EC Treaty provides for the harmonisation of Company law. To counterbalance the liberal granting of the right of establishment by the EC Treaty, harmonisation was thought to be required to bring the Standards of protection granted by Member States' Company laws to equivalent levels. The real seat doctrine applied by many Member States may have made it unnecessary to develop more uniform or harmonised rules in the past. The real seat principle requires that every Company intending to have its actual centre of administration in a certain country must incorporate according to the law of that country. The case law of the ECJ may now have changed this. Case law of the ECJ. The case law of the ECJ now permits "corporate law Shopping" by undertakings. The main cases are Centros (case 212/97), Überseering (case 208/00) and Inspire Art (case 167/01). The ECJ first limited the effect of the real seat doctrine in Centros and Überseering and then went on to Interpret the connecting factors under Article 48 of the EC Treaty in Inspire Art.

See generally Teubner G, Legal Irritants: Good Faith in British Law or How Unifying Law Ends Up in New Divergences, MLR 61 (1998) pp 11-32. Article 5 of the EC Treaty. Council Regulation 2157/2001/EC on the Statute for a European Company (SE). See for example Hopt KJ, Gesellschaftsrecht im Wandel. In: Festschrift für Herbert Wiedemann (2002) pp 1012-1032; Wymeersch E, Gesellschaftsrecht im Wandel: Ursachen und Entwicklungslinien, ZGR 2001 pp 294-324. Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) pp 9 and 13.


39

Whether the case law of the ECJ will give a new impetus to Company law harmonisation by EU institutions is still unclear,^^ but what is clear is that "corporate law Shopping" by undertakings may lead to competition between Member States. These judgments - especially Inspire Art - may also have an impact on the regulatory techniques that Member States will use in the future. Competition between Member States. "Corporate law Shopping" and fears of the popularity of incorporating as a UK limited liability Company have already resulted in the amendment of the Company laws of some Member States. The UK limited liability Company is often regarded as a flexible and competitive Company form. 22 There is also competition between Member States as regards the way laws affecting corporate govemance are being approximated. For example, while the Takeover Directive (2004/25/EC) was largely modelled on the City Code on Takeovers and Mergers and supported by the UK govemment, the SE Regulation (2001/2157/EC) and the Directive on Cross-Border Mergers^^ contain provisions on employee co-determination as required by the German govemment. Existing harmonisation. Fast harmonisation may make future harmonisation easier or lead to flirther convergence. For example, the piece-meal approach of Company law harmonisation may in practice force Member States to change even those parts of their national laws that have not yet been harmonised, because legislators need to ensure that the provisions of national law form a meaningflil whole. In the long mn, the approximation of core issues of Company law may thus result in greater homogenity of non-core issues. The SE Regulation is an example of how piece-meal harmonisation can lead to the convergence of provisions not directly affected by it. At first sight, the adoption of the SE Regulation in October 2001 would not seem to have any major consequences for the further harmonisation of European Company laws.^^ One might think that the SE Regulation can only rarely be used as a model for further harmonisation because it contains uniform mies only on very few issues of Company law. On the other hand, when implementing the provisions of the Regulation, Member States may find it necessary to change their laws even when there is no Obligation to do so. For example, when implementing the provisions of the Regulation on the one-tier and two-tier board stmcture of an SE, a Member State may feel 2^ See Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) p 13; Merkt H, Die Pluralisierung des europäischen Gesellschaftsrechts, RIW 1/2004 p 4. ^^ See Mankowski P, Entwicklungen im Internationalen Privat- und Prozessrecht 2003/2004 (Teil 1), RIW 7/2004 p 486; Enriques L, Schweigen ist Gold: Die Europäische Aktiengesellschaft als Katalysator für regulative Arbitrage im Gesellschaftsrecht, ZGR 2004 p 742. ^^ The Council reached an agreement on the Directive on cross-border mergers on 25 November 2004. ^^ See especially Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) pp 7-8.

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compelled to change even provisions applicable to public limited-liability companies in general if failure to do so would lead to intolerably large divergences between national provisions that govem these two Company forms. To some extent it is possible that large companies press for domestic law to be altered so as to give them the same options.^^ Where the SE Regulation does set out detailed rules, it can be applied as a model for further harmonisation. For example, it has already been possible to agree on a Directive on cross-border mergers after a deadlock of more than 15 years. The core provisions of the Directive are based on the principles and rules already laid down for the formation of an SE. International initiatives. In contrast, international initiatives have so far not played any significant role in the regulation of corporate govemance in the EU. For example, soft law initiatives such as the codes of conduct of the UN and the OECD regarding multinational/transnational companies and on Corporate Govemance have not had any direct impact on Company law. There are nevertheless two exceptions. Firstly, listed companies are required to use IFRS from 1 January 2005. The International Accounting Standards (lAS) Regulation (1606/2002/EC), adopted in June 2002, requires all EU companies listed on a regulated market to use IFRS and allows Member States to extend this requirement to all companies. Where IFRS are not applied, the Accounting Directives will continue to be the basis of EU accounting requirements. In the short term, the result is two levels of comparability of fmancial information to be produced by companies: a first level of minimal comparability established by the Fourth and Seventh Company Law Directives (78/660/EEC, 83/349/EEC), and a second level of enhanced comparability for financial Statements of companies covered by the lAS Regulation. In the long term, there will be a gradual alignment of national accounting requirements with IFRS. The second exception relates to corporate govemance codes. Corporate govemance Codes adopted in the Member States are already surprisingly similar. According to the Commission, forty or so corporate govemance codes relevant to the EU have been adopted since the 1990s at national or intemational level.^^ The Commission is of the opinion that the EU should shape intemational regulatory developments in the future. At the moment, corporate govemance Standards are to a large extent being set unilaterally by the USA. For this reason, it becomes necessary for the EU to define its own European corporate govemance approach, tailored to its own cultural and business traditions.^''

See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 317318; Fleischer H, Gesetz und Vertrag als alternative Problemlösungsmodelle im Gesellschaftsrecht, ZHR 168 (2004) p 682. In March 2002, the European Commission produced a comparative study on corporate govemance codes in the EU. See Merkt H, Die Pluralisiemng des europäischen Gesellschaftsrechts, RIW 1/2004 p 2.


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Regulatory developments in the USA. The regulatory developments in the USA, in particular the Sarbanes-Oxley Act of 2002, contribute to the harmonisation of rules that govem corporate govemance in Europe. The Sarbanes-Oxley Act was adopted on 30 July 2002 as a response to a series of scandals. From a European perspective the Act creates a series of problems due to its extra-territorial application and its effects on those European companies that are listed or want to list on a US stock exchange,^^ and auditors. For European companies, compliance with the Act can mean conflicts with home country laws. The European Commission is therefore engaged in a regulatory dialogue with the US Securities and Exchange Commission (SEC). The SEC is charged with implementing most of the provisions of the Act.^^ What the Commission tries to achieve is the recognition by the SEC of EU rules as at least "equivalent". But the Commission cannot speak with the voice of Europe unless the rules applied by different Member States are sufficiently similar. This makes it necessary to harmonise, at least to some extent, matters covered by the Sarbanes-Oxley Act. Financial Services Action Plan. The rules made necessary by the need to match the Sarbanes-Oxley Act in Europe can at the same time be motivated by the need to restore confidence in European capital markets. The purpose of these rules is to increase transparency and empower shareholders. But even more generally, the regulation of corporate govemance by EU Directives is to some extent necessary due to the Integration of capital markets in Europe. There is a Financial Services Action Plan (FSAP) according to which a framework for an integrated capital market should be in place by 2005. The FSAP consists of an ambitious programme of mies for the financial industry. In addition to the FSAP, there is a "disclosure and transparency agenda"; several directives have been necessary in order to achieve a greater level of transparency and information in respect of issuers whose securities are traded on regulated markets.^^ Industrial policy. EU Company law is influenced by industrial policy in two ways. Firstly, Company law sets a part of the general market framework, and it is relevant from an industrial poHcy perspective generally.^ ^ Secondly, Company law 28

See Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Govemance and Its Implications, Nw U L Rev 93 (1999) pp 673-679 on the migration of foreign firms to the US market. See also Merkt H, Zum Verhältnis von Kapitalmarktrecht und Gesellschaftsrecht in der Diskussion um die Corporate Govemance, AG 2003 pp 130-131 on the effect of the Sarbanes-Oxley Act on the intemal corporate govemance of German companies. The SEC is an 'independent agency' which has executive, legislative and judicial powers. The Sarbanes-Oxley Act required the SEC to make many mies within specific time limits. See Moloney N, Time to Take Stock on the Markets: The Financial Services Action Plan Concludes as the Company Law Action Plan Rolls Out, ICLQ 53 (2004) pp 9991009. See also Norman P, Bück T, A legislative mountain: Europe wants to slow the pace of financial Services reform, Financial Times, 18 January 2005 p 11. See Commission of the European Communities, Industrial Policy in an Enlarged Europe, Communication of the Commission, COM (2002) 714.

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harmonisation can be an instrument of European industrial policy in certain crossborder situations. Harmonisation can remove obstacles to the free movement of companies within the internal market and obstacles to structuring and restructuring multinational firms. The principles of the SE Regulation have already been used as a model for further legislative initiatives. Enlargement, The enlargement of the EU is an important reason to modemise the European regulatoiy framework for Company law and corporate govemance. When joining the EU, "old" Member States were market economies with established rules on the regulation of companies. These rules were often based on the mies and principles developed in other Member States. Many of the new Member States still face a füll transition to flilly competitive modern market economies. More harmonisation may be necessary in order to maintain a high level of legal certainty in intra-Community Operations and also to ease this transition. The Views ofthe Commission. The Commissi on is convinced of the need for an initiative in the area of Company law and corporate govemance. In November 2002, a High Level Group of Company Law Experts chaired by Jaap Winter presented its Final Report on 'A modem regulatory framework for Company law in Europe'. In May 2003, the Commission published its response in the form of a Communication.^2 The Commission's Communication on Modemising Company Law and Enhancing Corporate Govemance explains why, according to the Commission's view, the European regulatory framework for Company law and corporate govemance needs to be modemised. It defines key policy objectives, contains an action plan and indicates which type of regulatory instmment should be used. In parallel with this Action Plan on Company Law, the Commission presented a Communication on Statutory Audit. The Company Law Action Plan thus rolls out as the FS AP concludes. However, the Company Law Action Plan is considerably less interventionist than the FSAP.33 Action Plan on Company Law. In the Action Plan on Company Law, the Commission listed many general reasons for new initiatives at EU level: the completion of the Internal Market; the integration of capital markets; the use of modem technologies (above all the Intemet); enlargement; and the restoration of confidence after the recent financial scandals. The Commission presented two key policy objectives in the area of Company law. The Commission considered that fliture actions at EU level should: strengthen the rights of shareholders and the protection of third parties; and foster the efficiency and competitiveness of business.

^^ Communication from the Commission to the Council and the European Parliament Modemizing Company Law and Enhancing Corporate Govemance in the European Union - A Plan to move forward, COM (2003) 284. ^^ See Moloney N, Time to Take Stock on the Markets: The Financial Services Action Plan Concludes as the Company Law Action Plan Rolls Out, ICLQ 53 (2004) pp 10091012; van Hülle K, Maul S, Aktionsplan zur Modernisierung des Gesellschaftsrechts und Stärkung der Corporate Govemance, ZGR 2004 pp 484-505.

3,2 The Harmonisation of Corporate Govemance Rules

43

The Action Plan contains measures which the Commission wants to implement over the short term (until 2005), medium term (until 2008) and long term (until 2010).34 The Commission referred to the benefits of piece-meal harmonisation and flexibility available to companies. According to the Commission, "a certain degree of harmonisation of defined national issues reduces legal uncertainties and can thereby significantly enhance business efficiency and competitiveness". In addition, the Commission pointed out that "[fjlexibility should be available to companies as much as possible: where Systems are deemed to be equivalent, maximum room should be left open to the freedom of the parties involved". It is clear that "corporate law Shopping" permitted by the ECJ will guarantee some flexibility. However, the Commission's proposals would not necessarily make those corporate govemance rules that companies must be comply with more flexible. Corporate govemance is regulated by legal mies. The proposals would increase flexibility if corporate govemance were deregulated or Member States' existing corporate govemance mies made less binding. However, this is not the case. The Commission proposes more mies at national level: the mandatory, dispositive or non-binding nature of these mies would be determined by the Member States. Flexibility is thus basically guaranteed by the case law of the ECJ on the freedom to incorporate the Company anywhere within the EU and by Member States' laws. Furthermore, the proposed measures, the stated purpose of which is to strengthen shareholders' rights, relate mainly to disclosure of Information and the exercise of shareholders' rights through electronic means but not, for example, to the distribution of powers within the Company or the effective enforcement of shareholders' rights through courts. They are not designed to make shareholders more powerful. In addition to its stated policy objectives, the Action Plan seems to have at least two other objectives at a higher level. The scope of actions proposed by the Commission implies that the objectives of the Action Plan include reacting to the Sarbanes-Oxley Act and, in the long term, changing the ownership stmcture of companies. Reacting to the Sarbanes-Oxley Act is hardly controversial. The Commission proposes mies in a number of matters dealt with in the Sarbanes-Oxley Act. As regards the composition of the board and its activities, the Commission proposes modest mies such as mies clarifying the role of non-executive directors. The Commission also recommends minimum Standards applicable to nomination, remuneration and audit committees.

^^ The Action Plan contains the following headings: "Corporate Govemance"; "Enhancing Corporate Govemance disclosure"; "Strengthening shareholders' rights"; "Modemising the board of directors"; "Co-ordinating corporate govemance efforts of Member States"; "Capital Maintenance and Alteration"; "Groups & Pyramids"; Corporate Restmcturing and Mobility"; "The European Private Company"; "The European Co-operative Society and other EU legal forms of enterprise"; and "Enhancing the transparency of national legal forms of enterprise".

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The second higher-level objective of the Action Plan is perhaps more controversial. In the Action Plan, the Commission proposes new disclosure obligations to major shareholders and institutional investors. In addition, the Commission favours "a real shareholder democracy" and says that it would undertake a study on the consequences of adopting the one share / one vote principle.

3.2.3 The Effect of the Sarbanes-Oxiey Act If a European Company wants to be in the US capital markets, it must comply with the Sarbanes-Oxley Act. The Sarbanes-Oxley Act expands corporate govemance and accounting requirements for SEC-registered non-US companies. Extra-territorial effect. The international scope of the Sarbanes-Oxley Act is wide for several reasons. For example, the interpretation of the "interstate commerce clause" of the US Constitution is very wide;^^ the legislator did not find conflicts with foreign companies' home country regulation as important as effective oversight over the fmancial reporting process for listed securities of any issuer, regardless of its domicile; and Clements of the Act were hastily drafted. The Act makes generally no distinction between US and non-US issuers and it does not provide any specific authority to exempt non-US issuers from its reach. The Act leaves it to the SEC to determine where and how to apply the Act's provisions to foreign companies. Shiftfrom disclosure to Substantive regulation. The Sarbanes-Oxley Act creates new Problems for foreign companies listed in the US because it imposes new Substantive requirements that may conflict with foreign companies' home country laws.^^ The Act reflects a potential shift in the philosophy underlying the US securities laws. Firstly, the Sarbanes-Oxley Act represents an incursion of the US federal govemment into the corporate govemance area. Under the federal System, State govemments, rather than the central govemment, enact most corporate laws. The basic philosophy is for the states and the stock exchanges to determine their corporate govemance requirements. Secondly, the Sarbanes-Oxley Act reflects a potential shift fi*om disclosure to Substantive regulation of corporate govemance. Main areas of concern. Although the European Commission Supports the objectives of the Sarbanes-Oxley Act to enhance corporate govemance, audit and accounting Standards in the US, the Commission wants to avoid its undesirable extra-territorial effects.

^^ US Constitution, Article I, Section 8: "The Congress shall have power ... To regulate commerce with foreign nations, and among the several states, and with the Indian tribes ..." See also Kersting C, Auswirkungen des Sarbanes-Oxley-Gesetzes in Deutschland: Können deutsche Unternehmen das Gesetz befolgen? ZIP 2003 p 235; Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Govemance and Its ImpHcations, Nw U L Rev 93 (1999) pp 690-691. ^^ See for example Ribstein LE, International ImpHcations of Sarbanes-Oxley: Raising the Rent on U.S. Law, JCLS 3 (2003) p 306.

3.2 The Harmonisation of Corporate GovemanceRules

45

The Commission has identified seven broad areas of concem, namely: the registration of audit firms with the new Public Company Accounting Oversight Board; the direct US access to EU audit working papers; the audit committee requirements; the rules on auditor independence; the issue of loans to directors and executive officers (notably for banks); the certification of financial reports; and the certification of internal control. Certification. The Sarbanes-Oxley Act provides that the chief executive officer (CEO) and chief financial officer (CFO) of an issuer must certify the quarterly financial Statements filed with the SEC.^"^ They must certify that the periodic report containing the financial Statements complies with the Securities Exchange Act of 1934^^ and that information contained in the periodic report fairly presents, in all material respects, the financial condition and results of Operations of the issuer. In addition, the CEO and CFO must certify the internal controls of the issuer.^^ The SEC has already brought the first civil fraud charges against the CEO of a non-US Company for alleged breaches of the Sarbanes-Oxley provisions on certification."*^ One of the most burdensome parts of the Sarbanes-Oxley Act is Section 404 that came into effect on 15 November 2004. It requires the management and the Company's extemal auditor to appraise the internal controls over fmancial transactions and to report any weaknesses. While the Sarbanes-Oxley Act Covers the evaluation of the effectiveness of internal controls, the Act does not cover the evaluation of board Performance. The Act is nevertheless complemented by the corporate govemance rules of the New York Stock Exchange (NYSE) and similar rules."*^ The corporate govemance rules of the NYSE require companies to adopt and disclosure corporate govemance guidelines, and these guidelines must "address" annual Performance evaluation of the board. This falls short of a mandatory requirement, but it would be difficult for a Company to address the issue and declare it had decided against doing anything about it. Audit Committees. The Sarbanes-Oxley Act expands the role and responsibilities of the audit committee of the board of directors.'*^ Sarbanes-Oxley requires the audit committee to be responsible for the outside auditor relationship, including the responsibility for the appointment, compensation, and oversight of a Company's outside auditor. The Act requires that members of the audit committee be "independent" from Company management (in addition, the corporate govemance

^•7 The United States Code, title 18, Chapter 63, § 1350. ^^ In particular, section 13(a) or 15(d) of the Securities Exchange Act of 1934. Section 302(a) of the Sarbanes-Oxley Act of 2002. 40 See Authers J, Silver S, *It's absurd for the SEC to use a Mexican Company and Mexican Citizens to try to impose US regulations...' Financial Times, 20 January 2005 p 11. For the effect of the NYSE rules on German companies see Schäfer A, Der Prüfungsausschuss - Arbeitsteilung im Aufsichtsrat, ZGR 2004 pp 416-431. Section 301 of the Sarbanes-Oxley Act of 2002; see further Kersting C, Auswirkungen des Sarbanes-Oxley-Gesetzes in Deutschland: Können deutsche Unternehmen das Gesetz befolgen? ZIP 2003 p 234.

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mies of the NYSE set out a cooling-off period of three years for former employees43)^

The SBC has made exemptions for the needs of other countries' practices.'^'^ For example, the SEC incorporated changes to accommodate the German requirement of non-management employees' serving as members of a Company's audit or supervisory board. If a non-US issuer utilises an exemption to audit committee independence, this information must be disclosed to US investors. In addition, audit committee requirements do not affect the appUcation of the provisions of an issuer's governing law, which require that instead of an audit committee, the matter must be decided on by shareholders."^^ The SEC has no authority to make exemptions conceming the Obligation of foreign issuers to appoint an audit committee and the Obligation of audit committees to take care of their responsibilities. Financial experts. The Sarbanes-Oxley Act and the SEC mies provide that every issuer, including a non-US issuer, must disclose whether or not there is at least one "fmancial expert" in the audit committee of the board of directors"^^ and whether the fmancial expert is independent from management. If the answer is negative, the issuer must disclose the reasons for it. The SEC has decided to delay the disclosure requirement as far as non-US issuers are concemed."^"^ Public Company Accounting Oversight Board. The Act provides that a new Public Company Accounting Oversight Board shall oversee the accounting profession and public Company audits."^^ The Act requires foreign public accounting firms that audit SEC-registered issuers, including non-US issuers, to register with the Oversight Board and be subject to its oversight. There are also mies on direct US access to audit working papers. According to the express provisions of the Act, foreign accounting firms are deemed to have consented to these obligations."^^ The USA have so far refused the EU's request for an exemption and the Commission has threatened with retaliation. Lawyers. The SEC was directed by the Sarbanes-Oxley Act to adopt mies regarding minimum Standards of professional conduct for lawyers.^^ Foreign lawyers seem to have been fully exempted from the SEC mle imposing reporting duties on lawyers, provided that they are "non-appearing foreign attomeys", that is,

43 NYSE Listed Company Manual § 303 A.02. "^ Section 301 of the Sarbanes-Oxley Act of 2002; Section 10A(m)(3)(c) of the Securities Exchange Act of 1934; Standards Relating to Listed Company Audit Committees, Securities Act Release No. 33-8220. ^^ See also Kersting C, Auswirkungen des Sarbanes-Oxley-Gesetzes in Deutschland: Können deutsche Unternehmen das Gesetz befolgen? ZIP 2003 p 239. 46 Section 407 of the Sarbanes-Oxley Act of 2002. 4^ Standards Relating to Listed Company Audit Committees, Securities Act Release No. 33-8220. 48 Section 101 of the Sarbanes-Oxley Act of 2002. 49 Section 106 of the Sarbanes-Oxley Act of 2002. 50 Section 307 of the Sarbanes-Oxley Act of 2002.


