Guarantees and collateral for acquisition financings in France

Guarantees and collateral

Are there restrictions on the provision of related company guarantees? Are there any limitations on the ability of foreign-registered related companies to provide guarantees?

French joint-stock companies (SA), simplified stock corporations (SAS) and limited liability companies (SARL), the three most common forms of business entities in France, may provide upstream and cross-stream guarantees for the financial obligations of other group companies, subject to compliance with the rules relating to corporate benefit, statutory object clause and the prohibition of misuse of corporate assets. Further, if a guarantee is being provided in the context of an acquisition, the specific French financial assistance prohibition would apply. See also question 33 regarding situations where guaranteed claims would be voidable. The granting of a guarantee or security by a company to secure payment obligations of another company incorporated in France may also in certain circumstances bear tax consequences on the ability of that French company to deduct interest expenses from its revenues.

Corporate benefit

The guarantor company must receive some real and adequate benefit. Note that this rule also applies in relation to the provision of any intra-group assistance, whether a guarantee or an intra-group loan. The absence of benefit renders the guarantee unenforceable and criminal sanctions may be imposed on directors for misappropriation of a company’s assets. What constitutes real and adequate benefit is not defined, but examples include financial remuneration, the existence of cross guarantees in favour of the guarantor and the interest of the guarantor in the financial success of the primary debtor. The three established rules of thumb are that:

• the companies involved must form part of a genuine group operating under a common strategy aimed at a common objective;
• the risk assumed by the guarantor must be proportionate to the benefit; and
• the financial support by the guarantor should not exceed its financial capabilities.

While corporate benefit can generally be assumed where a parent company guarantees the obligations of one of its direct or indirect subsidiaries, the second and third requirements of the corporate benefit test may be slightly more difficult to meet with respect to upstream or cross-stream guarantees. As a result, current market practice is to limit upstream or cross-stream guarantees to facilities that are, or are capable of being, lent to the guarantor by way of intra-group loan and to limit the amount of the guarantee at all times to that which the guarantor and its subsidiaries have received directly or indirectly from the guaranteed borrower as a borrower by way of an intra-group loan. This, in essence, means that upstream and cross-stream guarantees will be limited to working capital or capital expenditure facilities, or to refinancing facilities made available to a borrower with a view to reallocate loan proceeds from that borrower to other members of the group.

Object clause

The guarantee should be granted for a purpose within the object clause of the company and must bear a direct relationship to the main activity of the company. Obviously, specific corporate procedures that vary depending upon the corporate form and the by-laws of the guarantor may have to be complied with.

Financial assistance

Article L.225-216 of the Commercial Code strictly prohibits any joint-stock company (which includes the SA, SAS and the less common commercial company (with at least three partners), from granting guarantees and security in respect of facilities used for the acquisition or subscription of its own shares by a third party. This prohibition does not apply to SARLs or commercial partnerships (SNCs). However, if a target was transformed into one of these companies shortly prior to its acquisition and subsequently issued a guarantee or granted security in respect of facilities used for the acquisition or subscription of its own shares, there would be a substantial risk that this would be deemed a fraudulent transaction if the sole purpose was to circumvent the prohibition. In addition, corporate benefit restrictions would still apply, and it is highly unlikely that the target company guaranteeing acquisition debt would be found to pass the corporate benefit test set out above.

The restriction on financial assistance is also considered to apply to French subsidiaries (ie, the indirect assets) of the target company and there is no whitewash procedure available and no exceptions to the prohibition (other than in the particular case of an acquisition by an acquisition vehicle owned by the employees of the target company or group).

These prohibitions do not, however, prohibit either the acquisition vehicle from granting a pledge over the target’s shares or the distribution of dividends (including distributable reserves) or a share capital repayment by the target to the acquirer where the corresponding proceeds serve acquisition debt service.

