Download the article in pdf.

I. Introduction

Corporate seat transfers: for more than 20 years, this corporate law topic has stimulated intense academic discussion, had a continuously high profile position on the policy agenda of various EU actors in the field of European company law^[1] and can probably be found in any European law text book that also covers the freedom of establishment.

In 1988 the Court of Justice of the European Union (CJEU) decided in Daily Mail that corporate seat transfers fall outside the scope of internal market law.^[2] During the following 20 years, the Court gradually attempted to reverse its judgment,^[3] at least in respect of other corporate restructuring operations, and finally stated in paragraph 112 of the 2008 Cartesio judgment that there is no immunity from Article 49 TFEU for national legislation ‘preventing [… a] company from converting itself into a company governed by the law of the other Member State, to the extent that it is permitted under that law to do so’ (emphasis added).^[4]

From this statement, most academics infer that the Member State of incorporation (hereafter ‘home Member State’) cannot restrict a cross-border company conversion (as a method of company restructuring) anymore, meaning that a company seeking to fall under the company law of another Member State (hereafter ‘host Member State’) by transferring its corporate seat(s), may not be restricted unless such a restriction can be justified.^[5] However, confusion arose as to how the last part of the sentence should be interpreted. Is the legislation of the host Member State still subject to immunity because this legislation has to permit an international company conversion? In practice this would mean that in most cases cross-border company migration would still not be possible because many Member States do not have procedures in place which allow foreign companies to transfer company seat(s) to their territory. On the other hand, if the sentence is interpreted in a way that the restructuring operation as such would have to be known and recognized in the host state (meaning for instance that under domestic law a company of a certain type is permitted to convert itself into another type of company) the question arises whether, and if so, what kind of restrictions may be imposed by the home state in that regard.

Another case and another judgment were necessary in order to clarify this issue and eventually complement Cartesio accordingly. Finally, on 28 July 2010, the case VALE Építési Kf was lodged before the CJEU dealing specifically with the obiter dictum situation: when a company seeks to accomplish a cross-border company conversion, but is hindered by the host Member State.^[6]

On 15 December 2011, Advocate General Jääskinen delivered his Opinion in this case.^[7] Due to the importance of this case for the further development of corporate migration in the EU and the issues which arise in that context, it is worth commenting on this AG Opinion.

After shedding some light on the facts of the case, this note will summarize the Advocate General’s Opinion. Then it will appraise how the corporate construct used to transfer the corporate seat from Italy to Hungary has to be qualified, and subsequently assess in how far a CJEU ruling in accordance with the AG Opinion would clarify and complement the findings in Cartesio and, then briefly comment on the non-existence of the VALE companies and the impact that this can have on the potential inadmissibility of the case and the legal succession of the rights and obligations between the companies as such.

II. Facts

In general, the case is about an Italian company, VALE Costruzioni Srl, which attempted to convert into a Hungarian company on the basis of an (international) company conversion: a procedure known in Hungary for domestic companies but not in a cross border situation.

The Italian VALE nevertheless went ahead. On 3 February 2006, the company requested to be deleted from the Italian commercial register with the note that it planned to transfer its seat and activities to Hungary. Ten days later, on 13 February 2006, it was deleted from the register.

Nine months later, VALE Építési kft, a Hungarian private limited liability company, was established by one of the directors of VALE Costruzioni Srl and a second natural person. On 19 January 2007, a representative of Hungarian VALE sought to have VALE Építési kft registered at the Hungarian commercial register and requested that VALE Costruzioni be referred to as its legal predecessor in the sense that all rights and obligations of the Italian VALE would be transferred to the Hungarian VALE. As the lawyer acting for VALE Építési kft stated during the hearing of the case, this was done in order to achieve a cross-border company conversion. As mentioned, this procedure was available for domestic Hungarian companies in the sense that they could convert into a different Hungarian company form by setting up a new company and a subsequently there would be a universal succession of rights from the old to the new company.

However, as Hungarian law did not have a provision allowing for such a reference to a foreign legal predecessor, the request was rejected. Legal proceedings followed, and reached the Supreme Court of Hungary, which referred four preliminary questions regarding the application of the freedom of establishment to the CJEU.

In essence the Supreme Court asked for clarification whether, based on the freedom of establishment, VALE Építési kft was allowed to have VALE Costruzioni Srl as its legal predecessor, signifying that Hungarian law had to allow an international company conversion.

III. The Opinion of Advocate General Jääskinen

The Advocate General focuses on the following issues. He first dealt with whether VALE can rely on the freedom of establishment. Then, he analysed in how far this fundamental freedom is applicable to such a, in his words, ‘cross-border new establishment’ situation, and finally, he examined in how far there is a restriction to said freedom and if so, whether it can be justified. The last two issues in particular form a clarification of the Cartesio judgment.

As regards the first issue, the Advocate General was confronted with a number of government representatives who argued that VALE cannot rely on Article 49 TFEU. Article 54 TFEU stipulates the criteria under which a company can rely on Article 49 TFEU and essentially requires a company to be incorporated in one of the EU Member States. The problem was that the Italian VALE no longer existed according to Italian rules because it was deleted from the Italian commercial register. At the same time, the Hungarian VALE did not yet exist because its request to be entered in the Hungarian commercial register had been refused. It only ‘existed’ in the context of the legal proceedings.

The Advocate General deals with this issue by stating that the Italian VALE is an economic entity and that despite losing its corporate personality under Italian law and not gaining such personality under Hungarian law, the Hungarian VALE or its shareholders have to be able to rely on the freedom of establishment in order to continue the company´s activities in Hungary. The Advocate General further stresses that it is not the Italian VALE that is invoking the freedom of establishment, but the Hungarian company in formation and the shareholders, which created this company.^[8]

Therefore, the Advocate General reasons that there are shareholders who have carried out economic activities first in one Member State and then in another, and so the situation falls either under Article 54 or 49 TFEU.

Regarding the second issue, the application of the freedom of establishment to the situation in VALE, the Advocate General essentially refers to paragraphs 111 and 112 of the Cartesio judgment where the Court had stated that Article 49 TFEU applies to situations in which a company seeks to convert itself into a company governed by the law of another Member State.^[9]

The Advocate General further refers to the SEVIC case in which the Court determined that the scope of Article 49 TFEU also includes provisions regulating the access to a Member State different to the Member State of incorporation. On this basis, the Advocate General argues that in an internal market, companies must be able to choose the best economic conditions and the most suitable company law.^[10] Therefore, according to the Advocate General, the freedom of establishment applies to the case at hand.

Regarding the third issue, as to whether there is a restriction and if so, whether this restriction can be justified, the Advocate General first deals with the unclear, but essential sentences in paragraph 112 of the Cartesio judgment in which the Court had determined that a company conversion is possible ‘to the extent that it is permitted under that law [the law of the host Member State] to do so’.

The Advocate General argues that this refers to the law of the Member State to which the seat is transferred, and in accordance with SEVIC, such a Member State has to accept the ‘cross-border new establishment’.

However, the Member State can require the company to comply with all requirements that also apply in a national context. The Advocate General stresses that this does not mean that national rules can prohibit a cross-border new establishment merely on the grounds that this has not been regulated by national law. Thus, the Advocate General concludes that in the case at hand, Hungary may apply its domestic provisions regarding incorporation and conversion of a company with limited liability.^[11]

The Hungarian VALE must therefore comply with all requirements of national law for limited liability companies, for instance in relation to minimum capital requirements, shareholders and the content of the articles of association. Furthermore, in order to verify the transfer of the assets and liabilities to the new company, a Member State may require that there is continuity in terms of accounting between the companies and that the balance sheets correspond. The Member State may also require that the assets and liabilities are controlled and verified through an accountant in order to protect compliance with minimum capital requirements.^[12]

The Advocate General is further of the opinion that a Member State can also apply specific rules to cross-border situations in as far as they are not discriminatory and proportionate.^[13]

After this, he states that the most important question is whether the company in formation can require that a company from another Member State is entered into the commercial register as its legal predecessor. He argues that this has to be the case in as far as the company can show that such a succession is allowed in accordance with the legislation of the Member State in which the potential legal predecessor was incorporated. This is the case because based solely on the law of this Member State, it is possible to transfer the assets to the company in formation.^[14]

Finally, the Advocate General states that such a transfer by universal succession of title is not possible if the legal predecessor has already lost its legal personality at the moment of registration of the legal successor. Therefore, he concludes that the Hungarian authorities do not have to recognize the Hungarian VALE as a legal successor of the Italian VALE unless the decision by the Italian commercial registry to delete the Italian VALE is declared invalid.^[15]

IV. Comments

This part will address three issues. First of all, how the operation attempted by VALE should be classified in the context of corporate restructuring operations. Secondly, it will be pointed out in how far the ruling proposed by the Advocate General could clarify and complement the interpretation given in Cartesio. Finally, some remarks regarding the non-existence of the VALE companies and the impact that this can have on the legal succession of rights in this case and a possible inadmissibility of the case are necessary.

