A Social Enterprise Company in EU Organizational Law?

In my recent article, A Social Enterprise Company in EU Organizational Law?, I discuss the present and future regulation of social enterprises in Europe. For the moment, social enterprises – like other “social economy” organizations – have been harnessed to act as surrogates for governments in coordinating the administration, financing, and implementation of domestic social and welfare policy.[1] To a greater or lesser extent, therefore, social enterprises are regulated domestically by individual member states of the EU (“Member States”), “with little private leeway for initiative-taking outside government policy”.[2] This means that social enterprises do not enjoy the freedom of establishment, in the way that traditional corporations do, as provided for by the EU treaty framework and the CJEU’s case law.[3] Consequently, there is no European social enterprise law market; social enterprises lack cross-border mobility and are confined to the particular jurisdiction of incorporation. However, there is reason to think that the situation in Europe could soon change due to Union-level policy developments that would, partially, transfer regulatory control to the EU.

This claim is based upon an analysis of the most recent policy activity in this area – the European Parliament’s July 2018 non-legislative resolution proposing to the European Commission a directive for facilitating social enterprises’ cross-border activities (the “Proposal”). It is important to underscore that the European Commission declined to implement the Proposal.  Citing perceived differences in national legal traditions and contexts, the European Commission was not convinced that Member States would be amenable. I disagree. I undertook an empirical survey of frameworks for regulating social enterprises in the EU and found that 16 of the 27 Member States have legislation that accords, or is close to complying, with the Proposal. Therefore, I tentatively argue that there may already be a consensus for the Proposal’s adoption under Article 50 of the Treaty on the Functioning of the European Union (“TFEU”). As the Proposal’s legal base, Article 50 of the TFEU requires only a qualified majority in the Council.[4] Even if this prediction is wrong, however, I show that there are economic and political reasons to surmise that Member States would be open to the Proposal at some future point, if they are not already. In this way, a key finding of the study is that we can expect some degree of legal harmonization to occur through Union-level coordination, and by extension a proliferation of social enterprise law across the EU, in the coming years. While the above prospect will be of interest to legal commentators outside Europe, I argue that the Proposal is deficient. This is, among other things, because the terms of the Proposal would generate a social enterprise law market that could be abused by opportunistic actors.

Normally, opportunistic actors would not think to form a social enterprise. While there are a number of commercial and financial incentives to form a social enterprise in Europe that I discuss in the article, the vast majority of the capital flowing from them cannot usually be extracted for personal gain. That is, most Member States’ social enterprise regulatory frameworks feature “lifelong” constraints on managerial remuneration, mid-stream profit distributions to shareholders, and the amount of capital that can be extracted upon a voluntary conversion to a traditional corporation or winding up (there are customarily also rules in place that govern disguised distributions).[5]

However, with the Proposal in effect, a firm’s participants would have the prerogative to choose the body of rules under which they wished to be governed. This is the case even if that choice afforded opportunistic actors the flexibility to select a Member State’s regulatory framework with weaker constraints, making it possible to secure and leverage unfair competitive advantages. As the “Delaware of Europe” in the social enterprise context, the French legal regime is noteworthy. Granted, the French enterprise solidaire d’utilié sociale does include constraints on both managerial remuneration and mid-stream profit distributions to shareholders.[6] Nevertheless, these constraints are only annual – and the legislation features a loophole. Namely, if the decision were taken to convert or wind up, the French legislation provides a firm’s participants with the contractual option to extract all the capital, free of public oversight.[7]

Of course, the host Member State register could decline the application of the French social enterprise regulatory framework and attempt to apply its own local provisions, requiring some or all of the remaining assets to be left behind for public benefit. However, this action would not conform to the terms of the Proposal. While Member States are free to impose stricter rules with regard to constraining profit distributions and the allocation of profit on firms that incorporate under their domestic regulatory frameworks, they must also respect social enterprises that choose to be governed by less strict rules. This is mandatory under the Proposal, irrespective of any justification the Member State in question may think it has. To be sure, the CJEU has “very explicitly encouraged private parties to profit from the divergences between Member States’ laws,” and there is no indication that the Proposal would be treated differently.[8]

For example, in the Inspire Art case, where the issue was whether a Member State’s imposition of stricter disclosure obligations on the branch of a corporation not provided for by the “eleventh company law directive” was contrary to its requirements, the court easily brushed away arguments defending the national legislation. The CJEU simply held that it is “contrary to…[the directive]…to impose on the branch of a company formed in accordance with the laws of another Member State disclosure obligations not provided for by that directive”.[9] It is argued that utilization of the French legislation is no different, as a host Member State’s deviation from the registered office as the connecting factor and the imposition of its law would undermine the integrity and reach of the Proposal.

