This is the second in our series of four articles examining the legal considerations that non-French real estate lenders should examine when financing commercial real estate in France in a non-distressed context. It is reminded that the considerations examined in this series of articles are those peculiar to France; those common to all countries (or at least all EU countries) are not examined.
This second article, which is probably the most key in our series, contains a summary of the legal considerations relevant to the structuring of a commercial real estate loan in France.
After a preliminary comment on (1) liquidity LTV limitations, we shall examine cross-collateralisation limitations resulting from (2) corporate law, (3) tax rules and (3) mortgage costs as well as (5) limitations resulting from the "'specialty" principle and (6) the non-availability of the "'Dailly-law" security assignment to certain lenders, and conclude with (7) anti-insolvency "double Luxco" structures.
Liquidity LTV limitations
Lenders considering a syndication - or simply concerned about the liquidity of their loan assets - should be aware that the cost of capital of commercial real estate loans increases when LTV exceeds a certain threshold varying according to the type of lender:
- 50% (based on market value) or 60% (based on mortgage lending value) for EU banks under Basel III's standardised approach;
- 75% for most EU insurance companies under Solvency II's standard formula;
- 65% at the time of origination (unless the loan takes the form of shares and bonds issued by a securitisation fund qualifying as a "fonds de prêt à l'économie") for smaller French insurance companies and mutuals that fall outside the scope of application of Solvency II.
Cross-collateralisation limitations resulting from corporate law
French corporate law limits cross-collateralisation so far as:
- the mandatory provisions of article L. 225-216 of the French Code de commerce prohibit a French stock company from advancing funds, granting loans or providing a security or a guarantee for the purpose of enabling a third party to acquire or subscribe its shares or the shares in its holding company and
- the officers of any French company (of any type) have the duty to act in the "best interest" of that company when, amongst others:
- causing the latter to lend money to a company of the same group other than a subsidiary, or;
- granting a guarantee (or an in rem security interest) as security for the obligations of a company of the same group other than a subsidiary.
In the case of a guarantee, the granting company must normally receive an adequate consideration in return and the secured amount must not exceed its "financial capabilities".
Lack of corporate interest may result not only in the criminal, civil and/or insolvency liability of the relevant company's officers, as well as adverse tax consequences, but also in the nullity of the transaction where the contracting party is aware of the lack of corporate interest according to case law. Since 1 October 2016, this case law appears to be codified in the new article 1145 of the French Code Civil, which provides that, "[t]he capacity of legal entities is limited to the acts that are useful to the realisation of their purpose as defined in their articles of association and acts incidental thereto, in compliance with the rules applicable to each of them".
It follows that cross-collateralisation through upstream or cross-stream loans/guarantees granted by French property-owning special purpose vehicles ("SPVs") can only be limited. A French company's guarantee (or joint and several) obligations in respect of the loan (or allocated loan amount) of another company of its group other than a subsidiary will often be limited to the amount of the intra-group debt owed by the former (or its subsidiaries) toward the latter (or its subsidiaries) at the time the guarantee (or joint and several liability) is called, so as to avoid any debate on the adequacy with the company’s "financial capabilities".
In case of multiple SPVs guaranteeing each other’s loans (or most likely - for mortgage costs reasons - being jointly and severally liable to the same loan divided in allocated loan amounts ("ALAs")), this capped liability can be increased to a percentage less than 100% of the surplus of the disposal proceeds generated by the disposal of the relevant company's property. This is after repayment of that property's loan allocated amount and forgiveness of the related subordinated debt, subject to certain adaptations if the ALAs of the SPVs are materially different one from the other. This is sort of the real estate finance version of the guarantee limitation found in some corporate loans based on a percentage less than 100% of the net asset value of the company, based ideally (but not necessarily) on the liquidation value of the disposable assets minus all liabilities except subordinated liabilities which are to be forgiven in case the guarantee is called.
Some cross-collateralisation can also be achieved by each SPV contracting a cash pooling agreement and forwarding their "excess cash" to a parent company, whose bank account is pledged.