1) VALE in the context of cross border restructuring: a qualification of the attempted operation

The first question that arises is how the attempted operation should be qualified. The Advocate General defines it as a ‘cross-border new establishment’.^[16] This makes it necessary to ask whether based on the facts of the case, the legal community can expect VALE to complement Cartesio at all. Is a ‘cross-border new establishment’ the same as a ‘cross-border company conversion’, and is it possible to draw conclusions from these interpretations with regard to other cross-border restructuring operations?

To clarify the term ‘cross-border new establishment’ and to contrast it with a traditional ‘cross-border company conversion’: the latter is generally achieved by transferring the seat(s) of a company from one Member State to another. Since (one of the) the seat(s) form the connecting factor to domestic company law, the law of the host Member State will apply. Consequently the company is converted into a form of company defined by the host Member State. Factually it includes changing the seat in the articles of association if the registered office is to be transferred, and moving the headquarters if the central administration is to be transferred. In essence, this is what was envisaged by the 14^th Company Law Directive.

Yet this is not what happened in VALE. In this case, the shareholders of an Italian company set up a new company in Hungary and attempted to effectuate a transfer of all assets by universal succession of title to this company. This involves a universal succession of rights from one company to another and thus is not based on the legal continuity of one legal person: the construct is more similar to a cross-border merger than a company conversion. Therefore, it is a valid remark of the Advocate General that the applicant could also have used the Cross-Border Merger Directive to achieve the same result.^[17]

However, it is important to state that some countries have allowed company conversions only by setting up a second company and with a subsequent asset-liability transfer through a universal succession of rights. An example is the Netherlands which applied such a system until 1992.^[18] In Hungary the situation seems to be at least similar.^[19] To stress this point – the discrimination in this case is not that Hungary allows transfer of company seats within the country but not in a cross-border context. The discrimination lies in the fact that a company conversion is possible within the national context by registering a domestic company as the legal predecessor from which rights and obligations can be transferred by means of universal succession, while it is not possible to register a foreign company as legal predecessor.

As a consequence, this case is at least very similar to a company conversion as dealt with for example in the 14^th Company Law Directive and therefore primarily about corporate seat transfers because this is the general measure used to achieve a cross-border company conversion. The only difference is that there is no continuity in the legal personality of the company.

2) VALE: Does it complement Cartesio?

A second important issue to be addressed then is in how far the ruling proposed by the Advocate General would clarify and complement the judgment in Cartesio. The main question in that regard is in how far the possibility to accomplish a cross-border company restructuring operation depends on the host Member State’s legal rules. More precisely, it depends, in particular, on the interpretation given to the wording in paragraph 112 of the Cartesio judgment and, consequently, on any criterion that would be added to the ‘state of the art’ pursuant to Cartesio. In that regard the sentence ‘preventing [… a] company from converting itself into a company governed by the law of the other Member State, to the extent that it is permitted under that law to do so […]’ (emphasis added)^[20] has to be interpreted.

First, according to the Advocate General, Cartesio clarified that the company becomes subject to the rules of private international law in the host (inbound) state when moving into its territory. Accordingly, any company not fulfilling the relevant connecting factor for corporate residence would not have to be recognized as a domestic company by the home state nor by the host state; the freedom of establishment does not per se confer upon the company the possibility to maintain its legal status as a company of the home state while making use of a certain restructuring operation in a cross border setting; in the reverse situation it also does not confer upon a company the possibility to change its legal status to that of a company of any other state while not complying with the relevant connecting factor of that state.^[21] However, as long as the connecting factor under private international law is adhered to in both states, the company could make use of available restructuring operations to relocate itself to the host state’s territory. In that regard home states are precluded from prohibiting certain cross border restructuring operations as such.^[22] This applies to host states accordingly.^[23]

Second of all, however, and this constitutes an element that would be added by VALE, the host state is permitted to impose its substantive company law upon a converted company of that state without this imposition forming a restriction to the freedom of establishment. In that respect the host state is permitted to require that the conditions set out in the host state’s company law, such as minimum capital requirements, are fulfilled.^[24]

Thirdly, the obiter dictum from paragraph 112 of the Cartesio judgment also poses the question whether the terms ‘that law’ mean that the host Member State has to know such a cross-border operation. Regarding a cross-border corporate conversion it would mean that this would only be possible in Member States like Luxembourg, Cyprus or Spain, as these States have specific provisions for such cross-border operations. The AG emphasizes with a reference to SEVIC that the terms ‘that law’ from paragraph 112 of the Cartesio ruling are to be interpreted as requiring that reliance on Article 49 TFEU is only possible if the law of the host Member State recognizes the restructuring operation as such in the national context (for instance a domestic company seat transfer or domestic conversion).^[25] As is also constantly reiterated by the CJEU in European direct tax law cases, a Member State is not allowed to discriminate between a domestic and a cross-border situation.^[26] This means that the Advocate General rules out both extremes: on the one hand that cross-border restructuring operations are only possible if the host Member State has a specific procedure for them. On the other hand that cross-border restructuring operations have to be possible regardless of whether the host Member State actually knows the operation.

More importantly however, connecting the forgoing with point 77 of the Advocate General’s Opinion, VALE would add a condition to the reverse-Cartesio situation: according to the Advocate General, the restructuring operation as such not only has to exist in the domestic context in the host (inbound) state but also in the home (outbound) state.

As a result, a structured approach can be identified with respect to the application of the freedom of establishment to cross-border restructuring of companies. In that regard Article 49 TFEU would be applicable as far as the relevant connecting factors are adhered to and where a restriction is not the consequence of the application of the substantive company law of the host state. Moreover, the restructuring operation pursued by the company must be an operation that is recognized in the domestic context by both home and host state. It should also be stressed that this does not mean that Member States have to apply the same procedure to an international company conversion as to their domestic counterparts. Member States can apply higher standards, but they have to be able to justify them, for example, on the basis of creditor or employee protection. In this context, one can imagine Member States applying a similar procedure as exists in Article 8 of the SE Regulation^[27] for corporate seat transfers.

To conclude, the general approach adopted by the Advocate General would not only constitute a rather clear and transparent rule in terms of legal certainty, it would also strike a solid balance between internal market objectives and national sovereignty in terms of application of company laws and the safeguards contained therein. Also, from a practical point of view it would allow a high level of corporate mobility within the EU as Member States generally have domestic procedures for corporate restructuring operations, such as for instance corporate seat transfers. However, it would not force them to effectuate operations alien to their domestic law.

3) Problems regarding the legal succession and the admissibility

Finally, two comments have to be made concerning the existence or non-existence of the VALE companies. This issue might be a bar for the CJEU to look at the preliminary questions at all. However, even if the Court will deal with the references and eventually find that the Hungarian legislation is in violation of the freedom of establishment, it might hinder the VALE companies from accomplishing the transfer of the rights and obligations from the Italian to the Hungarian company, with the effect that the cross border company conversion in this case will have failed.

With regard to the succession of rights in this particular case AG Jääskinen remarks that it does not seem likely that VALE Hungary will be able to enter the Italian VALE company as its legal predecessor into the commercial register. According to him, for a legal succession to take place, the company from which the assets and liabilities originate still needs to exist. To turn it around: rights and obligations have to exist in relation to a natural or legal person, who can then transfer them to someone else. If this is the case, one may wonder how it can be that the Italian VALE does not exist anymore, even though there are still assets and liabilities. The reason seems to be located in an incorrect decision of the Italian commercial register. Italy allows for a company conversion, however, the register is only allowed to delete the company upon proof of registration in another Member State. As stated in the hearing by the Italian government, this requirement has not been followed in this case. Therefore, as the Advocate General states, this decision would have to be declared void before the transfer of assets and liabilities can take place.^[28] It should be stressed that this issue depends solely on national company law. In the Netherlands for instance it is possible that a company which does not exist anymore, but that is not yet liquidated, can merge with a second company.^[29] In principle, this is also what happens in VALE.

Finally, the non-existence of the companies also leads to remarkable conclusions by the Advocate General in the EU law analysis: he states that Article 49 TFEU is applicable, based on the freedom of establishment of the shareholders of VALE. This is an unusual argumentation regarding the fact that the applicant in the national proceedings is the not (yet) existing Hungarian VALE company. The shareholders do not seem to be a party to the proceedings. Without having more in-depth information about the national proceedings and therefore admitting that the situation at the national level could be different, this seems to imply that the company will not be able to rely on Article 49 TFEU via Article 54 TFEU in their proceedings, in order to claim that the rejection by the Hungarian registry violates their rights under said Article. This is the case because the company does not fall within the personal scope of this provision. However, it does not mean that the CJEU cannot find that the Hungarian legislation is precluded by Article 49 TFEU. In a preliminary ruling procedure the Court answers questions as to the interpretation of European law and is not concerned with the standing and legal interests of parties.^[30] Thus, the Court can come to the conclusion that the Hungarian legislation is in violation of internal market law because it violates the right of a party other than the applicant in the national proceedings.^[31] However, and this might be a problem in the case, the CJEU only answers questions that are relevant for the national proceedings and are not hypothetical.^[32] There seems to be at least the possibility that the CJEU will find the preliminary references to be inadmissible if Hungarian VALE will not be able to rely on Article 49 TFEU in the national proceedings. In this case, a potential ruling of the CJEU will thus not be relevant at the national stage.

