By Lucas Nacif, LLB Candidate at the Dickson Poon School of Law, King’s College London
Introduction
In Re Easynet Global Services Ltd[1] (“Re Easynet”) the Court of Appeal considered the scope of the Companies (Cross-Border Mergers) Regulations 2007 (“Cross-Border Regulations” or “the Regulations”), [2] which transposes the Cross-Border Mergers Directive 2005/56/EC[3] (“Cross-Border Directive” or “the Directive”) into domestic law.
For the first time the Court of Appeal decided on whether the Cross-Border Regulations can be triggered by the inclusion of a dormant EU subsidiary in mergers.[4] Significantly, reversing the decision of the Companies Court, the Court of Appeal adopted a pragmatic approach to the issue and decided that this is indeed the case.
In the following lines, I will firstly provide a factual and legal background of the Re Easynet decision. I will then analyse the significance of the Court of Appeal’s decision in facilitating future cross-border merger practices for British businesses. Finally, I will comment on the potential significance that Re Easynet has on cross-border merger practices after Britain leaves the European Union.
Facts
The case in Re Easynet Global Services Ltd involved the merger of 22 companies into one. The appellant (Easynet) was the transferee company.[5]
21 of the 22 companies were registered in the UK, whilst only one company was registered in the Netherlands. The Dutch company was dormant, meaning that it had never traded, nor did it have any appreciable assets or liabilities. Instead, the company only existed so that the merger had a cross-border element to trigger the application of the Regulations. Indeed, it will be seen below that the Cross-Border Regulations can only apply to situations that are not purely “internal”, that is, regulated merely by national law.[6]
The merging companies’ interest in triggering the application of the Cross-Border Regulations – which led them to use a dormant company – lays in the fact that the EU regime is normally considered to be far more attractive than the domestic alternatives – be it a scheme of reconstruction, governed by s.900 of the Companies Act 2006, or a scheme of reconstruction governed by s.110 of the Insolvency Act 1986.[7]
Indeed, under the Insolvency Act 1986, [8] which enables a company to be voluntarily wound up in order for it to be wholly or partly transferred or sold to a transferee company, tax implications and reputational risks of associating the company with insolvency[9] make it an unpopular route. The procedure under s.900 of the Companies Act 2006, [10] which enables a transfer of undertakings, is also disadvantageous as transferring contracts from transferor companies into the transferee company is difficult:[11] the transfer can only arise through a deed of novation, which requires the consent from third parties who have contractual relations with the transferor companies.[12]
Pursuant to the procedural obligations under Regulation 11 of the Cross-Border Regulations, the transferee company had to seek permission from the Companies Court to convene a meeting of its sole shareholder so that the merger could take effect.[13]
At the Companies Court,[14] Birss J held that the proposed merger was not within the scope of the Cross-Border Regulations as the cross-border element achieved by the dormant was purely “formal”. For Birss J, the merger was thus “not, in reality, a cross-border merger at all” and Regulation 11 of the Cross-Border Regulations thus could not apply.[15] Therefore Birss J held that the court should refuse to sanction it, as the use of the dormant Dutch company as a mere “device” constituted an “abuse of right”.[16]
Easynet appealed Birss J’s decision, arguing that the proposed merger arrangement did fall within the Cross-Border Regulations, and that the use of a dormant Dutch company was perfectly legitimate and it did not constitute any abuse of right.[17]
The Law
Cross-Border Directive
The implementation of the Cross-Border Directive facilitates the right to free movement of establishment under Article 49 of the Treaty on the Functioning of the European Union (“TFEU”).[18]
The Directive applies if the proposed merger involves at least two companies governed by the laws of different Member States.[19] By reducing administrative and legal obstacles, the Directive aims to create favourable conditions for companies to carry out cross-border mergers,[20] and, by that token, facilitates the free movement of establishment and capital within the European Union.[21]
For this reason, when implementing the Directive, Member States can only introduce more restrictive measures when justified under CJEU case law or because of overriding requirements, subject to the principle of proportionality.[22]
Abuse of right
The principle of “abuse of right” – invoked by Birss J – is recognised as a general principle of EU law and finds its origin in the “common legal traditions” of the Member States.