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lawyers who are not admitted in the United States and do not advise clients regarding US law.^^

3.2.4 The Present Approach to Harmonisation One could say that there are two main models for the regulation of the govemance of public limited-liability companies: the US model and the Continental European model.^^ In both cases companies are regulated by a mix of: (a) either securities markets rules or traditional Company law rules; and (b) either mandatory rules or rules that are dispositive or non-binding. The weight given to different factors depends on the legislator's choice of the default form of raising finance. The General Model The approximation of corporate govemance mies by the institutions of the EU seems to follow the US model. According to the US model, companies are assumed to raise finance in the capital markets. In order to protect investors and the efficiency of capital markets, capital market transactions are regulated by federal securities laws that lay down mandatory mles.^^ These mies contain in particular mandatory disclosure requirements that enhance market transparency. As regards traditional Company law matters, State Company laws only set out the most fundamental mies. Mandatory mies are necessary where disclosure requirements would not prevent expropriation by the management. Party autonomy can cover many traditional Company law matters. According to the traditional Continental European model, companies are assumed to raise finance privately. In order to protect minority shareholders and creditors, companies are to a large extent regulated by mandatory provisions of Company law. Existing EU legislation has so far focused on key areas such as: the maintenance and alteration of capital; the representation of the Company in its dealings Implementation of Standards of Professional Conduct for Attomeys, Securities Act Release No. 33-8185; Groskaufmanis KA, Climbing 'up the ladder': corporate counsel and the SEC's reporting requirement for lawyers, Comell L Rev 89 (2004) p 516. Merkt H, Zum Verhältnis von Kapitalmarktrecht und Gesellschaflsrecht in der Diskussion um die Corporate Govemance, AG 2003 p 127. See also Hopt KJ, Gestaltungsfreiheit im Gesellschaftsrecht in Europa - Generalbericht. ZGR Sonderheft 13 (1998) pp 123-147. Section 14 of the Securities Act of 1933 (15 USC Section 77n): "Any condition, stipulation, or Provision binding any person acquiring any security to waive compliance with any provision of this subchapter or of the rules and regulations of the Commission shall be void." Section 29(a) of the Securities Exchange Act of 1934 (15 USC Section 78cc(a)): "Any condition, stipulation, or provision binding any person to waive compliance with any provision of this chapter or of any rule or regulation thereunder, or of any rule of an exchange required thereby shall be void."

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with third parties; financial reporting; and disclosure of information to Investors. While some of these rules belong to the traditional area of Company law, others belong to the field of securities markets law. Coro Company Law Matters The EU has acted with some sensitivity in the area of Company law. The Company Law Action Plan is thus considerably less Interventionist than the Financial Services Action Plan. For example, the maintenance and alteration of capital is govemed by the Second Company Law Directive (77/91/EEC). The Second Directive is one of the comerstones of EU Company law. It imposes a minimum legal capital to public limited liability companies and contains a number of detailed provisions aiming at protecting shareholders and creditors. These provisions apply for example to the formation stage, to distributions to shareholders, to acquisitions of own shares, to increases in capital and to reductions in capital. The Second Directive also provides for the equal treatment of shareholders who are in the same position (Article 42). The Commission regards a simplification of the Second Directive as a priority and has presented a proposal for a Directive to simplify measures related to capital. The representation of limited-liability companies is govemed by the First Company Law Directive (68/151/EEC). The First Directive co-ordinates the validity of obligations entered into by companies and the disclosure of basic information about the Company, especially particulars of the persons who are authorised to bind the Company. On the other hand, there is little legislation at EU level on the internal Organisation of companies. The Commission presented a proposal for a Fifth Directive on the structure of public limited liability companies in 1972, but this proposal has now been dropped. In October 2004, the Commission adopted two non-binding Commission Recommendations on the role and remuneration of directors.^"* The Commission also proposed a Directive that would provide for the coUective responsibility of board members to the Company for the financial and other key information that they publish; the Directive would also require a corporate govemance Statement in annual reports. A consultation on shareholders' rights was launched by the Commission in September 2004.^^ i^ addition, the Transparency Directive (2004/109/EC) was Commission Recommendation of 15 February 2005 on the role of non-executive or supervisory directors and on the committees of the (supervisory) board (2005/162/EC); Commission Recommendation of 14 December 2004 fostering an appropriate regime for the remuneration of directors of listed companies (2004/419/EC); Proposal for a Directive amending Directives 78/660/EEC and 83/349/EEC conceming the annual accounts of certain types of companies and Consolidated accounts. Fostering an appropriate regime for shareholders' rights, Internal Market Directorate General, 16 September 2004.


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adopted in December 2004. The Transparency Directive Updates existing EU law on the inforaiation provided to shareholders and bondholders at a general meeting through proxies and by electronic means. However, a European corporate govemance code is not part of the Action Plan. In 2001, the Commission launched a review of the main corporate govemance Codes relevant to the EU. The füll comparative study was finalised in March 2002 and concluded that the EU should not devote time and effort to the development of a European code. The High Level Group of Company Law Experts confirmed this result in its Final Report. The Commission does not think that the development of a European code would offer significant added value. The Commission is of the opinion that "the adoption of such a code, if it were even possible, would be an inevitable and possibly messy political compromise, which would be unlikely to achieve füll Information for investors about the key corporate govemance mies." The basis of codes of corporate govemance should therefore "come from the markets and/or national legislation".^^ There is no general directive on the govemance of groups. The Commission is of the opinion that there is no need to revive the old draft Ninth Directive on group relations.^^ The Commission thinks that particular problems should be addressed through specific provisions in three areas: disclosure, the Implementation of a coordinated group policy, and the risks associated with chains of holding companies ("pyramids"). The draft Ninth Directive was influenced by German and French law. Its main features were: (a) a definition of a "subsidiary undertaking" which would oblige Member States to provide for "control contracts", (b) mies about the disclosure of shareholdings in public limited-liability companies, (c) mies as to the conduct of a "parent undertaking" towards a public limited-liability subsidiary (including the liability of the parent undertaking for loss sustained by subsidiary, and for its debts), (d) mies applicable when the parent undertaking had entered into a "control contract" with a public limited-liability Company, or when it had made a "unilateral declaration instituting a vertical group". Disclosure The piece-meal measures in the traditional area of Company law can be contrasted with the extensive harmonisation of disclosure requirements. The purpose of the Accounting Directives is to improve the quality, comparability and transparency of the financial Information provided by companies. The Fourth Company Law Directive (78/660/EEC) is complemented by the Seventh Directive (83/349/EEC) that appHes to Consolidated accounts. One of the purposes ^^ The Speech of Charlie McCreevy, European Commissioner for Internal Market and Services, Corporate Govemance in Europe, European Corporate Govemance Forum, Brüssels, 20 January 2005. ^'^ Ninth Company Law Directive on the Conduct of Groups containing a Public Limited Company as a Subsidiary. A draft was circulated by the Commission in December 1984 for consultation.

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of EU legislation in this area is to ensure compatibility with international Standards. The lAS Regulation (1606/2002/EC) thus requires that all listed companies prepare their Consolidated accounts in accordance with IFRS from 2005 onwards. There is a package of Financial Services Action Plan measures to establish a common financial disclosure regime across the EU for issuers of listed securities. The "disclosure and transparency agenda" consists of the following legislative projects: the lAS Regulation (1606/2002/EC); the Directive on Market Abuse (2003/6/EC) v^hich requires issuers to publish inside information;^^ the Prospectus Directive (2003/71/EC) which deals vîth initial disclosure requirements at the point of public offer of securities/its admission to trading on a regulated market;^^ and the Transparency Directive (2004/109/EC). In addition to these legislative projects, the Financial Services Action Plan contains the proposed Directive on statutory audit.^^ The Takeover Directive (2004/25/EC) sets out both disclosure requirements and conduct rules relating to mandatory or voluntary bids.^^ For example, the Takeover Directive contains a "breakthrough rule" which limits the effect of restrictions on voting rights provided for in the articles of association of the target Company or in contractual agreements. The Main Disclosure Obligations Although Information and disclosure requirements are at the intersection of Company law and securities markets law, there are more disclosure rules in EU securities markets law than in EU Company law. Periodic information. EU Company law contains rules on the publication of annual accounts (the Fourth Directive) and Consolidated accounts (the Seventh Directive).^^ Current EU law requires only annual and semi-annual reports. There is no Obligation to publish quarterly reports. The Financial Services Action Plan and the disclosure and transparency agenda also have a big impact on the disclosure of periodic information. The Transparency Directive (2004/109/EC) will revise and replace provisions of the Listing Directive (2001/34/EC). The Transparency Directive is less demanding than the highest existing national Standards on quarterly reporting. For example, quarterly reporting is required in the UK, and by the operator of the Frankfurt stock exchange.

^^ Article 6. The Member States shall bring into force the laws, regulations and administrative provisions necessary to comply with the Market Abuse Directive not later than 12 October 2004 (Article 18). 59 Article 3.

^^ Proposal for a Directive of the European parliament and the Council on statutory audit of annual accounts and consolidtated accounts and amending Council Directives 78/660/EEC and 83/349/EEC. ^^ Member States shall implement the Takeover Directive by 20 May 2006. ^2 See also Article 62 of the SE Regulation; Directive 2000/12/EC (credit institutions) and Directive 91/674/EEC (insurance undertakings).


51

The Transparency Directive provides for annual and half-yearly financial reports.^^ These reports are in effect mini-prospectuses. They must contain the audited (annual) or Condensed (half-yearly) financial Statements of the Company, a management report and Statements. These Statements are made by the "persons responsible within the issuer" to the effect that, to the best of their knowledge, the financial Statements prepared in accordance with the applicable set of accounting Standards give a true and fair view. The Transparency Directive also lays down a minimum Standard of liability for the breach of these rules.^"^ Somebody - at least the issuer or its administrative, management or supervisory bodies - must be responsible for the information to be drawn up and to be made public in accordance with the provisions of the Directive. Somebody - either the issuer, its administrative, management or supervisory bodies or "persons responsible within the issuer" - must also be liable for failure to do so. Member States are free to determine the extent of this liability.^^ The Commission has proposed a new Directive in order to make the monitoring of the Company more objective: the Directive on statutory audit in the EU.^^ At the moment, the Accounting Directives require that the annual accounts or Consolidated accounts are audited by one or more persons entitled to carry out such audits, and the Eighth Directive (84/253/EEC) deals primarily with the approval of statutory auditors in Member States. But these Directives do not contain requirements on how a statutory audit should be conducted. In the past, the Commission has issued a Recommendation on quality assurance for the statutory auditor in the EU (November 2000)^"^ and a Recommendation on Statutory Auditors' Independence in the EU (May 2002).^^ The proposed new Directive on statutory audit in the EU would now clarify the duties of statutory auditors and set out certain ethical principles to ensure their objectivity and independence. For example, the proposed Directive contains provisions on: the introduction of an annual transparency report for audit firms; auditor rotation; audit quality reviews; the appointment of the statutory auditor or audit firm on the basis of a selection by the audit committee; and contacts between the statutory auditor and the audit committee. Ad-hoc disclosure, Ad-hoc disclosure is regulated by EU securities markets law. The most important rules are contained in the new Market Abuse Directive (2003/6/EC) and in the new Transparency Directive. The Listing Directive (2001/34/EC) contains further rules on ad-hoc disclosure. The new Market Abuse Directive not only prohibits abuse but also requires issuers to publish information.^^ (a) There is an Obligation to disclose inside infor-

^^ Articles 4, 5 and 6. ^"^ Article 7. See also Article 24 . 65 Recital 10. 66 Proposal for a Directive o f the European parliament and the Council on statutory audit of annual accounts a n d consolidtated accounts a n d amending Council Directives 78/660/EEC and 83/349/EEC. 6^ Commission Recommendation 2002/590/EC. 6^ Commission Recommendation 2001/256/EC. 69 See Articles 2, 3 and 6 of the Market Abuse Directive (2003/6/EC).

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mation to the public (Article 6(1)).^^ Under some circumstances, disclosure of inside information may be delayed, provided that the delay would not be likely to mislead the public and the issuer is able to ensure the confidentiality of that information (Article 6(2)). There is a new rule on selective disclosure: "Member States shall require that, whenever an issuer, or a person acting on his behalf or for his account, discloses any inside information to any third party in the normal exercise of his employment, profession or duties ... he must make complete and effective public disclosure of that information, simultaneously in the case of an intentional disclosure and promptly in the case of a non-intentional disclosure" (Article 6(3)). (b) Primary insiders^^ are prohibited from disclosing inside information to any other person unless such disclosure is made in the normal course of the exercise of his employment, profession or duties (Article 3(a)). (c) They are also prohibited from recommending or inducing another person, on the basis of inside information, to acquire or dispose of financial instruments to which that information relates (Article 3(b)). The Listing Directive contains regulations on the information that must be published in the listing particulars and on continuing obligations. Like the new Market Abuse Directive, the Listing Directive provides that "[t]he Company must inform the public as soon as possible of any major new developments in its sphere of activity which are not public knowledge and which may, by virtue of their effect on its assets and liabilities or financial position or on the general course of its business, lead to substantial movements in the prices of its shares" (Article 68(1)). The Transparency Directive provides that a person acquiring or disposing of shares so that its holding with a publicly traded Company reaches, exceeds or falls below certain thresholds informs the Company, which is in its tum responsible for disclosing this information to the public (Article 9(1)). The Transparency Directive also lays down a general Obligation of the issuer to "ensure that all the facilities and information necessary to enable holders of shares to exercise their rights are available in the home Member State" (Article 13(2)). Like the Second Company Law Directive (Article 42), it also provides for the equal treatment of all holders of shares who are in the same position (Article 13(1)). Transactions. There are several provisions on the disclosure of information relating to transactions. The Second and Third Company Law Directives (77/91/EEC, 78/855/EEC) contain disclosure rules relating to transactions that "^^ Article 1(1) provides that inside information "shall mean information of a precise nature which has not been made public, relating, directly or indirectly, to one or more issuers of financial instruments or to one or more financial instruments and which, if it were made public, would be likely to have a significant effect on the prices of those financial instruments or on the price of related derivative financial instruments ..." ^^ Articles 2(1) and 2(2). Article 2(1)(2): *'The first subparagraph shall apply to any person who possesses that information: (a) by virtue of his membership of the administrative, management or supervisory bodies of the issuer; or (b) by virtue of his holding in the capital of the issuer; or (c) by virtue of his having access to the information through the exercise of his employment, profession or duties; or (d) by virtue of his criminal activities."

3.3 Freedom to Choose the Company Form in the EU

53

must be approved by the general meeting (see above). The Listing Directive (2001/34/EC) provides that "[t]he listing particulars shall contain the information which, according to the particular nature of the issuer and of the securities for the admission of which application is being made, is necessary to enable investors and their investment advisers to make an informed assessment of the assets and habihties, financial position, profits and losses, and prospects of the issuer and of the rights attaching to such securities" (Article 21(1)). The Takeover Directive (2004/25/EC) provides for disclosure rules in the context of voluntary or mandatory takeover bids.

3.3 Freedom to Choose the Company Form in the EU Freedom to choose the Company form can be regarded as one of the comerstones of the regulation of corporate govemance in the EU. Recognition of Foreign Companies under National Law Each Member State has its own business forms for public hmited-liabiHty companies. The parties are not really free to choose the Company form unless the Company is recognised as such in all other Member States. National Company laws lay down under which circumstances a Company is recognised as a Company, and rules of private international law (conflicts of law rules) designate the national Company law that shall govem the issue. Both rules rules of national Company law and rules of private international law - may vary in different states. As regards the private international law of companies, the Member States apply either the incorporation doctrine (like the United Kingdom, Ireland, the Netherlands and the Nordic Countries) or the real seat doctrine (like Germany, France and most Continental Member States). Some Member States apply a combination of both doctrines (Italy and Portugal). The incorporation doctrine regards the place of registration as the decisive factor connecting the Company to national Company law. According to the real seat doctrine, the central administration or principal place of business is the decisive connecting factor.^^ Thus, if a businessman intends to build up a firm with its centre of administration in Bonn, Germany, traditional German law says that he cannot choose English law to be the governing law for the firm.^^ Traditional German international private law excludes party autonomy by using residence (the real seat) as an objective and mandatory connecting factor. The use of an objective and mandatory 72

For the benefits of the real seat doctrine see Schmidt K, Sitzverlegungsrichtlinie, Freizügigkeit und Gesellschaftsrechtspraxis, ZGR 1999 pp 23-24; Roth WH, From Centros to Ueberseering: Free Movement of Companies, Private International Law, and Community Law, ICLQ 52 (2003) pp 181-182. Roth WH, From Centros to Ueberseering: Free Movement of Companies, Private International Law, and Community Law, ICLQ 52 (2003) p 181.

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connecting factor reflects the fact that German Company law is tainted by mandatory Substantive provisions the purpose of which is to protect creditors and minority shareholders; even the regulations on employee representation presuppose the existence of a Company govemed by German Company law. On the other hand, English law says that the businessman can choose English law to be the governing law for the firm regardless of the fact that the centre of administration of the firm is in Bonn. The basic rule of English international private law of companies is party autonomy. Instead of residence, English law uses domicile as a connecting factor, the domicile being determined by the registered Office in the country under the law of which it has been incorporated.^"* The Company's business may thus be conducted anywhere. Similarly, companies formed under foreign law will be recognised if the law of claimed incorporation confers validity on them. Recognition of Foreign Companies According to tiie ECJ The refusal to recognise the legal capacity of the Company raises questions as to consistency with the freedom of establishment of companies. The real seat doctrine especially prevents companies from moving their business undertakings between states without serious risk of being seriously disabled in law. The real seat doctrine has been under examination by the ECJ in Centros,''^ Überseering,''^ and Inspire Art?'' In Centros, the ECJ confirmed that the right of establishment allows foreign investors to incorporate a business under a more attractive foreign Company Statute and operate that business in another Member State in the form of a branch; the extent to which Member States may enact specific rules to regulate pseudo-foreign companies is severely limited.^^ The Court held that "the fact that a national of a Member State who wishes to set up a Company chooses to form it in the Member State whose rules of Company law seem to him the least restrictive and to set up branches in other Member States cannot, in itself, constitute an abuse of the right of establishment".^^ As a rule, a Company that fulfils the conditions set out in Article 48 of the EC Treaty - a Company or firm formed in accordance with the law of a Member State (that is, any Member State) and having its registered office, central administration or principal place of business within the Community (that is, in the same or any other Member State) - does not have to conduct any business in the Member State in which it has its registered office and is not prohibited fi*om pursuing its activities only in the Member State where its branch is established.^^ Roth WH, From Centros to Ueberseering: Free Movement of Companies, Private International Law, and Community Law, ICLQ 52 (2003) pp 182-183. C-212/97 Centros [1999] ECR1-1459. 76 C-208/00 Überseering [2002] ECR 1-9919. ^^ C-167/01 Inspire Art [2003] ECR 1-10155. ^^ Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) p 11. ^9 Para27. ^^ Para29.


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This led to fears that the real seat doctrine is contrary to Community law as far as companies established in the EU are concemed. In Überseering, the Court seems to have confirmed this by holding that a "necessary precondition for the exercise of the freedom of establishment is the recognition of those companies by any Member State in which they wish to establish themselves".^^ Centros and Überseering will have an impact not only on the scope of the real seat doctrine of some Member States^^ but also on the regulatory techniques of all Member States.^^ For example, German Company law contains mandatory Substantive provisions, which are meant to protect creditors and minority shareholders, and the German regulations on employee representation presuppose the existence of a Company govemed by German Company law.^"* The German govemment pleaded in Überseering that the application of the real seat principle was justified by the need to enhance legal certainty as well as by the protection of creditors (paragraph 87) and employees (paragraph 89). Germany and other Member States intending to adopt mies for the protection of these interest groups will now have to draft them in a way that accommodates foreign companies incorporated in other Member States.^^ How this can be done is still open. The ruling of the ECJ in Inspire Art was expected to provide some guidance as to which regulatory techniques will be permitted. In Inspire Art, AG Alber was of the opinion that a Company established in Member State A is not fully recognised in Member State B if: (1) the Company is generally govemed by the law of Member State A but (2) Member State B applies its own Company law to specific questions such as minimum capital and the liability of the directors.^^ On the other hand, since the EC Treaty is silent on the matter of the law of which Member State shall govem companies, what is regarded as a matter of Company law is not expressly defined in the EC Treaty. According to traditional mies, the Classification of a matter as one of Company law is determined in accordance with the private international law of lex fori, and different Member States can in practice classify the ^^ Para 59. Further Leible S, Hoffmann J, „Überseering" und das deutsche Gesellschaftskollisionsrecht, ZIP 2003 pp 926 and 929 after footnote 42; Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) p 13; Zimmer D, Ein Internationales Gesellschaftsrecht für Europa, RabelsZ 67 (2003) p 310; Roth WH, From Centros to Ueberseering: Free Movement of Companies, Private International Law, and Community Law, ICLQ 52 (2003) pp 206-207. ^^ See for example the judgment of the Austrian Oberster Gerichtshof of 15 July 1999 (6 Ob 123/99 b) and the judgment of the German Bundesgerichtshof of 13 March 2003 (VII ZR 370/98); further Leible S, Hoffmann J, „Oberseering" und das deutsche Gesellschaftskollisionsrecht, ZIP 2003 pp 928-930. ^^ Micheler E, Recognition of Companues Incorporated in Other EU Member States, ICLQ vol 52, April 2003 p 529. ^"^ Roth WH, From Centros to Ueberseering: Free Movement of Companies, Private International Law, and Community Law, ICLQ vol 52, January 2003 p. 181. ^^ Micheler E, Recognition of Companues Incorporated in Other EU Member States, ICLQ 52 (2003) p 529. 86 Para 100.