Endnotes:

[*] Thomas Biermeyer, Visiting Researcher at the Harvard Law School and PhD researcher at Maastricht University. Thore Holtrichter, LL.M Candidate, Maastricht University.

[1] See Consultation on the future of European Company Law (2012), http://ec.europa.eu/yourvoice/ipm/forms/dispatch?form=companylaw2012&lang=en (last visited 28 February 2012), questions 14-16; Report of the Reflection Group On the Future of EU Company Law (2011), http://ec.europa.eu/internal_market/company/docs/modern/reflectiongroup_report_en.pdf (last visited 15 February 2012); European Parliament resolution of 4 July 2006 on recent developments and prospects in relation to company law, P6_TA(2006)0295, OJ C 303 E, 13.12.2006, p. 114, p. 32-33; Communication from the Commission to the Council and the European Parliament, Modernising Company Law and Enhancing Corporate Governance in the European Union – A Plan to Move Forward, COM(2003) 284 final, 21.5.2003; Consultation on an outline for a Directive on transfer of the registered office (2004); Commission Legislative and Work Programme 2007, COM(2006) 629 final.

[2] Case 81/87, R v. HM Treasury and Commissioners of Inland Revenue, ex p Daily Mail and General Trust plc, 1988 E.C.R. 5483.

[3] C-212/97, Centros, 1999 E.C.R I-1459; C-208/00 Überseering, 2002 E.C.R. I-9919; C-167/01, Inspire Art, 2003 E.C.R. I-10155; Case C-411/03, SEVIC, 2005 E.C.R. I-10805.

[4] Case C-210/06, Cartesio, 2008 E.C.R. I-09641, para. 112.

[5] See e.g. Adriaan Dorresteijn & Barend Verkerk, Nakaarten over Cartesio: Grensoverschrijdende zetelverplaatsing en omzetting, 17 Onderneming en Financiering 2 (2009); António Frada De Sousa, Company’s Cross-border Transfer of Seat in the EU after Cartesio, Jean Monnet Working Paper No 7(2009); Daniel Zimmer, Christoph Naendrup, Das Cartesio-Urteil des EuGH: Rück- oder Fortschritt für das internationale Gesellschaftsrecht?, Neue juristische Wochenschrift (2009).

[6] Case C-378/10 VALE, pending, lodged on July 28, 2010, not yet reported.

[7] Case C-378/10 VALE, 15 December 2011, not yet reported (Opinion of AG Jääskinen).

[8] Id., point 43-52.

[9] Id., point 65.

[10] Id., point 66-69.

[11] Id., point 70-74.

[12] Id., point 75.

[13] Id., point 76.

[14] Id., point 77.

[15] Id., point 77-79.

[16] This is a translation. The Opinion is not available in English.

[17] Opinion of Advocate General Jääskinen in VALE (note 7), point 35.

[18] Leon Verstappen, Rechtsopvolging onder algemene titel (1996), p. 42.

[19] Id., point 30-31.

[20] Case C-210/06, Cartesio (note 4), para. 112.

[21] Opinion of Advocate General Jääskinen in VALE (note 7), point 64.

[22] Id., point 65, concerning a conversion.

[23] See Case C-411/03, SEVIC (note 3), concerning a merger; Opinion of Advocate General Jääskinen in VALE (note 7), point 72.

[24] Opinion of Advocate General Jääskinen in VALE (note 7), point 73 to 75.

[25] Opinion of Advocate General Jääskinen in VALE (note 7), point 70 to 74.

[26] It is settled case law that discrimination arises through the application of different rules to comparable situations or the application of the same rule to different situations, compare for instance Case C-279/93, Schumacker, 1995 E.C.R. I-00225, para. 30; Case C-391/97, Gschwind, 1999 E.C.R. I-05451 para. 21; Case C-440/08, Gielen, 2010 E.C.R. I-02323, para. 38.

[27] Council Regulation (EC) No 2157/2001 of 8 October 2001 on the Statute for a European company (SE), OJ L 294, 10.11.2011, p. 1-21.

[28] Id., point 79.

[29] Leon Verstappen, Rechtsopvolging onder algemene titel (1996).

[30] See for example Joined Cases C-87/90, C-88/90 and C-89/90, A. Verholen and others v Sociale Verzekeringsbank Amsterdam, 1991 E.C.R. I-03757, para. 24. See also Paul Craig and Grainne De Burca, EU Law: texts, cases and materials (2011), p. 473.

[31] It is beyond the scope of this case note to go into an in-depth discussion as to whether shareholders of the Italian or Hungarian VALE can rely on Article 49 TFEU. However, as some preliminary notes, it seems correct that the AG chose the freedom of establishment and not the free movement of capital. The Hungarian legislation does not deter shareholders from investing in Hungarian companies as in the Golden Shares cases, but hinders the (two) shareholders from establishing a Hungarian company that can refer to an Italian company as its legal predecessor. Even if it concerns the Hungarian shareholders, it would not be an internal situation because a cross-border element exists. See on the scope of internal situations, for example, Case C-57/96, H. Meints v Minister van Landbouw, Natuurbeheer en Visserij. 1997 E.C.R. I-6689, para. 40. A question that also depends on national law is, however, whether these shareholders exist if the companies do not exist.

[32] See for example Case C-83/91, Wienand Meilicke v. ADV/ORGA F.A. Meyer AG, 1992 E.C.R. I-4871; Case C-18/93, Corsica Feries Italia Srl v. Corpo dei Piloti del Porto di Genova, 1994 E.C.R. I-1783. Regarding the rumours that Vale is a test case, it should be noted that this is not a criterion for a case to be hypothetical as long as the conflict as such is a fact. See e.g. Case C-412/93, Leclerc-Siplec v. TFI Publicite and M6 Publicite, 1995 E.C.R. I-179 and Case C-200/98, X AB and Y AB v. Rikssatteverket, 1999 E.C.R. I-8261.

I. Introduction

The European policy agenda on corporate social responsibility (CSR) has been both broad and underdeveloped. But although the European Commission (the Commission) has thus far been reluctant to adopt legislation on the issue, it has recently signaled its intention to break with the idea that CSR is inherently voluntary. In December 2010 the University of Edinburgh published a study which identifies opportunities for improvement in various policy areas like trade and investment law, corporate law and private international law.^[1] In October 2011, the Commission issued a Communication as the first step towards a renewed EU strategy on CSR.^[2] This article explores one of the most feasible options for legal reform: enhanced reporting requirements on social, environmental and governance issues. Many European companies already publish CSR reports.^[3] Yet more comprehensive legislation at the supranational level is needed (1) to catch up with progressive domestic laws adopted in several EU Member States, (2) to create more clarity on the legal requirements regarding scope and substance of these reports, and (3) to remove the discretion for the vast majority of companies —most notably the non-branded ones— to not publish CSR reports at all.

II. The current legal framework

European companies have no general legal obligation under EU law to adopt CSR policies or to report on them. However, the 2003 Accounts Modernization Directive, which amends the Fourth and Seventh Directives on Company Law and deals with a range of issues on corporate accounting and reporting, contains some language that hints to such an obligation.^[4] It is provided that:

To the extent necessary for an understanding of the company’s development, performance or position, the analysis [in the annual report and the consolidated annual report, RZ] shall include both financial and, where appropriate, non-financial key performance indicators relevant to the particular business, including information relating to environmental and employee matters.^[5]

Due to the requirement of necessity, companies seem to have near total discretion to decide whether, or to what extent, they will report.^[6] There are, to my knowledge, no case-law in which the scope of this requirement was contested. Furthermore, it is unclear from the text what encompasses “environmental and employee matters.” With regard to the former, the Preamble of the Modernization Directive does refer to Commission Recommendation 2001/453/EC that deals with environmental issues in the annual accounts and annual reports of corporations such as energy use, materials use, water use, emissions and waste disposals.^[7] Secondly, it has been argued, primarily based upon CSR-resolutions by the European Parliament, that the term “employee matters” should be interpreted broadly and should cover a wide range of issues like health and safety, human rights, schooling and education.^[8] But arguably it still is narrower than the reference to “social aspects” in the Preamble and it does not seem to warrant non-financial indicators on broader social issues like labor rights in a company’s supply chain, or social concerns outside the own workforce. Lastly, Member States may, when implementing the Directive, waive the obligations on non-financial reporting for small and medium size enterprises (SMEs).^[9] A bright spot, on the other hand, is that the fact that the Directive deals with consolidated annual reports, which means that companies will have to report on their worldwide operations.^[10] But in sum the CSR-reporting requirements under the Modernization Directive are at best ambiguous, and at worst completely undemanding. It still strongly aligns with the traditional definitions of CSR that refer, either implicitly or explicitly, to the voluntary nature of CSR and thus by definition exclude regulatory interference.^[11] Eur J Int Law (2004) 15 (3): 457-521.

