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.