The scope of application of freedom to establishment to cross-border conversions: The Opinion of the Advocate General in the Polibud case

Under EU law a cross-border conversion is a process by which a company incorporated in a EU Member State, relying on the freedom of establishment enshrined by the EU Treaties, converts into a type of company governed by the law of another EU Member State, the country of destination. The Opinion recently delivered by the Advocate General (AG) Kokott in Polbud (Case C-106/16, ECLI:EU:C:2017:351) has considered a peculiar form of cross-border conversion whereby the moving company transferred its statutory seat abroad but it retained the centre of its commercial activities in the Member State of origin. What the AG was asked was whether a company that puts in place this form of cross-border conversion can enjoy the freedom of establishment. The AG concluded that the freedom of establishment applies to such transactions provided that the company transferred its seat to pursue a genuine economic activity in the country of destination.

The legal background

In essence, the AG had to assess whether the restrictions imposed by the Polish authorities to an outgoing domestic incorporated company infringed Articles 49 and 54 TFEU. The CJEU has already dealt with outgoing restrictions of cross-border conversions in Daily Mail (Case 81/87, ECLI:EU:C:1988:456), Cartesio (Case C-210/06, ECLI:EU:C:2008:723) and VALE (Case C-378/10, ECLI:EU:2011:841). By the above judgments, the CJEU clarified that companies are creatures of the national laws of Member States, which have the power to apply their own connecting factors to national companies. Member States are also empowered to decide that national companies have to maintain a certain connection with the legal system under which they were incorporated. Member States that allow internal conversions shall also allow cross-border conversions. The legality of restrictions on cross-border conversions is to be assessed on the basis of the Gebhard test, whereby the restrictive national measures have to be necessary and proportionate to the aim of protecting the general interest. National measures imposing a complete prohibition of cross-border conversions are unlikely to pass the Gebhard test.

Moreover, in Cartesio, the CJEU ruled that the transfer of the seat of a company to another Member State, with the ensuing modification of the lex societatis, is covered by the freedom of establishment. Accordingly, the Member State of origin may not prevent the relocation of the company by imposing the winding up or liquidation of it. As a way of obiter dictum, whose force of binding precedent was unclear, the CJEU also added that moving the statutory seat of the company and altering the originally applicable national law to it falls outside the freedom of establishment and can be blocked by the Member State of origin. As hinted above, the peculiarity of the facts of the case in in Polbud, was that the company only transferred its statutory seat or registered office but not the centre of the economic activities or its head office. In light of the CJEU case law, it was uncertain whether the principle of the freedom of establishment could be invoked for this form of conversion too.

In addition to the general rules on the freedom of establishment in the EU Treaties, companies intending to implement a cross-border conversion can also rely on EU secondary law provisions on the Societas Europaea or SE (Regulation 2157/2001/CE) and on cross-border mergers (Directive 2005/56/EC). However, executing cross-border conversions in compliance with Directive 2005/56/EC requires substantial time and financial resources. And, because a SE must have a minimum legal capital of € 120,000.00, smaller companies cannot form an SE to transfer their seats abroad.    

The facts of the case

Polbud is a private company incorporated under Polish company law. On 30 September 2011, its members passed a resolution to transfer its statutory seat from Poland to Luxembourg though it continued carrying on its economic activities in Poland. On 19 October 2011 Polbud filed an application to the competent registry court to start its liquidation procedure. However, on 28 May 2013, before the termination of the liquidation procedure and without forming a new company, the Polbud’s members resolved to transfer the company’s seat to Luxembourg, with effect from that date. The members also agreed that Polbud would take the legal form of a private limited liability company governed by Luxembourg law and be renamed as Consoil Geotechnik Sarl (Consoil). Then, on 24 June 2013, Polbud applied to the registry court to be removed by the commercial register.

This application was rejected by the registry court as well as the appeals subsequently filed against that decision. In June 2014 Polibud lodged an appeal with the Polish Court of Cassation. It contended that when it transferred its statutory seat to Luxembourg it became a company governed by the law of that country. Hence, the liquidation procedure had ended and Polibud should have been removed by the Polish register.