III. DIVERGING PRACTICE IN EU MEMBER STATES

Most EU Member States have implemented the Directive including the provision on non-financial reporting,^[12] yet several of them have adopted more detailed legislation. Pursuant to the article in the Dutch Civil Code implementing the Modernization Directive’s provision, the Netherlands Council for Annual Reporting (“Raad voor de Jaarverslaggeving”) has adopted an explanatory guideline on the application of the article. The guideline is reviewed regularly, and now includes inter alia recommendations on supply chain disclosure and due diligence.^[13] Its application is furthermore extended to pension funds, while small and medium size enterprises are exempted. Listed companies in the Netherlands are subjected to a more boldly formulated provision in the Dutch corporate governance code (“Code Tabaksblat”), whereby the management board shall report in the annual report on corporate social responsibility issues but, again, only insofar on the particular issues that the company deems relevant.^[14] Thirdly, Dutch companies that participate in trade missions or receive any other forms of government support are required to report specifically on the observance of relevant International Labor Organization’s Conventions on child labor and forced labor within their own operations and at the “first essential supplier.”^[15] Other EU Member States that have enacted legislation on CSR-transparency depart from the Directive’s ambiguous language and curtail the discretion of companies whether or not to report. In France, listed companies are required to report on social and environmental issues in their annual reports. This includes the environmental impact of foreign subsidiaries, the subsidiaries’ respect for core ILO Conventions and the way in which the normative requirements derived from these Conventions are passed on to arms-length suppliers in contractual relations.^[16] Currently a bill is pending that will extent application to non-listed large companies.^[17] In Denmark, large companies that have a CSR-policy in place have to report on the implementation and the results of this policy. When the company does not have a CRS-policy it has to state reasons. There are no requirements on form or substance, but the Danish Government encourages companies to use the Global Reporting Initiative (GRI) format when reporting, and companies that have signed up to the UN Global Compact or the UN Principles for Responsible Investment are exempted. The GRI format is also adhered to in Sweden, where state-owned companies have to report on GRI indicators according to a ‘comply or explain’ approach. Also Belgium^[18] and Germany^[19] have adopted broader definitions or more stringent laws on CSR-transparency. In sum, EU Member States have adopted a patchwork of obligations, which is neither intended nor desirable.^[20] Although the French and Danish regulations are the more robust on paper, it is difficult to measure the effects in practice, let alone benchmark them. It is also important to note that the United States has recently adopted transparency requirements, adding its model to the list of idiosyncratic laws. The Dodd-Franck Act, the broad financial reform law, contains two provisions that require listed companies to perform due diligence and disclose information on the use of minerals from the Democratic Republic of Congo or an adjoining country, and —when applicable— to disclose payments made to foreign governments for the purpose of the commercial development of oil, natural gas, or minerals.^[21] Dodd-Frank thus adds to the complex menu of CSR transparency requirements. Since many European companies trade securities in the United States, it is not inconceivable that some multinational enterprises have to comply with two or three different models of CSR-transparency. And on top of domestic obligations come requirements imposed by institutions like the European Investment Bank or the International Finance Corporation, all with their own models and templates.

Iv. THE COMMISSION’S COMMUNICATION: CHOOSING DIRECTIONS

The recent communication first posits a new and less voluntary definition of CSR, which opens the way for a more demanding directive.^[22] With regard to disclosure requirements, the Commission announces that it “will present a legislative proposal on the transparency of the social and environmental information provided by companies in all sectors.”^[23] It provides no further details on what should be disclosed to whom. However, with regard to the financial sector, “[the] Commission intends [to consider] a requirement on all investment funds and financial institutions to inform all their clients (citizens, enterprises, public authorities etc.) about any ethical or responsible investment criteria they apply or any standards and codes to which they adhere.”^[24]

A new European Directive on non-financial reporting can combine the most ambitious national CSR regulations to set a new European minimum standard. It should therefore contain at least five elements in order to resolve divergence problems and make a notable step forward. First, unnecessary ambiguities as to whether, when and what companies have to report on must be eliminated. Much of the current discretion is based upon the notion that non-financial reporting is relevant insofar the information is “necessary” to comprehend the financial situation of the company. In his recently published ‘Guiding Principles’, UN Special Representative on Business and Human Rights John Ruggie recommends that this issue needs clarification.^[25] It would be best, however, to eliminate materiality requirements altogether, as the importance of corporate reporting on social and environmental issues lies beyond financial risks or value creation.^[26] This aligns with the idea that CSR-reports are not only intended for shareholders, but aim to inform a broader group of stakeholder. Secondly, a new European Directive would have to contain certain specific performance indicators that set a minimum standard, above which companies can report on self-selected indicators. Issues that are eligible to serve as minimum performance indicators relate to e.g. labor rights, climate change, corruption and corporate activities in conflict areas. Practice in France and the Netherlands indicates that it is possible to base performance criteria on international (human rights) conventions. The additional indicators, which a company is free to select, may be based on private initiatives like multi-stakeholder programs, ISO 26000, the UN Principles for Responsible Investment or the Global Reporting Initiative. The latter provides a template that is currently used by over 1800 companies worldwide. The EU could make an effort to increase the use of the GRI to standardize the way companies report, but this has to be balanced against potential overreliance on a private organization. Thirdly, the Danish three-prong test of disclosure of (1) policies, (2) implementation and (3) results should form the subject matter of CSR-reports. The reports should be verified by external auditors, similar to the requirements under Dodd-Frank. To strengthen the enforcement even further, it should be clarified that interested parties have a right to bring action when companies report false or misleading information, similar to financial reporting laws. Fourthly, it is important to determine the scope of application. In addition to the activities of foreign subsidiaries, companies should be required to report on supply chain due diligence. It makes sense that small and medium size enterprises were exempted in the old Directive because of the potential regulatory burden. But transparency templates like GRI have now adopted specific models for SMEs that address this problem. Other categories that warrant special consideration are state-owned enterprises, companies that receive any form of government support, financial institutions and pension funds.^[27]

V. Concluding remarks

In the years ahead, countries, businesses and NGOs will have to work on concrete measures to implement the “smart mix” of policy initiatives as proposed by Special Representative Ruggie. Increased corporate transparency has a pivotal role in this policy mix. A more univocal European framework for CSR-reporting will meet consumer demand, strengthens the market for sustainable investment and confronts companies with (potential) social and environmental risks in their operations and supply chains. The fact that many large companies are already reporting on their CSR-policies will surely make the political task of clarifying and converging the relevant legal requirements less daunting for the European Commission.

I. Introduction

Exactly one year after its last ruling on golden shares^[1], involving the same Member State, the Court of Justice (‘the Court’) reiterated its position on the illegality of these rights, vested in the State and which confer a particular control in privatised entities, in its judgement of November 10, 2011, Commission v. Portugal^[2]. Even though the Court’s scrutiny appears constant and straightforward^[3], some comments still needs to be made on the legality of golden shares, especially at a time where the excessive liberalisation of the economy shows some limits and may support for a reuse of this instrument^[4].

II. Factual and Legal Background

The intensive restructuring undergone since 1999 in the Portuguese energy sector, incited by community law provisions^[5], concluded with the adoption of Decree-Law No 137-A/99 of 22 April 1999^[6], incorporating GALP Energia SGPS SA (‘GALP’), a publicly-owned holding company for the State’s direct shareholdings in various public entities^[7]. GALP is the major group for oil and natural gas in Portugal.

Under Law No 11/90 of 5 April 1990 concerning the Framework Law on Privatisations^[8], GALP was progressively privatised, so that the Portuguese State currently holds, indirectly, 8% of the share capital of GALP. Under the Decree-laws approving GALP’s privatisation, the articles of association of companies provided for golden shares which were intended to remain the State’s property. Irrespective of their number, such shares conferred on the State a right of veto over major decisions, including the amendments to the company’s articles of association. In addition to such right of veto, a shareholders’ agreement was concluded between some of GALP’s shareholders, whereby the State, indirectly, was to appoint a director, required to be the chairman of the board of directors.

Upon a careful review of those golden shares and the special rights attached, the European Commission decided to challenged them, deemed to be contrary to the principles of free movement of capital (article 56 EC^[9]) and freedom of establishment (article 43 EC). The Court declared that, by maintaining in GALP special rights attributed to it by means of golden shares, Portugal had failed to fulfil its obligations in respect of the free movement of capital.

As a preliminary remark, it is regrettable to notice the lack of any reference to article 295 EC. Strongly defended by Advocate General Colomer^[10], this provision had always been rejected by the Court in situations involving golden shares. The Court usually stated that “the system of property ownership was not exempted from the fundamental rules of the Treaty”^[11]. The main argument of such eviction was never made clear by the Court. We however agree that a large interpretation of this provision would have been contrary to the fact that many Treaty articles have an inevitable effect on property rights.

III. Freedom of Capital, Freedom of Establishment, or Both?

The Court differentiates provisions of national laws which fall within the scope of the freedom of establishment^[12] and those which fall under the freedom of capital^[13]. In its ruling, the Court only focused on the respect of the free movement of capital, and did not discuss the freedom of establishment^[14]. Such approach could be, a priori, subject to criticism.