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matter in different ways. The opinion of AG Alber was silent on how Company law should be determined for this purpose. A possible Solution could be that the EC Treaty does not prevent a Member State from applying its own law - laws governing Company matters or other matters - to a foreign Company provided that a Company established in another Member State is recognised and the application of the law of that Member State does not amount to a restriction of the right of establishment. The question should not be, to what extent the host Member State of a Company from another Member State is still allowed to apply its own Company law rules to the foreign Companyj^"^ but to what extent the host Member State of a Company from another Member State is still allowed to apply rules other than the rules of the foreign Company's home Member State (that is, not only Company law rules, but any rules designated by the applicable choice of law rules).^^ - It is of course clear that the application by a host Member State of its own or a third country's law cannot always restrict the right of establishment. For example, the Regulation on insolvency proceedings (1346/2000/EC) provides that the law applicable to a Company's insolvency proceedings and their effects shall, as a rule, be that of the Member State within the territory of which the debtor Company's registered office is situated. However, what is decisive is not the place of the registered office as such but the centre of the debtor Company's main interests, and there is only a rebuttable presumption that these places are the same (Articles 3(1) and 4(1), see also Article 3(2)).^^ Therefore, a Company's insolvency is not always govemed by the law under which the Company has been incorporated. In Inspire Art, the ECJ then held that the registered office, central administration or principal place of business of the Company are "connecting factors" under Article 48 of the EC Treaty.^^ The wording of the judgment is a bit misleading. In light of the wording of Article 48 of the EC Treaty, the ECJ must have meant that the connecting factor is the formation of the Company in accordance with the law of a Member State provided that the Company has its "registered office, central administration or principal place of business within the Community". Although the ECJ did identify the connecting factors, it did not expressly identify the provisions to be connected with a legal System. Regardless of which provisions the ECJ had in mind, the ECJ indicated that they are subject to an autonomous Classification instead of being classified under the Classification rules of

^"^ Compare Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) pp 12-13. ^^ See also Micheler E, Recognition of Companies Incorporated in Other EU Member States, ICLQ 52 (2003) p 529: "The ruling of the ECJ in Inspire Art will Start to demarcate the boundaries within which Member States may regulate companies incorporated in other Member States." ^^ Recital 13: "The * centre of main interests' should correspond to the place where the debtor conducts the administration of his interests on a regulär basis and is therefore ascertainable by third parties." See also Zimmer D, Ein Internationales Gesellschaftsrecht für Europa, RabelsZ 67 (2003) p 310. 90 Para97.


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Member States' private international law.^^ The ECJ seemed to apply the "connecting factors" based on Article 48 of the EC Treaty to provisions that, in light of their effect, could be classified as "company-law rules".^^ It followed that the application of "company-law rules" other than those designated by Article 48 of the EC Treaty constituted a restriction on freedom of establishment as guaranteed by Articles 43 and 48 of the EC Treaty.^^ The "connecting factors" based on Article 48 of the EC Treaty are connecting factors only for the purposes of Article 43 of the EC Treaty. Article 43 does not automatically replace the Member States' traditional choice of law rules. The ECJ in effect held that the application of Substantive rules designated by Member States' choice of law rules could constitute an impediment to freedom of establishment, not the choice of law rules as such. If the Substantive rules constitute an impediment to freedom of establishment, it must be considered whether they can be justified on one of the grounds set out in Article 46 of the EC Treaty or, failing that, by an overriding reason relating to the public interest.^"^ The application of national law to a Company established in another Member State. Accordingly, the application of Substantive "company-law" rules in Member State A to a Company established in Member State B can constitute a restriction on freedom of establishment as guaranteed by Articles 43 and 48 of the EC Treaty under the Inspire Art principles. The Classification of rules in Member States A and B is not relevant, because the "company-law" nature of rules is determined by EU law.^^ In a Member State, "company-law" rules covered by the Inspire Art principles can belong to other fields of law such as contract law, tort law, insolvency law or criminal law.^^ It is also interesting to note that the SE Regulation seems to establish a presumption of equivalence between national regimes. The Regulation seems to be based on the principle of mutual recognition of national Company laws: (a) An Option is allowed between the one-tier and two-tier board structure, with very few Substantive provisions as to the Organisation and functioning of the board. (b) The rules on workers' participation are based on the "avant-apres" or "before-after" principle meaning that the workers' participation regime is based on the regimes applied to the national companies involved in the formation of a SE: it is basically permissible to create an SE subject to a regime for workers' participation ranging from the German model to none at all. (c) As regards many important Company law matters, the Regulation refers, directly or indirectly, to the national Company law of the Member State of incorporation of the SE.

9^ 92 9^ 94 9^

Para99. ParalOO. Para 104. See also paras 107 and 133 (justification). Paras 107 and 133. See Spindler G, Hemer O, Der Gläubigerschutz im Gesellschaftsrecht nach Inspire Art, RIW 1/2004 p 9. 9^ See Spindler G, Hemer O, Der Gläubigerschutz im Gesellschaftsrecht nach Inspire Art, RIW 1/2004 pp 11-13 and 15; Schön W, Zur "Existenzvemichtung" der juristischen Person, ZHR 168 (2004) pp 290-295.

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SE and the Real Seat Doctrine It may be surprising at first sight that the real seat doctrine, the scope of which has been effectively limited by the case law of the ECJ, has been adopted in the SE Regulation. Article 7 of the SE Regulation sets out that the registered office of an SE shall be located within the Community, in the same Member State as its head office. Both the transfer of the registered office and the transfer of the head office have been expressly regulated - and limited - by the Regulation, (a) The registered office of an SE may be transferred to another Member State without the winding up of the SE or the creation of a new legal person (Article 8(1)). An SE will nevertheless be required to reregister if it moves its registered office from the State of formation (Articles 8(2)-(13)), and this will lead to a change of the law governing the Company (Articles 9(1) and 8(16)). (b) The head office of an SE may not be transferred to another Member State. If it is, and the SE does not either re-establish its head office in the Member State in which its registered office is situated or transfer its registered office, the Company will be liquidated (Article 64). The SE Regulation is based on the assumption that one must distinguish between a Company's freedom to move in and the freedom to move out: Articles 43 and 48 EC are expected to apply to the former but not to the latter, and a Member State has a power to destroy the Company when the Company intends to exercise its right of establishment by moving out. It will be seen whether or not the provisions of the Regulation can be reconciled with the judgments of the ECJ in Centros and Überseering.^'^

3.4. The European Company 3.4.1 Introduction There are at the moment two Company forms based on Community law, namely the European Company or "Societas Europaea" (SE) and the European Economic Interest Grouping (EEIG). Only an SE is regarded as a public limited-liability Company, and other European business forms are not relevant for the purposes of this study. The legal basis of the SE is the European Company Statute adopted by the Member States in October 2001. The Statute consists of a Regulation,^^ which sets

Compare Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) pp 9-10; Roth WH, From Centros to Ueberseering: Free Movement of Companies, Private International Law, and Community Law, ICLQ 52 (2003) pp 206-207; Zimmer D, Ein Internationales Gesellschaftsrecht für Europa, RabelsZ 67 (2003) p 310; Werlauff E, SE - The Law of the European Company (2003) p 19. Regulation 2157/2001/EC on the Statute for a European Company (SE).

3.4. The European Company

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out the core Company law framework, and a Directive,^^ which Supplements the Regulation with regard to the involvement of employees. The Regulation entered into force with a delay of 3 years on 8 October 2004 (Article 70). What the Regulation tries to achieve is that companies established in more than one Member State would be able to merge and operate throughout the EU on the basis of a single set of rules and a unified management and reporting System. It should be possible to avoid the need to set up a network of subsidiaries govemed by different national laws. The Regulation meets this objective only partly. It does contain some very detailed provisions on the cross-border restructuring of companies. A further benefit of the Regulation is that it enables European firms to use a simple group structure after mergers or acquisitions, foregoing intermediate holding companies.^^^ However, there is no such thing as a genuinely European European Company. Instead of a European European Company, each Member State has its own form of European Company, and some rules applicable to an SE vary depending on the home country of the companies that participated in its founding. In principle, a regulation has general application and is directly applicable in all Member States.^^^ It does not necessarily have to be "implemented" by the Member States. The SE Regulation is different: it includes 31 Member State options, there are requirements in the SE Regulation for Member States to enact certain measures, and new legislation may be required in the Member States to ensure its effective application.^^^ Different Member States have implemented the Regulation in different ways depending on the preferences of each Member State and the contents of national Company law.^^^ In the UK, the European Public Limited-Liability Company Regulations came into force on 8 October 2004. In Germany, a corresponding Act (Gesetz zur Einführung der Europäischen Gesellschaft, SEEG) entered into force on 29 December 2004. This results in different regulation of SEs formed in different Member States. An SE is basically a public limited-liability Company that is formed under the law of a Member State and govemed by the law of the Member State in which it has its registered office. ^^ Directive (2001/86/EC) supplementing the Statute for a European Company with regard to the involvement of employees. ^00 See Wenz M, Einsatzmöglichkeiten einer Europäischen Aktiengesellschaft in der Unternehmenspraxis aus betriebswirtschaftlicher Sicht, AG 2003 pp 185-196. 101 Article 249(2) of the EC Treaty. 10^ See for example the Explanatory Memorandum for the UK Parliament on the European Public Limited-Liability Regulations 2004 (SI2004/2326), para 10. 10^ See Bundesministerium fiir Justiz, Diskussionsentwurf eines Gesetzes zur Einfiihrung der Europäischen Gesellschaft (SEEG); Neye HW, Teichmann C, Der Entwurf für das Ausfiihrungsgesetz zur Europäischen Aktiengesellschaft, AG 2003 pp 169-179; Hommelhoff P, Zum Konzemrecht in der Europäischen Aktiengesellschaft, AG 2003 pp 179-184; DTI, Implementation of the European Company Statute: The European Public Limited-Liability Company Regulations 2004. A Consultative Document (October 2003).

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There are therefore many general questions relating to governing law and corporate govemance. Which mies govem the govemance of an SE? In particular: What is the relationship between the provisions of the Regulation and Member States' laws? How is the governing law determined? To what extent does the Regulation permit party autonomy? How may Member States implement the provisions of the Regulation conceming corporate govemance? The SE Regulation contains relatively few mies on shareholders' powers. Instead of the SE Regulation, these powers are based on Member States' laws applying to public limited-liabihty companies in general.

3.4.2. The Applicable Ruies in General An SE is established by two pieces of legislation, namely a Regulation (directly applicable in Member States) establishing the Company law mies and a Directive (which must be implemented in national law in all Member States) on employee involvement. In addition, Member States' laws and party autonomy play a significant role. An SE is not able to operate on the basis of a single set of European mies, and it is possible that SEs incorporated in the same Member State operate on the basis of different mies. Both the Directive and the Regulation contain mies on corporate govemance, governing law and the extent of party autonomy. The Directive on Employee invoivement The key question delaying the European Company Statute was co-determination. According to Article 1(4) of the SE Regulation, employee involvement in an SE shall be govemed by Directive 2001/86/EC. This makes co-determination mandatory in some cases. On the other hand, these provisions allow a circumvention of German mies on co-determination. Earlier legislation on employee involvement. There is some earlier EU legislation on employee involvement. Hundreds of multinational companies operating across Europe have set up European Works Councils as a result of the 1994 Directive on European Works Councils (94/45/EC). European Works Councils bring together employee representatives from each EU (or EEA) country in which the Company has Operations, for the purposes of the disclosure of information and consultation with group-level management. In 2002, the information and consultation Directive (2002/14/EC) was adopted. The purpose of this Directive is to establish a general framework setting out minimum requirements for the right to information and consultation of employees in undertakings or establishments within the Community. No uniformity. The complex regime under the Directive on employee involvement (2001/86/EC) does not amount to a Substantive uniformity. ^^"^ Instead, the Directive provides for alternative forms of co-determination to be applied in an ^^^ See Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) p 8.


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SE. The Directive recognises that it is not possible to set up a single European model of employee involvement applicable to all SEs (recital 5). On the other hand, the establishment of an SE should not reduce practices of employee involvement existing within the participating companies (recital 3). This leads to a "before and after" principle: employee rights in force before the establishment of an SE should provide the basis for employee rights of involvement in the SE (recital 18). The Directive on employee involvement determines the law of which country shall govem the co-determination rights of employees and, at least partly, designates the applicable rules. In some cases the so-called Standard rules apply, in some cases not. The underlying principle is that the concrete procedures of codetermination should be defined primarily by means of an agreement between the parties concemed or, in the absence thereof, through the application of a set of subsidiary rules (recital 8). Standard rules. Each Member State must lay down Standard rules on employee involvement. In normal cases, the place of the registered office of the SE will determine the governing law: the Standard rules as laid down by the legislation of the Member State in which the registered office of the SE is to be situated apply from the date of the registration of the SE.^^^ However, Member States must distinguish between 'Information and consultation" and "participation" in the Standard rules. While rules on information and consultation are a factor that must be taken into account when Company representatives exercise their powers on behalf of the company,^^^ rules on participation partly lay down who will be empowered to exercise some of these powers (especially the power to take care of the Company's internal decision-making):^^^ The former can be described as rules on constraints on govemance, but the latter are rules on govemance. The Standard rules on information and consultation apply if the Standard rules apply. It is the purpose of the Directive to ensure information and consultation procedures at transnational level (recital 6). With regard to information and consultation, the competence of the employees' "representative body"^^^ is limited to "questions which concem the SE itself and any of its subsidiaries or establishments situated in another Member State or which exceed the powers of the decision-making organs in a single Member State". The Standard rules on participation will not apply unless there was a sufficient amount of employee participation within the various participating companies (the "before and after" principle).^^^ The "before and after" principle means in practice

^05 Article 7(1) of the Directive. ^^^ See Articles 2(i) and 2(j) of the Directive. ^^'^ Article 2(k) of the Directive. ^^^ Article 2(f) of the Directive. ^^9 Article 7(2) of the Directive.

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that it is potentially permissible to create an SE subject to a regime for workers' participation ranging from the strict German or Dutch model to none at all.^^^ No Standard rules. In some cases the Standard rules are not applicable at all. (a) As Said above, the applicability of the Standard rules on participation is subject to the "before and after" principle. (b) In addition, the employees' "special negotiating body"^" may under some circumstances decide to rely on the normal rules on information and consultation of employees in force in the Member States where the SE has employees.^^^ (c) Furthermore, the Standard rules will not apply if the competent organs of the participating companies and the special negotiating body of the employees have reached an agreement on employee involvement but not an agreement on the application of those Standard terms. The Directive permits freedom of contract and allows for tailor-made Solutions. Application of German co-determination. For an SE established by way of merger, the threshold for the application of German co-determination is 25% of the workforce under the "before-after" principle (Article 7(2) of the Directive). If the participating companies choose a straightforward cross-border merger under the new Directive on cross-border mergers, the threshold will be slightly higher. The final version of the Directive on cross-board mergers says, in effect, that after a merger involving a German Company, the merged entity will have to adopt German co-determination if one-third or more of the workers are German. However, German co-determination can also be circumvented. For example, it is possible to found an SE in another Member State without merging or transforming any existing German Company; such an SE is recognised and may carry on business even in Germany. It may be that this makes German companies less attractive as mergers partners. It is also possible to convert an SE into a public limited-liability Company govemed by the law of the same State (Article 66 of the Regulation). An SE registered in France can thus be converted into a French SA that is not subject to mandatory employee participation of the German kind. The SE Regulation The SE Regulation contains a number of rules on corporate govemance. For example, Article 38 lays down the basic management structure and organs of an SE and Article 1(4) of the Regulation sets out that employee involvement in an SE shall be govemed by the provisions of Directive 2001/86/EC. However, the Regulation contains detailed rules on relatively few issues. For example, the Regulation sets out the legal nature of an SE and how an SE can be set up. These rules are necessary since this Company form is based on Community law; it is not possible to set up an SE on the basis of national Company law only. ^^^ See for example Henssler M, Unternehmerische Mitbestimmung in der Societas Europaea. Neue Denkanstöße für die „Corporate Govemance'-Diskussion. In: Festschrift für Peter Ulmer (2003) pp 199-200; Heinze M, Die Europäische Aktiengesellschaft, ZGR 2002 p 69-70. ^^^ Article 2(g) of the Directive. ^^2 Article 3(6) of the Directive.


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In addition, the rules on the setting up of an SE address several legal problems relating to the cross-border restructuring of Operations. The lack of detailed rules can be explained by the basic legislative technique used in the Regulation and great reliance on Member States' laws. The minimum use of uniform rules is based on the principle of subsidiarity (recital 29).^^^ An SE founded in the UK is thus largely govemed by UK law, and an SE founded in Germany by German law. Basic legislative technique. The basic legislative technique used in the Regulation is, firstly, that the provisions of the Regulation set out some general rules which are directly applicable in the Member States and, secondly, that the modalities of different rights and obligations are based on the provisions of national laws.114

The SE Regulation contains both a general reference (Article 9(1)) to national law - in particular to provisions "which would apply to a public limited-liability Company formed in accordance with the law of the Member State in which the SE has its registered office" - and specific references thereto. Furthermore, Members States are expected to implement the SE Regulation by adopting some specific rules for SEs. This means that the SE Regulation is different from a typical regulation that is binding in its entirety and directly applicable in all Member States^ ^^ and does not need to be implemented by them. But although the SE Regulation can be described as a framework regulation,^ ^^ it should not be described as a directive-like regulation. Its general rules are directly applicable and binding whether the Member States implement them or not. The hierarchy of sources of rules. Because of the legislative technique of the SE Regulation, the rules governing an SE can be based on EU, national and Company sources. Article 9(1) of the Regulation partly lays down their hierarchy. In addition, the hierarchy of rules is govemed by the Substantive provisions of the Regulation, the provisions of Directive 2001/86/EC and the provisions of Member States' laws. To begin with, Article 9(1) provides that "[a]n SE shall be govemed: (a) by this Regulation, (b) where expressly authorised by this Regulation, by the provisions of its Statutes or (c) in the case of matters not regulated by this Regulation or, where matters are partly regulated by it, of those aspects not covered by it, by: (i) the provisions of laws adopted by Member States in implementation of Commu113 See also recital 9; Teichmann C, Die Einführung der Europäischen Gesellschaft. Grundlagen der Ergänzung des europäischen Statuts durch den deutschen Gesetzgeber, ZGR 2002 pp 391-392. 11"^ Kubier F, Leitungsstrukturen der Aktiengesellschaft und die Umsetzung des SE-Statuts, ZHR 167 (2003) p 223: "Die VO gibt nur einen Rahmen vor, der durch die schon bestehenden Aktiengesetze der Mitgliedstaaten und durch die von ihnen zu schaffenden Rechtsvorschriften implementiert wird." 115 Article 249(2) of the EC Treaty. 11^ See Hopt KJ, Company Law in the European Union: Harmonization or Subsidiarity, 31 Saggi, conferenze e seminari del Centro di studi e ricerche di diritto comparato e straniero di Unidroit (1998) pp 11-12 on framework directives.

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nity measures relating specifically to SEs; (ii) the provisions of Member States' laws which would apply to a public limited-liability Company formed in accordance with the law of the Member State in which the SE has its registered Office; ^^^ (iii) the provisions of its Statutes, in the same way as for a public limitedliability Company formed in accordance with the law of the Member State in which the SE has its registered office". These rules are complicated. In any case, the hierarchy of rules governing an SE seems to be as follows:'^^ the applicable provisions of the EC Treaty;^ ^^ provisions of the Regulation, all of which are mandatory in the sense that neither the Member States nor the parties may derogate from them (Article 9(1 )(a)); provisions of Statutes expressly authorised by the Regulation (Article 9(1 )(b)); mandatory provisions of laws adopted by Member States in implementation of Community measures relating specifically to SEs (Article 9(l)(c)(i)); the agreement on arrangements for the involvement of the employees within the SE set out in Article 4 of Directive 2001/86/EC (Articles 1(4) and 12(4));^2o ^ê Standard rules on employee involvement laid down by the Member States (Article 1(4));^^^ other rules according to Member States' hierarchy of rules: these rules must contain at least mandatory or dispositive provisions of Member States' laws applicable to public limited-liability companies (Article 9(l)(c)(ii)), and mandatory or dispositive provisions of Statutes (Article 9(l)(c)(iii)).^^^

3.4.3 Party Autonomy under the SE Regulation The hierarchy of rules affects party autonomy and an SE's internal rule-making. As said above, the hierarchy of rules governing an SE is based on Article 9(1) of the Regulation, the Substantive provisions of the Regulation, the provisions of Directive 2001/86/EC and the provisions of Member States' laws. To what extent is there scope for party autonomy in an SE's internal rule-making? To what extent ^^^ See also Article 9(2): "The provisions of laws adopted by Member States specifically for the SE must be in accordance with Directives applicable to public limited-liability companies referred to in Annex 1.3 ..." Further to Article 9(2) Werlauff E, SE - The Law of the European Company (2003) pp 23-24. '^^ Compare especially Kubier F, Leitungsstrukturen der Aktiengesellschaft und die Umsetzung des SE-Statuts, ZHR 167 (2003) pp 224-225. ^^^ For example, Article 48 of the EC Treaty in light of the case law of the ECJ in Centros and Überseering; Article 12 of the EC Treaty. See Werlauff E, SE - The Law of the European Company (2003) pp 82-83. ^^^ Article 1(4) of the Regulation: "Employee involvement in an SE shall be govemed by the provisions of Directive 2001/86/EC." Article 12(4) of the Regulation: "The Statutes of the SE must not conflict at any time with the arrangements for employee involvement ..." See also Articles 4 and 12 of Directive 2001/86/EC. 121 Article 7(1) of Directive 2001/86/EC. 122 Article 9(1) raises questions such as: the scope of the Regulation, the scope of its specific provisions and the role of gap-filling; the effect of Article 9(1) on private international law; the adoption of provisions either for pubhc limited-liability companies generally or for SEs specifically; and party autonomy.