The Court of Cassation stayed proceedings and referred to the CJEU the following preliminary questions:    

‘1.      Do Articles 49 and 54 TFEU preclude the application by a Member State, in which a [private limited liability] company was initially incorporated, of provisions of national law which make removal from the commercial register conditional on the company being wound up after liquidation has been carried out, if the company has been reincorporated in another Member State pursuant to a shareholders’ decision to continue the legal personality acquired in the State of initial incorporation?

If the answer to that question is in the negative:

2.      Can Articles 49 and 54 TFEU be interpreted as meaning that the requirement under national law that proceedings for the liquidation of the company be carried out — including the conclusion of current business, recovery of debts, fulfilment of obligations and sale of company assets, satisfaction or securing of creditors, submission of a financial statement on the conduct of those acts, and indication of the person to whom the books and documents are to be entrusted — which precede the winding-up thereof, which occurs on removal from the commercial register, is a measure which is appropriate, necessary and proportionate to a public interest deserving of protection in the form of safeguarding of creditors, minority shareholders, and employees of the migrant company?

3.      Must Articles 49 and 54 TFEU be interpreted as meaning that restrictions on the freedom of establishment include a situation in which — for the purpose of conversion to a company of another Member State — a company transfers its registered office to that other Member State without changing its place of principal establishment, which remains in the State of initial incorporation?’

The analysis of the AG

The AG started her analysis by tackling the third preliminary question which could be bogged down on whether the Polbud’s conversion was protected by the freedom of establishment. In that regard, the AG reminded that the concept of establishment in Article 54 TFEU ‘involves the actual pursuit of an economic activity through a fixed establishment in that State for an indefinite period’ and ‘it presupposes actual establishment in the host Member State and the pursuit the of genuine economic activity there’ (para. 34). Accordingly, the freedom of establishment should only apply to transactions involving actual establishment. This is the case with a cross-border conversation that is accompanied by actual establishment and not where the conversion is an end in itself. The requirement of actual establishment is met when in the host Member State there exist a level of infrastructure such as to enable an economic activity to be pursued there on a stable and continuous basis. Also, the mere intention to effect such establishment may be sufficient.

Hence, the AG concluded that to the reply to the third question is that ‘the freedom of establishment provided for in Articles 49 and 54 TFEU applies to an operation whereby a company incorporated under the law of one Member State transfers its statutory seat to another Member State with the aim of converting itself into a company governed by the law of the latter Member State, in so far as that company actually establishes itself in the other Member State, or intends to do so, for the purpose of pursuing genuine economic activity there. This does not detract from the power of the latter Member State to define both the connecting factor required of a company if it is to be regarded as incorporated under its national law, and the connecting factor required to maintain that status’ (para. 43).

The finding that the determination of the connecting factors of companies falls within the jurisdiction of Member States is consistent with the past case law of the CJEU. Yet, the AG seems to have departed from case law when she considers the pursuit of a genuine economic activity in the country of destination as a condition for the exercise of the freedom of establishment. Distinguishing Polbud from Centros and Inspire Art on their facts, the AG argued that her Opinion confirmed and did not change the previous case law. She explained that Centros (Case C-212/97, ECLI:EU:1999:126) and Inspire Art (Case C-167/01, ECLI:EU:C:2003:512) dealt with immigration of a company towards the country where its owners resided. In Polbud, instead, a company intended to change its legal form but not move the main place of activities.

The AG also argued that her conclusions did not conflict with the rulings in Cartesio. She noted that, unlike Polbud, Cartesio concerned an outgoing transfer of the seat of the company without a change in the law governing it. Bearing in mind the principal findings and the facts of Cartesio, the AG said that the above quoted obiter dictum in that judgment should not be read in the sense that any cross-border conversion is within the scope of the freedom of establishment regardless of the existence of any act of establishment. On the contrary, Cartesio means that, to determine whether a cross-border conversion is within the scope of freedom of establishment, it must be established whether the transfer of seat entails or not a change in the law governing the company.

