Corporate & International Law
A Guide To Incorporating a United States Subsidiary
Part I of II: Comparison of European vs. US Laws
BY WILLIAM F. SWIGGART & ARVID Von TAUBE1
There is no better way for the European Union (EU) or Scandinavian business to build a significant presence in the United States (US), than to set up a US subsidiary. However, it is well to know that the corporation laws in the United Statesranging from those affecting of governance down to the details of running the businessdiffer significantly from the laws of Europe, Scandinavia and Britain. This article will survey some of the principal differences.
The majority of European nations follow a much different philosophy than the US when it comes to governing corporations within their borders.
a. U.S. Corporation Laws
Any US state, regardless of entity type, will recognize a lawfully constituted company from another US state. Thus, the internal governance of a company generally falls subject to the sovereignty of the state where it is organized, while its external activitiesin terms of managing employees and selling productsare governed by federal laws and the laws of the state where it actually does business. So, for example, Montana residents operating a company organized in Delaware or Nevada will find that Delaware or Nevada corporation laws determine their internal governance, while Montana state law and to a certain extent US federal law determine how the company actually conducts its business.
Two theories of corporation law have emerged. Firstly, because management may choose to organize in a "foreign" (meaning from another US jurisdiction) state, the "race to the bottom" and, conversely, "race to the top" theories each explain some effects of this "competition" for state incorporation.
"Race to the bottom" posits that company founders will choose states to organize where governance laws are most favorable to management. This process will encourage more management-friendly laws everywhere, and cause governance laws less and less to protect the interests of shareholders and creditors.
"Race to the top" argues, in the obverse that, management will seek corporate laws that protect the company as a whole, including shareholders and creditors in order to attract and retain investors and obtain credit. That is, if corporate laws are unfair, stakeholders will "vote with their feet" and invest in (or lend to) companies organized elsewhere. Legislatures are thus encouraged to pass more favorable shareholder and creditor laws, and the courts of the state to interpret those laws in ways that protect stakeholders.
Given that most US industrial states offer corporate procedures that are fairly easy for management to use, and that the corporate statutes, and case law interpreting them, also tend to protect the economic interests of shareholders and creditors, a blend of the two theories is probably correct.2
With respect to the external activities of an entity, state lawsespecially those governing contracts, employment, intellectual property and real estateapply no matter where the corporation is domiciled. For example, a Massachusetts or New York domiciled corporation doing business in California may not be able to enforce within California a covenant not to compete against a former employee that is valid under Massachusetts law. Though courts in most eastern states will enforce such covenants, courts in California and other Western states often refuse to enforce such covenants due to a well-codified public policy against them.
Adding complexity, foreign domiciled entities must comply with many of the same corporate registration requirements and pay similar franchise taxes as "domestic" (locally organized) entities. So the Delaware corporation doing business just in Massachusetts faces double the corporate filing requirements and franchise taxes as its domestically domiciled cousin down the street.
b. Incorporation in Europe
Two incorporation styles exist in Europe: (1) the minority, "incorporation" method that resembles US corporation law, and (2) the "real seat" method. "Incorporation" method nations include: the Netherlands, the UK, Ireland, and the Scandinavian nations. These nations generally recognize any lawfully organized European or Scandinavian company regardless of domicile or the location of company's principle place of business.
The prevailing, real seat method, however, requires the internal affairs of a company to be governed by the laws of the nation where the company has its headquarters. Real seat nations therefore do not recognize a company that does not actually do business or locate its management within the nation of its incorporation. So a company organized in France that transfers its real seat to Germany must re-incorporate in Germany.
c. More Differences
There are thus clear difficulties in the cross-border recognition of business entities in the EU that do not exist in the US, where it is easy to change the laws that control an entity's governance simply by switching the state where it is organized.
In the EU, though, a Real Seat company must first liquidate or wind up its affairs before changing corporate jurisdiction. Management will therefore think twice before deciding to move its operations. And because of this difficulty, the concept of "forum shopping" for a favorable state of corporate domicile will probably be new to a foreign company looking to set up a US subsidiaryespecially if it is from a "Real Seat," EU member nation.
II. Maintaining the Corporation
a. Basic Structure
This article will compare US corporation structures with those of the German corporation, which may vary from entities elsewhere in the EU though most jurisdictions there are similar to one another in their structural requirements for corporations.
In Germany, for example, a publicly held entity is called an Aktiengesellschaft ("AG"), and its governance rules are set forth in the Aktiengesetz ("Stock Corporation Act"). German corporate structures might be considered somewhat rigid in comparison with those of US states' corporation laws.
b. Registration / Formation
While a German AG is registered with its local chamber of commerce, a US corporation usually is registered only with the Secretary of State of its domicile and also that of any state where it is considered to be doing business. An AG must have its articles of incorporation reviewed and authorized by a notary and, among other things, entered in the Register (Registrar) of Companies before announcing the company in writing at the local court. After the local court checks the documents submitted for accuracy and completeness, the corporation is added to the German Register of Companies.