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may shareholders and other internal rule-makers make internal rules for the Company? Sources of internal rules. An SE may have different kinds of internal rules. The Statutes are not the only source of internal rules. The Statutes of the Company are nevertheless the most important source of an SE's internal rule-making.^^^ Statutes are the only source of an SE's internal rulemaking that the Regulation regulates in a relatively detailed way. But while some provisions of Statutes are expressly authorised by the Regulation (Article 9(1 )(b)), most provisions must comply with Member States' laws applicable to public limited-liability companies (Article 9(l)(c)(iii)). Another regulated source of internal rule-making is related to employee involvement. Article 4 of Directive 2001/86/EC^2'^ provides for an agreement on arrangements for the involvement of the employees within the SE. According to the Regulation, the Statutes of the SE must not conflict at any time with the arrangements for employee involvement (Article 12(4)). The Directive provides that each Member State shall ensure that the obligations laid down by the Directive are not breached (Article 12).i25 In contrast, the effect of internal guidelines and ad-hoc decisions is regulated by the provisions of Member States' laws. The SE Regulation provides for the most fundamental rules only; these rules must be supplemented by Member States' laws laying down the modalities of different rights and obligations.^^6 Statutes. The SE Regulation contains some rules on the Statutes of an SE. The amendment of Statutes requires a majority of at least two thirds of the votes cast (Article 59). According to the wording of Article 9(1) of the Regulation, the provisions of Statutes can be based either on the express provisions of the Regulation or on the law governing the SE.^^'^ If the provisions of the Statutes are "expressly authorised" by the Regulation, they are permitted whether or not they are permitted under national law.

^^^ According to Article 6, "the Statutes of the SE" shall mean both the instrument of incorporation and, where they are the subject of a separate document, the Statutes of the SE. ^'^^ Article 1(4) of the Regulation: "Employee involvement in an SE shall be govemed by the provisions of Directive 2001/86/EC." See also Articles 4 and 12 of Directive 2001/86/EC. ^25 Article 12(1) of Directive 2001/86/EC: " Each Member State shall ensure that the management of establishments of an SE and the supervisory or administrative organs of subsidiaries and of participating companies which are situated within its territory and the employees' representatives or, as the case may be, the employees themselves abide by the obligations laid down by this Directive, regardless of whether or not the SE has its registered office within its territory." See also Article 12(2) of the Directive. ^^^ See also Hommelhoff P, Satzungsstrenge und Gestaltungsfreiheit in der Europäischen Aktiengesellschaft. In: Festschrift fiir Peter Ulmer (2003) p 276. ^^^ See also Kubier F, Leitungsstrukturen der Aktiengesellschaft und die Umsetzung des SE-Statuts, ZHR 167 (2003) pp 224-225; Werlauff E, SE - The Law of the European Company (2003) p 23.

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Some provisions can be adopted in the SE's Statutes because they have been expressly permitted in the Regulation. ^^^ For example, the Statutes must contain a choice between the two-tier System and the one-tier System (Article 38), and the number of members of the management organ or the rules for determining it must be laid down in the SE's Statutes (Article 39(4)). A Member State may also require or permit the Statutes to provide that the member or members of the management organ shall be appointed and removed by shareholders in general meeting under the same conditions as for public limited-liabihty companies (Article 39(2)). As regards these rules, the limits to the discretion available to the parties and Member States vary.^^^ For example, a Member State may stipulate the number of members of the supervisory organ for SEs registered within its territory or a minimum and/or maximum number (Article 40(3)); a Member State may set a minimum and, where necessary, a maximum number of members of the administrative organ (Article 43(2)); members of Company organs shall be appointed for a period laid down in the Statutes not exceeding six years (Article 46(1)); and an SE's Statutes shall list the categories of transactions which require authorisation of the management organ by the supervisory organ in the two-tier System or an express decision by the administrative organ in the one-tier System (Article 48(1)). On the other hand, the administrative organ shall meet at least once every three months at intervals laid down by the Statutes (Article 44(1)); an SE's Statutes may, in accordance with the law applicable to pubhc limited-liability companies in the Member State in which the SE's registered office is situated, lay down special conditions of eligibility for members representing the shareholders (Article 47 (3)); and the Statutes may provide for internal rules relating to quorums and decision-taking in SE organs (Article 50).

3.4.4 The Basic Governance Structure under the SE Regulation The SE Regulation sets out the basic governance structure but leaves some room for interpretation. For example, although the Regulation names the organs of an SE and provides for a choice between a two-tier System and a one-tier System, it is a matter of interpretation whether an SE can have other organs than those listed in the Regulation, what the two-tier System and the one-tier System exactly mean, and whether the managing director must be a board member.

Organs The Regulation provides that "an SE shall comprise: (a) a general meeting of shareholders and (b) either a supervisory organ and a management organ (two-tier ^^^ See Hommelhoff P, Satzungsstrenge und Gestaltungsfreiheit in der Europäischen Aktiengesellschaft. In: Festschrift für Peter Ulmer (2003) pp 274-275. ^^^ Compare Hommelhoff P, ibid p 275: "Ermächtigungen mit Regelungsauftrag an den Satzungsgeber", "Ermächtigungen ohne Regelungsauftrag".


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System) or an administrative organ (one-tier System) depending on the form adopted in the Statutes" (Article 38). These are the organs of the Company as far as the management, supervision and administration of an SE are concemed. As a rule, Member States' laws may not provide for any other management Organs for an SE. The matter as to which organs are empowered to take care of the management, supervision and administration of an SE has been regulated by the Regulation, and the provisions of Member States' laws that would apply to public limited-liability companies will not govem this issue (Article 9(l)(c)(ii)).^^° According to the preamble of the Regulation, the respective responsibilities of those responsible for management and those responsible for supervision should be clearly defined in order for an SE to be efficiently managed and properly supervised (recital 14). There are some exceptions to the rule that Member States' laws may not provide for any other organs as far as the management, supervision and administration of an SE are concemed: (a) The first exception relates to accounts. The Regulation provides that an SE shall be govemed by the rules applicable to public limited-hability companies as regards the preparation of its annual accounts including the accompanying annual report and the auditing and publication of those accounts (Article 61). (b) A similar exception relates to winding up, liquidation, insolvency, cessation of payments and similar procedures (Article 63). In these two cases, it is possible that other bodies are partly empowered to take care of the management, supervision and administration of public limited-liability companies (Article 9(l)(c)(ii)). (c) There is also an exception relating to the representation of the Company in dealings with third parties and in legal proceedings. Article 12(1) of the Regulation provides that every SE shall be registered in accordance with Article 3 of the First Directive (68/151/EEC). Article 3 of the First Directive refers to Article 2 of the same Directive, and Article 2(1 )(d) of the First Directive distinguishes between persons who either as a body constituted pursuant to law or as members of any such body: (i) are authorised to represent the Company in dealings with third parties and in legal proceedings; or (ii) take part in the administration, supervision or control of the Company. This means that in addition to the management organs mentioned in Article 38, an SE and a public limited-liability Company may, under national law, have bodies, which are authorised to represent the Company in dealings with third parties. (d) An SE can have a managing director or managing directors (Articles 39(1) and 43(1)). The role of managing directors is a matter of interpretation. The same can be said of the secretary of a UK Company. As will be discussed below, the wording of the SE Regulation may create Problems for both the UK and Germany.

Choice Between the Two-tier System and the One-tier System The choice between the two-tier System and the one-tier System has been left to the Company. An SE shall have either a two-tier System or a one-tier System depending on the form adopted in the Statutes (Article 38(b), recital 14). This is not a 130

See also Werlauff E, SE - The Law of the European Company (2003) p 73.

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matter for the discretion of Member States, and both Systems must be available in every Member State. Since the laws of many Member States have not offered the choice between these two Company forms in the past, they must be amended accordingly (Articles 39(5), 43(4) and 68(l)).^3i Failure to implement. The fact that a Member State fails to adopt these measures will not prevent the Company from choosing either one of these two Systems (Article 38(b) and recital 14).^^^ £yen in this case, the principles laid down by the Regulation will be complemented by the laws of a Member State under Article 9(1). For example, the modalities of "management" may, in the absence of appropriate legislative measures, have to be determined by applying the general principles of national Company law or by the use of analogy.^^^ Existing Systems and appropriate measures. The Regulation is based on the idea that there are just two main ways to organise the management of public limited-liability companies in Europe: either a one-tier System or a two-tier System in the sense of Article 38(b) of the Regulation with no grey area between the two. This might seem natural from the perspective of German law (an AG has a twotier System, a GmbH can have a one-tier System or a two-tier System) or French law (both Systems available), but not from the perspective of UK law (great flexibihty as regards the internal management of companies) or the law of the Nordic States. May a Member State adopt "appropriate measures" in relation to SEs where there is already a one-tier or two-tier System of some kind but not a System identical to that laid down by the provisions of the Regulation, or where the System adopted by the Member State cannot be regarded as any of these two Systems? The answer must be yes in order not to deprive Article 38(b) - which provides for a right to choose either a two-tier System or a one-tier System in the Statutes of its effectiveness.^^"^ Member States' rights to adopt these measures must then be based either on Articles 39(5) and 43(4) or Article 9(l)(c)(i). Articles 39(5) and 43(4) should be interpreted as in no way restricting the scope of Article

^^^ See also Werlauff E, ibid p 77: "not merely a question of 'appropriate measures', but rather of 'corresponding provisions', which is something rather different and more precise". *^^ See also Teichmann C, Die Einführung der Europäischen Gesellschaft. Grundlagen der Ergänzung des europäischen Statuts durch den deutschen Gesetzgeber, ZGR 2002 p 442. ^33 Compare Teichmann C, ibid pp 442 and 398-399. ^^'^ This matter may have been unclear. See first DTI, Implementation of the European Company Statute, para 3.41: "It is arguable that GB does not have either a 'one-tier' or 'two-tier' System of the same legal nature as those mandated in the Regulation. This would prevent the use in GB of the powers in Articles 39(5) or 43(4)..." Para 3.42: "... the Department proposes not to make use of Articles 39(5) or 43(4)." Compare this with the Explanatory Memorandum for the UK Parliament on the European Public LimitedLiability Regulations 2004 (SI 2004/2326), para 14: "The principal Option in the EU Regulation ... is that set out in Article 39(5) ... Following consultation the regulations have been amended to make clear how the references to directors ... will apply to members of two-tier SEs. These amendments are made by virtue of Article 68 of the EU Regulation ..."


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9(l)(c)(i).^^^ The Obligation of Member States to adopt provisions that are appropriate to ensure the effective application of the Regulation is based on Article 68(1). Party autonomy - choice ofa third System. According to the wording of Article 38(b), one of only two Systems may be chosen. It is probably clear that the System adopted in the Statutes may not differ from the models laid down by the Regulation (Articles 9(1)). But can the Statutes provide that the Company shall have other management, supervision or administrative bodies than those permitted by the Regulation? Is the choice of a management structure at the discretion of the Company so long as its Statutes comply with the provisions of the Regulation? To what extent is the choice of a management structure in the discretion of an SE's internal rule-makers? When answering these questions, one gets little guidance from the wording of the Regulation. It is probably necessary to distinguish between the regulation of the management structure in the Statutes and regulation by means of other internal rule-making. It could be argued that the Statutes cannot provide for management, supervision or administrative bodies not expressly authorised by the provisions of the Regulation. This is because this matter is regulated by the Regulation, that is, covered by Article 38(b). If Member States' laws do not govem an SB in this respect in the first place (Article 9(1 )(c)), party autonomy cannot be based on Member States' laws. To this extent, Article 38(b) could be mandatory law as far as an SE's internal rule-making is concemed. On the other hand, this does not necessarily apply to an SE's other internal rulemaking. Since Article 38(b) does not provide for the modalities of an SE's management, supervision or administration, the matter of delegation of these powers could be govemed by Member States' laws (Article 9(l)(c)(ii)). It is unclear to what extent Article 38(b) restricts delegation of the management function to subboard bodies. The Basic Characteristics ofthe Two Systems The Regulation contains mies specifically for the two-tier System, rules specifically for the one-tier System, and rules common to both Systems. The special rules governing either the two-tier System or the one-tier System set out an SE's management organs, the division of powers between these organs and the number and appointment of organ members. In addition, the Regulation contains provisions on managing directors (Articles 39(1) and 43(1), see below). The two-tier System. The two-tier System consists of a supervisory organ and a management organ. No member may serve on both the management board and the supervisory board at the same time (Article 39(3)).

^35 But compare Teichmann C, Die Einfuhrung der Europäischen Gesellschaft. Grundlagen der Ergänzung des europäischen Statuts durch den deutschen Gesetzgeber, ZGR 2002 p 443.

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The role of the supervisory organ is to "supervise" the work of the management Organ, that is, to check and monitor the management organ. The supervisory board may not itself exercise the power to "manage" the SE, that is, to engage in management tasks or represent the Company in transactions with third parties (Article 40). The members of the supervisory organ are normally appointed by shareholders in general meeting. However, this is without prejudice to any employee participation arrangements determined pursuant to Directive 2001/86/EC (Articles 40(2) and 47(4)). The management organ is responsible for "managing" the SE (Article 39(1)). In addition, the management organ must report to the supervisory organ on a regulär basis, pass information promptly on events likely to have an appreciable effect on the SE and respond to enquiries (Article 41). The member or members of the management organ are appointed and removed by the supervisory organ. A Member State may, however, require or permit the Statutes to provide that the member or members of the management organ shall be appointed and removed by the general meeting under the same conditions as for public limited-liability companies that have registered offices within its territory (Article 39(2)). One of the benefits of the two-tier System is that it can create an institutional and personal Separation of monitoring and management organs and help realise a distinct distribution of responsibilities and powers within the Company. The one-tier System. Under the single-tier structure, the SE is managed by an administrative organ instead of a supervisory organ and a management organ (Article 43). Members of an administrative organ are normally appointed and removed by shareholders in general meeting unless the rules on employee participation provide otherwise (Articles 43(3) and 47(4)). Management and supervision and Member States' laws. It is not easy to draw a line between "management" and "supervision". Although the supervisory organ is not supposed to exercise the power to manage an SE (Article 40(1)), the Regulation does not prevent the supervisory organ from exercising some fundamental management powers: the supervisory organ may appoint and remove members of the management organ (Article 39(2)) and authorise or refuse to authorise transactions (Article 48(1)). It is also clear that "management" includes even supervision such as the maintaining of internal controls: financial, operational and compliance Controls and risk management Systems.^^^ This means that a two-tier System can be "genuinely" two-tier for the purposes of the Regulation although the supervisory organ has some powers that in real life could just as well be said to belong to management. ^^^ ^^^ Compare for example the Combined Code of Corporate Govemance, provision C.2.1. ^^'^ But compare Werlauff E, SE - The Law of the European Company (2003) p 77: "[Article 40(1) of the Regulation] ensures that the two-tier System is genuinely two-tier, and not as in Denmark, where the board of directors both has supervisory tasks and takes part in the management of the Company, even if not in the daily management, but only the ' Overall' management."


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As the exact duties of an SE's supervisory, management and administrative Organs - the modalities of "management" and "supervision" - have not been defined in the Regulation (see nevertheless Article 41 on reporting), they must be govemed Member States' laws (Article 9(l)(c)(ii)). Rules common to both Systems. The provisions setting out rules common to both Systems cover some fundamental matters relating to organ membership and voting (such as the term of organ membership, conditions of eligibility for organ members and quorums)^^^ as well as certain matters preventing expropriation by Company insiders of the Company and its shareholders (such as decision-making on important transactions, the duty of confidentiality, and liability).^^^ The Managing Director There is room for a managing director or managing directors under both Systems. According to the wording of Articles 39(1) and 43(1), a Member State "may provide that a managing director or managing directors shall be responsible for the current management under the same conditions as for public limited-liability companies". An SE can thus have one or more managing directors depending on the implementation of the Regulation in the Member States. The wording of the Regulation raises some questions. Is the managing director or the body of managing directors an organ of the Company? Must a managing director be a member of the management organ or the administrative organ? Can an SE appoint a managing director if the position of managing directors has not been regulated by laws that apply to public limited-liability companies generally? There are differences between Member States' existing laws. Germany. A German AG does not have a "managing director" although the chairman or "Speaker" of the management board is often perceived as "CEO" by foreigners dealing with German companies. The business of an AG is managed by a management board (Vorstand) the members of which are executives who actually run the Company's affairs in their capacity as board members. A management board may not delegate its powers to lower ranking officers. If a German SE chooses the two-tier structure, it cannot appoint managing directors. The board structure will be that of an AG. However, a German SE must appoint one or more managing directors (Geschäftsführende Direktoren) under the one-tier structure. These managing directors can but do not have to be members of the administrative organ. Even other persons can be appointed.*"^^ The role of managing directors resembles the role of management board members (Vorstand) under the statutory two-tier structure of a German AG. In effect, a German SE that appoints one or more managing directors

^^^ Articles 46, 47 and 50, respectively. ^^^ Articles 48,49 and 51, respectively. 140 § 40(1) SEEG.

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will end up with a board structure that resembles that of an AG.^"*^ The supposedly one-tier structure looks like a two-tier structure. ^"^^ 77?^ United Kingdom. Whether a UK Company can appoint one or more managing directors depends on the wording of its articles of associaton. According to a regulation in model articles (Table A), a board member can be appointed as a managing director.^'*^ Most companies have adopted this regulation. A managing director is thus an executive board member who takes care of the day-to-day management of the Company and who has been appointed as a managing director by the board. The European Public Limited-Liability Regulations 2004 are silent on managing directors. The UK legislator did not make use of the Member State options under Articles 39(1) and 43(1) of the SE Regulation. On the other hand, it was believed that there was nothing in previous law that prevented a public limitedliability Company from regulating its board structure in articles of association, and it was obviously assumed that the SE Regulation did not change the law that applies to managing directors.^"^"^ There is therefore no Statute in the UK that would say that an SE incorporated in the UK might appoint a managing director. A UK Company must have a Company secretary,^"*^ A Company secretary has been described as "an officer of the Company with substantial authority in the administrative sphere and with powers and duties derived directly from the articles and the Companies Act".^"^^ A Company secretary is "the chief administrative officer of the Company". ^"^^ For example, a Company secretary regularly "enters into contracts ... which come within the day-to-day running of the Company's business".^"^^ A Company secretary is arguably a person who is to some extent "responsible for the current management" of the Company in the sense of the Regulation. The European PubHc Limited-Liability Regulations 2004 are silent on the Company secretary as well. The DTI had earlier indicated that the SE Regulation does not require an SE registered in the UK to appoint any Company secretary. Duties that would normally fall to the Company secretary (for example the filing of documents at Companies House) would need to be undertaken by one of the board ^"^^ There are some exceptions. For example, managing directors must follow directions given by the administrative organ under § 44(2) SEEG. ^^'^ See for example Hoffmann-Becking M, Organe: Strukturen und Verantwortlichkeiten, insbesondere im monistischen System, ZGR 2004 pp 371-372. ^^^ Section 8 of the Companies Act 1985. Table A, regulation 84 allows directors to "appoint one or more of their number to the office of managing director or to any other executive Office under the Company". Table A, regulation 72 provides that directors may "delegate to any managing director or any director holding any other executive office such of their powers as they consider desirable to be exercised by him". ^^^ See the Explanatory Memorandum for the Parliament on the European Public LimitedLiability Regulations 2004 (SI2004/2326), para 14 and Annex A. ^^^5 Section 283(1) of the Companies Act 1985. 14^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 298. ^"^^ Salmon LJ in Panorama Developments (Guildford) Ltd v Fidelis Fumishing Fabrics Ltd [1971] 2 QB 711, [1971] 3 All ER 16 (Court of Appeal). ^^^ Lord Denning MR in Panorama Developments.


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members of the SE.^"^^ However, the Consultation Document published by the DTI contained no express proposals to this effect. On the contrary, the DTI was of the opinion that "[pjrovisions in GB Company law that apply to PLCs will also apply to SEs ... and will apply equally to one-tier and two-tier boards unless specific different provision is made in respect of the latter under Article 39(5)".^^^ Organ. Therefore, the position of managing directors can be different in different Member States. It is probably not relevant whether the managing director is or is not regarded as an organ under Member States' laws governing public limitedliability companies. It is clear that a managing director will not be regarded as an independent organ under the SE Regulation because the management organs of the Company are those listed in Article 38; this matter is not govemed by Member States' laws (Article 9(l)(c)(ii)). The fact that the managing director is or is not regarded as an organ under national law will not affect the effectiveness of the SE Regulation's provisions as such. But whether the managing director is regarded as an organ under Member States' law can affect the managing director's rights and obligations under the governing law. It is not the objective of the SE Regulation to change these rights and obligations; Articles 39(1) and 43(1) set out expressly that a managing director or managing directors shall be responsible for the current management "under the same conditions as for public limited-liability companies". Member. It seems more interesting to ask whether the managing director must be a board member under the Regulation. One alternative could be to assume that since the Regulation does not lay down any express rules on the matter, the appointment and activities of managing directors are govemed by national law only. A better view could nevertheless be that only a member of the management organ or the administrative organ can be appointed as a managing director.^^^ This conclusion can be based on the objectives and the internal structure of the Regulation and it can be supported by the regulation of public limited-liability companies in UK and German law. According to the preamble, an SE must be "efficiently managed and properly supervised" and "the respective responsibilities of those responsible for management and those responsible for supervision should be clearly defined" (recital 14). While the Regulation contains some provisions on the responsibilities of organ members, it is silent on this matter as far as managing directors are concemed, although current management constitutes the most visible part of an SE's management.