One must point out that it is common to distinguish two types of special rights^[15], those which relate to the decision-making process of the corporate body of the company, and those which influence the shareholder structure, not part of the business strategy of the company as such. In the present case, the specific rights (right of veto and right to appoint the chairman of the board of director) are part of the first category. From the differentiation established by the Court, the freedom at stake was the freedom of establishment. Both the right of veto and the right to appoint the chairman of the board concerned fundamental management decisions of the company, and as such, were encompassed in the definition of article 43 EC given by the Court^[16].

The Court had however provided guidelines, in situation where both freedoms overlap, for determining when one freedom takes precedence over the other one, on the basis of the “definite influence” criterion^[17]. In the current case, the approach of the Court allows for a better protection of the investors^[18]. Indeed such national provisions might affect all shareholders and potential investors, and not only those exerting a definite influence over the management and control of the entity concerned^[19]. The main difference between the use of article 43 EC over article 56 EC also lies in the fact that the free movement of capital applies to capital movements to and from third countries (on a non-reciprocal basis). As such, investors from third countries willing to hold shares in some companies see their rights protected^[20]. The outcome would have been however substantially similar, with respect to both the restrictive effect and the level of justification of the contested provisions^[21].

IV. A Rather Short Discussion on the Restrictive Effects of the National Measure

An initial discussion led to the question on the authority vested with the special rights, via an analysis of the instrument conferring such rights^[22]. The Portuguese State argued that the contested provisions were not a creature of state legislation but were enacted through the articles of association of the companies. The Portuguese State would therefore not be acting in a public capacity and the Treaty provisions should not be implicated. However, the Court held that it was the Portuguese Republic itself which, first, through the intermediary of the national legislature, authorised the creation of golden shares in the share capital of GALP and, secondly, in its capacity as a public authority, decided to introduce golden shares into GALP’s share capital, to allocate them to the State and to define the special rights which they confer^[23]. This assertion is in line with previous case law^[24] and the Advocate General Maduro’s opinion: with regard to the source of a public authority’s rights in a company, he explained that “it is immaterial how those powers are granted or what the legal form they take”^[25]. The position of the Court conceptualizes the State as being incapable of acting in a private capacity, because of the inherent regulatory nature of its actions.

The Court then discussed why the national measures had a restrictive effect. It considered that the Portuguese State’s right of veto over a large number of significant resolutions and, especially, over any amendment of GALP’s by-laws, purported that the influence of the Portuguese State could not be reduced except with its consent. Such influence over GALP’s management and control, unwarranted by the proportion of the State’s shareholding, would have discouraged operators of other Member States from making direct investments since they could not be involved in the management and control of that company in proportion to the value of their shareholdings^[26]. Likewise, that right of veto would have had a deterrent effect on portfolio investments, since a possible refusal by the Portuguese State to approve an important decision in the company’s interests would have depressed the value of the shares and thus reduced the attractiveness of an investment^[27]. The right to appoint the chairman of the board of directors, available exclusively to the State and to the exclusion of all other shareholders^[28], restricted, in the same way, the ability of shareholders other than the State to participate effectively in the management or control of the company. Such right would have rendered direct investments in its capital less attractive to investors.

V. A Clear-cut Approach on the Justification of the Restrictions

Following a long-established method^[29], the Court further held that such restrictions were not justified. While the objective of ensuring a secure energy supply in case of crisis, war or terrorism could indeed be characterised as one of the overriding reasons in the public interest which would justify restrictions on the free movement of capital, that ground could be relied upon only if there was a genuine and sufficiently serious threat to an interest of society^[30]. Portugal had however not clearly stated why its special rights could ensure that public security was not jeopardised, especially with respect to certain investments coming from sovereign wealth funds or investments that might be linked to terrorist organisations.

The Court also considered that the provisions at issue did not define the specific circumstances in which the State’s special powers could be exercised and, accordingly, conferred on the national authorities an important marge de manoeuvre^[31]. The measures created an uncertainty which entailed serious interference with the free movement of capital. As a consequence, the provisions could not, in any event, be proportionate to the objectives pursued.

VI. Conclusion

As in other matters such as direct taxation, the Court seems to be rather reluctant to accept protection of national resources as justifications of restrictions to free movement of capital^[32]. This being said, the economic conjuncture, with the current crisis in – and of – the European Union, may encourage some governments to reconsider the use of the golden shares as a way to protect national sovereignty^[33]. It goes without saying that the Court’s scrutiny of the golden shares may be difficult to circumvent.

Endnotes:

[*] Ph.D. candidate in European Union Law at the University of Nanterre – member of the CEJEC (Paris 10) and Associate within the law firm Loyens & Loeff (Luxembourg). The author wishes to thank Ludovic Bernardeau, former law clerk at the European Court of Justice and lecturer at the University of Nanterre – member of the CEJEC (Paris 10), for his useful comments to this article.

[1] Case C-543/08, Commission v. Portugal, [2010], not yet published.

[2] Case C-212/09, Commission v. Portugal, [2011], not yet published.

[3] For previous cases on golden shares, see Case C- 58/99, Commission v. Italy, [2000], ECR I-3811; Case C-367/98, Commission v. Portugal, [2002], ECR I-4731; Case C-483/99, Commission v. France, [2002], ECR I-4781; Case C-503/99, Commission v. Belgium, [2002], ECR I-4809; Case C-463/00, Commission v. Spain, [2003], ECR I-4581; Case C-98/01, Commission v. United Kingdom, [2003], ECR I-4641; Joined Cases C-282/04 and C-283/04, Commission v. The Netherlands, [2006], ECR I-9141; C-174/04, Commission v. Italy, [2005], ECR I-4933; Case C-112/05, Commission v. Germany, [2007], ECR I-8995; Joined Cases C-463/04 and C-464/04, Commission v. Italy, [2007], ECR I-10419; Case C-274/06, Commission v. Spain, [2008], ECR I-0026; Case C-326/07, Commission v. Italy, [2009], ECR I-2291; Case C-171/08, Commission v. Portugal, [2010], not yet published.

[4] Ringe W.G. and Bernitz U., “Company law and economic protectionism”, Oxford Legal Studies Research Paper, No. 24/2011, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1789082

[5] See Devroe W., “Privatizations and Community Law: Neutrality Versus Policy”, 34 CML Rev. (1997), p. 267.

[6] Diário da República I, Series A, No 94, of 22 April 1999.

[7] For a more detailed explanation see supra Case C-212/09, para 2 to 19.

[8] Diário da República I, Series A, No 80, of 5 April 1990.

[9] References will be made to provisions of the EC Treaty, as applicable in this case. Articles 43 EC and 56 EC become articles 49 and 63 of the Treaty on the Functioning of the European Union.

[10] Advocate General Colomer’s opinions of July 3, 2001 under Case C-367/98, Case C-483/99 and Case C-503/99; of February 6, 2003 under Case C-463/00 and Case C-98/01; of February 13, 2007 under Case C-112/05; of November 6, 2008 under Case C-326/07.

[11] Case 44/79, Liselotte Hauer v. Land Rheinland-Pfalz, [1979], ECR 3747/3760.

[12] Supra, Case C-212/09, para 42: “Provisions of national law which apply to the possession by nationals of one Member State of holdings in the capital of a company established in another Member State, allowing them to exert a definite influence on that company’s decisions and to determine its activities, fall within the scope ratione materiae of Article 43 EC on freedom of establishment.”

[13] Idem, para 43: “Direct investments, that is to say, investments of any kind made by natural or legal persons which serve to establish or maintain lasting and direct links between the persons providing the capital and the company to which that capital is made available in order to carry out an economic activity, fall within the scope of Article 56 EC on the free movement of capital.”

[14] However, the Court held that the exercise by the Portuguese State of special rights which it derives from golden shares in GALP’s share capital must be examined in the light of both Article 43 EC and Article 56 EC. It further stated, in its very last paragraph, para 98, that “since the national measures at issue involve restrictions on freedom of establishment, such restrictions are a direct consequence of the obstacles to the free movement of capital considered above, to which they are inextricably linked”.

[15] Grundmann S. and Möslein F., “Golden shares – State control in privatised companies: comparative law, European law and policy aspects”, EUREDIA 2001-2002/4, p.627, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=410580

[16] In Case C-452/04, Fidium Finanz AG v. Bundesanstalt für Finanz-dienstleistungsaufsicht, [2006] ECR I-9521, the Court stated that where a measure restricts both the free movement of capital and another freedom, and one freedom is more directly in point than the other, then the measure should be analysed for its compatibility with only the freedom to which it most closely relates. See O’Brien M. “Case Annotation: Case C-452/04, Fidium Finanz Ag v. Bundesanstalt Für Finanzdienstleistungsaufsicht”, 44 CML Rev. (2007) 5.