Foreign subsidiaries

While corporate benefit and financial assistance restrictions may not directly apply to foreign subsidiaries of a French target, one must be careful that the guarantee obligations of any such foreign subsidiary, which would otherwise not be permitted in France, are not transferable to French entities within the group as a result of the operation of cross-guarantee provisions. For instance, if a French target provides a guarantee for the payment obligations of its subsidiaries as borrowers and guarantors, and if any one or more of those subsidiaries is a foreign entity that provided guarantees or granted a security interest that would be illegal for a French entity to grant, then the corresponding payment obligations should be carved out from the French target’s guarantee. Another approach, and the common market practice, is to limit any downstream guarantee by a French entity to payment obligations of its subsidiaries as borrowers and of its French subsidiaries only as guarantors.

Misuse of corporate assets

The ‘misuse of corporate assets’ and the closely related ‘misuse of power’ are criminal offences that impose penalties on persons who, in the course of managing a company, knowingly use the assets of that company, or their authority or voting rights, in a way that is contrary to the corporate interest of that company, either for their personal benefit or for the benefit of another company in which they are personally interested. It should be noted that where the use of assets or authority is attributable to a particular person, the fact that it may also serve the interest of other persons (such as potential minority shareholders) does not prevent the characterisation of a misuse of corporate assets or misuse of power. For the purpose of determining whether a particular action was contrary to the interest of the company, French courts will assess the foreseeable results of that action in the light of its economic context at the time it was taken.

The persons who may be held criminally liable on these grounds include not only the members of the board of directors or management board but also the executive officers and shadow directors.

On the non-criminal side, misuse of corporate assets or power would constitute an act of mismanagement entailing tax consequences as well as civil liability in the form of damages to compensate the company. Shareholders would also be entitled to damages provided that they establish the existence of a prejudice distinct from that suffered by the company itself (in practice, shareholders are seldom awarded specific damages in such situations).

Are there specific restrictions on the target’s provision of guarantees or collateral or financial assistance in an acquisition of its shares? What steps may be taken to permit such actions?

See question 14.

What kinds of security are available? Are floating and fixed charges permitted? Can a blanket lien be granted on all assets of a company? What are the typical exceptions to an all-assets grant?

There is no general concept of a floating charge under French law, and no concept of a debenture or blanket security agreement covering all or most of the assets of a company. As a consequence, separate pledges are generally required to be taken over all the assets of a company, and each type of asset is subject to a different set of statutory provisions governing the creation and perfection of security over that asset. In addition, while the Civil Code recognises the possibility of creating security over future assets, provided that they can be sufficiently identified and determined, creating security over potential future assets is not allowed. This means that for the security interest to be valid there must be a high level of certainty that the pledged asset will come into existence or be acquired by the pledgor and that the parties must be able to properly identify the asset in the relevant security document.

The French law security interests that are closest in form to a floating charge are the pledge over the ongoing business described below, which is both limited in scope and cumbersome to enforce, and the pledge over inventory.

There follows a non-exhaustive list of the most common types of security interests that may be granted over assets located in France.

Securities account pledge

This type of security interest is available only with respect to securities issued by a joint-stock company, which, in France, are in dematerialised form and take the form of entries into paper accounts (opened with the issuing company) or electronic accounts (opened with a bank or other entity licensed to operate securities accounts). The pledge is created through the execution and delivery by the pledgor of a statement of pledge, which must follow a prescribed format. However, legal practitioners generally also require that the pledge be recorded in the register of securities transfers and the register of individual securities account of the issuing company. There are no particular perfection requirements. The pledge agreement may provide that other securities held by the pledgor from time to time shall be credited to the pledged securities account, whereupon they shall be deemed to have been included in the original pledge with effect from the date of the original statement of pledge without any further formalities.

Share pledge

Shares in SARLs and certain other companies are not classified as financial securities and security is taken through a pledge over the shares themselves. New pledges must be entered into to cover any new shares transferred to or subscribed by the pledgor. With regard to perfection requirements, registration of the pledge with the relevant public registry is necessary to make the pledge enforceable against third parties.