^^9 Source: Mr. Peter Brower, DTI. 150 j)ji^ Implementation of the European Company Statute, para 3.39. See also para 3.41. ^^^ See also Hommelhoff P, Einige Bemerkungen zur Organisationsverfassung der Europäischen Aktiengesellschaft, AG 2001 p 284 (a managing director is a member). For another view see Neye HW, Teichmann C, Der Entwurf für das Ausfuhrungsgesetz zur Europäischen Aktiengesellschaft, AG 2003 p 179 (a managing director can be a member).

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This means that a managing director must be a member of the management Organ or the administrative organ, as the case may be. The provisions of the Regulation seem to be based on this idea: (a) Under a two-tier System (the same principles apply under a one-tier System), the management organ shall be responsible for managing the SE. According to the wording of the Regulation, a Member State may provide that a managing director or managing directors shall be responsible for the current management of the SE (Article 39(1)), which could imply that a managing director is a member of the management organ. (b) The members of the management organ shall be appointed and removed by the supervisory organ (Article 39(2)), but there are no express provisions on the appointment and removal of a managing director. Such provisions are not necessary if the managing director is a member of the management organ. (c) The number of members of the management organ or the rules for determining it shall be laid down in the SE's Statutes (Article 39(4)), and the same rule should probably apply to the number of managing directors. (d) No person may at the same time be a member of both the management organ and the supervisory organ of the same SE (Article 39(3)). It is probably clear that a managing director should not be a member of the supervisory organ of the same SE. (e) The supervisory organ shall supervise the work of the management organ (Article 40(1)), but there are no express rules on the supervision of the work of a managing director. Such rules are not necessary if the managing director is a member of the management organ. (f) The management organ shall report to the supervisory organ at least once every three months on the progress and foreseeable development of the SE's business (Article 41(1)). It is not necessary to have express rules on the managing directors' duty to report if the managing directors are members of the management organ and the management organ reports collectively to the supervisory organ. The same can be said of the duty of the management organ to promptly pass the supervisory organ any information on events likely to have an appreciable effect on the SE (Article 41(2)) and the right of the supervisory organ to require the management organ to provide Information of any kind which it needs to exercise supervision (Article 41(3)). (g) Members of Company organs shall be appointed for a period laid down in the Statutes not exceeding six years (Article 46(1)). It would be contrary to the objectives of this Provision not to apply it to managing directors. The same can be said of the eligibility of organ members (Article 47(2)), the duty of confidentiality (Article 49), and the liability for breach of duty (Article 51). (h) An SE's Statutes shall list the categories of transactions which require authorisation of the management organ by the supervisory organ in the two-tier System or an express decision by the administrative organ in the one-tier System (Article 48(1)), but there is no express Provision on authorisation of the managing director or managing directors by the management organ in the two-tier System. Even this implies that a managing director is a member of the management organ or the administrative organ. Same conditions. According to the wording of the Regulation, a Member State "may provide" that a managing director or managing directors shall be responsible for the current management "under the same conditions as for public limitedliability companies". On the other hand, Article 9(l)(c)(ii) provides that an SE shall be govemed by the provisions of Member States' laws that would apply to a


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public limited-liability Company. Is the reference to "the same conditions" meaningless in light of the fact that an SE is govemed by the provisions applicable to public limited-liabiHty companies anyway?^^^ This is not the case. A managing director either is or is not regarded as an organ, or an organ member, under Member States' laws applicable to public limited-liability companies, but a managing director is definitely not regarded as an organ under the Regulation. The reference to "the same conditions" could therefore mean the following things: (a) The managing director of an SE and the managing director of a public limited-liability Company are basically not the same thing because the rules governing them are not the same (provisions of the Regulation v. provisions of Member States' laws). (b) Basically, the rules applicable to the managing director of a public limited-liability Company do not govem an SE under Article 9(l)(c)(ii) because this matter is regulated by Articles 38, 39(1) and 43(1) of the Regulation, (c) If a Member State provides that a managing director or managing directors shall be responsible for current management, a managing director must, because of the reference to "same terms", nevertheless have the powers, rights and obligations conceming current management that a managing director would have in a public limited-liability Company (Articles 39(1) and 43(1)). (d) While the appointment and remuneration of members of a management organ or an administrative organ are covered by the provisions of the Regulation (Articles 39(2) and 43(3)), the appointment and remuneration of a managing director are not. In this respect, the "same terms" will apply (Articles 39(1) and 43(1)). (e) Different terms are permitted at least where they are appropriate to ensure the effective application of the Regulation (Articles 68(1) and 9(l)(c)(i)). For example, they may be necessary in light of the managing director's Status as member of the management organ or administrative organ of an SE. (f) The term "current management" does not have to be defined independently and given a Community meaning because the distribution of powers within a management organ or an administrative organ does not have to regulated by the Regulation (recitals 14^^^ and 29) and is generally not covered by its specific provisions. Can the laws of a Member State provide for a managing director or managing directors under Article 39(1) or 43(1) although there are - like in Germany^^"^ - no provisions on managing directors for public limited-liability companies in this Member State? The answer must be yes. The organs of an SE are regulated in Article 38, and the right of Member States to provide for a managing director or managing directors in implementing legislation is regulated in Articles 39(1) and 43(1). A managing director in the sense of the Regulation is not a body whose existence is based on Member States' provisions on public limited-liability compa'^2 See Neye HW, Teichmann C, Der Entwurf für das Ausfuhrungsgesetz zur Europäischen Aktiengesellschaft, AG 2003 p 176 at footnote 38. ^^^ According to the wording of recital 14, "the respective responsibilities ofthose responsible for management and those responsible for supervision should be clearly defined", but the distribution of powers within the management organ or the administrative organ has not been mentioned. ^^"^ See Neye HW, Teichmann C, Der Entwurf für das Ausführungsgesetz zur Europäischen Aktiengesellschaft, AG 2003 p 176.

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nies. It is arguable that it would amount to discrimination on grounds of nationality^^^ to allow some Member States to adopt provisions on managing directors for SEs but prohibit other Member States from doing so. Furthermore, the different treatment of Member States on this point cannot be justified by the need to protect third parties or employees or to enable restructuring and Cooperation Operations involving companies from different Member States, it would go beyond what is necessary to attain the objectives of the Regulation (see recital 29), and it would be contrary to its objectives (see especially recital 7). If this analysis is correct, a Member State like Germany may provide that a managing director or managing directors shall be responsible for the day-to-day management without changing the provisions that govem pubhc limited-liability companies generally^^^ or copying the rules that govem the Vorstand. Germany has implemented the Regulation in effect by doing the latter. It is clear that a managing director cannot be responsible for day-to-day management under the same conditions as in a public limited-liability Company if there is no legislation setting out those conditions in the first place. A Member State must then adopt such provisions as is appropriate under Article 68(1) and may do so under Article 9(l)(c)(i). The General Meeting An SE must have a general meeting of shareholders (Article 38). The Regulation contains some provisions on the powers of the general meeting (Article 52). However, the legal nature of the general meeting has been left open in the Regulation. For example, the Regulation does not say that the general meeting of shareholders is an "organ" of the Company (see Chap. 5.2.2 below).^^"^ Powers. The powers of the general meeting are generally govemed by the provisions of the law of the Member State in which the SE's registered office is situated. In this case, the governing law is determined not by Article 9(l)(c)(ii) and the applicable rules of private international law but by an express rule in the SE Regulation. The general meeting shall also decide on matters for which responsibility is given to the general meeting by the SE's Statutes in accordance with that law. In addition, the general meeting shall decide on matters for which it is given sole responsibility either by the Regulation^^^ or the rules on employee involve-

^^^ Article 12(1) of the Treaty establishing the European Community. ^^^ Compare Neye HW, Teichmann C, Der Entwurf für das Ausfuhrungsgesetz zur Europäischen Aktiengesellschaft, AG 2003 p 176. ^57 See also Werlauff E, SE - The Law of the European Company (2003) pp 95-96. ^58 See especially Article 8(4) (transfer of registered office); Article 23(1) (approval of the draft terms of merger); Article 32(6) (formation of a holding SE); Articles 37(5)-37(7) (conversion of an existing public limited-liability Company into an SE, approval of the draft terms of conversion); Article 39(2) (appointment and removal of a member or members of the management organ); Article 40(2) (appointment of the members of the supervisory organ); 43(3) (appointment of the member or members of the administrative

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ment supplementing its provisions (that is, the legislation of the Member State in which the SE's registered office is situated adopted in implementation of Directive 2001/86/EC). For example, amendment of an SE's Statutes shall require a decision by the general meeting taken by a majority which may not be less than two thirds of the votes cast, unless the law apphcable to public limited-liabihty companies in the Member State in which an SE's registered office is situated requires or permits a larger majority (Article 59(1)). Voting. The Regulation contains some provisions on the Organisation and conduct of general meetings and on voting procedures (Article 53), on majorities (Article 57) and the amendment of an SE's Statutes (Article 59). These provisions are dispositive in that: the general meeting's decisions shall be taken by a majority of the votes validly cast unless Member States' laws require a larger majority (Article 57); the amendment of an SE's Statutes requires a majority not less than two thirds of the votes cast, unless Member States' laws provide otherwise (Article 59); and the matter of Organisation and conduct of general meetings and voting procedures is govemed by Member States' laws (Article 53). The Regulation contains even some provisions on decision-making in the event that an SE has two or more classes of shares.^^^ Constraints on the exercise of voting rights are generally covered by Member States' laws in the absence of specific provisions in the Regulation (Article 9(l)(c)(ii)).

3.5 Conclusion The possible powers of shareholders to make the rules according to which a public limited-liability Company is run are, with some exceptions, govemed by the provisions of Member States' laws rather than the derivative EU Company or securities markets law. The regulation of the govemance of companies has been a sensitive issue in the EU. EU Company law Directives have relied on a piece-meal approach and the harmonisation of a few core issues. For example, shareholders in general meeting decide on measures relating to share capital and structural change. On the other hand, there is extensive harmonisation of securities markets laws in the EU. Rules governing the disclosure of information to shareholders and investors have largely been harmonised by securities markets Directives.

organ); Article 59 (amendment of an SE's Statutes); Articles 66{A)-66{6) (conversion of an SE into a public limited-liability Company, approval of the draft terms of conversion). ^^^ Where an SE has two or more classes of shares, every decision by the general meeting shall be subject to a separate vote by each dass of shareholders whose dass rights are affected thereby (Article 60(1)). Where a decision by the general meeting requires the majority of votes specified in Article 59(1) or (2), that majority shall also be required for the separate vote by each dass of shareholders whose dassrightsare affected by the decision (Article 60(2)).

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For many reasons, there is likely to be more piece-meal harmonisation regarding the govemance of public limited-hability companies in the future. In the long run, the legislative developments in the USA and the stated objective of setting international Standards based on EU law may make it necessary to codify core corporate govemance principles in the EU. The lack of detailed mies means that the SE Regulation can hardly be used as a model for the regulation of corporate govemance or the power of shareholders to act as a mle-maker. With this in mind, one would assume that the SE Regulation could only to a limited extent lead to the convergence of mies that govem shareholders' rights in Europe. It is nevertheless possible that the SE Regulation leads to some convergence, because some of its provisions may act as legal irritants and force Member States to amend laws that govem public limited-liabihty companies in general, and the fear of competition between Company forms or between Member States can have the same effect. For example, the SE Regulation can make it more difficult for Germany not to change its co-determination laws.

4 The United Kingdom

4.1 General Remarks 4.1.1 Introduction UK law and the work carried out by the Cadbury, Greenbury and Hampel Committees have had an effect on the corporate govemance debate in other European countries. Many think that the corporate govemance framework adopted in the UK is more stringent and highly developed than those in other European markets. But Problems related to the regulation of corporate govemance in the past have led to wide-reaching reforms in recent years. It is interesting to note that although the legal powers of shareholders to influence management are quite limited, UK shareholders might be more powerful than their US counterparts.^ Environment. A distinctive feature of the corporate govemance System in the UK is that the environment in which its public companies operate strongly resembles that which exists in the USA.^ Common features in the UK and the USA include the presence of welldeveloped equity markets, relatively dispersed share ownership,^ and the important role played by institutional Investors who prefer a highly diversified portfolio of shares and freedom to seil their shares (an "exit Option")."^ The stmcture of ownership and control in the UK and the USA has been characterised as an "outsider" or "arm's-length" System.^ Institutional Investors have given executives significant managerial discretion in the past.

See Bebchuk LA, The Case for Increasing Shareholder Power, Harv L Rev 118 (2005) pp 847-850. For differences see Armour J, Cheffins BR, Skeel DA, Corporate Ownership Stmcture and the Evolution of Bankruptcy Law: Lessons from the United Kingdom, Vand L Rev 55 (2002) pp 1714-20. See La Porta R, Löpez-de-Silanes F, Shleifer A, Vishny RW, Law and Finance, J Polit Economy 106 (1998) p 1146 and Table 7: in the world as a whole, dispersed ownership in large public companies is "simply a myth". Schmidt RH, Tyrell M, What Constitutes a Financial System in General and the German Financial System in Particular? In: Krahnen JP, Schmidt RH (eds) The German Financial System (2004) p 58. See for example Cheffins BR, Law as Bedrock: The Foundations of an Economy Dominated by Widely Held Public Companies, OJLS 23 (2003) pp 3-4.

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In addition, both countries are said to have a "shareholder economy", where private enterprise is about maximising profits for those who invest, and where shareholders occupy the central position with respect to companies.^ In the UK, the tolerance of inequality is higher than in Germany. For example, London is the economic, financial and political center of the country. Britain is perceived as a class-oriented society and the distribution of income is slightly less equal than in Germany;'^ the UK can generally be regarded as less committed to a Cluster of European social values called "social democracy" than Germany.^ On the other hand, Britain is usually associated with a sense of "fair play" and pragmatism. Traditionally, the position of the State has been weak in comparison to the rest of Europe. On the other hand, the key relationship that established and maintained the City of London's pre-eminence in the UK economy was its connection with the Crown and central govemment.^ A further factor that should not be forgotten here is legal costs. In the UK, the general "loser pays" principle applies. The court has discretion as to whether and when costs are payable, but the general rule is that the loser pays the winner's costs to an extent that reflects the success of the winner, taking into account the conduct of the parties before and during proceedings and any payment into court or offers to settle. Contingency fee agreements are not allowed in the UK. The use of Conditional Fee Arrangements (no win/no fee) and After the Event insurance policies (insurance against the costs of unsuccessflil litigation) is on the increase, although their legal Status is uncertain. Regulation, This environment is reflected also in the regulation of corporate govemance. To begin with, the regulation of markets is path dependent, and all UK markets have firm, long-held traditions of self-regulation: "They are legally grounded in the law merchant and common law, and have at their heart the belief that commerce is a domain of private transactions. The private regulatory structures of the

See Armour J, Cheffms ER, Skeel DA, Corporate Ownership Structure and the Evolution of Bankruptcy Law: Lessons from the United Kingdom, Vand L Rev 55 (2002) p 1715. See for example The Economist 4 September 2003, Inequality. Would you like your dass war shaken or stirred, sir? Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) Comparative Corporate Govemance - The State of the Art and Emerging Research (1998) p 252. See Mark J. Roe, Political Preconditions to Separating Ownership from Corporate Control, Stan L Rev 53 (2000) pp 573-577; Coffee JC, The Rise of Dispersed Ownership: The Roles of Law and the State in the Separation of Ownership and Control, Yale L J 111 (2001) pp 15-16; Armour J, Cheffms BR, Skeel DA, Corporate Ownership Structure and the Evolution of Bankruptcy Law: Lessons from the United Kingdom, Vand L Rev 55 (2002) p 1717. Gilligan GP, The Origins of UK Financial Services Regulation, Comp Lawyer 18 (1997) pl69.

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City's markets therefore reflect national characteristics and are partially explained by the relative weakness of the central state."^^ What is characteristic of the regulation of the govemance of public limitedliability companies by traditional Company law is that: courts are reluctant to interfere with the internal administration and business decisions of the Company; traditional Company law is flexible; the guiding principle is disclosure; articles of association are the main source of rules on the distribution of powers in the Company; and articles of association usually confer wide powers on the board of directors. But apart from the disclosure principle, this cannot be said of the regulation of UK securities markets. Securities markets laws are not flexible but contain a large number of mandatory provisions. The govemance of listed companies is increasingly being regulated by these rules. The large powers of the board under traditional Company law and articles of association are nowadays limited both by extemal rules, such as listing rules and corporate govemance codes, and by intemal mle-making. It is normal that the acts of executive directors are constrained by the board membership of independent non-executive directors. In addition, the powers of the statutory board to mn the Company are de facto constrained by the delegation of many management functions to sub-board executive bodies. At the same time, some of the mies that govem the activities of statutory board members are applied, either directly or by analogy, to sub-board managers.

4.1.2 The Most Important Legal Forms of Business Organisation In the UK, most companies are registered companies, that is, companies incorporated under the Companies Act 1985. A registered Company can be a Company limited by shares,*' a Company limited by guarantee^^ QJ. ^n unlimited Company. ^^ The registered Company is not the only Company form in the UK. For historical reasons, there are even chartered companies (companies whose existence is based on a charter granted by the Crown) and statutory companies (companies incorporated by Statute). These Company forms are not govemed by the Companies Act 1985. The Limited Liability Partnerships Act 2000 introduced the LLP, a British Version of the US limited liability Company (LLC). A hybrid between a Company and a partnership, an LLP offers limited liability protection to its members and the flexibility of management and the taxation stmcture of a partnership. The openended investment Company (OEIC) is also a new Company form,^"^ and Part 2 of the Companies (Audit, Investigations and Community Enterprise) Act 2004 makes

Gilligan GP, ibid p 169. Section l(2)(a) of the Companies Act 1985. See also Table A. Section l(2)(b) of the Companies Act 1985. Section l(2)(c) of the Companies Act 1985. See section 262 of the FSMA 2000 and the Open-Ended Investment Companies Regulations2001.

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Provision for the establishment of a new corporate vehicle, the Community interest Company (CIC), in order to promote the development of social enterprise. Like the Company laws of other Member States of the EU, the Companies Act 1985 distinguishes between private companies and public limited companies.^^ This distinction is nowadays based on the provisions of the Second Company Law Directive. The regulations governing public companies are more extensive than those governing private companies: ownership and management are normally separated in a public Company, but in a private Company they are often in the same hands. In many areas, however, no distinction is made between these two types of Company. While the form of the Companies Act 1985 reflects the needs of large companies, most companies incorporated in the UK are registered as private companies. In its Final Report,'^ the Steering Group of the Company Law Review made a ränge of recommendations that are intended to change the framework of Company law for small firms. In particular, the Final Report recommends measures that would simplify the administration of private companies.

4.1.3 Sources UK Company law is only partly codified. The regulation of the govemance of public companies is based on statutory law and uncodified common law, Standards and practices that are in effect binding, and market self-regulation. This makes it difficult and time-consuming to find out about the governing rules. The Companies Act 1985 applies both to private companies and to public companies. The Companies Act 1989 and the Companies (Audit, Investigations and Community Enterprise) Act 2004^^ are two of the important Acts amending the 1985 Act. In the following, references to the provisions of the Companies Act 1985 include also references to provisions amended or inserted by other Acts. In July 2002, the Department of Trade and Industry (DTI) published its White Paper on Company law reform.^^ It was the Government's first official response to the Final Report and Recommendations of the Company Law Review (CLR) exercise, which was published in July 2001.^^ The White Paper not only set out the Government's intentions for the shape of the planned Companies Bill but also set out around 200 draft clauses of the Bill for comment by interested parties.

^5 Section 1(3) of the Companies Act 1985. ^^ Modem Company Law for a Competitive Economy: Final Report (July 2001). ^'' There is also a commencement order which brings the 2004 Act's provisions into effect. The Companies (Audit, Investigations and Community Enterprise) Act 2004 (Commencement) and Companies Act 1989 (Commencement No 18) Order 2004. ^^ Modemising Company Law White Paper Cm 5553 (July 2002). '^ Modem Company Law for a Competitive Economy: Final Report (July 2001).