[17] This criterion was first formulated by the Court in Case C-251/08, C. Baars v Inspecteur der Belastingen Particulieren/Ondernemingen Gorinchem, [2000], ECR I-2787, where the Court interpreted it as a member state national with a holding in the capital of a company established in another member state, giving him definite influence over the company’s decisions and allowing him to determine its activities is exercising his right of establishment, the size of shareholding being then a central element in the definition of the concept. In Case C-492/04, Lasertec Gesellschaft für Stanzformen mbH contre Finanzamt Emmendingen, [2007], ECR I-3775, the Court later considered the “definite influence” notion by referring to the purpose of the legislation.

[18] See the analysis under Kronenberger V. “The rise of the “golden” age of free movement of capital: A comment on the golden shares judgments of the Court of Justice of the European Communities”, European Business Law Review, 4, 2003, p.115.

[19] Supra, Case C-212/09, para 45. The Court also mentioned at para 44, “National legislation not intended to apply only to those shareholdings which enable the holder to exert a definite influence on a company’s decisions and to determine its activities but which applies irrespective of the size of the holding which the shareholder has in a company may fall within the scope of both Article 43 EC and Article 56 EC.”

[20] In Case C-326/07, the Court “lifted the freedom of establishment from its secondary position and gave it a primary place in its golden share case law”, see Van Bekkum J., “Golden Shares: a new approach”, European Company Law, Volume 7, issue 1, February 2010; see also O’Brien M., “Case Annotation, Case C-326/07, Commission of the European Communities V. Italian Republic, Judgment of the Court of Justice (Third Chamber) of 26 March 2009”, 47 CML Rev. (2010).

[21] See in this respect, Grundmann S. and Möslein F., supra, p.649.

[22] Cata Backer L., “The private law of public law: public authorities as shareholders, golden shares, sovereign wealth funds, and the public law element in private choice of law”, Tulane Law Review, Volume 82, Issue 1, 2008, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1135798. See also Oxera, “Special rights of public authorities in privatized EU companies: the microeconomic impact”, Report prepared for the European Commission (November, 2005), available at: ec.europa.eu/internal_market/capital/docs/2005_10_special_rights_executive_summary_en.pdf

[23] Supra, C-212/09, para 52. At para 53, the Court goes even further, “the creation of the right of the State to appoint the chairman of GALP’s Board of Directors is not the result of a normal application of company law.”

[24] See for instance supra Case C-543/08, para 61.

[25] Advocate General’s opinion Maduro of April 6, 2006 under Joined Cases C-282/04 and C-283/04, para 19.

[26] Supra, Case C-212/09, para 57.

[27] Idem, para 58.

[28] The Court nevertheless added that “while it is true that that facility can be conferred by legislation as a right of a qualified minority, it is clear that it must, in such a case, be accessible to all shareholders and must not be reserved exclusively to the State”, idem para 59.

[29] For an analysis of the method, see for instance Gaydarska N., “The legality of the Golden Shares under EC law”, Maastricht Faculty of Law Working Paper, Volume 5, No. 9, 2009, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1426077&http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1426077&http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1426077.. See also Camara P.,”The end of the “Golden” Age of Privatisations? The recent ECJ Decisions on Golden Shares”, European Business Organization Law Review, 3, 2002, p. 506.

[30] Idem, para 83.

[31] Idem para 89 to 94. The Court explained as well that the task conferred on GALP of providing a service of general economic interest could not be relied on to justify the provisions concerned. In that regard, the Court observed that the Commission did not, in this action, challenge GALP’s special or exclusive rights, but those attributed to the Portuguese State as a shareholder of that company.

[32] See for instance the recent Case C-20/09, Commission v. Portugal, [2011], not yet published, where the Court considered that the Portuguese 2005 scheme amnesty legislation, by providing for different treatment for public debt securities issued by the Portuguese State compared with those issued by other Member States, did not comply with the proportionality requirement and was in breach of the free movement of capital, O’Shea T. “Portugal Tax Regularisation Scheme in breach of EU Law”, Tax Notes International, May 2, 2011, p.374, available at http://www.ccls.qmul.ac.uk/docs/staff/oshea/52133.pdf

[33] Papadopoulos T., “Greek legislation on strategic investments; the next ‘golden share’ case before the European Court of Justice?”, European Company Law, Volume 6, issue 6, 2009, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1541635&http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1541635

1. Introduction

The directive on the regulation of alternative investment fund managers[1] (hereinafter: “AIFM Directive”) entered into force in November 11 2010. The aim of the directive is to create a pan-European regulatory and supervisory framework for alternative investment fund managers. An alternative investment fund manager (hereinafter “AIFM”) is defined as any entity managing alternative investment funds (hereinafter “AIF”) as a regular business. An alternative investment fund is considered any “collective investment undertaking” which raises capital from a number of investors in order to invest it according to a defined investment policy and does not require authorization pursuant to Article 5 of Directive 2009/65/EC (commonly known as “UCITS Directive”).[2] Therefore, the directive applies to managers of hedge funds, private equity funds, real estate funds, and commodity funds. This article will focus on the regulation of private equity fund managers. Private equity is a generic term encompassing a wide variety of investments. The common characteristic of private equity investments is their illiquidity since they involve unregistered securities.[3] Private equity includes venture capital, development capital, mezzanine capital, leveraged buyouts and distressed investing. Private equity firms periodically establish private equity funds which make investments in private companies, including “taking private” public companies, financing them by a high amount of debt.

2. Background

The AIFM Directive was adopted in the aftermath of the financial crisis against a backdrop of several years of a politically motivated policy debate regarding the regulation of alternative investment fund managers.[4] The legislative process was marked by heated negotiations and intense lobbying by the alternative investment industry. The two goals of the directive are to increase the transparency of the alternative investment industry and to tackle the systemic risks that it poses. The need to increase transparency was prompted by the sharp increase in buyouts involving public companies and a perceived lack of adequate investor disclosures.[5] Regarding systemic risk, the main concern stems from the use of debt to finance leveraged buyouts. Banks are the main financiers of private equity buyouts and a widespread failure of portfolio companies could have adverse consequences on the banking system.[6]

3. Scope of the Directive

The AIFM Directive applies to AIFMs established in the EU which manage or market one or more AIFs, EU based or not and also AIFMs established outside the EU which manage AIFs in the EU or market one or more AIFs in the EU, EU-based or not.[7] The directive provides exemptions for two categories of AIFMs, namely for AIFMs which manage funds with assets less than 100 million if they are leveraged or less than 500 million if they are not leveraged and offer investors no redemption rights for the first 5 years.[8] The second category applies mainly to private equity funds. An EU AIFM managing an EU or non-EU based fund must be authorized by the competent authority of its Member State and fulfill the requirements imposed by the directive.[9] If authorization is granted the AIFM will be able to manage AIFs established in any Member State[10] and market EU AIFs to professional investors across the EU.[11] The directive includes provisions for the authorization of non-EU fund managers and the marketing of non-EU AIFs to professional investors in the EU but these provisions will not come into force with the rest of the directive. Instead, national private placement regimes established by individual EU Member States will continue to apply.

4. Particular provisions of the Directive affecting private equity fund managers

a) Capital and ongoing compliance requirements

The AIFM Directive imposes minimum capital requirements on private equity fund managers.[12] For a fund manager that is an internally managed fund there is a minimum capital requirement of EUR 300,000 and EUR 125,000 for a manager that is appointed as an external manager of funds. If the value of the portfolios of funds managed by the fund manager exceeds EUR 250 million, the manager shall provide additional funds equal to 0.02 per cent of the amount by which the value of the portfolios exceeds EUR 250 million. However, the total amount of the initial capital and additional amount shall not exceed EUR 10 million.

Furthermore, the AIFM Directive introduces certain ongoing compliance requirements for fund managers. Fund managers must ensure that a single depositary is appointed for each fund under management[13] and ensure that all funds are independently valued at least once per year.[14] Fund managers must put in place remuneration policies and restrictions for senior staff[15] and maintain organizational and administrative arrangements in order to manage and monitor conflicts of interest that arise in the course of managing one or more funds.[16]

b) Transparency and disclosure requirements

The AIFM Directive contains a wide range of transparency and disclosure requirements. Specific information such as the investment strategy and objectives of the fund must be disclosed to investors before they invest in a fund.[17] In addition, there is an annual reporting requirement in respect of each EU fund managed and each fund marketed in the EU.[18] These reports which must be audited must be provided to regulators and, upon request, to investors. Periodic disclosures must be made to both investors and regulators regarding the percentage of assets which are illiquid, the risk profile of the fund and the risk management systems put in place in order to manage these risks.[19]

What is more, the directive imposes disclosure obligations on private equity fund managers managing funds which acquire control of EU non-listed companies and issuers. Certain disclosures must be made by the fund manager to its regulator when the proportion of voting rights in a non-listed company held by one of its funds exceeds reaches or falls below certain thresholds starting at 10% of voting rights.[20] When a private equity fund obtains 50% control of a non-listed company or 30% control of an issuer the fund manager must disclose certain information to the company, its shareholders and its regulator such as the policy for preventing and managing conflicts of interest.[21] In case control of a listed company is acquired, the fund or the fund manager must disclose to the company and its shareholders its intentions regarding the future business of the company and the likely repercussions on employment.[22]Furthermore, the annual report of a fund exercising control over a non-listed company or the annual report of the company itself must contain a fair review of the development of the company’s business, the company’s future development and an indication of any important events that have occurred since the end of the financial year.[23] Finally, information regarding the financing of the acquisition of control of a non-listed company must be made available by the fund manager to its regulator and the investors of the fund which acquired control.[24]

c) Asset stripping

Article 30 of the AIFM Directive seeks to directly regulate buyouts of listed or non-listed companies and protect companies against short-term investment strategies by private equity investors. When a fund acquires control of a listed company or an issuer the manager of the fund is prohibited for a period of 24 months following the acquisition of control from facilitating, supporting or instructing any distribution, capital reduction, shareholder redemption and acquisition of own shares by the company.