It also follows that, in case of a share acquisition, the target property company cannot borrow more than needed for refinancing its (bank and intra-group) debt, at least not without adding complexity to the deal by having recourse to a share capital reduction or a subsequent merger with the acquisition vehicle…
Cross-collateralisation limitations resulting from tax rules
When French corporate tax is relevant (which is not the case in tax-free vehicles like OPCIs and their tax transparent subsidiaries), tax thin capitalisation rules limit the deductibility of interest paid to related companies according to certain ratios. Consequently, the capital structure of property companies is often structured with 1 of capital for 1.5 of intra-group debt in order to maximise the interest tax shield. These rules must be considered when structuring cross-collateralisation because, since 2011, bank debt is generally assimilated to intra-group debt when it is secured by a guarantee (or a security interest) granted by a related company, other than a pledge over the shares in the borrowing company and/or a pledge over the receivables owed by it. There is however an exception for "forced refinancings" of debt predating 2011 (or debt refinancing debt predating 2011) pursuant to a change of control prepayment clause in the refinanced loan, which therefore only avails in a share deal.
Because of this, sponsors may propose schemes without guarantees or security interests (other than permitted share and receivable pledges) from parents and other SPVs, where cross-collateralisation results from the unlimited liability of shareholders in SCIs and SNCs (two types of French companies often used because they are tax transparent and in which shareholders have unlimited liability).
Where a parent guarantee or other security interest is required, such as the pledge of the shares in an intermediate holding company, it is possible - though this is not standard practice - to insert a cap (e.g., based on the value of the relevant collateral) in order to assimilate only part of the bank loan to an intra-group loan. Drafting-wise, this may require the bank loan to be divided into tranches only one of which would be secured by the guarantees and/or security interest (other than permitted share and receivable pledges) granted by parent companies.
Another tax rule to be aware of is that 25% of net financial expenses are not tax-deductible unless they are lesser than €3 million at the level of the SPV or tax group. This is one of the reasons (other than exit strategies not relying on a portfolio sale) why sponsors prefer to partition real estate portfolios in multiple tax transparent SPVs (each having less than €3 million of financial expenses).
Cross-collateralisation limitations resulting from mortgage costs
Unlike personal property security interest costs (which are nominal), mortgage costs are significant in France. They are composed of up to three items: proportional notary fees called "emoluments", a tax called the "contribution de sécurité immobilière" (the "CSI") and a tax called the "taxe de publicité foncière" with related collection dues (the "TPF").
The registration of a commercial real estate mortgage - for a secured amount composed of a principal amount (securing principal and up to three years of interest) and an additional amount called "accessoires" (securing other fees and costs, mainly enforcement costs) - will generally trigger emoluments of 0.447% of the principal amount (subject to possible discount), CSI of 0.05% of the secured amount and TPF of 0.715% of the secured amount.
The TPF can however be avoided if:
- the mortgage takes the form of a "privilege de prêteur de denier" ("PPD"), which is possible only in case of an asset deal and where the loan is drawn immediately upon the acquisition and is governed by French law or another law that recognises this sort of security interest (which is not the case of English law) or;
- pre-existing mortgage-secured debt is refinanced (in case of a share deal or a simple refinancing): the new lender may then avail of the existing mortgage by way of "subrogation" or, if it is the same lender, by way of "novation with reserve of security interests". In case of subrogation, an additional mortgage must be taken corresponding to the lost accessoires of the subrogated mortgage. Additional emoluments may also apply for the renewal of the subrogated or reserved mortgage.
The release of a mortgage will also generate costs albeit less significant, namely emoluments of 0.136% of the original principal amount and CSI of 0.10% of the original secured amount or, in case of a partial release, of the value of relevant parcel if lesser (for both emoluments and the CSI).
It follows that sponsors will be reluctant to grant mortgages for an aggregate principal amount exceeding the loan amount, except for the mortgage benefitting to the hedging bank, will try to negotiate accessoires below the traditional 20% and may push for the hedging mortgage - as well as any cross-collateralisation mortgage - not to be immediately registered.
