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Typical transaction structures – public companies
What is the typical structure of a business combination involving a publicly traded real-estate owning entity?
This depends on the structure of the investor, whether it is a foreign or domestic investor, its final goal and its tax regime.
Depending on the above, several special purpose vehicles (SPVs) can been used:
- a regulated vehicle, such as a French real estate investment trust (REIT) or a real estate collective fund (OPCI), both of which benefit from tax exemptions;
- an alternative investment fund dedicated to real estate; or
- an SPV, such a real-estate unlimited partnership or a limited liability company (SARL), which are simple vehicles designed to hold and lease real-estate assets.
Typical transaction structures – private companies
Are there are any significant differences if the transaction involves a privately held real-estate owning entity?
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Typical transaction process
Describe the process by which public and private real-estate business combinations are typically initiated, negotiated and completed.
In France, the process for acquiring a real-estate-related business is relatively standardised. Different terms would apply in cases of purchasing a corporate vehicle owning the property. A share deal may be carried out according to a private sale and transfer agreement, without the participation of a public notary.
For major real-estate-related business a broker will be involved, frequently two brokers are appointed on a co-exclusive basis.
The first step is for the purchaser to send a letter of intent (LoI) to the seller. This must be carefully drafted so that it may not be deemed to be a firm offer. The parties will only be bound once a call option or a bilateral undertaking to sell and purchase is signed.
It is customary to negotiate an exclusivity period, during which the purchaser carries out all legal and technical due diligence over the real-estate asset or the target company, and the seller undertakes not to negotiate with any third parties.
Two types of preliminary contracts can be executed: a call option agreement and a bilateral undertaking.
Call option agreements
A call option agreement is where the seller irrevocably undertakes to sell the property and the purchaser has the option of purchasing the property during the allotted time. In consideration of the option, the purchaser pays a deposit that is usually 10 per cent of the sale price. This deposit is not refundable if the purchaser does not exercise the option, but if he or she does exercise it, the deposit is deducted from the purchase price. However, the 10 per cent deposit is refunded to the purchaser if any of the conditions stipulated in his or her favour are not fulfilled.
A bilateral undertaking to sell and purchase is where both parties are committed. The seller to sell and the purchaser to buy - but most often the transfer of title will be subject to conditions. It is normal practice for the purchaser to pay a deposit (usually 10 per cent of the price), which will be refunded if the conditions are not satisfied. Once the conditions are met, the sale is final and the registration duties or taxes must be paid within one month, or the notarial deed of sale must be executed within such a period.
Notaries are necessarily involved in the conveyancing procedure relating to direct real-estate investments (ie, purchase of the property as opposed to purchase of the shares of the company owning the property). This is because the direct purchase of a property must occur by means of a notarial deed of transfer, in order to be published at the Land Registry and so be enforceable against third parties. Notaries have a monopoly in this respect.
The notary will draw up the contract (although lawyers are very frequently involved as well), witness the signatures, collect and make the purchase payment, and publish the transfer.
The choice of notary is usually in the hands of the seller (or the lender for a loan). The notary’s fees are payable by the purchaser, unless the parties agree otherwise.
Law and regulation
Legislative and regulatory framework
What are some of the primary laws and regulations governing or implicated in real-estate business combinations? Are there any specific regulations or laws governing transfers of real estate that would be material in a typical transaction?
The primary laws governing, or involved in, real-estate-related business combinations in Franc is the French Civil Code. But other regulations may apply, depending on the underlying asset, such as:
- the French Commercial Code, for commercial leases;
- Law No. 89-462 of 6 July 1989 for residential leases; and
- the Rural and Sea Fishing Code for agricultural real-estate assets.
Cross-border combinations and foreign investment
Are there any specific material regulations or structuring considerations relating to cross-border real-estate business combinations or foreign investors acquiring an interest in a real-estate business entity?