5) Concluding remarks

The AIFM directive was adopted in response to the financial crisis based on the premise that the alternative investment fund industry contributed to it. However, it is now widely accepted that the industry neither caused nor contributed to the financial crisis.[25] Furthermore, the adoption of the directive was primarily driven by the desire to regulate hedge funds with private equity being swept along.[26] In particular, the directive has been criticized for burdening the private equity industry with unjustifiable costs.[27] As mentioned above, the directive imposes significant transparency and disclosure obligations to investors and regulators. However, investors in private equity funds are sophisticated and usually demand this information by themselves. Disclosure to regulators is a welcome development since it will enable regulators to monitor systemic risk.[28] Additional costs will also be generated by the requirement to use depositaries and valuation mechanisms. On a more positive note, the creation of an internal market for private equity funds will benefit both investors and the private equity industry.

Introduction

Unlike the US, the EU competition law recognizes margin squeeze as a separate, stand-alone form of abusive behaviour, prohibited under Article 102 of the Treaty on Functioning of the European Union.[1] This view was clearly articulated by the ECJ in its judgment of February 2011 in TeliaSonera.[2] Although it was not the first time when the ECJ was called on to pronounce itself on the question of margin squeeze (also referred to as price squeeze), the ruling is of significant importance. This is because unlike the earlier decision in Deutsche Telekom,[3] the facts in TeliaSonera were not distorted by the existence of a regulatory framework. As a result, the judgment provides a clear formulation of the margin squeeze test under the EU competition rules. Another interesting feature of the case is the divergence of positions between the ECJ and the US Supreme Court. In the Linkline[4] case, the latter rejected the view that margin squeeze may constitute a separate form of Sherman Act § 2 violation.[5] Instead, it limited the claim to cases where vertically integrated firm applies predatory pricing in the downstream market. Therefore, comparison of both court’s opinions is particularly valuable, as neither of them seems to give a satisfactory answer to the question of a test for price squeeze practices.

1. The nature of margin squeeze

The problem of margin squeeze reflects a more general concern in competition law related to profit-sacrificing by companies enjoying market power. One possible explanations of such behaviour is to make the market less attractive to actual or potential competitors by artificially lowering prices. This may lead to exclusion of other players and allow dominant company to subsequently reap monopoly profits. In general, one can speak of profit sacrificing when given behaviour would be regarded as unprofitable, assuming that undertaking cannot raise prices following the exit of its competitors from the market.[6] On the other hand, lower prices is precisely what the competition is all about. Therefore, one has to be very cautious when condemning pricing inferior to a profit-maximizing level.[7] A narrow version of profit sacrificing is the test of predatory pricing.[8] Under that scheme, a company decides to temporarily lower price of output below marginal cost, hoping that competitors will not be able to match the price and eventually will be forced to leave the market. Once this happens, the predator may raise the price again to supra-competitive levels and recoup incurred loss.[9]

However, a vertically integrated company has an alternative to pricing at a loss. Provided that it enjoys market power upstream and supplies downstream competitors with a necessary input, it may increase latter’s costs rather than pursue unprofitable sales.[10] This may be achieved through setting a high wholesale price charged to competitors, while leaving the amount paid by final consumers unchanged. As a result, the margins of competitors on the retail market will shrink. In that context two essential questions arise. First, how much of competitors’ profit has to be squeezed for the infringement to be found. Second, whether competitive assessment in case of a margin squeeze varies depending on whether the upstream incumbent is subject to a duty to deal. In TeliaSonera the ECJ addressed both of these issues and the following parts will attempt to analyse its views.

2. How much profit should be squeezed?

In TeliaSonera the ECJ reiterated the position taken previously in Deutsche Telekom, by stating that:

[T]he unfairness [of a price squeeze] is linked to the very existence of the margin squeeze and not to its precise spread, it is in no way necessary to establish that the wholesale prices (…) to operators or the retail prices (…) to end users are in themselves abusive (…)[11]

Consequently, the ECJ accepted the proposition that unlawful margin squeeze takes place where competitors would need to offer services not only at a loss, but also “at artificially reduced levels of profitability”.[12] This approach contrasts with the decision of the US Supreme Court in Linkline.[13] In that judgement, the Supreme Court ruled that a claim of too low prices can be successful under § 2 Sherman Act only where the test of predation is satisfied.[14] The rationale for such permissive approach was the fear that courts would have to act as price regulators when asked to determine a fair margin, or a fair price.[15] These concerns were not shared by the ECJ which pointed out that Article 102 (a) TFEU expressly prohibits dominant undertakings from imposing unfair prices.[16] Such view may seem troubling both, from economic and legal perspective. First, it is unclear what a sufficient profit for competitors should be and how it could be established.[17] Second, requiring dominant firm to allow its downstream competitors earning sufficient profits sits uncomfortable with the paradigm of perfect competition.[18] Under that scenario, every player on the market sets its prices at marginal cost. The perfect competition model does not require thus any profits to be secured.[19] It is true that perfect competition is an utopian model. Therefore, it is argued that some profit would allow permit smaller players to invest in the quality of products and services and effectively compete with the incumbent.[20] In particular, a limited margin would allow such players to recover part of the investment-related fixed costs.[21] Strangely, however, this reasoning does not apply to other types of pricing conduct, such as predatory pricing. Arguably, this difference in treatment may be justified by would be a specific nature of a vertically integrated dominant company. Thanks to joint costs and economies of scope, it may significantly reduce specific cost of downstream product or service and make their proper attribution very difficult.[22] Nonetheless, this does not explain departure from a standard accepted under the EU competition law that only pricing below cost may be anticompetitive.

3. Duty to deal

Analysing the spread between wholesale and retail prices of a vertically integrated company makes sense for cases where downstream competitors have no other choice but to buy the input from such undertaking. Hence the question of significance of a duty to deal for finding a margin squeeze abuse. In the opinion preceding the ECJ’s judgment, Advocate General (AG) Jan Mazák noted that margin squeeze constitutes a specific type of refusal to deal.[23] According to the AG, price squeeze leads to the same effects as so called “constructive refusal to deal”.[24] Both types of conduct result in a prohibitory high price of input, without formally refusing to supply a customer. From this AG Mazák inferred that, as a matter of principle, dominant company cannot be held liable of a margin squeeze if it is not subject to a duty to deal.[25] Such obligation may arise from regulatory provisions, but it may also be established under antitrust doctrine.[26] Consequently, where alternative source of supply is available, the incumbent cannot successfully raise the cost of downstream competitors by increasing the wholesale price of input.

Interestingly, the ECJ did not follow the AG. Instead, it referred to earlier case-law allowing application of competition law whenever discretion of undertaking is not fully pre-empted by regulatory framework.[27] For the ECJ, antitrust provisions should therefore apply with even greater force “where an undertaking has complete autonomy in its choice of conduct”.[28] Leaving aside the logic of this argument, the ECJ’s conclusion may produce adverse results. This is because an incumbent may prefer to withhold sales to downstream competitors rather than face scrutiny under onerous margin squeeze test. This may in turn lead to less input available for downstream firms and ultimately stifle competition.

4. Conclusion

Antitrust assessment of margin squeeze cases appears to be particularly difficult. This is due to the peculiarity of network industries, where functioning of competition is far from perfect and where such practices mainly occur. The ECJ had therefore the choice whether to apply more permissive US-style approach, or run the risk of false positives. It opted for the latter, probably in the awareness of market power frequently exercised by vertically integrated incumbents in network industries. The ECJ seems thus to have sided with the weaker. Unfortunately, that has been done at the cost of legal certainty and uniform application of competition law standards.

Abstract:
The clear intention of the European Commission is to involve intermediaries more closely to the prevention and termination of online infringements by suggesting preventive measures and “notice and take-down policies”. In case C-324/09 (L’Oreal v. eBay) the Advocate General argued that the real meaning of Article 11 of the Directive is that the injunction does not impose impossible, disproportionate, or illegal duties on intermediaries, like a general obligation of monitoring. In case C-70/10 (Scarlet v. SABAM) the referring court asked ECJ whether the national courts may issue an injunction against intermediaries to order an ISP to introduce, for all its customers, in abstracto and as a preventive measure, for an unlimited period, a system for filtering all electronic communications. Since protection of Article 10 of ECHR includes freedom to receive and impart information and ideas without interference by public authority, Internet blocking attempts can interfere with the right to freedom of expression.