Pledge over receivables

Security may be granted over any receivable through execution of a pledge agreement in writing between the pledgor and the secured creditor, indicating the secured obligations and properly identifying the relevant receivable and corresponding third-party debtor. While the pledge is valid and enforceable against third parties generally from the date of the pledge agreement, it is not enforceable against the third-party debtor unless and until it receives notice of the pledge, and the third-party debtor may continue to discharge payment obligations under the pledged receivable to the pledgor. Once the third-party debtor has received notice of the pledge, it must discharge any payment obligations under the pledged receivable to the secured creditor, regardless of whether acceleration of the secured debt has occurred.

Bank account pledge

This security interest is simply an unusual variant of a pledge over a receivable, and execution requirements are the same. The pledge is not enforceable against the third-party debtor (ie, the bank with whom the pledged account is open) unless and until it receives notice of the pledge. However, the pledge will only cover monies standing to the credit of the pledged bank account as at the date of enforcement of the pledge, and subject to completion of the current transactions affecting the pledged account.

Cash collateral arrangement

Security can be obtained over cash through payment of the relevant monies into an account opened in the name of the beneficiary (which, where the beneficiary is a bank, can be an internal account within that bank), and not in the name of the pledgor. The taking of cash collateral is subject to the general regime of pledge over tangible assets. However, given the fungible nature of cash, a cash collateral arrangement has the effect of transferring title to such cash to the beneficiary, subject to an obligation of the latter to repay an equivalent amount of money on expiry or discharge of the secured debt.

Pledge over ongoing business

This security interest covers:

• leasehold rights with respect to the premises at which the business is being operated;
• some fixed assets (such as machinery, equipment and tools, subject to these not being pledged under a pledge over plant and equipment);
• trade name and goodwill; and
• future assets of the nature of those mentioned above, either not yet in existence or not yet the property of the pledgor at the time the pledge is granted.

Its scope may be extended to include intellectual property rights (which can alternatively be pledged per se as described below). Such a pledge must be registered with the tax authorities within 10 days, and with the clerk of the commercial courts having jurisdiction over the principal place of business and every branch included in the scope of the pledge within 15 days of execution of the pledge agreement. If intellectual property rights are included in the scope of the pledge, specific registration requirements with the Trademark and Patent Office (INPI) also apply.

Pledge over intellectual property rights

Intellectual property rights can also be pledged independently from a pledge over ongoing business. Specific registration requirements with INPI apply.

Mortgage

The mortgage deed must be signed before a notary public. Mortgages are rather expensive due to the costs of registration with the French tax authority and the land registry and are, therefore, rarely seen in acquisition financings.

Civil law pledge over inventory

French law provides for two methods of creating a pledge over inventory. The first one, known as the civil pledge, requires that the secured creditor be effectively transferred possession and control of the items constituting the pledged inventory. This is generally achieved by the parties designating a third-party service provider who will segregate the pledged items, control in- and outflows and maintain a register accordingly. While difficult to implement and costly to administer, a civil pledge over inventory is a very efficient security interest, as possession by the secured creditor allows it to outrank even those creditors that would otherwise be legally privileged over enforcement proceeds.

Commercial law pledge over inventory

A second method of creating a pledge over inventory was introduced in the French legal system a few years ago. Pursuant to this simplified commercial pledge, the security interest is created by the parties executing a pledge agreement that identifies the pledged items and must be registered with the clerk of the commercial court having jurisdiction over the place where the inventory is located within 15 days of execution of the pledge agreement. The pledgor may sell items comprised in the pledged inventory without the beneficiary’s approval and without any particular release formalities having to be carried out, and the pledge will, within the limit of the initial description of the pledged items, extend automatically to new similar items making up the inventory. Such a pledge does not, however, outrank legally privileged creditors and is not as efficient as a civil pledge. In addition, there are certain statutory limitations to using such a pledge as it may only be granted by the borrower itself (and not by a guarantor), solely in favour of licensed credit institutions and only as security for its indebtedness under the loans (and not bonds or derivative instruments) made available by the relevant beneficiaries.

