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

In the U.S., corporations can be incorporated in any of the 50 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, since they only shift rules that address the shareholders - board relation, while creditors and other stakeholders are not affected.In the E.U., 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 has opened the doors to freedom of reincorporation from one member state to another. In the E.U., reincorporations have a much different impact than on the other side of the Atlantic, since 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 E.U., therefore, any change of the applicable corporate law risks to jeopardize creditors. Sophisticated creditors will discount this risk from the credit rate or will protect themselves through specific covenant, but non-sophisticated creditors will bear entirely the risk of opportunistic reincorporations. For this reason, many E.U. 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.