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Specialist Acts contain some of the material that was formerly contained within the Companies Act 1985 or previous Companies Acts. In particular, matters relating to financial Services and insolvency are regulated by specialist Acts.^^ Common law is based on case law. This is regarded as both good and bad. Carnwath LI has said: "One of the curses of the common law method in the 2Ist Century is unlimited accessibiUty to authorities, reported and unreported, and apparently unlimited resources for copying them ... On the other hand, one of the blessings is the availability of up to date and authoritative textbooks^^ on almost every relevant subject, in which the material cases have been sorted out and digested." Carnwath U described his own method in a recent case as follows: "For my part, at least where I am concemed with common law rather than Statute, I find it most helpful to Start by looking for a succinct Statement of the relevant principle: either in a recent binding decision of the higher courts, if there is one; or, if not, in a leading textbook (or, where available, a Law Commission report). Of course, that is only the starting point. Authorities may be needed to qualify, expand, or merely illustrate the basic principle. However, it is important to be clear for which of those purposes any case is being advanced. Furthermore, where the purpose is to qualify or expand, it is not enough simply to cite an authority, without being able to articulate with reasonable precision the proposition which it is said to Support. Occasionally, and exceptionally, the uncertainty of the law in a particular area may require a detailed examination of cases going back over a long period. In such cases, for my part, I welcome all the help I can get. In most disputed areas of the law, it is possible to identify a recent, informed academic treatment of the subject by a recognised authority, with a füll discussion of the relevant cases. Proliferation of academic articles is no more welcome than proliferation of authorities. However, an objective academic review can often provide the best framework for the discussion in court, and a useful corrective to the necessarily partisan viewpointofcounsel."22 The Practice Direction on the Citation of Authorities^^ seeks to limit the citation of previous authority to cases that are relevant and useful to the court. It may nevertheless be difficult to define the applicable rule. The works of academic writers are cited relatively seldom by courts. In the past, counsel were not entitled to quote living authors as authorities.^"*

^^ Insolvency Act 1986, Company Directors Disquahfication Act 1986, Financial Services and Markets Act 2000. 2^ Cheffins BR, Using Theory fo Study Law: A Company Law Perspective, CLJ 58(1) (1999) p 199: "A classic example familiär to British Company lawyers is Gower's Principles of Modem Company Law." 22 GEL Group Ltd v Nedlloyd Lines UK Ltd & another [2003] EWCA Civ 1716. 2^ Signed by the Lord Chief Justice of England and Wales on 9 April 2001. Referred to in Harvey Shopfitters Ltd v ADI Ltd [2003] EWCA Civ 1757 at [22], [23]. 2"* See Kötz H, Die Zitierpraxis der Gerichte. Eine vergleichende Skizze, RabelsZ 52 (1988) pp 649-653.

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A factor that contributes to the "uncertainty of the law" is the role of equitable considerations. Equitable considerations are an important part of traditional UK Company law and courts often try to avoid clear-cut rules.^^ The corporate Constitution of a Company is composed of two documents: the memorandum of association and articles of association.^^ The Companies Act 1985 is supplemented by Tables A to F 1985^'^ made under sections 3 and 8 of the Act. These Tables contain a model Constitution. A Company limited by shares may for its articles adopt the whole or any part of Table A. The Final Report of the Company Law Review and the Government's White Paper have recommended a Single constitutional document which would replace the memorandum and articles. A new Table A would then become necessary. Companies must comply with accounting Standards set by the Accounting Standards Board ASB). The ASB is a subsidiary of the Financial Reporting Council (FRC), an independent regulator.^^ The Financial Services and Markets Act 2000 (FSMA 2000), which replaced the Financial Services Act 1986, provides a statutory framework for the regulation of investment business. It sets out the obligations of issuers of hsted securities and makes provision for the making of listing rules. The specific activities regulated by the FSMA 2000 include also market abuse and the making of misleading Statements. Companies that are listed on the London Stock Exchange are required to comply with the Listing Rules approved by the UK Listing Authority; it says in the Listing Rules that issuers must comply with them (paragraph 1.1). The Financial Services Authority (FSA) is the UK Listing Authority. The Listing Rules contain a reference to the Combined Code of Corporate Govemance (paragraph 12A3A)}^ Listed companies must therefore adhere to the Combined Code as well. The Combined Code focuses on principles and rules conceming the board. It is a set of main principles, supporting principles and provi^^ In the past, the were courts of equity and law courts. ^^ A Single constitutional document has been proposed, to replace the articles and memorandum of association. See Modem Company Law: Final Report, para 9.4. 27 Companies (Tables A to F) Regulations 1985 (S.I. 1985 No. 805). 2^ The first Part of the Companies (Audit, Investigations and Community Enterprise) Act 2004 gave the subsidiary bodies of the FRC new powers to exercise statutory functions in relation to accounting and auditing. 2^ The Listing Rules, 12.43A: "In the case of a Company incorporated in the United Kingdom, the foUowing additional items must be included in its annual report and accounts: (a) a narrative Statement of how it has applied the principles set out in Section 1 of the Combined Code, providing explanation which enables its shareholders to evaluate how the principles have been applied; (b) a Statement as to whether or not it has complied throughout the accounting period with the Code provisions set out in Section 1 of the Combined Code. A Company that has not complied with the Code provisions, or complied with only some of the Code provisions or (in the case of provisions whose requirements are of a continuing nature) complied for only part of an accounting period, must specify the Code provisions with which it has not complied, and (where relevant) for what part of the period such non-compliance continued, and give reasons for any non-compliance."

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sions. The Combined Code is not binding, but an issuer must: (a) apply the principles set out in Section P^ of the Combined Code and explain how they have been apphed; and (b) either comply with the provisions set out in Section 1 of the Code provisions or give reasons for any non-compliance. The purpose of this "comply or explain" principle is to secure sufficient disclosure so that investors and others can assess a listed Company's corporate govemance practices and respond in an informed manner. In addition, the Listing Rules require companies to report to shareholders on directors' remuneration.^^ While the previous Combined Code embraced work carried out by the Cadbury, Greenbury and Hampel Committees, the new Combined Code of Corporate Govemance is to a large extent based on the draft revision of the previous Code that Derek Higgs suggested in his report on non-executive directors published in January 2003. The Code was approved by the Financial Reporting Council on 23 July 2003.32 The City Code on Takeovers and Mergers (the City Code) and the Rules Governing Substantial Acquisitions of Shares (the SARs) apply to the acquisition of shares. Both the City Code and the SARs are administered by the Panel on Takeovers and Mergers.33 They have also been endorsed by the Financial Services Authority (FSA).3'* The purpose of endorsing the City Code and the SARs is to provide them with statutory support.^^ Statutory support means, for example, that there are administrative sanctions for breach of these rules.^^ The City Code and the SARs do not form part of the listing rules although they have been endorsed by the FSA and are supported by the UK Listing Authority (the FSA).^^ There is overlap between regulators. For example, corporate finance activities or transactions may give rise to the involvement of more than one regulator at a time. A public Company takeover offer involving the issue of securities to be listed on the Official List as consideration for the offer will thus be regulated by the FSA, UKLA, the Stock Exchange and the Takeover Panel simultaneously: the FSA and UKLA because of the promotion of and listing of securities, the Stock

3^ Section 1 applies to companies and Section 2 to institutional shareholders. Companies are not required to report on whether and how they have complied with the provisions set out in Section 2 of the Code. 31 The Listing Rules, 12.43A(c). 32 The Financial Reporting Council (FRC) with its subsidiaries, the Accounting Standards Board (ASB) a n d the Financial Reporting Review Panel (FRRP) together m a k e u p an Organisation whose purpose is to promote and secure good financial reporting.

33 See FSA Handbook, Market conduct, Endorsement of the Takeover Code, para 4.2.4. 34 Section 143 o f the F S M A 2000; F S A Handbook, Market conduct, Endorsement of the Takeover Code, paras 4.2.1 and 4.2.2. 3^ F S A Handbook, Market conduct, Endorsement of the Takeover Code, para 4.1.3. 36 Section 143 o f the F S M A 2000; F S A Handbook, Market conduct, Endorsement o f the Takeover Code, paras 4.2.3 and 4.3.1. 3*^ The Listing Rules, Chapter 10, Scope of chapter.

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Exchange for admission of securities to trading and the Takeover Panel because of the takeover offer.^^

4.1.4 The Extent of Party Autonomy in Ruie-making What is the general approach of UK law to party autonomy in the law of public limited-liability companies? How much extemal rule-making is there? To what extent are the extemal provisions mandatory? Which matters are left to the discretion of shareholders? It is necessary to look at both Company law and securities markets law to answer these questions. General approach in Company law. UK Company law is regarded as flexible. It has been said in the UK that UK Company law "gives greater flexibility to the founders and Controllers of companies to design and structure their businesses to suit their needs than any other legal System". This has been viewed as "a great strength, which is likely to prove a major competitive advantage".^^ Flexibility is complemented by disclosure. Sealy has said that disclosure is "one key Word which more than any other sums up the underlying principles of [UK] Company law". He has also observed that "when it comes down to a choice between having a fixed rule about something on the one hand and having no fixed rule as to what a Company must do but saying that whatever it does has to be openly disclosed, the natural choice within the traditions of English Company law has always been to opt for the second approach"."*^ According to the Final Report of the Steering Group of the Company Law Review, freedom and transparency must go hand in hand: "the basic framework of [UK Company] law should provide the maximum possible freedom to the participants, but combined with the necessary supporting transparency to empower the effective exercise ofthat freedom"."*^ Regulatory Intervention in Company law, The Company Law Review listed some justifications for regulatory intervention.'^^ Four justifications were given, with the qualification added that "[w]hen intervention is necessary it should be designed, so far as possible, to avoid inhibiting freedom of choice and flexibility for development"."*^ According to the Company Law Review, justification arises where: legal provision is required to achieve an outcome that is otherwise unobtainable (for example, obtaining the company's separate legal personality); the desired outcome is predictable and the law can supply the parties with default rules ^^ See Slorach S, Corporate Finance, Mergers & Acquisitions 2004. Legal Practice Course Guides (2004) pp 4-5. ^^ Modem Company Law: Final Report, para 1.26; see also Goddard R, Modemising Company Law: The Govemment's White Paper, MLR 66 (2003) p 408. ^^ Sealy LS, Company Law and Commercial Reality (1984) p 21; see also Goddard R, Modemising Company Law: The Govemment's White Paper, MLR 66 (2003) pp 408409. "^^ Modem Company Law: Final Report, para 1.15; see also Goddard R, op cit p 409. ^'^ For an analysis of the justifications see Goddard R, op cit pp 402-424. ^^ Modem Company Law for a Competitive Economy: Developing the Framework, para 2.6.

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thereby reducing transaction costs (for example, a model Constitution); individuals are unable to protect their interests (for example, because of market failure); or the public interest intrudes upon the activity in question."^"^ The first two justifications reflect a narrow role for the State in corporate affairs. Significant emphasis is placed upon the value of party autonomy. The third and fourth justifications show that there can be a legitimate interest for mandatory rules. For example, a public interest mentioned in the fourth justification already exists in the State's provision of a structure for corporate activity. The fourth justification is also illustrated by rules without which confidence in the process of private ordering would be undermined: mandatory disclosure provisions facilitate the flow of information to the market, and rules prohibiting fraud and dishonesty protect the process of private ordering from abuse. The role of mandatory provisions in Company law. In Company law, the traditional approach has been to leave the making of rules on the govemance of companies to the discretion of shareholders and Company bodies. The numbers of statutory provisions and mandatory provisions have nevertheless increased over the years. The mandatory provisions of the Companies Act 1985 relate especially to disclosure and the duties and accountability of directors or officers. There are also an increasing number of criminal offences related to these duties. It is worth noting that the interests of the workforce are not directly protected by mandatory rules in the companies legislation,"^^ but can be protected by provisions of labour law. For example, it has been recognised that contracts of employment are not equated with commercial contracts, and implied terms can protect employees from the "harsh and unacceptable employment practices" to which they could otherwise be exposed."^^ Express contract terms nevertheless take precedence over implied terms. As regards the rights of shareholders to "opt out" of extemal regulation, it is necessary to distinguish between four things: (a) Company law and rules such as the Combined Code of Corporate Govemance on one hand; and (b) party autonomy when the Company is founded and party autonomy during the life of the Company on the other.^"^ When the Company is founded, the founders and shareholders have plenty of discretion as far as the Constitution of the Company is concemed. But the discretion available to shareholders is limited during the life of the Company by statutory and common law rules on the distribution of powers, internal decision-making, and amendment of the Constitution. One could say that part of the discretion available to shareholders is consumed when shareholders make use of it by founding a Company or deciding on its con^^ Modem Company Law: Final Report, para 1.11. ^^ See Wedderbum A, Employees, Partnership and Company Law, ILJ 31 (2002) pp 99111. 46 Lord Steyn in Johnson v Unisys Limited [2001] UKHL 13; [2001] 2 All ER 801; [2001] 2 WLR 1076. See especially paras 19 and 20. ^'^ See also Rajak H, Gestaltungsfreiheit im Gesellschaftsrecht des Vereinigten Königreichs, ZGR-Sonderheft 13 (1998) p 191.

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stitution. After that, Company law makes it difficult for shareholders to change things but gives the board of directors and management relatively free hands. Formation. The founders of a Company draft the memorandum of association and articles of association for the Company. Both the number of provisions and the Contents of Substantive provisions have largely been left to the discretion of founding members. The articles of association of a UK Company typically contain both more regulations and more detailed regulations than the articles of association of a German Company; many matters that would be regulated by mandatory statutory rules in Germany are thus regulated by articles of association in the UK. In the UK, a Company must have a memorandum of association to specify its Constitution and objects."*^ In principle, the Registrar will not register a company's memorandum unless he is satisfied that all the statutory requirements have been complied with."*^ In practice, the memorandum of association is a simple document that contains only very fundamental Information. The memorandum of a Company limited by shares must State:^^ (a) the name of the Company;^^ (b) whether the company's registered office is to be situated in England and Wales or in Scotland; (c) the objects of the Company; (d) that the liability of the members is limited; and (e) the maximum amount of capital the Company may raise and its division into shares of a fixed amount. The memorandum of a public Company must State that it is to be public company.^2 Precedents for the memorandum of association for a public Company are set out in Table F (SI 1985 No 805). In practice the Contents of a memorandum will be more elaborate than the suggested form. The Companies Act 1985 contains some important restrictions relating to capital that must be observed in the memorandum. These provisions are based on the Second Company Law Directive, which contains a number of detailed provisions aiming at protecting shareholders and creditors. For example, the authorised minimum capital ofa public Company is £50,000.^^ A public Company may not allot a share except as paid up at least as to one-quarter of its nominal value and the whole of any premium of it.^"^ There are detailed rules on the transfer to a public Company of non-cash assets,^^ and a public Company may not accept, in payment ^^ Section 1(1) of the Companies Act 1985: "Any two or more persons associated for a lawful purpose may, by subscribing to a memorandum of association and otherwise complying with the requirements of this Act in respect of registration, form an incorporated Company, with or without limited liability." ^^ Section 12 of the Companies Act 1985. ^^ Section 2 of the Companies Act 1985. ^^ The choice ofa name for a Company is subject to a number of restrictions. See sections 25 and 26 of the Companies Act 1985. ^^ Section l(3)(a) of the Companies Act 1985. In a public Company, each subscriber to the memorandum must take at least one share in the Company, section 2(5) of the Companies Act 1985. 5^ Section 118(1) of the Companies Act 1985. ^4 Section 101(1) of the Companies Act 1985. 55 Sections 104-195 of the Companies Act 1985.

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up of its shares, an undertaking given by any person that he should do work or perform Services. ^^ In addition to a compulsory memorandum of association, a Company limited by shares may have articles of association.^^ The contents of the articles of association are in most cases at the discretion of the shareholders because they are not compulsorily laid down by the Companies Act. Table A attached to the Act becomes the articles of association of a Company limited by shares if no articles are registered, or if the articles that are registered do not exclude or modify Table A.^^ In addition, the Companies Act merely forbids the inclusion of certain clauses or makes them of no effect if they do appear.^^ Life of the Company. During the life of the Company, the role of mandatory Company law is different. Statutory law is basically mandatory.^^ In the event of a conflict between the Constitution of the Company and statutory law, statutory law will prevail. Statutory law also affects shareholders legal powers to influence management. For example, the provisions of Companies Act 1985 on the alteration of the memorandum and articles of association are mandatory: the articles of association can be altered by special resolution,^^ and the memorandum can be altered by special resolution with respect to the Statement of the Company's objects.^^ Like these provisions, the provisions of Companies Act 1985 protecting creditors or minorities are mandatory. There is nevertheless plenty of case law on how binding the provisions of the Companies Act are, and the principle of unanimous consent is an exception to this main rule. According to this principle, "the Company is bound in a matter intra vires by the unanimous agreement of its members".^^ Because the informal consent of the members must be unanimous,^"^ this principle cannot be applied in a public Company with plenty of shareholders, but it can be applied in a subsidiary Company or private Company with few shareholders. It is therefore important in Company groups. ^^ Section 99 of the Companies Act 1985, see also section 102. ^'' Section 7 of the Companies Act 1985. ^^ Section 8 of the Companies Act 1985. ^^ For example, section 310 of the Companies 1985. ^^ Parts of statutory law can also be merely enabling. For example, provisions on the acquisition of separate legal personality or the conferring of limited liability are enabling. See Rajak H, op cit pp 208-209; Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) p 2: "An enabling Statute allows managers and investors to write their own tickets, to establish Systems of govemance without Substantive scrutiny from a regulator." ^^ Section 9 of the Companies Act 1985. ^2 Section 4 of the Companies Act 1985. ^^ Lord Davey in Salomon v Salomon & Co [1897] AC 22, cited in Re Express Engineering Works Ltd [1920] 1 Ch 466. See also Parker & Cooper Ltd v. Reading [1926] Ch 975; Re Horsley & Weight [1982] Ch 442; [1982] 3 All ER 1045 (ratification of an act done by directors); Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd [1983] Ch 258 (effect on directors' liability). 64 EBM Co Ltd V Dominion Bank [1937] 3 All ER 555.

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The scope of this principle as well as the binding nature of Company law and the Company's Constitution have varied in the past. In Scott v Frank F Scott (London) Ltd^^ the Court of Appeal took a strict approach to formalities. In this case it was held that the court had no Jurisdiction to rectify the memorandum or articles of association: "It seems to us that there is no room in the case of a Company incorporated under the appropriate Statute or Statutes for the application to either the memorandum or articles of association of the principles upon which a court of equity permits rectification of documents whether inter partes or not." In Cane v Jones^^ the principle of informal assent was nevertheless applied to special and extraordinary resolutions. The High Court judge argued that an informal unanimous shareholders' agreement may be as effective as an extraordinary or special resolution: "In my judgment, [the section of the Companies Act on the alteration of articles by special resolution^^] is merely laying down a procedure whereby only some of the shareholders can validly alter the articles: and if, as I believe to be the case, it is a basic principle of Company law that all the corporators, acting together, can do anything which is intra vires the Company, then I see nothing in [this section] to undermine this principle ..." This case was followed in Re Home Treat Ltd.^^ The Company, which was in administration, had carried on the business of a nursing home for many years without having power to do so under its objects clause. The administrator wished to continue to run the business with a view to selling it as a going concem. Harman J held that, since the Company's only shareholders had agreed to the change of activity, it must be deemed to have changed its memorandum under section 4 of the Companies Act 1985. Cane v Jones has been criticised. It has been argued that it is difficult to reconcile the lax view taken of the importance of formalities in Cane v Jones with the stricter approach of Scott v Frank v Scott (London) Ltd,^^ In any case, the principle in Cane v Jones'^^ seems to be an established principle of Company law: all the corporators of a Company acting together may do anything which is intra vires the Company. One of the illustrations of this principle is the principle in Re DuomaticP^ In Re Duomatic, Buckley J held that where it could be shown that all shareholders with the right to attend and vote at a general meeting (not necessarily all shareholders) had assented to some matter, which a general meeting of the Company could carry into effect, such assent was as binding as a resolution in general meeting. The Duomatic principle has been adopted in Table A, regulation 53."^^

^5 Scott V Frank F Scott (London) Ltd [1940] Ch 794. See also Bratton Seymour Service Co Ltd v Oxborough [1992] BCLC 693. 66 Cane v Jones [1981] 1 All ER 533. 6"^ Now sections 9 and 378 of the Companies Act 1985. 68 Re Home Treat Ltd [1991] BCLC 705. 6^ Sealy LS, Cases and Materials in Company Law, Sixth Edition (1996) p. 194; see also Rajak H, op cit pp 208-209. 70 Cane v Jones [1981] 1 All ER 533 at 537c-538a. ^^ Re Duomatic [1969] 2 Ch 365. ^2 See also Table A, regulation 93 (proceedings of directors).

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The Duomatic principle originally covered the authorisation of, and assent to, acts by a Company that were intra vires the Company and involved simply a failure to observe the provisions of the articles of the Company. This principle has nevertheless been applied to a failure to observe even other procedural requirements. It has been applied to a failure to observe procedural requirements laid down by Statute such as statutory requirements as to notice,''^ and Monecor (London) Limited V Euro Brokers Holdings Limited''^ implies that the Duomatic principle can be applied to all kinds of procedural requirements: "It is a sound and sensible principle of Company law allowing the members of the Company to reach an agreement without the need for strict compliance with formal procedures, where they exist only for the benefit ofthose who have agreed not comply with them. What matters is the unanimous assent of those who ultimately exercise power over the affairs of the Company through their right to attend and vote at a general meeting. It does not matter whether the formal procedures in question are stipulated for in the Articles of Association, in the Companies Acts or in a separate contract between the members of the Company concemed. What matters is that all the members have reached an agreement. If they have, they cannot be heard to say that they are not bound by it because the formal procedure was not followed." Whether the Duomatic principle can be applied is dependent on the purpose and underlying rationale of the particular formality in question. Failure to comply with statutory requirements cannot always be remedied by waiver of the formalities or assent to the transaction by a Company's shareholders. But can the Duomatic principle be applied even where the rules as to procedure are not merely procedural and do not exist for the benefit of current members only? The case law seems to be changing in this direction. In Re RWPeak (Kings Lynn) Limited^^ the court still took a narrow view. The shares of a shareholder had been sold to the Company. A shareholder argued that the agreement was void for failure to comply with the provisions of the Companies Act 1985, because the Company was not authorised to purchase its own shares by its articles^^ and no special resolution had been proposed or passed authorising the contract before it was entered into."^^ The Company argued that the formalities required by the Companies Act did not have to be strictly complied with, because the shareholders had unanimously assented to the transaction. Lindsay J held that the Duomatic principle could not operate to eure the failure. He said that section 164(2) required the terms of the agreement to be approved by a special resolution of shareholders before the agreement was entered into. Lindsay J additionally founded his decision upon policy considerations: "In the circumstances it is not possible, in my view, to regard the provisions of ss 162 and 164 which ensure that Re Oxted Motor Company Ltd [1921] 3 KB 32. See also In Re Express Engineering Works Limited [1920] 1 Ch 466; Atlas Wright (Europe) Ltd v George Peter Wright and Ann Wright [1999] EWCA Civ 669. Monecor (London) Limited v Euro Brokers Holdings Limited, [2003] EWCA Civ 105 at 62 (per Mummery LJ). 75 Re RW Peak (Kings Lynn) Limited [1998] IBCLC 193. "^^ As required by section 162 of the Companies Act 1985. "^^ As required by sections 164(1) and (2) of the Companies Act 1985.