The principle prohibits legal and natural persons from taking advantage of EU law in an improper or fraudulent manner.[23] Its raison d’être is to prevent individuals from exercising their legitimate legal rights for illegitimate purposes[24] or artificially creating the conditions to obtain particular benefits derived from EU law.[25]
When courts consider whether the exercise of legal rights constitute an abuse of right, they balance that consideration with the importance of legal certainty and the commercial realities behind transactions, namely that individuals are entitled to advance their own financial interests.[26]
The Court of Appeal’s Decision
On appeal, Birss J’s decision was reversed: the Court of Appeal decided that the proposed merger by Easynet fell within the scope of the Cross-Border Directive and Regulations.[27]
The Court based its reasoning on the following points. Firstly, notwithstanding the overriding requirement of protecting the interests of members and others, the Directive does not identify any other justification for a member state to restrict the exercise of the right to freedom of establishment.[28] Hence, impeding this proposed merger would constitute a material restriction of the freedom of establishment. This point was acknowledged by Sales LJ who recognised the “commercial importance” of promoting flexibility, cost savings, and minimising tax liabilities when companies make decisions regarding their corporate structures.[29]
Secondly, the proposed merger arrangement in Re Easynet was held not to constitute an abuse of right as the companies involved were exercising their legitimate freedom of establishment rights, consistent with the Directive’s aim of facilitating cross-border mergers.[30] On this point, Sales LJ observed that there was nothing in the case that suggested that the companies were using their rights under article 49 TFEU “for a purpose other than that for which they exist”, or for a “collateral purpose other than what was contemplated when rights of this wide ambit were created”.[31] Davis LJ also took the view that taking advantage of a dormant Dutch company in order to have a cross-border element did not constitute an abuse of right, as the appellants were pursuing “legitimate commercial considerations and objectives”.[32]
Analysis
By allowing the appellants to rely on the Cross-Border Regulations, the Court of Appeal greatly facilitated the appellants’ merger, allowing them to avoid the more onerous schemes of reconstruction under s.900 of the Companies Act 2006 or s.110 of the Insolvency Act 1986.
Whereas Birss J’s decision was criticized by practitioners for causing uncertainty on the scope of the Cross-Border Regulations,[33] the Court of Appeal’s decision was welcomed[34] in that it simplifies companies’ internal restructuring, even when predominantly based in the UK.[35] Indeed, the Court of Appeal’s commercially pragmatic approach is in line with the Cross-Border Directive’s policy aim of facilitating the ability of companies to benefit from the right of freedom of establishment.[36] By refusing to adopt Birss J’s purposive approach, the Court of Appeal’s decision shows that Courts will not easily question the applicability of the Regulations to proposed cross-border mergers.
This decision is also in line with the case-law of the ECJ, under which incorporating a company in a member state solely to benefit from more favourable legislation does not constitute an abuse of right – even if the company conducts most of its activities in another member state.[37] More specifically, the Court tends to deem irrelevant the subjective reasons for a company incorporating in a particular Member State, unless fraudulent purposes emerge.[38] For instance, the subjective intention to avoid tax is not considered sufficient for there to be an abuse of right – and the courts are instead asked to look instead at objective factors to assess whether the individual’s exercise of his legal rights constitute an abuse of right.[39]
Practitioners note that Re Easynet may facilitate the restructuring of UK businesses in view of Britain leaving the European Union.[40]
However, it should also be noted that – as the Court of Appeal did not consider how the legal position could change after Brexit[41] – Re Easynet seems only beneficial for British businesses so long as they continue benefitting from the right to freedom of establishment under EU law.[42] Much will however depend on the Withdrawal Agreement with the EU.
Conclusion
The Court of Appeal’s decision in Re Easynet has been praised for its pragmatism, as it recognises and sanctions the legitimate commercial reasons of using a dormant company to trigger the Cross-Border Directive.
By allowing companies to rely on the Cross-Border Regulations by means of a dormant EU incorporated subsidiary, Re Easynet facilitates internal restructuring for UK companies so as to avoid the burdensome schemes of reconstruction under s.900 of the Companies Act 2006 or s.110 of the Insolvency Act 1986.
However, Re Easynet’s status after Brexit remains uncertain. As things stand, it appears that Re Easynet will only be useful in the short-term, so long as British businesses continue having the right to freedom of establishment under EU law. Until Brexit day, British businesses will be able to rely on the Re Easynet decision to prepare for the commercial uncertainty associated with Brexit, by restructuring their corporate structures by using the Cross-Border Regulations, which is far more advantageous than the procedure under the Companies Act 2006 or the Insolvency Act 1986.
What will happen afterwards remains greatly uncertain and will depend on the ongoing political negotiations with the EU.
