It looks as though the new European Union services directive, cruelly dubbed by critics the 'Frankenstein directive', is to go back to the laboratory for some major corrective surgery.

In the past few weeks, the proposals designed by the former single market commissioner Frits Bolkestein to help European companies win business in other EU countries by cutting back on regulation and increasing competition have drawn heavy fire.

Jacques Chirac, the French president, at the end of last month [March] forced a significant rewrite of the directive amid fears that the controversy surrounding it could wreak havoc in the French referendum on the EU constitution in May.

The French claim to be anxious about 'social dumping', whereby companies from eastern European countries erode the higher standards of protection in other member states, and want to secure protection of key public services from competition.

German opposition is just as vehement and Chancellor Gerhard Schroder accuses his European policymakers of spreading "fear and terror" in his country.

A diplomatic rift threatened when Tony Blair hit back at Jacques Chirac, insisting Britain has the backing to push through the directive, which he claims "would have been a grave error for Europe's economy" to scrap.

The British Government reads Continental concerns over the directive as a symptom of wider resistance to free-market solutions. Mr Blair reflected on the debate between countries that are turning their back on a 'social model' of expensive welfare benefits and subsidies, such as Britain, and others that want to hang on to it.

"Some, notably France, believe this model should remain in its existing form," he said. "Some, like Britain, believe firmly in Europe's social dimension but want it updated to take account of modern economic reality."

Impact on UK business

What does this all mean for UK business? Not everyone is as sanguine as our political leaders. The most explosive element of the proposals is the so-called 'country of origin' principle, whereby service providers from one member state - a British architect or a Czech builder - could work short-term contracts at other EU companies under their own domestic legal framework without having to go through the bureaucracy of applying for local qualifications.

If the directive applies as originally drafted in January 2004, the UK construction industry predicts chaos. Gillian Birkby, legal advisor to the Construction Industry Council and a partner at City law firm Fladgate Fielder, gave evidence this month to the House of Lords EU Committee's inquiry into the feasibility of the directive. So what is the problem?

"In the UK construction industry, we have building regulations and they provide the rules as to what your building is like and, for example, restrictions ensuring access to disabled people," the lawyer explains.

"But if an overseas architect comes over here and complies with their own rules and ignores our regulations, that's going to be a major problem because you're going to have building that doesn't comply with the standards laid down here."

But that is not where the differences end. Birkby cites varying approaches to health & safety. "Contractors and subcontractors who are also considered to be service providers could come over from all sorts of countries where standards are far lower, and even though some of the health and safety considerations are based on EU directives, the way they are implemented varies dramatically," she explains.

Such discrepancies could cause problems on the day-to-day running of sites. "For example, quite often smoking isn't allowed on the site here, whereas in some European countries it isn't considered a problem and under the country of origin principle they can smoke," she says.

"The main contractor has a major problem if there is friction between the different members of the workforce."

Union reaction

Some 75,000 trade unionists marched in Brussels a few weeks ago to protest against the 'neo- liberal' Bolkestein directive. Brendan Barber, TUC general secretary, claims that it would "fire the starting gun on a race to the bottom".

"It would create flags of convenience across the whole of Europe, in every part of the service sector," he argues. "It would undermine the very point of the European social model."

Birkby argues that such liberalism could lead to a "dumbing down" of standards. She says: "Somebody could decide that they don't want to bother with all these high falutin' regulations and say: 'Let's go and set up business in Lichtenstein', for example, or somewhere where regulations are lax and then come over and work here."

There is a derogation, or exemption, that refers to "requirements with which compliance is indispensable for reasons of public policy or public security or for the protection of public health or the environment".

According to the Construction Industry Council (CIC), this is "apparently intended" to exempt requirements relating to health and safety and planning but, it would argue, it "fails to recognise that design work, advice given and construction on site are part of a seamless process".

Many European law experts reckon that the directive's critics fail, or refuse, to understand its most controversial component. "The facts get lost in a welter of rumour and speculation and then member states misunderstand for their own purposes," comments Jane Welch, director of the European Financial Law Centre at the British Institute of International and Comparative Law.

She argues that fears that engineering companies in the Midlands would be undercut by Continental competitors running UK subsidiaries according to the laws of their countries of origin are wide of the mark. For a start, she points out, the country of origin principle would not apply to a subsidiary or a permanent branch.

The country of origin principle is relevant only where services are provided on a temporary cross-border basis from one member state to another - for example, where a French company sends IT technicians from France to the UK.

"In many instances, the directive is simply setting out what EU law already requires but, as is quite frequently the case, member states don't pay any attention until they see it in black and white - and then they take great exception to it," she says. "It's all part of the game."

The global law firm Clifford Chance was also called to give evidence to the House of Lords this month, in particular to shine some light on the opaque workings of the country of origin principle.

"Nobody had really explained it to them," says Oliver Bretz, an EC law specialist and partner with the firm. "It only really applies in a very limited number of circumstances.

"It is only going to apply in a situation where a business is contracting with another business and not a business-to-consumer transaction, where services can be provided across borders without the posting of workers, plus where it doesn't concern a regulated profession."

He is unimpressed by French and German commentators and trade unionists claiming that it would undermine the 'European social model'.

Their concerns have "nothing to do with that", he says, but are purely about protectionism. "It's all about having to protect your incumbents from competition from abroad," he adds.

Accelerating growth

The Forum of Private Business (FPB), which represents 25,000 small to medium-sized UK firms, reckons the furore currently threatening the directive is "panic and hysteria". It believes that the proposals could "have a massive effect on the economic climate and will accelerate economic growth in Europe".

The FPB's Brussels spokeswoman, Victoria Carson, is backing the country of origin principle.

"Adoption of this principle will benefit SMEs by encouraging them to investigate new markets without bearing the considerable expenses currently associated with it," she says. "It will help drive the European economy forward, keeping pace with the Far East and the US."

"Any small and medium-sized enterprise in the UK that sells both goods and services should be in favour of this directive," agrees Bretz.

"It will make their lives so much easier because instead of having to rely on arcane case law from the European Court of Justice, there will be a list of measures in the directive in which members states will have to abolish restrictions, such as residency requirements or requirements about nationality."

The directive also proposes a single point of contact for authorisation for would-be service providers.

But where does the proposed rewrite leave the directive? The opinions of legal experts are mixed. "There are already a lot of exclusions and the reality is now that there will be a whole host more," predicts Craig Pouncey, a competition specialist based at the Brussels office of law firm Herbert Smith.

It remains to be seen whether "a coach and horses" is going to be driven through the fundamental principle that every service provider could go in to a country on the basis of the country of origin principle, he adds.

Yes, there will be more exceptions from the directive, agrees Nelson Jung at Clifford Chance. "But the basic principle already exists in the case law of the European Court and can't be abolished by means of this directive and, even if they don't mention it in the directive, it will still exist as a matter of European law."