Introduction
Several months ago European Commission (EC) initiated a consultation process designed to lead to the amendment of Intellectual Property Rights Enforcement Directive – Directive 2004/48/EC (IPRED);^[1] EC invited the rest of the institutions of the European Union, the member states, but any interesting party as well (e.g. citizens of the member states) to submit their evaluations of the implementation of IPRED up to March 31, 2011.^[2] The major goal of this process is to improve the effectiveness of that Directive, especially as it relates to the always-increasing volume of infringements of IP rights through the use of the Internet.^[3]

Following the description of the proposed ways to address the challenges Internet causes to IP rights, the main purpose of this article is to argue against the necessity of imposing a general monitoring obligation on intermediaries whose services are used to infringe IP rights in order to handle this situation. The main focus is on the scope of Article 11 of IPRED and the circumstances required to issue an injunction against those intermediaries. After setting the limits of this topic I will try to counter the arguments of the defenders of preventive filtering measures and argue for a less absolute and extreme approach on the challenges Internet causes to IP rights.

I. Intention of European Commission to Involve intermediaries to the termination of online infringements

A.The liability of Internet Service Providers according to E-Commerce Directive

To begin with, Article 11 of the Directive provides that, besides the infringers themselves, member states’ judiciaries should issue injunctions against the intermediaries as well when requirements are met.^[4] It is important to realize at the outset that injunctions should not depend on the liability of the intermediaries, as EC explicitly mentions in its Report to the European Parliament.^[5] That means that, although EU law has already limited Internet Service Providers’ (IPS) liability,^[6] member states still can impose injunctions against those intermediaries whose services are used to infringe IP rights, irrespective of their potential liability under Directive 2000/31/EC.^[7] An additional argument in support of this position derives from the Information Society Directive 2001/29, Recital 59, which allows explicitly for injunctions against non-infringing ISPs; thus, it has been argued that for the sake of coherence, the same approach should also apply to Article 11 of IPRED.^[8]

B. The implied suggestions of European Commission
To get to the core of the topic, it is the EC’s clear intention to involve intermediaries more closely in the prevention and termination of online infringements.^[9] The Commission’s argument is that the currently available legislative and non-legislative instruments are not powerful enough to effectively combat online infringements of IP rights.

Further, in the same Report, the EC argues that Internet platforms such as online marketplaces or search engines can also play an important role in reducing the number of the infringements, and the argument continues by suggesting two particular solutions: preventive measures and “notice and take-down policies”.^[10] This could be interpreted as leading to a generalization of the restricting measures that could be imposed to the intermediaries as injunctions; the EC seems to imply that injunctions that are related only to past and present infringements do not solve the problem adequately, so they should expand to cover future infringements as well. The language the EC uses in the accompanying Staff Working Paper confirms this underlying intention; it criticizes the fact that, in the music and film sectors, injunctions often tend to be “title specific”, and that at the same time infringements with a view to titles not contained in the list (that right holders have to provide when asking for an injunction) can continue.^[11]

II. The Case Law of Member States and the Role of European Court of Justice

A. Case L’Oreal v. eBay
Directly related to the above position is the case C-324/09 (L’Oreal v. eBay).^[12] In this leading case the European Court of Justice directly examined the scope of the injunction that Article 11 requires national courts to grant against intermediaries.^[13] In other words, in L’Oreal the UK High Court asked ECJ whether the real meaning of Article 11 was that member states could obtain an injunction against an intermediary to prevent only the continuation of that specific act of infringement or further infringements of the infringed trademark as well.^[14] According to the EC’s point of view preventing future infringements would require general monitoring, which would impose a heavy burden on intermediaries.

1. The position of the Advocate General
Interestingly, the Advocate General handled the above issue quite recently;^[15] although its opinion is not binding for the Court, it usually corresponds with the final decision.^[16] According to the Advocate General, hosting providers generally can be required to terminate past and present infringements, but exceptionally also future infringements would be covered in case the same user would commit the same type of infringement and thus there is a “continuous infringement”.^[17] When intermediaries would not voluntarily remove or block the material (which is preferable for them in order to avoid liability), the trademark owner can request to impose an injunction. In other words, such injunction can extend to the prevention of repetition of similar infringements in the future. But this is not to be translated in a general obligation of monitoring, which would be too much for the hosting providers; the Advocate General is straightforward on this, requiring that two conditions have to be met when imposing injunction for future infringements: that the hosting provider can know with certainty what is required from him, and that the injunction does not impose impossible, disproportionate, or illegal duties like a general obligation of monitoring.^[18]

B.Case Scarlet v. SABAM
Further, case C-70/10 (Scarlet v. SABAM) touches even more directly the issues discussed here.^[19] As expressly discussed in EC’s Staff Working Document^[20] in this case the referring Cour d’appel de Bruxelles asked ECJ whether the national courts may also issue an injunction against intermediaries to order an ISP to introduce, for all its customers, in abstracto and as a preventive measure, exclusively at the cost of that Internet service provider and for an unlimited period, a system for filtering all electronic communications, both incoming and outgoing, passing via its services, in particular those involving the use of peer-to-peer software, in order to identify on its network the sharing of electronic files containing a musical, cinematographic or audio-visual work in respect of which the applicant claims to hold rights, and subsequently to block the transfer of such files, either at the point at which they are requested or at which they are sent. It also asked whether the principle of proportionality should be applied when deciding on the effectiveness and dissuasive effect of the measures sought.^[21]

The foregoing question, i.e. whether an ISP should introduce, for all its customers, in abstracto and as a preventive measure, for an unlimited period, a system for filtering all electronic communications, is to my opinion so broadly and generally articulated that it would not be that probable for the ECJ to answer affirmatively; it just goes too far to ask a ISP to filter in advance all of its communications for an unlimited period and on their own cost! A decision issuing such an injunction would not respect the required balance between the opposing interests.

III. The Protection of Freedom of Expression by the European Convention on Human Rights

A.The Proportionality Test of Restrictions on Freedom of Expression
Moreover, apart from how the above cases contribute to the dialogue, what argues against the imposition of the general monitoring obligation is Article 10 of the European Convention on Human Rights (ECHR), which provides the right to freedom of expression;^[22] as it is directly expressed in par. 2 of this Article the exercise of that freedom may be subject to restrictions under three conditions: it should be a legitimate and proportionate (i.e. appropriate, necessary and proportionate stricto sensu) restriction that serves the objective of protecting the rights of others, like IP rights.

To answer the question posed by the EU, even if assuming that this object is legitimate, still we have to answer whether they are proportionate; given the current development of technology, imposing filtering measures to intermediaries does not seem suitable for effectively determining whether a communication infringes or not IP rights.^[23] Since there is no technological certainty yet as far as these filtering techniques are concerned, it is always possible that legal content and legal uses of IP rights are blocked as well.^[24] At the same time Internet users have a lot of alternative opportunities to infringe upon those rights, and in this way those measures just seem insufficient.^[25] It gets even more complicated if one bears in mind that many users are not aware of the specific restrictions on IP rights infringements or of the penalties attached.^[26] Since protection of Article 10 of ECHR includes freedom to receive and impart information and ideas without interference by public authority,^[27] Internet blocking attempts (i.e. preventing people access to online information or to make available such information) can interfere with the right to freedom of expression.^[28]

Conclusion
Given the current technology development, ill intended Internet users have many alternative ways of online infringing upon IP rights; at the same time intermediaries’ systems are not that sophisticated to filter effectively only the infringing online content without affecting legitimate uses of IP rights. The effort of the EC to get those intermediaries involved should seek alternative paths, since preventive filtering measures prove to be insufficient and unnecessary. The amendment of IP rights enforcement Directive should avoid the imposition of a general monitoring obligation on intermediaries and should remain content and case specific.

–

This “volume” of The Columbia Journal of European Law Online is exactly what was anticipated in Judge Parker’s will and exactly what was pursued by the scholars who implemented his donation in the first half-century of the Parker School’s existence.  The division between law and equity was an achievement of late medieval English law.  A major equitable accomplishment was the use, later called trust, that enforced a separation between possessor and beneficiary, crucial if known and unknown widows, born and unborn children, and intended charitable recipients were to receive their entitlements.  The importance of the trust was demonstrated when it overcame Henry VIII’s Statute of Uses and sprang back to life.  For the United States, the reliance on trusts is high on the list of legal inheritances from the days of English colonialism.

Meanwhile, law in post-Napoleonic Europe progressed very differently following legal principles that accomplished similar goals with different institutional arrangements.   So it is a perfect subject for the Journal of European Law to take up, pulling together the different national European stories, analyzing them, and making the information available to Americans and Europeans who will learn and perhaps even influence what happens next.

Comparative law, once a small part of the curriculum and research agenda of American law schools, is now of great importance.  This project is exactly the kind of scholarly work that can be valuable as well as interesting.

Professor Lance Liebman, March 2011.

Jacopo Crivellaro, New York, January 2012