[1] Re Easynet Global Services [2018] EWCA Civ 10
[2] ibid, [5]
[3] Council Directive 2005/56/EC on cross-border mergers of limited liability companies [2005] OJ L310/1
[4] ‘Katherine Apps in first Court of Appeal case on cross border mergers’, (Littleton Chambers, 24 January 2018), <http://www.littletonchambers.com/katherine-apps-in-first-court-of-appeal-case-on-cross-border-mergers-1221/>, Accessed 13 June 2018
[5] Re Easynet [2018], [2] – [4]
[6] Companies (Cross-Border Mergers) Regulations 2007, reg.2(2)
[7] Re Easynet [2018], [5] – [6]
[8] Insolvency Act 1986, s.110(1)
[9] Re Easynet [2018], [7]
[10] R. Bramwell Q.C., et.al., Taxation of Companies and Company Reconstructions (9th ed., Sweet & Maxwell, 2018), Vol. 3, Division W: Reconstructions, [W1.1.3]
[11] Re TSB Nuclear Energy Investment UK Ltd [2014] EWHC 1272 (Ch), [11] – [12]
[12] LexisNexisUK Blogs, ‘Court of Appeal overturns decision in Easynet cross-border case (Easynet Global Services Ltd)’, (LexisNexis Corporate Law, 22 January 2018), <https://blogs.lexisnexis.co.uk/corporate/court-of-appeal-overturns-decision-in-easynet-cross-border-case-easynet-global-services-ltd/>, Accessed 12 June 2018
[13] Re Easynet [2018], [4], [8]
[14] Re Easynet Global Services [2016] EWHC 2681 (Ch)
[15] ibid, [32]
[16] Ibid, [33]
[17] Re Easynet [2018], [12]
[18] C-411/03 SEVIC Systems AG v Amstgericht Neuwid, [19]; see also recitals (1) – (3) of Directive 2005/56/EC
[19] Article 1 of Directive 2005/56/EC
[20] European Commission, ‘Proposal for a Directive of the European Parliament and of the Council on cross-border mergers of companies with share capital – Explanatory Memorandum’, 18.11.2003, COM(203) 703, <http://www.europarl.europa.eu/meetdocs/2004_2009/documents/com/com_com(2003)0703_/com_com(2003)0703_en.pdf> at [1], Accessed 13 June 2018
[21] Recitals (1) – (2) of Directive 2005/56/EC
[22] Recital (3) of Directive 2005/56/EC
[23] C-321/05 Kofoed v Skatteministeriet, [38]
[24] Revenue and Customs Commissioners v Pendragon Plc [2015] UKSC 37, [5]
[25] C-110/99 Emsland-Starke GmbH v Hauptzollamt Hamburg-Jonas, [59]
[26] Pendragon Plc [2015], [5], [11]; see also Secret Hotels2 Ltd v HMRC [2014] UKSC 16, [57]
[27] Re Easynet [2018], [26] – [27]
[28] ibid, [29]
[29] ibid, [30] – [31]
[30] ibid, [35] – [36]
[31] ibid, [39]
[32] ibid, [59]
[33] Davis Polk & Wardwell LLP, ‘Life after Brexit: redomiciling in the European Union’ (Lexology, 16 August 2017), <https://www.lexology.com/library/detail.aspx?g=263fe581-c16f-4db6-8eb3-d296a28e7549>, Accessed 13 June 2018.
[34] Davis Polk & Wardwell LLP, ‘Cross-border mergers: recent case law upholding freedom of establishment’ (Lexology, 7 March 2018), <https://www.lexology.com/library/detail.aspx?g=2d327a84-a30e-448a-b9cd-46f9eeb73cb3>, Accessed 13 June 2018
[35] ‘Court of Appeal Decision in Easynet Global Services Ltd’ (Erskine Chambers, 2018), <http://www.erskinechambers.com/court-of-appeal-decision-in-easynet-global-services-ltd/>, Accessed 13 June 2018
[36] P. Morrison, ‘A permissive approach to cross-border mergers: Easynet Global Services Ltd’, Comp. Law. 2018, 39(7) 229, 231
[37] C-167/01 Kamer van Koophandel en Fabreken voor Amsterdam v Inspire Art Ltd, [96]
[38] ibid, [95]
[39] C-196/04 Cadbury Schweppes Plc v Inland Revenue Commissioners, [64], [68] – [69]
[40] Court of Appeal Decision in Easynet Global Services Ltd’, Op.Cit., <http://www.erskinechambers.com/court-of-appeal-decision-in-easynet-global-services-ltd/>, Accessed 13 June 2018
[41] ‘Katherine Apps in first Court of Appeal case on cross border mergers’, <http://www.littletonchambers.com/katherine-apps-in-first-court-of-appeal-case-on-cross-border-mergers-1221/>, Op.cit., Accessed 13 June 2018
[42] Davis Polk & Wardwell LLP, ‘Cross-border mergers: recent case law upholding freedom of establishment’, Op.Cit., <https://www.lexology.com/library/detail.aspx?g=2d327a84-a30e-448a-b9cd-46f9eeb73cb3>, Accessed 13 June 2018