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time is afforded for a measured and informed consideration by members of the wisdom or propriety of any proposed purchase, as merely procedural and for the benefit only of current members."^^ This can be contrasted with Atlas Wright (Europe) Ltd v Wrighf"^ in which the court took a wider view. Potter LJ said in this case that the reasoning m Re RW Peak did not apply to the requirements of section 319 of the Companies Act 1985. But section 319 deals with directors' long-term employment contracts and it contains rules that are not merely procedural. For example, section 319(6) sets out that "[a] term incorporated in contravention of this section is, to the extent that it contravenes the section, void". General approach in securities markets law. While UK Company law leaves the govemance of companies largely to the discretion of shareholders and Company bodies, this is not the approach adopted in UK securities markets law. The obligations of issuers of listed securities and their managers are subject to extensive regulation under the FSMA 2000 and the Listing Rules. The nature of the regime under the FSMA 2000 and the Listing Rules is mandatory. Compliance with these largely mandatory provisions is safeguarded by penal or administrative sanctions in addition to civil liability. The FSA has wide supervisory powers, and market participants place much reliance on interpretative guidance published by it. Issuers must comply with all listing rules applicable to them.^^ If the UK Listing Authority (the FSA) considers that an issuer has breached any provision of the listing rules it may impose on the issuer a financial penalty or publish a Statement censuring the issuer subject to the provisions of the FSMA 2000.^^ Even directors may be punished. If a person, who was at the material time a director of the issuer, was knowingly concemed in the breach, the UK Listing Authority may impose on that person a financial penalty or publish a Statement censuring that person under the FSMA 2000.«^ The Combined Code of Corporate Govemance. While statutory law is basically mandatory, the Combined Code is not. The revised Combined Code of Corporate Govemance is a recommendation, and companies may opt out of it. However, companies cannot opt out of a "comply or explain" Obligation. The Listing Rules require listed companies to make a disclosure Statement which Covers the principles and provisions in the Code.^^ Although the Combined Code is a recommendation only, non-compliance with this disclosure Obligation and the Listing Rules can have consequences for companies that are perhaps even more serious than those arising from breaches of the Companies Act.^"^ 78 At205(d)-(f). "^^ Atlas Wright (Europe) Ltd v George Peter Wright and Ann Wright [1999] EWCA Civ 669. 80 The Listing Rules, 1.1. 81 The Listing Rules, 1.8. The Listing Rules, 1.9. 83 The Listing Rules, 12.43A. 8"* See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 322323. Those consequences includefinancialpenalties of an unlimited amount on both de-

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The disclosure Statement must be made in two parts: 1) In the first part of the Statement, the Company has to report on how it appHes the principles set out in Section 1 of the Code. The form and content of the first part of the Statement are not prescribed; companies have a free hand to explain their govemance pohcies in light of the principles, including any special circumstances applying to them that have led to a particular approach. 2) In the second part of the Statement the Company has either to confirm that it complies with the Code's provisions or to provide an explanation if it does not.

4.2 Basic Govemance Structure 4.2.1 Introduction The main organs recognised by Company law are the board of directors and the shareholders' meeting. At first sight, the Companies Act 1985 seems to provide for a one-tier board, but UK Company law is very flexible and does not prohibit two-tier board structures.^^ There is nothing in law to prevent public companies incorporated in the UK from adopting a structure under their articles under which the powers granted to directors are divided between two tiers of directors, one exercising management functions and the other exercising a supervisory role in relation to these functions.^^ Furthermore, the law does not prevent the delegation of management powers to a non-statutory body below board level. For example, the day-to-day management of the Company can be conducted through a sub-board executive committee. The Company Law Review found some evidence that the practice of delegating dayto-day management and major operational questions to a "management board" is becoming increasingly common in the UK.^^

faulting companies and defaulting directors, actions by the PSA to obtain an injunction or restitution, and, ultimately, de-listing of the Company. ^^ See for example DTI, Implementation of the European Company Statute, para 3.41. ^^ See DTI, Implementation of the European Company Statute, para 3.39; Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 317. ^^ Modem Company Law for a Competitive Economy: Developing the Framework, para 3.139; Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 317.

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4.2.2 General Meeting of Shareholders There are two types of general meetings of shareholders.^^ Every Company must every year hold a general meeting as its annual general meeting.^^ A Company can also hold extraordinary general meetings.^^ Ordinary, extraordinary and special resolutions. There are three different kinds of resolutions in a public limited-liability Company: ordinary resolutions, extraordinary resolutions^^ and special resolutions.^^ An ordinary resolution is passed by a simple majority of members who vote on it. As only extraordinary and special resolutions have been defined in the Companies Act 1985, a resolution is "ordinary" when it is not an extraordinary or special resolution.^3 For example, a resolution to remove a director can be passed by an ordinary resolution.^"* In some cases the Companies Act provides that an ordinary resolution is not sufficient. A resolution is an extraordinary resolution when it can be passed "by a majority of not less than three-fourths of such members as (being entitled to do so) vote in person or, where proxies are allowed, by proxy, at a general meeting of which notice specifying the intention to propose the resolution as an extraordinary resolution has been duly given".^^ For example, the Variation of dass rights^^ and the voluntary winding up of the company^^ require the passing of an extraordinary resolution. Special resolutions are important from a corporate govemance perspective because the alteration of articles^^ and the alteration of the Company's objects^^ require a special resolution. Shareholders in general meeting can also give directions to the board by special resolution. A special resolution is like an extraordinary resolution but requires 21 days' notice. In other words, a resolution is a special resolution when it can be passed "by such a majority as is required for the passing of an extraordinary resolution [that is, three-fourths]) and at a general meeting of which not less than 21 days' notice, specifying the intention to propose the resolution as a special resolution, has been duly given".^^^

^^ Generally, sections 366-383 of the Companies Act 1985 and regulations 36-63 of Table A. ^^ Section 366 of the Companies Act 1985. 90 Section 368 of the Companies Act 1985. ^' Section 378(1) Companies Act. See also s. 125 Companies Act 1985; ss. 84, 165 Insolvency Act 1986. 92 Section 378(2) Companies Act 1985. 93 Table A, regulations 64, 78, 82 and 96 . 9^ Section 303 of the Companies Act 1985. 95 Section 378(1) of the Companies Act 1985. 96 Section 125(2)(b) of the Companies Act 1985.

97 Section 84(1) of the Insolvency Act 1986. 9^ Section 9 of the Companies Act 1985. 99 Section 4 of the Companies Act 1985. O ' ö Section 378(2) of the Companies Act 1985.

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Powers. The articles of association normally vest few management and monitoring powers in shareholders in general meeting. For example, articles of association can give, but do not always give, shareholders the power to choose who sits on the board.

4.2.3 Board of Directors Every public Company must have at least two directors.^^^ The legal obligations placed on directors arise by virtue of a combination of case law principles and statutory provisions, but their powers are to a very large extent regulated by articles of association. ^^^ Powers. Articles of association normally vest the authority to manage the business in the hands of the board of directors. Table A, regulation 70 gives directors the power to manage the business of the Company and exercise all the powers of the Company. ^^^ For this reason, the powers of the board of directors are normally very wide. Lord Wilberforce said in Ampol^^^ that "[t]he Constitution of a limited Company normally provides for directors, with powers of management, and shareholders, with defined voting powers having power to appoint the directors, and to take, in general meeting, by majority vote, decisions on matters not reserved for management". He said also that "directors, within their management powers, may take decisions against the wishes of the majority of shareholders", and that "the majority of shareholders cannot control them in the exercise of these powers while they remain in office". There are detailed statutory provisions laying down what directors may not do. The Companies Act 1985 provides for more than 200 punishable offences for directors, and directors can also face sanctions under a wide ränge of other Statutes such as the Insolvency Act 1986. However, there are only very general principles about what directors should do, that is, how directors should manage the Company. For example, directors should act "bona fide in the interests of the Company as a whole". The Combined Code ^^^ Section 282 of the Companies Act 1985; regulation 64 of Table A. See also sections 291 (share qualification), 292 (voting), 293 (age limit) and 741(2) (shadow directors). For shadow directors see even section 214(7)) of the Insolvency Act 1986. ^^^ See for example Davies PL, Struktur der Untemehmensführung in Großbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 p 276. ^^^ Table A, regulation 70: "Subject to the provisions of the Act, the memorandum and the articles and to any directions given by special resolution, the business of the Company shall be managed by the directors who may exercise all the powers of the Company. No alteration of the memorandum or articles and no such direction shall invalidate any prior act of the directors which would have been valid if that alteration had not been made or that direction had not been given. The powers given by this regulation shall not be limited by any special power given to the directors by the articles and a meeting of directors at which a quorum is present may exercise all powers exercisable by the directors." 104 Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821.

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says that every listed Company should be headed by an "effective board" which should "lead and control the Company". Where powers are conferred on the directors under the Company's articles, they are conferred upon the directors collectively as a board.^^^ According to Table A, "the business of the Company shall be managed by the directors who may exercise all the powers of the Company".^^^ According to Mitchell & Hobbs (UK) v Mill,^^'^ this means that the power to manage the Company can be exercised by the board of directors, but not by a Single director. In principle, all directors owe the same legal duties and are equally responsible for decisions taken by the entire board. In practice, the carrying out of director's duties is dependent on the knowledge and experience of each director, and directors may have different functions in the Company. The different functions of different directors have been recognised in Table A. Table A, regulation 72 sets out that "[t]he directors may delegate any of their powers to any committee consisting of one or more directors". The Company may also have one or more managing directors. However, the board will not be entitled to delegate its powers without an express authorisation in the articles, and the individual director or managing director may not have any powers unless and to the extent that the board has exercised its authority to delegate.^^^ Chairman ofthe board. In the UK, the functions of the chairman of the board are expanding due to the new monitoring role played by non-executive directors. A listed Company normally has a dual corporate leadership consisting of a parttime non-executive chairman ofthe board and a full-time chief executive.^^^ The role of chairman ofthe board is partly based on articles of association. According to Table A, regulation 91, "directors may appoint one of their number to be the chairman ofthe board of directors and at any time remove him from that Office". Table A, regulation 88, provides that the chairman shall have a second or Casting vote in the case of an equality of votes. The role of the chairman nevertheless varies depending on the Company. In some companies the chairman is "some sort of overlord and remunerated as such", in other companies "merely an omamental figurehead".^^^ The chairman could be expected to act as a link to shareholders and Company executives and pass information to other board members. According to the Combined Code, the board should be supplied in a timely manner with information in a form and of a quality appropriate to enable it to discharge its duties,^^^ and the ^^^ See also Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 320. ^^^ Table A, regulation 70. 107 Mitchell & Hobbs (UK) v Mill [1996] 2 BCLC 102. 10^ See also Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 320. 10^ In the USA, the chief executive is typically also the chairman. See The Economist 9 January 2003, Corporate boards. The way we govem now. i'o Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 160 footnote 62. 111 Principle A.5.

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chairman is responsible for ensuring that the directors receive accurate, timely and clear information.^^^ It is not prohibited to combine the posts of chairman and chief executive in one person, but a decision to combine the posts of chairman and chief executive in one person should be publicly justified.^^^ The Combined Code points out that the running of the board and the executive responsibility for the running of the Company's business are two key tasks at the top of every pubhc Company and that there should be a clear division of responsibility at the head of the Company. ^^"^ In the majority of listed companies, the posts are held by different people. Executive and non-executive directors. Some board members are usually executive directors. The Combined Code provides that "[t]he board should include a balance of executive and non-executive directors (including independent nonexecutives) such that no individual or small group of individuals can dominate the board's decision taking". This means that "[n]on-executive directors should comprise not less than one third of the board". It is Standard practice to appoint non-executive directors in larger companies. Non-executive directors can be for example former executives or members of the founding family. The Combined Code nevertheless provides that the majority of them should be independent, that is, "independent of management and free from any business or other relationship which would materially interfere with the exercise of their independent judgment". In principle, Company law does not recognise non-executives as a separate dass of director: all directors owe the same legal duties and are equally responsible for decisions taken by the entire board. Independent non-executive directors are nevertheless expected to fulfil two key flinctions: (a) The first is monitoring management. Due to the lack of a statutory two-tier board, executive directors are not effectively accountable to other organs of the Company in large public companies. Outside directors add, at least in theory, a supervisory dement to the board structure.^^^ (b) The second is advisory. Outside directors are thought to bring in their expertise and links with other organisations. In practice however, non-executive directors are often "expected to do little or nothing other than to attend a reasonable number of board meetings and, perhaps, some of the committees that the board may establish. As such they will be modestly rewarded by directors' fees resolved upon by the Company in general meeting."^^^ The role and ejfectiveness of non-executive directors. In any case, nonexecutive directors are expected to play a central role in corporate govemance. The Company Law Review noted "a growing body of evidence from the US sugî2prindpleA.2. ^^^ Provision A.2.2. ii4PrindpleA.2. '^^ See also Leyens PC, Deutscher Aufsichtsrat und U.S.-Board: ein- oder zweistufiges Verwaltungssystem? Zum Stand der rechtsvergleichenden Corporate GovemanceDebatte, RabelsZ 67 (2003) p 76. '^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 319.

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gesting that companies with a strong contingent of non-executives produce superior Performance". In April 2002, building on the work of the Company Law Review and other reviews, the Government commissioned Derek Higgs to lead an independent review of the role and effectiveness of non-executive directors in the UK.^^^ The preferred starting-point of the Government in this area was an approach based on best practice, not regulation or legislation. Derek Higgs pubHshed his report on 20 January 2003. The report included guidance for non-executive directors, guidance for chairmen and a proposal for a revised combined code. While institutional investors mostly supported the Higgs proposals, companies were critical about them. For example, the provisions conceming the designation of a senior non-executive director and the chairing of the committee nominating new directors seemed problematic. Although the chairman was generally made responsible for communicating with shareholders, the proposal called for a senior independent director to join regulär management meetings with big shareholders and report back to the board. And although the chairman was allowed to sit on the nomination committee, the proposal required the nomination committee to be chaired by an independent non-executive instead of the chairman of the board. Companies worried that the role of the chairman would be undermined if the senior independent director was required to hold separate regulär meetings with investors. The revised Combined Code of Corporate Govemance gives companies more flexibility to opt out of the recommendation. The language of the recommendation has been tempered to make it less prescriptive. In the revised Code, the role of the senior non-executive director has been watered down.^^^ A Company chairman can chair its board nomination committee.^^^ The provisions relating to the senior nonexecutive director highlight the role of the chairman in any meetings with shareholders. ^^^ A Chief executive can become chairman. If the board of directors feels that a Chief executive should become a chairman, then it should consult shareholders and State its reasons.^^^ Remuneration. The remuneration of directors may be based on articles of association or contract. Mere appointment to a directorship does not entitle a director to remuneration^^^ but the articles of association may provide for a director's pay. Table A, regulation 82 provides that the "directors shall be entitled to such remuneration as the Company may by ordinary resolution determine". The right to re-

'^^ The reviewer was asked to assess: the population of non-executive directors in the UK; their "independence"; their effectiveness; their accountability; their relationship with institutional investors; issues relating to non-executive directors' remuneration; the role of the Combined Code; and what, if anything, could be done to strengthen the quality, independence and effectiveness of non-executive directors. "^ See for example provision A.1.3. 119 Provision A.4.1. 120 Provision A.B.3; principle A.2.

121 Provisions A.2.1 and A.2.2. ^22 Re George Newman and Co. [1895] 1 Ch 674.


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muneration may also arise from a Service contractu ^^ or a contract of employment made with the Company. ^^^^ Removal ofa director. Shareholders can at least in theory oust board members even if they have not elected them. The Companies Act 1985 provides that "[a] Company may by ordinary resolution remove a director before the expiration of his period of Office, notwithstanding anything in the articles or in any agreement between it and him".^^^ It should nevertheless be distinguished between Company law and the law of contract. The fact that a Company may remove a director does not mean that the Company cannot at the same time be made liable for breach of contract for doing so. A resolution to remove a director does not deprive the director removed of compensation or damages payable to him.^^^ Delegation of functions. In theory, the board of directors could manage the Company as a collegiate body. Table A, regulations 70 and 88 set out that "the business of the Company shall be managed by the directors" who may, subject to the provisions of the articles, "regulate their proceedings as they think fit". In practice, much authority is delegated to a managing director and other executives who manage the Company full-time. The Company Law Review found evidence that the practice of delegating day-to-day management and major operational questions to a "management board" is becoming increasingly common in the UK.127 The board will not be entitled to delegate its powers without an express authorisation in the articles of association, but Table A allows directors to "appoint one or more of their number to the office of managing director or to any other executive Office under the company"^^^ and lets them "appoint any person to be the agent of the Company for such purposes and on such conditions as they determine".i29 The board may not delegate the exercise of its discretion (delegatus non potest delegare). Even when the directors in fact do not manage the Company, control of management will always rest with the board. For example, all directors should

^^^ See section 318 of the Companies Act 1985. ^2^ See section 319 of the Companies Act 1985. 125 Section 303(1) of the Companies Act 1985. 12^ Section 303(5) of the Companies Act 1985. This principle can be found in Stirling v. Maitland (1864) 5 B&S 840 where Cockbum LJ said: "if a party enters into an arrangement which can only take effect by the continuance of a certain existing set of circumstances, there is an implied engagement on his part that he shall do nothing of his own motion to put an end to that State of circumstances under which alone the arrangement can be operative". 12*^ Modem Company Law for a Competitive Economy: Developing the Framework, para 3.139; Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 317. 128 Table A, regulation 84A. 129 Table A, regulation 71.

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monitor the functioning of a sub-board "management board" or "executive committee" in order to avoid risking breach of their common law duties.^^^ In Re Barings plc (No. 5),^^^ Jonathan Parker J (as he then was) summed up the mies on the delegation of fünctions as follows: "(0 Directors have, both collectively and individually, a continuing duty to acquire and maintain a sufficient knowledge and understanding of the Company's business to enable them properly to discharge their duties as directors. (ii) Whilst directors are entitled (subject to the articles of association of the Company) to delegate particular fünctions to those below them in the management chain, and to trust their competence and integrity to a reasonable extent, the exercise of the power of delegation does not absolve a director from the duty to supervise the discharge of the delegated fünctions. (iii) No rule of universal application can be formulated as to the duty referred to in (ii) above. The extent of the duty, and the question whether it has been discharged, must depend on the facts of each particular case, including the director's role in the management of the Company."

4.2.4 Managing Director A listed Company usually has a chief executive. The chief executive reports to the board, which usually has a non-executive chairman.^^^ As discussed above, the main rule governing the power to manage a Company is based on Table A, regulation 70. This regulation provides that "the business of the Company shall be managed by the directors who may exercise all the powers of the Company". In Mitchell & Hobbs (UK) v Mill,^^^ it was held that these powers could be exercised by the board of directors, but not by a single director. However, the Company can have a managing director, who acts as the chief executive, and other executive directors. Table A allows directors to "appoint one or more of their number to the office of managing director or to any other executive Office under the company".^^"^ The fünctions of a managing director are not fixed by law, but depend on the particular terms of his appointment.^^^ The powers ofa managing director are thus based on delegation by the board. Table A, regulation 72 provides that directors may "delegate to any managing director or any director holding any other executive Office such of their powers as they consider desirable to be exercised by him". These powers were considered in Mitchell & Hobbs (UK) v Mill}^^ The court held that Table A, regulation 72 did not give any powers to a managing director

^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 317. ^31 Re Barings plc (No. 5) [1999] 1 BCLC 433, upheld in the Court of Appeal on 25 February 2000. ^^^ The Economist 9 January 2003, Corporate boards. The way we govem now. 133 Mitchell & Hobbs (UK) v. Mill [1996] 2 BCLC 102. 134 Table A, regulation 84A. 135 Holdsworth & Co (Wakefield) Ltd v Caddies [1955] 1 WLR 352. 136 Mitchell & Hobbs (UK) v Mill [1996] 2 BCLC 102.


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over and above those held by the other directors unless such powers had been delegated by the board.