The next step in the analysis of the AG Kokott was to reply to the first preliminary question, which focused on whether the national measure under scrutiny constituted a restriction of the freedom of establishment. According to the settled case-law of the CJEU, all measures which prohibit, impede or make less attractive the exercise of the freedom of establishment must be regarded as restrictions on that freedom. On one side, the relevant Polish rules allowed Polbud to keep its legal personality under the newly-formed Luxembourg corporate vehicle, Consoil; but, on the other side, Polish law laid down that the resolution to transfer a company’s seat had to be followed by opening of the liquidation procedure of the company and its wining up. The conclusion reached by the AG was that the Polish authorities’ refusal to remove Polbud from the commercial register, unless it is first liquidated and wound up, impedes the completion of the cross-border conversion. And this refusal amounted to a restriction of the freedom of establishment.

Finally, the AG considered the second preliminary question, which regarded the issue whether the national restrictive measures could be justified by overriding reasons in the public interest. Poland submitted that its national measures were justified by the need to combat abusive practices as well as in the protection of the interests of creditors, minority shareholders and employees.

 The AG dismissed as superfluous the Poland’s defensive argument that the imposition of the liquidation of the relocating company was an appropriate tool to prevent abuse of domestic law. This argument was solely based on the assumption made by Poland that Polbud intended to move abroad with the only aim of changing its applicable law. However, as indicated above, a cross-border conversion being made not to pursue a genuine economic activity in the country of destination is outside the freedom of establishment. Moreover, the AG also said that the requirement of the liquidation procedure was not proportionate to the aim of combating abusive practices, resulting in an impermissible general presumption of an abuse.

Equally, the liquidation procedure was not an appropriate tool to protect the interests of creditors, minority shareholders and employees. The liquidation would imply the termination of the legal relationships between the company and those persons who, accordingly, have to rely on the proceeds of the liquidation to satisfy their claims against the company. 

Concerning the protection of creditors, AG pointed out that if the conversion harms their interests, the creditors of Polbud could ask the company for appropriate safeguards. In any event, considering that the real seat of Polbud will remain in Poland, creditors can still sue it before Polish courts. The AG also found that an appropriate approach to protect minority shareholders, whose legal status might be negatively affected by the change of the governing law, is to enable those that opposed to the conversion to sell their stake in Polbud for a fair price. As for the protection of employees, the AG observed that there is no difference between a cross-border conversion and a cross-border merger. Accordingly, she suggested that it would be appropriate for the Member State of origin to require the relocating company to comply with the measures for the safeguard of employee’s interests laid down by Directive 2005/56/EU.

In conclusion, the reply to the second preliminary question is that ‘All things considered, the answer to the second question must be that the general obligation to carry out a liquidation procedure does not constitute a proportionate means of protecting the creditors, minority shareholders and employees of a company that performs a cross-border conversion’ (para. 66).

Practical implications

If the Opinion of the AG is confirmed by the CJEU, Polbud will be likely to have important consequences on the mobility of companies across the EU internal market. The AG seems to require a further qualification for the application of the freedom of establishment to a cross-border conversion in the need that such a transaction is to be implemented to pursue a genuine economic activity. Businesses might no longer be allowed to incorporate in a Member State only to use a type of companies provided for by the national law of that country without running there any economic activity. No such further qualification, however, was laid down by the past judgments of the CJEU. The idea emerging from the more liberal past case-law, and namely from Centros, is that businesses are free to incorporate a company in the Member State, whose legal requirements better fit their needs, and carry out economic activities in other another Member State. Though the AG distinguished Polbud from Centros on the facts of the case, her reasoning in Polbud seemed to depart from the past case law of the CJEU on the mobility of companies.

Further side effects of Polbud might affect the connecting factors to determine the law applicable to companies. By implying that the statutory seat should be located in the same country as the centre of its economic activities, the AG appeared to have taken a position more favourable to the real seat doctrine. Also in this aspect, the AG apparently moved away from the past cast law that was more biased to the incorporation doctrine.