On its own, though, isolated or infrequent incidents of regulatory arbitrage and the exploitation of unfair competitive advantages across the EU would perhaps not amount to a cause for serious alarm. In the context of deterring traditional corporations from engaging in regulatory arbitrage, Member States have largely eliminated the competitive and financial advantages that could be gained from the avoidance of rules that govern outward-facing relationships with, for example, creditors and employees.[10] This has been achieved by exploiting gaps between Union legal instruments and the right of establishment, through the appropriate design of domestic law. Therefore, a cursory investigation would suggest that Member States could also limit the exploitation of unfair competitive advantages in the social enterprise context, akin to their supervisory handling of traditional corporations’ attempts to outflank inconvenient laws through (re)incorporation outside particularly restrictive jurisdictions.

However, this would not be possible with the Proposal. As discussed, social enterprises do not have a natural freedom of establishment – it is the Proposal itself that produces the right. Therefore, unlike other EU corporate law directives that merely harmonize conflict rules and explicate procedural boundaries for the exercising of the right of establishment, which exists independently for traditional corporations, the Proposal actually both cements a right of establishment for social enterprises and lays down the terms upon which they are permitted to move across borders. This means that the scope of the application of the relevant Union legal instrument – in this situation, the Proposal – and the scope of the right of establishment are synchronized. This effectively closes the gaps that Member States might otherwise occupy to deter regulatory arbitrage and the gaining of unfair competitive advantages. It follows that the Proposal would lock out Member States from implementing corrective measures.

The implicit deregulatory nature of the Proposal towards private ordering altruism would clearly create a litany of regulatory complications for maintaining public trust in social enterprises, not least because Member States have historically required “social enterprises to adhere to particular norms of organizational operation in connection with…profit-distribution, as well as giving priority to…[the selected social purpose] over profitmaking.”[11] The danger of the law’s not placing sufficient fetters on self-interest was pointed out a long time ago by Henry Hansmann,[12] and there is empirical evidence from the U.S. suggesting that, where social enterprise law is more malleable, market actors use it for personal benefit at the public’s expense.[13]

To avoid this outcome, I argue that the Proposal ought to require more detailed provisions in Member States’ domestic regulatory frameworks. Specifically, commentators provide that rules constraining profit distributions and the allocation of profit could be operationalized in three ways through a series of alternative combinations: “it can be applied to the profits generated, the assets accumulated, or the remuneration gained by the workers and managers employed,”[14] France only has annual constraint mechanisms that can be avoided through converting or winding up. If the Proposal required lifelong constraint mechanisms that only allowed for the partial appropriation of a firm’s capital after a conversion or winding up, the basic assumption would be that opportunistic actors could not use the Proposal to disarm Member States from preventing abuse.

At a minimum, uploading this suggested solution into the Proposal would, theoretically, reduce the possibility of suboptimal outcomes, but not outright strip Member States of the choice to set their own domestic rules. Thus, a revised Union legal instrument including the suggested solution could build legitimacy and confidence between the EU and Member States, leading to an increased likelihood of timely political agreement when the Proposal is eventually resuscitated.

ENDNOTES

[1] For a primer on European jurisdictions politically institutionalizing social enterprises in the context of social and welfare policy reform, see J S Liptrap, “The Social Enterprise Company in Europe: Policy and Theory” (2020) 20(2) Journal of Corporate Law Studies 495, 498-508.

