Hard Brexit: company law and governance implications

In a previous post, I discussed the three main Brexit scenarios and their potential impact on the UK company law in general. This post will look in more detail at two corporate law and governance areas that are likely to be affected by a hard Brexit: corporate cross-border mobility and risk management.

The first step in the exit process is for the UK to notify the European Council of its intention to withdraw, as required by Article 50 of the Treaty on European Union (TEU).[1] An Article 50 notice is irrevocable and cannot be given conditionally, so the inevitable result of issuing it will be that the UK will leave the EU.[2] The EU Treaties will cease to apply to the UK from the date of entry into force of the withdrawal agreement or, failing that, two years after the UK submits its notification of intention to withdraw, unless the 27 remaining Member States unanimously decide to extend this period.

The impact of Brexit on the role of EU law in the UK is not entirely clear. On October 2, Prime Minister Theresa May announced plans to introduce a “Great Repeal Bill” in 2017. The proposed Bill will repeal the European Communities Act 1972, thus removing the supremacy of EU law over domestic law in case of conflict, as well as the binding force of the Court of Justice of the EU decisions. The Bill will incorporate into UK law the full body of EU law not already implemented. It is unclear, however, whether the Bill will transpose EU law into domestic law without amendments, or will include material changes that will come into force after Brexit. It is also unclear whether the transposed law will continue to be updated in line with the changes made in the EU, and whether the UK courts will continue to look to the CJEU for guidance on interpreting the transposed EU law.[3]

Until the completion of the Art 50 procedure, and irrespective of the Brexit model adopted, the UK will remain a Member State of the EU and will remain bound by EU law. The trajectory of the UK company law upon completion of the Article 50 procedure will depend on the negotiated terms. Although there is great uncertainty about the Brexit model and process, commentators seem to agree that a hard Brexit scenario, involving a complete split from the EU with limited or no participation in the single market, will have no significant effect on the UK corporate law in the short term, with a few exceptions. These exceptions include freedom of establishment and risk management and disclosure.

The freedom of establishment and corporate mobility

Art 54 of the Treaty for the Functioning of the European Union (TFEU) provides for the right of establishment for companies or firms formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the Union. Such companies or firms enjoy the same rights conferred to natural persons by Art. 49 TFEU. In practice, taking advantage of the freedom of establishment is rendered more difficult by the differing legal traditions of the Member States as regards the conflict of laws rules that determine the applicable company law. Most continental EU jurisdictions (e.g. France, Germany) adopt the real seat theory, which determines the applicable company law based on the location of the company’s center of management and control. Under the incorporation theory (adopted, for example, in Scotland, England or the Netherlands), the applicable company law is determined by the jurisdiction where the company is incorporated. The jurisprudence of the CJEU has contributed significantly to reconciling the two doctrines, thus safeguarding the corporate mobility within the single market.[4] In light of the latest judicial developments, a host member state has an obligation to recognise a company duly incorporated in another member state, irrespective of the conflict of law rule of the host state. The host state may apply its own law only to the extent that this is justified in order to protect imperative requirements in the public interest.

In a hard Brexit scenario, the UK will acquire a third country status, which means that UK companies may no longer enjoy the same freedom of establishment as the other companies incorporated in the EU. The corporate mobility of businesses incorporated in the UK and seeking to establish themselves in the rest of the EU will be determined by the relevant private international rules concerning the law applicable to foreign legal persons. Following Brexit, companies registered in one of the UK jurisdictions but having their central administration in a real seat country (such as Germany) risk to be regarded as unincorporated associations, resulting in the removal of the corporate veil and of the limited liability of shareholders. This is likely to affect a significant number of foreign businesses incorporated in the UK. Following Centros, the UK attracted numerous foreign businesses, driven by lower incorporation costs, less restrictive minimum capital requirements and a flexible company law. [5] Consequently, it seems that the safest option for companies incorporated in the UK for legal arbitrage purposes, which have their central administration in real seat countries, is to convert into a company form of another member state prior to the implementation of Brexit.[6] At the same time, if UK chooses a hard Brexit it will no longer be bound by the CJEU decisions on freedom of establishment, and may implement restrictions on corporate mobility aimed at discouraging companies from fleeing the UK. Such measures may prevent some companies from migrating, but at the same time may reduce the attractiveness of UK as a place of incorporation.

Risk management and disclosure obligations

A hard Brexit will also require UK companies that have significant business relations with the rest of the EU to reassess their risk management and oversight systems, and to communicate to their relevant stakeholders the nature and extent of the impact of Brexit on their business.