The US process of filing articles of incorporation or a corporate charter is fairly simple by contrast, and most paperwork to complete and maintain a charter can now be found on most states' Web sites3. However, due to the need for competent review and interpretation of these documents, and legal representation in other areas, it is strongly advised to engage a US law firm for such activities.
c. Board Structure
A German corporation maintains three distinct components: a will of the shareholders as expressed at a general meeting of shareholders ("Vorstand"), an executive committee, and a supervisory board ("Aufsichsrat").
At the general meeting of an AG, shareholders may elect an auditor, discharge the executive committee and supervisory board, amend articles of incorporation, and elect representatives to the supervisory board. A German management board must obtain shareholder approval for each new share issuance. Shareholders may give advance approval of a new issuance, but it must be very specific in nature.
Like the German AG, a US corporation must obtain shareholder approval to increase authorized capital. But, in the US, shareholders may increase authorized capital prospectively, to create a reservoir from which directors may issue new shares from time to time as they see fit.
The mechanics of shareholder voting are very different in the US compared with Germany. Unlike the highly formal requirements of the Aktiengesetz, most US states' corporation laws provide that almost any action requiring approval through a vote at a general or special meeting of the shareholders may be approved with written consent instead of an actual meeting.
The executive committee manages the German AG and represents it to third parties. These functions typically resemble those of senior executives of a US corporation, but the members of a German executive committee, including chairman or speaker, are regarded as peers and thus share a collective responsibility for all management decisions. The roles of US officers are, by contrast, much more hierarchical.
Another difference is that, while the German corporation's executive committee and supervisory board must, by public policy, also consider interests of outsiders such as company employees and the general public, US corporations, for the most part, are required only to take into account the interests of shareholders.
The supervisory board of a German AG oversees the company's executive committee and appoints its members, consisting of shareholder and employee representatives. Members of the supervisory board generally may not be involved in day-to-day management. Depending on the company, up to half of supervisory board members might be elected by the AG's employees.
By contrast, the US corporation operates under a single board of directors consisting usually of significant investors, industry personages and sometimes, in the largest corporations, people with political connections. A US company's chief executive officer reports to this board, whose chief function is to oversee the performance of the company's officers for the benefit of the stockholders.
d. Board Control
Another example of management-friendliness in the US is that, whereas the recipients of dividendsthe shareholdersdeclare dividends in Germany, US directors bear sole responsibility to do so. US Directors also usually may approve and modify a company's by-laws, but in Germany, most governing elements are stated within the articles of incorporation, a document that is harder to modify.
A US board of directors will, typically, in the wake of the takeover wars of the 1980s, stagger its member elections. For example, a nine-member board will have only three members come up for election in given year, potentially thwarting any shareholder insurgency for two years.
While state laws in the US place few restrictions on the composition and activities of the board of directors, certain US federal considerations must now be taken into account by larger companies. Companies whose shares are publicly traded, must, for example, observe the proxy rules of the Federal Exchange Act of 1934 in communicating with shareholders, especially regarding contested elections of directors.
In addition, corporations listed on stock exchanges such as the NYSE or NASDAQ must, under the combination of federal accounting and exchange listing rules referred to generally as Sarbanes-Oxley, enforce certain corporate governance controls that exceed US state requirements, including matters such as:
- audit committees;
- independent directors; and
- mandatory shareholder approvals of certain transactions.
e. Liability Issues
A German AG's management board bears a duty to exercise the care of a diligent and prudent business executive. Since 1977, Germany has had a business judgment rule and the Corporate Governance Code committee. This is roughly similar to the potential liability faced by every US director for negligent exercise of his oversight responsibility.
To be continued...
Comment: The foreign company will find US company laws fairly accommodating, but also quite different. Use a local attorney, to help navigate those differences.
1Mr. von Taube is a 2006 Juris Doctor candidate at the Widener University School of Law, in Wilmington, Delaware
2See, e.g., Massachusetts' New Business Corporation Act - New Chapter 156D Compared with Old Chapter 156Bby one of the authorsreviewing some recent changes to the corporation law enacted by a prominent US industrial state.
3 See, for example, the site of the Corporations Division of the Massachusetts Secretary of State
© ASSOCIATION OF INDEPENDENT GENERAL COUNSEL 2005; (all rights reserved). This article is not intended as legal advice. Consult a qualified attorney for assistance concerning a specific issue or problem.