[2] Dennis R Young and Wesley Longhofer, “Designing the Zoo” in Dennis R Young, Elizabeth A M Searing and Cassady V Brewer (eds), The Social Enterprise Zoo: A Guide for Perplexed Scholars, Entrepreneurs, Philanthropists, Leaders, Investors, and Policymakers (Edward Elgar 2018) 30.

[3] Broadly, the right of establishment is considered a “fundamental freedom” in the EU treaty framework that facilitates setting up and managing undertakings, for a permanent activity of a stable and continuous nature, under the same conditions as those laid down by the law of the Member State concerned regarding incorporation for its own nationals.

[4] The Council is one of the three EU legislative bodies, and, together with the European Parliament, serves to amend and approve proposals of the European Commission, which holds legislative initiative. When the Council votes on a proposal, a qualified majority is reached if two conditions are met. First, 55 percent of Member States must be in favor – in practice this means 15 out of 27. Second, Member States representing at least 65 percent of the total EU population must support the specific proposal.

[5] For example, the Romanian întreprinderil sociale requires that at least 90 percent of a firm’s yearly profit must be allocated to achieving the selected social purpose. Because 90 percent of a firm’s yearly profit must be allocated to creating value for society, only 10 percent of the profit generated may be distributed to shareholders. The statutory language also provides that a firm must apply “social equity” to employees and ensure fair levels of pay, which means that the employee-manager remuneration ratio cannot exceed 1:8. Finally, in the event of a conversion or winding up, all assets must, by operation of law, pass to another entity pursuing pro-social goals with a verifiable asset lock. See Lege No. 219 din 23 iulie 2015 privind economia socială, art 8(4)(b)-(d).

[6] The average salary for the five highest paid managers cannot exceed seven times the minimum wage, and the salary for the highest paid manager cannot exceed 10 times the minimum wage. The yearly profit figure that must be set aside in support of the selected social purpose is 50 percent. The remaining 50 percent of the yearly profit is distributable to shareholders. See Loi No. 2014-856 du 31 juillet 2014 relative à l’économie sociale et solidaire, arts 1(II)(2)(c) and 11(1)(3)(A)-(B).

[7] ibid art 1(3)(b).

[8] Johan Meeusen, “Freedom of Establishment, Conflict of Laws and the Transfer of a Company’s Registered Office: Towards Full Cross-Border Corporate Mobility in the Internal Market?” (2017) 13(2) Journal of Private International Law 294, 311.

[9] Kamer van Koophandel en Fabrieken voor Amsterdam v Inspire Art Ltd, Case C-167/01, EU:C:2003:512, para 144(1).

[10] Carsten Gerner-Beuerle, Federico Mucciarelli, Edmund Schuster and Mathias Siems, “The Illusion of Motion: Corporate (Im)Mobility and the Failed Promise of Centros” (2019) 20(3) European Business Organization Law Review 425, 429.

[11] Dennis R Young and Jesse D Lecy, “Defining the Universe of Social Enterprise: Competing Metaphors” (2014) 25(5) Voluntas 1307, 1312.

[12] See generally Henry B Hansmann, “The Role of Nonprofit Enterprise” (1980) 89(5) Yale Law Journal 835.

[13] See generally eg Alicia E Plerhoples, “Nonprofit Displacement and the Pursuit of Charity through Public Benefit Corporations” (2017) 21(3) Lewis & Clark Law Review 525; Michael B Dorff, James Hicks and Steven Davidoff Solomon, “The Future or Fancy? An Empirical Study of Public Benefit Corporations” (2021) 11(1) Harvard Business Law Review 113.

[14] Carlo Borzaga and Giulia Galera, “New Trends in the Nonprofit Sector in Europe: The Emergence of Social Enterprises” in Ericka Costa, Lee D Parker and Michele Andreaus (eds), Accountability and Social Accounting for Social and Non-Profit Organizations, Vol 17 (Emerald 2014) 98. See generally also eg Vladislav Valentinov, “The Economics of the Non-Distribution Constraint: A Critical Appraisal” (2008) 79(1) Annals of Public and Cooperative Economics 35.

This post comes to us from J S Liptrap, a research associate in the Center for Business Research at the University of Cambridge’s Judge Business School. It is based on his recent article, “A Social Enterprise Company in EU Organizational Law?,” available here.

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