The UK Corporate Governance Code 2016, which is applicable to companies with a Premium Listing at the London Stock Exchange on a comply or explain basis, stipulates certain obligations with respect to risk management and oversight. Listed companies must establish “a framework of prudent and effective controls which enables risk to be assessed and managed”,[7] ensure that their “financial controls and systems of risk management are robust and defensible”,[8]  and carry out “a robust assessment of the principal risks […], including those that would threaten its business model, future performance, solvency or liquidity”.[9] Depending on the company’s size, field of activity and the extent of its trading relations with the EU, the impact of Brexit on companies’ risk profile may vary. All large companies, however, are likely to be affected in the medium or long term by issues such as market volatility and the fluctuation in value of the British pound (with consequences on exchange rates, import and export costs); cash flow risks resulting from decreased consumer spending, loss of international or EU-based customers, suppliers or investors; or other exposures in the supply chain, resulting from solvency risks of trading partners. [10] Moreover, companies seeking to raise new capital through issuance of new debt or equity securities will have to disclose in their prospectus any material business risks resulting from Brexit, and the mechanisms that the company has in place to manage them. Some companies may even consider establishing a dedicated Brexit response committee, in charge of coordinating the companies’ risk management oversight systems across all areas of business.[11]

[1] Art. 50 (2) of TEU states that the Member State which decides to withdraw “shall notify the European Council of its intention. In the light of the guidelines provided by the European Council, the Union shall negotiate and conclude an agreement with that State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union.” Currently, the anticipated date of an Article 50 notice is March 2017. This date may be delayed by the pending Supreme Court litigation regarding the Government’s power to serve the notice without prior approval of the Parliament. The notice may also be deferred until after the French and the German elections of spring and autumn 2017, respectively.

[2] The irrevocable nature of an exit notification is subject of academic debate. It might be for the Court of Justice of the EU to decide whether Article 50 is revocable. See House of Commons Library, “Brexit Unknowns”, Briefing Paper No 7761, 9 November 2016, p. 6.

[3] House of Commons Library, “Brexit Unknowns”, Briefing Paper No. 7761, 9 November 2016, p 7.

[4] Daily Mail [1988] ECR 5483, Centros Ltd. v Erhvervs-og Selskabsstyrelsen, [1999] ECR I-1459, Überseering B.V v Nordic Construction Baumanagement GmbH [NCC], [2002] ECR I-9919, Inspire Art [2003] ECR I-10155, Cartesio [2008] ECR I-9641 and VALE Építési kft. [2012] EUECJ C-378/10.

[5] Marco Becht et al, “Where do Firms Incorporate? Deregulation and the Cost of Entry” (2008) 14 Journal of Corporate Finance 241.

[6] Such conversion may be achieved via a cross-border merger or through a cross-border conversion, in light of Cartesio and VALE. See Michael Schillig, “Corporate Law after Brexit”, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2846755

[7] Principle A.1

[8] Principle A.4

[9] Principle C.2

[10] For a more detailed review of these risks see “Slaughter and May, “Brexit Essentials: Navigating Uncharted Seas; A Practical Guide for Businesses” (2016)

[11] Ibid.

What would a hard Brexit mean for company law?

On June 23, the UK voted in favour of leaving the European Union. The Leave campaign won 51.9% of the votes across the UK, while Remain won 48.1% of the votes.[1] Many aspects relating to the exit procedures or the legal and economic consequences of Brexit are unclear or unknown. The impact of Brexit on the UK company law and on the future development of the EU company law is equally uncertain. Although the details of the UK’s future relationship with the EU are likely to remain uncertain for several years, three main scenarios have emerged as potential Brexit models.

The ‘Norwegian model’ has the least severe consequences for the continuation of the existing UK-EU relations. Under this model, the UK would leave the EU but join the European Free Trade Association (EFTA) and the European Economic Area (EEA). It would retain access to the single market, in exchange for accepting the principles of free movement of goods, services, capital and persons. The EU company law framework would continue to apply, as EU legislation having EEA relevance.[2] The main downsides of this model are UK’s loss of voice in the EU law making process, and a continuing obligation to contribute financially to EU’s budget.