Assignment by way of security of business receivables

This is another quite efficient security interest, whereby a company can assign outright (and thereby transfer full title to) its present (provided they are sufficiently identified) and future (provided they arise out of the performance of sufficiently identified agreements) receivables arising out of the implementation of its business. Assignment is made effective by delivery by the assignor of a delivery form in a prescribed format and which lists the relevant receivables. Delivery of the list of receivables in electronic form is also permitted. It is market practice to have a master agreement that provides the general terms and conditions that govern the initial assignment, as well as any future assignments. Notice to the debtor is not required to perfect the assignment, but if payments are to be made directly to the secured creditor, notice must be given, otherwise payments will be made to the pledgor. Cash paid directly to the pledgor does not form part of the security and may be recovered by every other creditor of the pledgor, unless particular mechanisms (such as a pledge of the account to which payments are directed) are implemented. Similar statutory limitations as the ones described under ‘commercial law pledge over inventory’ apply to assignment by way of security of business receivables.

Pledge over plant and equipment

A number of strict and rather onerous requirements apply in order to create this type of security. In particular, it too may only be granted by the borrower, in favour of licensed credit institutions only, and as security for its payment obligations under loans made available to it for the purpose of acquiring (and not refinancing) identified plant or equipment and must be granted directly in the relevant loan facility agreement. The pledge must be registered with the clerk of the commercial court having jurisdiction over the place where the inventory is located within 15 days of execution of the loan agreement.

Are there specific bodies of law governing the perfection of certain types of collateral? What kinds of notification or other steps must be taken to perfect a security interest against collateral?

See question 16 for specific perfection requirements. In addition, certain security documents, such as a pledge over business or real estate mortgages, must be submitted to the tax registry and registration duties are payable per agreement. Failure to submit the instrument for registration can result in it being void. Other security documents may be voluntarily submitted for registration as this provides certainty of date to the corresponding document.

There is no general companies’ security register in which French or non-French companies with security interests over assets in France have to register security. However, for the pledge over tangible assets (without dispossession) or for particular assets (eg, mortgage over real estate, pledges over certain shares (civil companies, SARLs or SNCs), or a pledge over the ongoing business) registration is required either in the Commercial Registry or in specific registries in order to make such pledges enforceable.

Once a security interest is perfected, are there renewal procedures to keep the lien valid and recorded?

For those security interests with respect to which registration is mandatory, re-registration must be made to keep the lien valid and recorded. Procedural requirements and delays vary for each type of security.

Are there ‘works council’ or other similar consents required to approve the provision of guarantees or security by a company?

The provision of guarantees or security by a company carrying out business in France does not automatically require a prior consultation of the works council. However, a case-by-case analysis should be done in order to assess the content and extent of the proposed guarantee or security in order to determine whether or not a prior consultation should be undertaken. Pursuant to article L.2323-6 of the Labour Code, the works council must be informed and consulted on matters relating to the organisation, management and general business of the company. This article is usually interpreted broadly by French courts. In addition, the courts tend to consider that any decision that may have a significant impact on the company and on its employees requires a prior consultation of the works council.

In the context of any guarantee or security, the implementation of which would have an impact on the general business of the company and potentially affect its employees, the prior consultation of the works council should be considered. For example, the grant of a pledge over ongoing business (as further described in question 16) may constitute a decision requiring prior consultation. Indeed, realisation of such a pledge would lead to the sale of the going concern, which could affect, significantly, the general management or business of the company and could affect its employees. In the same manner, any security granted by the company, the implementation of which may result in a transfer of assets, may be regarded as having substantial consequences on the company’s business or on its employees and could be considered to require a prior consultation of the works council.

Any security granted by shareholders over the shares of the company, the implementation of which may result in a change of control or by the company over the shares of its subsidiaries will require a prior consultation of the works council pursuant to article L.2323-6 et seq of the Labour Code.

If a prior consultation is required, the works council should provide its opinion before the guarantee or the security is granted. It should be noted that a negative opinion will not prevent the company from taking the decision to grant the relevant guarantee or security. Failure to comply with the above information and consultation obligations can give rise to criminal sanctions against the legal representative of the company. In addition, a judge could decide to suspend the decision taken by the company until the completion of the consultation process.

Can security be granted to an agent for the benefit of all lenders or must collateral be granted to lenders individually and then amendments executed upon any assignment?