4.2.5 Company Secretary A Company can have a managing director but it must have a secretary. ^^"^ A board member can be appointed as a Company secretary unless he is a sole director.^^^ The role of Company secretary is interesting because the Company secretary sometimes acts in effect as the chief administrative officer of the Company. In the past, a Company secretary was not regarded as a management organ of the Company. It was argued that "the secretary's functions are purely ministerial and administrative and he is not, as secretary, charged with the exercise of any managerial powers".^^^ In Re Maidstone Buildings Provisions Ltd,^^^ it was said that "[s]o far as the position of a secretary as such is concemed, it is established beyond all question that a secretary, while performing the duties appropriate to the Office of secretary, is not concemed in the management of the Company", and that "he is not concemed in carrying on the business of the Company". In reality however, a Company secretary is often responsible for parts of the management of the Company although his role varies according to the size of the Company. A Company secretary is not a mere servant whose position is that he is to do what he is told.^"^^ The duties of the secretary have only to some extent been regulated by the Companies Act 1985 and Table A. There are common law principles on the duties of a Company secretary, and some provisions in the Combined Code. Some duties are based on self-regulation by the professional body of Company secretaries. The same can be said of his powers. The secretary does not automatically have any powers or rights under the Companies Act 1985. The Companies Act 1985 merely allows the secretary to sign certain forms and documents.^"*^ His rights depend on the terms of his contract with the Company. Internal administration. A Company secretary takes care of parts of the Company's basic intemal administration.^"^^ In particular, the secretary ensures that the ^^^ Section 283 of the Companies Act 1985. A draft Companies Bill would allow private companies to appoint a Company secretary if they want to but would remove the requirement to do so. 1^^ Section 283(2) of the Companies Act 1985. ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 296-298. 140 Re Maidstone Buildings Provisions Ltd [1971] 1 WLR 1085 at 1092; cited in Gower and Davies' Principles of Modem Company Law. ^^^ Panorama Developments (Guildford) Ltd v FideHs Fumishing Fabrics Ltd [1971] 2 QB 711, [1971] 3 All ER 16. 142 Sections 49(4), 51(4), 53(l)(b) and 43(3) of the Companies Act 1985. 143 See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 297. See also Modem Company Law: Final Report, para 15.41: "... we consider that certain aspects of basic administration should be the responsibility of the secretary as well as the directors, for example, maintenance of registers of members etc ..."

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documentation of the Company is in order, that the requisite retums are made to Companies' House,^"^"^ and that the Company's registers are properly maintained.^"*^ For example, the secretary may prepare resolutions of the Company in general meeting and decisions of the board of directors. Normally, the Companies Act 1985 does not require acts to be done only by the secretary; a common formula is to require an act to be done "by a director and the secretary of the Company or by two directors"^"^^ or "by a director of the Company or by the Company secretary".^"^^ The Combined Code contains some rules on the responsibilities and position of a Company secretary. The Company secretary is responsible to the board for ensuring that board procedures are complied with.^"^^ Under the direction of the chairman, the Company secretary's responsibihties include ensuring good information flows within the board and its committees and between senior management and non-executive directors, as well as facilitating induction and assisting with professional development as required. The Company secretary should be responsible for advising the board through the chairman on all govemance matters.^"^^ All directors should have access to the advice and Services of the Company secretary.^^^ The Institute of Chartered Secretaries and Administrators (ICSA), the professional body for chartered secretaries, has published a guide to the duties of the Company secretary in UK public and private registered companies.^^^ Representation of the Company. A Company secretary can represent the Company in its dealings with third parties. This power is based on common law principles and not on statutory law. The role of the Company secretary varies according to the size of the Company, but he has normally quite extensive powers as its agent. In Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd,^^^ Lord Salmon distinguished between matters concemed with administration and the commercial man^^^ Documents to be registered with Registrar of Companies at Companies' House include: the memorandum of association (section 10(1)); the articles of association (section 10(1)); Statements (sections 10(2) and 12(3)); and particulars of directors and secretary (section 10(3)). ^"^^ The following documents (the "statutory books") must be kept at the Company's registered Office and be available for inspection: register of members (sections 352-362); register of charges (sections 395-424); copies of instruments creating charges (section 406); minute book of General Meetings (section 383); register of debenture holders (sections 190-191); register of directors and secretary (sections 288-190); register of directors' share and debenture holdings in the Company (sections 324-325); copies of directors' Service contracts (section 318). ^46 Section 36A(4) of the Companies Act 1985. ^^^ Section 382A(2) of the Companies Act 1985, See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 298. ^4« Provision A.5.3. 149 Principle A.5. 1^^ Provision A.5.3. 1^1 Duties of a Company secretary - best practice guide (1998). 1^^ Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971] 2 QB 711, [1971] 3 All ER 16.


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agement of the Company. As regards matters concemed with administration, the secretary has ostensible authority to sign contracts on behalf of the Company. Management. One could say that the Company secretary is to some extent responsible for the current management of the Company. Lord Denning MR said in Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd^^^ that the secretary "is an officer of the Company with extensive duties and responsibilities. This appears not only in the modern Companies Acts, but also by the role which he plays in the day-to-day business of companies." The secretary has also been described as "an officer of the Company with substantial authority in the administrative sphere and with powers and duties derived directly from the articles and the Companies Act".^^"^ The secretary is "the chief administrative officer of the Company".^^^ For example, the secretary regularly "enters into contracts ... which come within the day-to-day running of the Company's business". ^^^ Differences to board ofdirectors. A Company secretary differs from the board of directors or the managing director in many ways. The Company secretary has no responsibility for corporate policy, as opposed to playing an administrative role in ensuring that the policy decisions are implemented.^^"^ In addition, the secretary can be appointed with less formality than a director. The secretary is appointed by the board of directors. In the articles of association, it is common to adopt regulation 99 of Table A which provides that: "Subject to the provisions of the Act, the secretary shall be appointed by the directors for such term, at such remuneration and upon such conditions as they may think fit; and any secretary so appointed may be removed by them". In the absence of a formally appointed secretary, any officer of the Company may be authorised by the board to act.^^^ Both the appointment and removal of the Company secretary should be a matter for the board as a whole.^^^ A Corporation can be appointed as a secretary. ^^^ For example, a separate professional firm is sometimes appointed to act as registrar to maintain the registers of members and debenture-holders.^^^ In National Westminster Bank Plc v Breeds,^^^ the company's solicitor and the Company secretary were the same person. ^^^ Panorama Developments (Guildford) Ltd v Fidehs Furnishing Fabrics Ltd [1971] 2 QB 711, [1971] 3 All ER 16. ^^"^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 298. ^^^ Salmon LJ in Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971] 2 QB 711, [1971] 3 All ER 16. ^^^ Lord Denning MR in Panorama Developments. ^^'^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 298. ^^^ Section 283(3) of the Companies Act 1985. 159 Provision A.5.3. ^^ö See section 283(4) of the Companies Act 1985. ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 297. ^^2 National Westminster Bank Plc v Breeds [2001] EWHC Ch 21.

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In the case of a public Company, the secretary must be professionally qualified or suitably experienced. The Companies Act 1985 provides that it is the duty of directors to take all reasonable steps to secure that the secretary or each Joint secretary of such a Company "is a person who appears to them to have the requisite knowledge and experience to discharge the functions of secretary of the Company" and who, in addition, fulfils requirements regarding previous experience or membership of specified professions or professional bodies.^^^ This shows the rising professional Status of the secretary in public companies. ^^"^

4.2.6 The Location of Management The location of top management is not based on law. The allocation of powers is largely a matter for the articles of association, and different companies can have regulated their top management in different ways. But since even articles of association are vague on this, one should look at the actual management of the Company. There are many reasons for this. To begin with, Table A, regulation 70 suggests that shareholders keep few matters for themselves, beyond what the law or other regulation requires, and that management powers have been delegated to the board of directors.^^^ Since the wording of Table A also curtails the rights of the general meeting to interfere, the general meeting does not really monitor management. The Combined Code then suggests that there can be a distinction between management and supervision within a single-tier board with executive directors having a management role and independent non-executive directors a monitoring role.^^^ In principle, a public Company could be run by its chairman and board of directors. But although the wording of Table A vests wide powers in the board of directors, the board is often a body that monitors management instead of actually running the Company. At least the board has the power to monitor management: "Somewhat like British monarchs, directors have the right to be consulted, the right to encourage and the right to warn. But they do not usually exercise control."i67

In practice, a public Company is to a very large extent run by its managing director and sub-board managers.^^^ The wording of Table A has legitimated centralised management below board level. Much authority is delegated to the managing director and other executives. The Combined Code provides that the annual report should include "a high level Statement of which types of decisions are to be taken

^^3 Section 286 of the Companies Act 1985. ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 297. '^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 299. ^^^ See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 325326. ^^^ The Economist 13 January 2005, Corporate directors. Stick *em up. 168 See for example Davies PL, Stmktur der Untemehmensfühmng in Großbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 p 271.

4.3 The Importance of Articles of Association

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by the board and which are to be delegated to management".^^^ Furthermore, a Company secretary has substantial authority in the administrative sphere.

4.3 The Importance of Articles of Association 4.3.1 Introduction The Contents of articles of association are important for shareholders who want to have a say in the Company, because the division of powers between shareholders in general meeting and the board is to a very large extent left by the law to be determined by the Company's articles. In normal cases, almost all management powers have been delegated to the board of directors. If a Company has adopted Table A, its shareholders cannot normally interfere in the day-to-day running of the Company; only a majority of not less than 75% of shares can do so.^^^ Furthermore, it is difficult to amend articles, because it requires a special resolution at a general meeting. This makes it important to find out how binding articles of association are and how they penetrate the hierarchy of the Organisation. The effect of articles of association is not quite clear. There are several reasons for this. Firstly, articles are regarded as a statutory contract, and the use of contractual concepts makes it more difficult to interpret the scope of rules contained in them. Secondly, the fact that articles constitute a statutory contract for the benefit of shareholders does not mean that shareholders would be able to enforce this contract. Thirdly, articles can in effect be binding even on board members, the Company secretary, and senior executives, who are not regarded as party to the statutory contract.

4.3.2 Parties Bound by the Memorandum and Articles Main Principles The main rule is that the memorandum and articles of association (the Constitution of the Company) constitute a "contract" binding on its parties. However, the main rule answers only partially the question on whom the Constitution of the Company is binding. Although this rule helps to limit the parties who may bring proceedings in the event that articles are breached to those who can sue for "breach of contract", breach of contract is not the only cause of action available. Contract. The legal effect of the memorandum and articles of association is set out in section 14 of the Companies Act 1985. When registered, they "bind the Company and its members to the same extent as if they respectively had been ^^^ Provision A. 1.1. ^"^^ Regulation 70 of Table A, section 378 of the Companies Act 1985.

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signed and sealed by each member, and contained covenants on the part of each member to observe all the provisions of the memorandum and of the articles". The legal effect of these documents is nevertheless controversial. The traditional view is that section 14 creates a contract, which forais the basis of legal relations between the Company and its members and between the members inter se.^^^ This view has its roots in the law of partnerships. Prior to the Joint Stock Companies Act 1856, companies were formed on the basis of a deed of settlement that was an elaborate form of partnership deed. In principle, the benefit of regarding articles of association as a contract could be flexibility in the stmcturing of the corporate Constitution. Statutory contract. What makes the interpretation of section 14 of the Companies Act so difficult is the fact that unlike a partnership, a Company is a separate legal person distinct from its shareholders. For many reasons the memorandum and articles of association do not constitute a normal contract based on the provisions of contract law. Section 14 of the Companies Act 1985 creates a "statutory contract" only. In Bratton Seymour Services Co Ltd v Oxborough,^'^^ it was noted that articles of association are "a statutory contract of a special nature with its own distinctive features. It derives its binding force not from a bargain Struck between parties but from the terms of the Statute". Section 14 is subject to other provisions of the Companies Act 1985. This means that party autonomy is limited by these other provisions, and the Company may alter the "contract" by special resolution.*^^ The extent of party autonomy in the articles is therefore dependent on the true construction of the provisions of the Companies Act 1985.^"^"^ For example, in Re Feveril Gold Mines Ltd,^'^^ it was held that a Company's articles could not prevent a shareholder from petitioning for the winding up of the Company because a shareholder may do so under the provisions of the Companies Act. Furthermore, section 310 of the Companies Act 1985 declares provisions exempting officers and auditors form liability void, and so forth.

^^^ Shareholders Remedies, Law Commission Report 246 (1997), para 7.2, footnote 2: "The precise nature of this statutory contract has been the subject of much academic debate. See, for example: K W Wedderbum, * Shareholders Rights and the Rule in Foss v Harbottle" [1957] CLJ 194; G D Goldberg, 'The Enforcement of Outsider Rights under Section 20 of the Companies Act 1948' (1972) 35 MLR 362; G N Prentice, *The Enforcement of Outsider Rights' (1980) 1 Co Law 179; R Gregory, *The Section 20 Contract' (1981) 44 MLR 526; G D Goldberg, 'The Controversy on the Section 20 Contract Revisited' (1985) 48 MLR 158; R Drury, 'The Relative Nature of a Shareholders Right to Enforce the Company Contract' [1986] CLJ 219." ^"^^ Steyn LJ (as he then was) in Bratton Seymour Services Co Ltd v Oxborough [1992] BCLC 693. ^''^ Section 9 of the Companies Act 1985. 174 See for example Bushell v Faith [1970] AC 1099, [1970] 1 All ER 53 (House of Lords) on what is now section 303 of the Companies Act 1985. 175 Re Peveril Gold Mines Ltd [1898] 1 Ch 122.


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The extent of party autonomy is in effect restricted also by the Listing Rules. For example, it was observed in Bushell v Faith that companies with a listing on the Stock Exchange may in practice not circumvent what is now section 303 of the Companies Act by provisions in their articles, for this is forbidden by the Listing Rules; there is in effect one regime for listed companies and another for all other companies.^^^ Many of the normal rules of contract such as rules on implication or remedies for breach do not apply to this "statutory contract": (a) The articles cannot be supplemented by additional terms implied from extrinsic circumstances. In Bratton Seymour Services Co Ltd v Oxborough,^'''' it was said that it is permitted to interpret articles of association on the basis of any language found therein and it is possible to imply a term purely from the language of the document itself, but "it is quite another matter to seek to imply a term into articles association from extrinsic circumstances". In Equitable Life v Hyman,^'^^ it was distinguished between the processes of interpretation and implication: "The purpose of interpretation is to assign to the language of the text the most appropriate meaning which the words can legitimately bear ... If a term is to be implied, it could only be a term implied from the language of [the relevant provision in the articles] read in its particular commercial setting. Such implied terms operate as ad hoc gap fillers ... The process 'is one of construction of the agreement as a whole in its commercial setting'^"^^ ... This principle is sparingly and cautiously used and may never be employed to imply a term in conflict with the express terms of the text." (b) The courts will not Order rectification of the statutory contract. In Scott v Frank F Scott (London) Ltd,^^^ it was held that courts have no Jurisdiction to rectify articles of association, although they do not accord with what is proved to have been the concurrent intention of all the signatories therein at the moment of signature. (c) The courts will not rescind the "statutory contract" for misrepresentation. In Bratton Seymour Service Co Ltd v Oxborough,^^^ it was held that "the Company or an individual member cannot seek to defeat the statutory contract by reason of special circumstances such as misrepresentation, mistake, undue influence and duress". (d) And lastly, rules on the right of a third party to enforce a term of a contract in some Situation under the Contracts (Rights of Third parties) Act 1999 do not apply to the memorandum and articles of association.^^^

1^6 Sealy LS, Cases and Materials in Company Law; Bushell v Faith [1970] AC 1099, [1970] 1 All ER 53 (House of Lords). ^"^^ Bratton Seymour Services Co Ltd v Oxborough [1992] BCLC 693. ^''^ Lord Steyn in Equitable Life v Hyman [2000] 3 All ER 961 (House of Lords). ^''^ Citing Lord Hoffmann in Banque Bruxelles Lambert S.A. v Eagle Star Insurance Co. Ltd. [1997] AC 191. 180 Scott v Frank F Scott (London) Ltd [1940] Ch 794. 181 Bratton Seymour Service Co Ltd v Oxborough [1992] BCLC 693. 182 Section 6(2); Unfair Contract Terms Act 1977; see G. H. Treitel, The Law of Contract, Eleventh Edition (2003) p 662.

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Effect on Shareholders and the Company The articles constitute a statutory contract only between individual members and between the Company and its members. Shareholders. This means that shareholders can be bound by the articles. In Rayfield v Hands,^^^ it was held that one member may sue another on the contract created by the articles. In Hickman's case,^^"* Ashbury J said that "a Company is entitled as against its members to enforce and restrain breaches of its regulations" and that "shareholders as against their Company can enforce and restrain breaches of its regulations". The Company. The Company is bound by articles of association. Although section 14 does not expressly State that the Company is bound by its own articles, it is regarded as clear on the wording of section 14 that this section gives rise to a contract binding the Company to the members on which it can sue and be sued.^^^ In Wood V Odessa Waterworks Co^^^ and Quin & Axtens Ltd v Salmon,^^'^ a shareholder could seek an injunction restraining the Company from acting on a shareholders' resolution that was inconsistent with the articles. Outsiders. The position of Outsiders differs from that of shareholders and the Company. The articles do not per se constitute an enforceable contract between a Company and an outsider. Even shareholders can sometimes be regarded as Outsiders. The articles bind members in their capacity as members, but the articles do not bind members in their other capacity. ^^^ Since the articles do not confer rights on a member in his capacity as an Outsider, it is necessary to distinguish between "personal and individual rights" of members in their capacity of members and their outsider-rights. For example, in Pender v Lushington,^^^ a shareholder, whose vote had not been recorded, had an individual right in respect of which he had a right to sue. This can be contrasted with Eley v Positive Government Security Life Assurance Co Ltd, ^^^ where the articles contained an Obligation to employ Eley as the Company's solicitor. It was held that the articles did not create any contract between Eley and the Company. The principle was formulated in Hickman's case,^^^ where it was said: "An Outsider to whom rights purport to be given by the articles in his capacity as such Outsider, whether he is or subsequently becomes a member, cannot sue on those articles treating them as contracts between himself and the Company to enforce those rights". This principle was applied to directors in Beattie v E & F Beattie Ltd,^^^ 183 Rayfield v Hands [1960] Ch 1, [1958] 2 All ER 194. 18"^ Hickman v Kent & Romney Marsh Sheep-Breeders' Association [1915] 1 Ch 881. 18^ Shareholders Remedies, Law Commission Report 246 (1997), para 7.3. 186 Wood V Odessa Waterworks Co (1889) 42 Ch D 636. 187 Quin & Axtens Ltd v Salmon [1909] AC 442 (House of Lords). 188 Shareholders Remedies, Law Commission Report 246 (1997), para 7.6. 189 Pender v Lushington (1877) 6 Ch D 70 (Court of Chancery (Master of the Rolls)). 190 Eley V Positive Government Security Life Assurance Co Ltd, [1876] 1 Ex D 88. 191 Hickman v Kent or Romney Marsh Sheep Breeders' Association [1915] 1 Ch 881. 192 Beattie v E & F Beattie Ltd [1938] Ch 708, [1938] 3 All ER 214.


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where a director, who was sued in his capacity as a director and not as a member, could not rely on the statutory contract. In Newtherapeutics Ltd v Katz,^^^ it was held that the appointment of a person to the office of director did not of itself establish a contractual relationship between him and the Company. Border-line cases. What could make the effect of the articles of association unclear is the existence of cases where the articles of association were held to be binding on directors who also happened to be members of the Company. In Pulbrook v Richmond Consolidated Mining,^^"^ every director was a shareholder because the Company's articles fixed the holding of shares as the qualification of a director. It was held that a director could bring a personal action against his fellow directors to restrain them from wrongfully excluding him from board meetings. In Rayfield v Hands,^^^ the articles of association contained an article entitling every member to seil his shares to the directors of the Company at fair valuation.^^^ In effect, the members enjoyed 'put' options exercisable against the directors. The directors happened to be shareholders. It was held that the obligations imposed by the article on the directors for the time being were enforceable against them on grounds that the obligations were imposed on the directors in their capacity as members of the Company. This case was approved in the Cumbrian Newspapers case.^^"^ Effect on the Board and Individual Board Members Although the memorandum and articles of association are not regarded as a "contract" between board members and the Company, they can de facto be binding on board members. Effect on individual board members. Directors must act in accordance with the Company's Constitution. The directors are under a duty to acquaint themselves with the terms of the Company's memorandum and articles and to remain within their constitutional powers.^^^ These duties are based partly on common law principles and trust analogy, partly on the provisions of the Companies Act 1985. In Regal (Hastings) v Gulliver,^^^ it was held that directors are not trustees, but they occupy a fiduciary position towards the Company whose board they form. In Belmont Finance Corp. v Williams Furniture Ltd (No. 2),^^^ it was concluded that although directors are not accurately described as trustees of the Company's assets ^93 Newtherapeutics Ltd v Katz [1991] Ch 226; [1991] 2 All ER 151. 194 Pulbrook V Richmond Consolidated Mining [1878] 9 Ch D 610. 195 Rayfield v Hands [1960] Ch 1, [1958] 2 All ER 194. 196 "Every member who intends to transfer shares shall inform the directors who will take the Said shares equally between them at fair value." i^*^ Cumbrian Newspapers Group Ltd v Cumberland and Westmoreland Herald Newspaper and Printing Co Ltd [1987] Ch 1, [1986] 2 All ER 816. 198 Davies PL, G o w e r and Davies' Principles of M o d e m C o m p a n y L a w (2003) p 383. 199 Regal (Hastings) v Gulliver (1942) [1967] 2 A C 134n, 159. 200 Belmont Finance Corp. v Williams Furniture Ltd (No. 2) [1980] 1 All E R 393.

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(the assets being vested in the Company), they have always been treated as trustees of assets which are in their hands or under their control. This principle was recently applied in Bairstow v Queens Moat Houses plc,^^^ where it was held: "There is ample authority ... establishing that although Company directors are not strictly speaking trustees, they are in a closely analogous position because of the fiduciary duties which they owe to the Company." Section 35(3) of the Companies Act 1985 provides that "[i]t remains the duty of the directors to observe any limitations on their powers flowing from the Company's memorandum". Section 35(2) empowers a member of a Company to bring proceedings to restrain the doing of an act that is contrary to limitations in the memorandum. According to section 35(3), such action by the directors may only be ratified by the Company by special resolution. The law will be clarified in the future, because the duty to act in accordance with the Company's Constitution has been adopted in a new draft Companies Bill published in July 2002.202 Effect on the board of directors. At common law, an act or decision of the directors which is outside the Company's Constitution is void and of no effect.2

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