A foreign investor selling a real-estate business in France is subject to certain constraints and, notably, the taxation of the capital gain realised upon the sale. However, some tax treaties provide for exemptions under certain conditions. It is therefore important to examine the tax treaty applicable when structuring the acquisition of a real-estate business by a foreign investor.
Choice of law and jurisdiction
What territory’s law typically governs the definitive agreements in the context of real-estate business combinations? Which courts typically have subject-matter jurisdiction over a real-estate-related business combination?
French law governs asset and share deals. Commercial courts have subject-matter jurisdiction over share deal, whereas civil courts have subject-matter jurisdiction over deals.
Approval and withdrawal
What information must be publicly disclosed in a public-company real-estate business combination?
There are two kinds of public company real-estate-related business combinations: the OPCI and the civil real estate investment company (SCPI). Both require an administrative agreement from the French Financial Markets Authority (AMF) prior to any investment from the public.
An OPCI, discloses information to the public in a prospectus and two documents provided by the AMF or the investment’s distributors: the key investor information document (KIID) and the prospectus.
An SCPI’s annual and quarterly reports can be provided to whoever asks the management company for them.
Duties towards shareholders
Give an overview of the material duties, if any, of the directors and officers of a public company towards shareholders in connection with a real-estate business combination. Do controlling shareholders have any similar duties?
Directors and officers of classic real-estate companies - that is a société anonyme (SA), a limited liability company by shares (SAS), or a real-estate company (SCI) - are not given specific duties by the company’s stakeholders.
However, specific rules do apply to OPCIs that are regulated fund vehicles commonly used for real-estate-related business. An OPCI director is necessarily a management company approved by the AMF. An OPCI must submit to the following distribution obligations:
- rental income: 85 per cent;
- net capital gain on sale of building: 50 per cent; and
- dividends from subsidiaries subject to a SIIC regime: 100 per cent.
There are no distribution obligations for other forms of income.
Subsidiaries of an OPCI, such as an SAS or limited liability company (SARL), may elect the SIIC regime under certain conditions resulting in a tax exemption on the rental income, capital gains on the sale of building and dividends of the subsidiaries subject to SIIC regime, subject to distribution requirements of, respectively, 95 per cent, 60 per cent and 100 per cent.
What rights do shareholders have in a public-company real-estate business combination? Can parties structure around shareholder dissent or rejection of a real-estate business combination, and what structures are available?
Unlike in other European jurisdictions, French law does not require that shareholders of a public company approve going-private transactions in a general meeting. The possibility to delist the target company depends on the ability of the bidder to acquire 95 per cent or more of the securities and voting rights of the company. If this threshold is reached, the bidder will be entitled, under the oversight of the AMF, to proceed with a squeeze-out transaction, with no shareholder approval required.
In a squeeze-out, minority shareholders have specific protections designed to ensure that they get a fair price for their shares.
First, the price offered in a buyout offer (ie, an offer aiming at reaching the 95 per cent squeeze-out threshold) following a tender offer pursuant to which a bidder has acquired the control of the target company must be at least equal to the price offered in the prior tender offer.
Second - and in all cases of buyout offers where the bidder has indicated that they will, or they may, proceed with a squeeze-out if they reach the 95 per cent squeeze-out threshold - the price offered needs to result from a valuation made according to a multi-criteria analysis that is confirmed by a fairness opinion delivered by an independent expert.
The need to reach the 95 per cent voting rights threshold in order to implement a squeeze-out transaction and to successfully take the company private will usually push potential bidders to approach key shareholders of the target to obtain from shareholders’ undertakings to tender shares in the upcoming tender offer.
A valuation from an independent expert may also be sought or required in transactions other than buyout offers and squeeze-out transactions when there are potential conflicts of interest or a risk of a breach of the requirement for equal treatment of the shareholders. This will allow the controlling shareholder to avoid or minimise the risks of seeing minority shareholders challenging a real-estate-related business combination in court.
Are termination fees typical in a real-estate business combination, and what is their typical size?