If it is decided that cross-collateralisation will be granted at the level of each SPV with real estate as collateral, then instead of having each SPV grant a mortgage for its own loan and an additional "cross-collateralisation mortgage" guaranteeing the loans of the other SPVs, it is possible to have all SPVs jointly and severally liable to the same loan (with appropriate limitation wording as discussed above). This way, the same contractual mortgage can be used to secure both the SPV's ALA and its (limited) joint and several liability for the ALAs of the other SPVs. Yet this trick works with new contractual mortgages but not always with PPDs and subrogated or reserved mortgages.
In case of the refinancing of an SPV that acquired different properties at different moments, an additional cross-collateralisation issue may arise if the mortgages saddling the first properties did not secure the new loans or loan tranches used for acquiring the subsequent properties. The sponsor will then want the existing mortgages to be subrogated or reserved in order to avoid paying TPF on new mortgages. The lenders will however want not only that each property be sufficiently mortgaged at the time of the refinancing (so that an additional mortgage may have to be taken on the properties that were financed with the lowest LTV or which have increased in value the most) but also some protection against the risk of subsequent variation of values among the properties, which may include (in addition to mandatory prepayment in case of excessive LTV on an individual property) the grant of an additional mortgage over each property as security for the whole loan.
Limitations resulting from the "specialty" principle
Unlike French in personam guarantees, French in rem security interests must comply with the so-called principle of "speciality", which requires that both the collateral and the secured obligations be either determined or - if future - "determinable".
It follows that French law does not recognise the concept of floating charge (though some security interests permit some in rem subrogation…) and that liabilities under future facility or hedging agreements can be secured by French-law security interests only if they are sufficiently described in the security document to be "determinable", which is a question of fact that a court may appreciate on a case-by-case basis.
Unavailability of "Dailly-law" security assignments to certain lenders
Rent, insurance and other receivables are typically collateralised by way of a so-called "Dailly-law" security assignment but it should be noted that only EU credit institutions (and French sociétés de financement) can be the original beneficiaries of such security assignments. The only way for other lenders to benefit from a Dailly-law security assignment is to acquire a participation in the loan subsequently; the benefit of the security assignments will remain attached to the secured liabilities despite the change of creditor.
If a receivable is to be collateralised for the benefit of a lender which is not a EU credit institution (or société de financement) after such lender has become a party to the relevant facility agreement, then a pledge or delegation should be used; these will also permit direct payments in case of insolvency proceedings of the pledgor or delegator.
Anti-insolvency "double luxco" structures
Lenders are at risk that their French borrowers encounter financial difficulties and negotiate a haircut or a time extension threatening to seek the opening of safeguard (sauvegarde) proceedings, typically after having had a mandataire ad hoc appointed and subsequently a conciliation proceeding opened. Often the lenders may be reluctant to accelerate the loan at this stage because of their obligation to act in good faith, depending on the nature of the events of default that are outstanding. Without acceleration or at least a payment default, many French security interests cannot be enforced as a matter of law.
In order to mitigate that risk in large transactions, where it is worth incurring the extra cost associated with this additional security interest, but also taking into consideration thin capitalisation rules implications, lenders may ask that the shares in a foreign intermediate holding company be pledged by its parent (also foreign) company. This is typically called a "double Luxco" structure because Luxembourg is often the preferred jurisdiction for incorporating intermediate holding companies (though it is less since the renegotiation of the France-Luxembourg tax treaty).
This way a lender's negotiation position in restructuring negotiations will be enhanced because it will be able to threaten to enforce that share pledge (often on more lender-friendly conditions than those applicable to French-law share pledges), thereby causing all officers of the foreign intermediate holding company and its subsidiaries to be revoked before they cause said companies to seek the opening of insolvency proceedings. This of course supposes the foreign company does not have its centre of main interests in France, which French courts have been ready to consider as possible for foreign parent companies dedicated to French SPVs thus opening French safeguard proceedings in their favour.
Now that we have commented on the legal considerations relevant to the structuring of commercial real estate loans in France, our next article will discuss those relevant to the drafting of commercial real estate loan documentation in France.