The Function of Corporate Law and the Effects of Reincorporations in the U.S. and the EU

Abstract

In the U.S., corporations can be incorporated in any of the fifty states and can
“reincorporate” afterwards in any other state. However, the competence of the state where a
company is incorporated is limited: on the one hand, it is restricted by federal laws and, on the
other hand, it regulates only the “internal affairs” of corporate activities. Consequently, in the U.S.
reincorporations are a relatively easy task, because they only shift rules that address the
shareholder—board relation, while creditors and other stakeholders are not affected.
In the EU, we find a partially similar scenario. In the last decade, the European Court of
Justice has liberalized initial incorporations and in 2005 the cross-border directive opened the
doors to freedom of reincorporation from one Member State to another. In the EU, however,
reincorporations have a much different impact than on the other side of the Atlantic, because the
agency problems between shareholders and the board are bundled with the agency problems
between shareholders and creditors, all being in the competence of the Member State of
incorporation. In the EU, therefore, any change of the applicable corporate law risks jeopardizing
creditors. Sophisticated creditors will discount this risk from the credit rate or will protect
themselves through specific covenant, but unsophisticated creditors will bear entirely the risk of
opportunistic reincorporations. For this reason, many EU Member States provide mechanisms for
creditors’ protection in case of reincorporation, often by requiring the debtor to give a security or to
pay the debts that are not yet due. These mechanisms are aimed at avoiding negative externalities,
yet they make reincorporations more expensive and will impede a certain number of efficient
transactions.