The ‘Swiss model’ is a compromise between a soft and a hard Brexit. Under this model, the UK would leave the EU and join EFTA but not the EEA. The Swiss Model would allow access to the single market only in the sectors agreed upon with the EU. The UK would be required to comply with the EU-derived corporate laws and regulations only to the extent that such instruments are relevant to the limited areas of access to the single market. Similarly to the Norwegian model, the UK would lose its decision-making rights as regards EU law, and will have to contribute to the EU budget (albeit a smaller amount than under the Norwegian model).[3]

The more radical option, often referred to as a ‘hard’ or ‘clean’ Brexit, would involve a total exit from the EU and the single market. It is likely that, in the short term, the UK would continue to trade with the EU within the framework of the World Trade Organisation (WTO). In the longer term, it could seek a customs union (the ‘Turkish option’), or seek to negotiate a new, bespoke free trade agreement (the ‘Canadian option’). The hard Brexit model would allow the UK extensive freedom to adjust its company law regime in order to make it more attractive for foreign businesses, as compared to the EU regime. The UK could pursue a deregulatory agenda in areas often considered burdensome for business. A recent study by the British Chamber of Commerce found that among the EU instruments that impose the highest financial costs on businesses are the Working Time Directive, the Pollution Directive, the Data Protection Directive and the Directive on the Sale of Consumer Goods.[4] In corporate law, the UK could create a simplified, more attractive regime by derogating from legal provisions that it opposed or considered cumbersome.

For example, the UK could abolish the requirement for shares to have a nominal value, the minimum share capital for public companies, the prohibition on the giving of financial assistance by public companies, or the prospectus form and content requirements imposed by the Prospectus Directive. The UK would also be freed from the obligation to implement the proposed Directive for improving the gender balance in the boards of listed companies, which sets a quantitative objective of at least 40% representation for each gender among non-executive directors by 2020. In other areas where the UK has been supportive of EU developments, such as the Shareholder Rights Directive II, or the Fourth Money Laundering Directive, the UK and EU laws are likely to remain aligned. Such deregulatory measures will render the UK more attractive to businesses focused on the UK domestic market or on non-EU countries. Businesses trading with the EU would continue to be bound by EU requirements (for example in areas such as consumer protection, or for the purpose of  financial services passports) and thus may have to comply with two potentially divergent sets of rules.

The Norwegian and Swiss models have the least impact on the future trajectory of the UK and EU corporate law and governance. They are, however, the least likely to be adopted. On the UK side, restricting the freedom of movement of persons by controlling immigration was a key issue on the Leave agenda, and remains a priority for the new Government.[5] On the EU side, the leaders of the EU Member States have recently dismissed any prospect of the EU retaining access to the single market without also accepting free movement of persons.[6]

The impact of a hard Brexit on the future of the UK and EU company law and governance is difficult to predict. Two aspects that are likely to be affected by a hard Brexit are the freedom of establishment of companies and the companies’ obligation to oversee and disclose their risks associated with Brexit. Overall, commentators appear to agree that fundamental corporate law revisions are unlikely to be a political priority post Brexit. The UK company law has recently undergone an extensive update and recodification process, resulting in the Companies Act 2006. Moreover, the current law enjoys a positive international reputation for stability and effectiveness, which the UK will seek to maintain post-Brexit.

[1] The Electoral Commission, “EU referendum results

[2] See Article 77 and Annex XXII of the EEA Agreement.

[3] It is estimated that the UK’s contribution to the EU budget would fall by about 59% under the Swill Model and by around 17% under the Norwegian Model. See Gavin Thompson and Daniel Harari, “The Economic Impact of EU Membership on the UK”  House of Commons Library (2013) pp 25-26.

[4] British Chambers of Commerce, “The Burdens Barometer” (2010)

[5] In an official statement in the House of Commons, David Davies, Secretary of State for Exiting the European Union, declared that the UK aims to “create an immigration system that allows us to control numbers and encourage the brightest and the best to come to this country.” (“Exiting the European Union: Ministerial Statement”, 5 September 2016). Similarly, in her speech at the 2016 Conservative Party conference, the Prime Minister Theresa May stated: “But let me be clear. We are not leaving the European Union only to give up control of immigration again. And we are not leaving only to return to the jurisdiction of the European Court of Justice.” (Theresa May, “Britain after Brexit: A Vision of a Global Britain”, 2 October 2016).

[6] “In the future, we hope to have the UK as a close partner of the EU and we look forward to the UK stating its intentions in this respect. Any agreement, which will be concluded with the UK as a third country, will have to be based on a balance of rights and obligations. Access to the Single Market requires acceptance of all four freedoms.” (the European Council and the Council of the European Union, “Informal meeting at 27: Statement”, 29 June 2016).