Under French law, security interests must be granted directly in favour of the creditors whose claim is the subject matter of the secured liabilities, and not to a person acting on account of the secured creditor or a group of secured creditors (ie, a security trustee). This is because of the accessory nature of security. Another consequence of this accessory nature of security is that the assignee of a loan receivable will benefit automatically from the security granted to secure those receivables.

With respect to secured bond facilities governed by French law, the Commercial Code provides that security may not be granted in favour of each bondholder individually. In accordance with articles L.228-71 and L.228-81, the bondholders form a group with legal personality and any security taken before or after completion of the issue in order to secure the bonds shall be granted for the benefit of the group of bondholders, without any need to identify them individually. Therefore, any transfer of bond triggers a transfer of the benefit of security interests securing those bonds. By law, security interest granted to a group of bondholders is administered and enforced by a bondholders’ representative, which must be an entity incorporated in France and appointed by the bondholders in a general meeting. Scholars and certain court decisions tend to demonstrate that the bondholders’ representative’s mandate is of a legal nature and cannot be delegated to another entity.

The Civil Code now includes a security agent concept, set out in articles 2488-6 and seq, which provide, notably, that the Civil Code’s security agent facilitates the execution, administration and (principally) enforcement of security where there are several secured creditors, by allowing one designated entity to carry out actions on behalf of (and, in accordance with instructions received from) the secured creditors. Such a concept may be assimilated to a trust mechanism because the security agent itself is the direct beneficiary of the security interest.

Note that none of the parallel debt and trust mechanism constructs have been generally recognised by French courts. Although the Supreme Court has held, in a decision (Cass com 13 September 2011 No. 10-25533 Belvedere) rendered in the context of safeguard proceedings opened in France, that subject to certain conditions being met, the concept of parallel debt governed by the laws of the state of New York was not incompatible with the French law concept of international public policy, this decision cannot be considered as a general recognition of the enforceability in France of the rights of a security agent benefiting from a parallel debt obligation and no assurance can be given that such a structure will be upheld by other French courts if tested.

The concept of ‘trust’ has been recognised by the Tax Code and the Supreme Court, which has held, in the same published decision referred to above, that a trustee validly appointed under a trust governed by the laws of the state of New York could validly be regarded as a creditor in safeguard proceedings opened in France. However, while substantial comfort may be derived from the above, France has not ratified the Hague Convention of 1 July 1985 on the law applicable to trusts and on their recognition, so that the concept of ‘trust’ has not been generally recognised under French law.

What protection is typically afforded to creditors before collateral can be released? Are there ways to structure around such protection?

There is no general legal protection for creditors in relation to the release of security. Facility agreements and, more recently, bonds documentation will, therefore, usually include contractual conditions for any release of security. Under a secured loan facility, the security agent must exercise any right vested in it in accordance with any instructions given to it by the lenders. The credit agreement usually provides that any amendment or waiver that relates to the scope or to any release of any security granted to the benefit of the lenders shall not be made without the consent of all the lenders except where such release is expressly permitted by a finance document or is the direct consequence or prerequisite of a disposal or transaction expressly permitted under the finance documents, in which case, that release will be given by the security agent acting upon instructions of the agent and the consent of the lenders will not be required.

With respect to secured bond facilities governed by French law, according to French law, if security must be released before all amounts due under the facility have been redeemed and unless the bonds documentation has specific provisions relating to the release of security, the bondholders’ representative will need the prior authorisation of the majority of the bondholders (majority being set, according to the Commercial Code, at two-thirds of the expressed votes), whereas if the release is granted as a consequence of the full redemption of the bonds, no such prior authorisation is required and the bondholders’ representative may deliver a release letter.

As such, because of the accessory nature of security, a release letter is not always required for the release to be completed, although such letter is almost always delivered by creditors. Release letters are, however, specifically required in order to proceed to the release of registered securities (such as pledge over ongoing business, pledge over intellectual property rights or pledge over quotas).

Describe the fraudulent transfer laws in your jurisdiction.

See question 33 on void and voidable transactions.