There is no equivalent to the English law concept of trust under French law. This means that where a syndicated loan is to be secured by French obligors, security interests must generally be granted independently to each member of the syndicate (there will be a list of pledgees contained in the security document). Any change to that group of lenders would generally entail the transfer of the French law security to each new lender.
On cross border transactions where the facilities agreement is governed by English law and French law security is required, this disadvantage is usually mitigated by the use of the parallel debt device, the validity of which has recently been recognised by the French courts. Parallel debt wording would generally be incorporated into the intercreditor agreement and the benefit of the French security then given to the security agent/trustee (appointed under an English law trust) in addition to being given to the named initial syndicate members.
In 2007 a new concept of fiducie was introduced into the French legal system. The fiducie is essentially the French version of Anglo Saxon trust arrangements where settlors (constituant) transfer rights or assets to a trustee (fiduciaire) which manages them with a defined objective for the benefit of beneficiaries. The fiducie involves a transfer of title to the secured assets to the fiduciaire. Until recently though it is fair to say that this tool had not seriously challenged the traditional security structures just outlined for the reasons we will now explain.
The previous concerns about using fiducie structures
It was intended that the fiducie should assist French syndicated loans and other complex structured financings, but French banks and sponsors were initially reluctant to use the revolutionary concept in an acquisition finance context.
As regards security over shares there was a particular problem because using a fiducie had a potentially unfavourable impact on the tax treatment of the transaction. The good news is that the French Amending Finance Act for 2014 has resolved this problem.
Until the introduction of this new law a fiduciaire structure for share security was not tax efficient because in making the transfer of title to the fiduciaire:
- the securities lost the benefit of the French participation-exemption regime for dividends ("Participation Exemption"), even if the securities would have otherwise qualified for the Participation Exemption; and
- the French tax consolidation regime ("Tax Consolidation") ceased to apply if, due to the transfer, the constituant owned less than 95% of the underlying subsidiary (even if the Tax Consolidation was available prior to the transfer).
The new law enables a fiducie arrangement in respect of up to 100% of a constituant's shareholding in its subsidiary (if correctly structured – see below) to be put in place without a loss of access to the Participation Exemption regime or the Tax Consolidation regime.
It is expected that these amendments to the tax neutrality regime will encourage a much wider use of fiducie arrangements by way of security in both corporate and acquisition financing transactions.
New French tax regime for fiducie arrangements involving share security
Shares transferred to a French fiducie will, in certain circumstances, be eligible for the Participation Exemption regime at the settlor's level on the dividends received (the latter under French tax law remains taxable on the fiducie's income). Such a transfer is now also disregarded in determining whether the 95% ownership requirement is still met for the Tax Consolidation regime at the settlor's level (as a reminder, the Tax Consolidation regime is only available to affiliated companies connected by 95% ownership links).
The new law provides that the Participation Exemption will continue to apply if the French constituant continues to exercise the voting rights in respect of the transferred securities, or if the fiduciaire exercises those rights in the manner determined by the constituant.
The Participation Exemption will apply even if, as is market standard, the constituant and fiduciaire agree that those voting arrangements include certain limitations to protect the rights of the beneficiaries of the fiducie (such as wording stipulating that no voting powers may be exercised by the constituant so as to jeopardise the value of the charged shares). Also, the new provision explicitly mentions that the minimum two year holding period under the Participation Exemption will not be interrupted by the transfer of the securities to the fiduciaire.
The new provision also provides that the Tax Consolidation will continue to apply in respect of shares subject to a fiducie security arrangement (with full voting and financial rights), subject to the same conditions in respect of the exercise of the relevant voting rights by the constituant (or the fiduciaire) as those mentioned above for the Participation Exemption.
Positive impact on secured leveraged financings
The tax provisions of the French Amending Finance Act of 2014 also clarify some legal uncertainties which were previously additional obstacles to the use of fiducie as a security sharing instrument in leveraged financings: the exercise of voting rights and the potential liability of the beneficiaries as de facto managers.
Exercise of voting rights
Sponsors were previously reluctant to place the shares of a target company in fiducie as there was a risk that in passing voting rights to the constituant the sponsor may then be deprived of those voting rights from the outset. The new law clarifies that this is not the case: the fiducie can exercise the voting rights in accordance with the instructions of the constituant (subject to any stipulated limitations of the type mentioned above imposed by the beneficiaries on that exercise) and for so long as the fiducie is not "activated" the Participation Exemption will continue to apply.
Fiducie is likely to produce a greater protection for the beneficiaries than security over target shares given by way of either a share pledge or a pledge over financial securities account, in particular when an insolvency proceeding is opened against the constituant. Whilst a share pledge or pledge over financial securities account gives a preferential right (droit de preference) it does not give a transfer of title of those shares to the security holders. In contrast where a fiducie is used, there will be a transfer of the ownership of the shares to the fiduciaire. This has the significant advantage that shares placed in fiducie may stave off stay of proceeding (suspension des poursuites) if a safeguard (sauvegarde) or judicial recovery proceeding (redressement judicaire) is opened against the constituant because those shares are no longer owned by the constituant.
As you may know, over the last few years it has been common to structure cross border transactions by employing a double Luxco structure, so as to mitigate the risk of the creditors finding themselves embroiled in lengthy safeguard proceedings. The fiducie tool is arguably less complex to put in place and effectively provides the same protection.
However, article L 622-13 VI of the French Code de commerce states that the arrangements pursuant to which the assets placed in fiducieremain at the constituant's disposal must be continued notwithstanding any such insolvency proceeding, if so requested by the judicial administrator (administrateur judiciaire). Consequently, the beneficiaries' security rights would be frozen if this were to happen. To avoid this risk the security could be drafted so that the constituant loses its ability to exercise the voting rights at a relatively early stage to make sure that this would always be prior to the opening of any insolvency proceeding, for instance upon the occurrence of a mere event of default. Unfortunately though the direct consequence of this arrangement might be to deprive the constituant of the benefit of the Participation Exemption regime when shares are placed in fuducie.
Clarification of beneficiaries' liability as de facto managers
Another uncertainty with the fiducie used to relate to the beneficiaries' possibly incurring liability as de facto managers of the target company where all voting rights are exercised by the fiduciaire on their behalf.
The French Amending Finance Act for 2014 has clarified this though. There is now a clear balance point whereby the sponsors keep control over the target company (subject to any beneficiaries' protective limitations), which prevents the beneficiaries from incurring liability on the grounds of interference in the target company's management.
If the parties agree to freeze the constituant's voting rights upon the occurrence of an event of default, the beneficiaries may argue that such freezing will only be requested as a protective measure (mesure conservatoire) in accordance with the provisions of the fiducieagreement, as agreed between the parties. Such fiducie agreement may also provide that the constituant will recover the ability to exercise the voting rights once the said event of default has been remedied or waived, which would make the freezing of voting rights only a temporary protective measure (mesure conservatoire) in favour of the beneficiaries rather than a sustainable means for the beneficiaries to exercise their control over the target company.
To conclude, clearly there is a need for a fiducie arrangement to be carefully structured so as to avoid the tax pitfalls outlined in this article. However, the transfer of title to the charged assets which is afforded by the fiducie offers an interesting alternative for transactions. As the French market becomes more used to this tool and digests the tax changes we have explained we should find that it is used more commonly, particularly in cross-border highly leveraged transactions and on restructurings.