It is not customary to have pre-agreed break-up fees during the negotiation period. The Civil Code provides for a negotiation in good faith. A party could, however, claim damages, if it considers that the other party acted in bad faith by wrongfully terminating the negotiation. The amount of the indemnity is usually capped to the costs incurred during the negotiation period.
After executing a promise to sell via asset deals or a share purchase agreement, break-up fees usually correspond to a maximum of 10 per cent of the underlying asset’s value.
Are there any methods that targets in a real-estate business combination can employ to protect against an unsolicited acquisition? Are there any limitations on these methods?
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How much advance notice must a public target give its shareholders in connection with approving a real-estate business combination, and what factors inform this analysis? How is shareholder approval typically sought in this context?
When a large-scale transaction is contemplated, involving the sale of a substantial part of the assets of a listed company or a major change in its business, it is recommended that the listed company convene a shareholders’ meeting to approve the transaction. The AMF recommends such meetings for transactions involving a sale representing at least 50 per cent of a company’s assets. Such a meeting must be convened with at least 30 days’ advance notice and the vote must be according to the conditions of quorum and majority of an ordinary general meeting.
Although this guidance is not a statutory requirement, if the board decides to not comply with this recommendation, it must justify its position to the AMF, which will exercise close scrutiny. In addition, in such situations minority shareholders may request the AMF require the controlling shareholder to launch a buyout offer.
Taxation and acquisition vehicles
Typical tax issues and structuring
What are some of the typical tax issues involved in real-estate business combinations and to what extent do these typically drive structuring considerations? Are there certain considerations that stem from the tax status of a target?
Real-estate structuring is mainly driven by the modalities of taxation of the capital gain realised upon sale. In all the tax treaties concluded by France, the right to tax the capital gain on a building is given to France. When the seller is a non-French resident company, capital gains is subject to a 33.33 per cent withholding tax, comparable to the corporate income tax (CIT) rate that companies resident in France for tax purposes are subject to. The withholding tax rate will progressively decrease to:
- 31 per cent in 2019;
- 28 per cent in 2020;
- 26.5 per cent in 2021; and
- 25 per cent in 2022.
The situation is slightly different for capital gains realised upon sale of shares in a French real-estate-oriented companies. Indeed, in some tax treaties the taxation of such capital gains is not given to France. With appropriate structuring, and provided that economic substance exist, taxation of such capital gains can be minimised. That is why, until 2014, most of real-estate funds were structured via Luxembourg, as the France-Luxembourg tax treaty applicable until that date preventing France from taxing capital gains on shares of real-estate companies. However, the treaty was modified in September 2014 to give France the right to tax all capital gains relating to French real-estate business (eg, buildings, shares in real-estate companies). Structuring real-estate business evolved and most of the major real-estate funds set up OPCIs, which are regulated vehicles that are fully exempt from CIT under certain conditions.
However, a new tax treaty was signed between France and Luxembourg on 20 March 2018 (its entry into force is expected in 2019 or 2020). This treaty increases the withholding tax rate applicable to dividends paid by an OPCI to a Luxembourg shareholder. Therefore structuring of real-estate business may evolve in the coming years.
One other typical tax issue is the ‘3 per cent tax’. All entities (French or foreign), directly or indirectly holding real-estate assets in France, are liable to an annual 3 per cent tax computed on the fair market value of the asset. A lot of exemptions are applicable. While structuring a real-estate transaction, it is essential to check investors’ 3 per cent tax status to ascertain if an exemption is applicable.
Mitigating tax risk
What measures are normally taken to mitigate typical tax risks in a real-estate business combination?
The French tax administration is allowed to challenge an operation and a structure if their purpose is mainly tax-driven and so an abuse of law. This must be kept in mind while structuring a real-estate transaction to minimise the tax leakage. It is essential to give economic and material substance to a structure to avoid a challenge of the structure for being an abuse of law.
Types of acquisition vehicle
What form of acquisition vehicle is typically used in connection with a real-estate business combination, and does the form vary depending on structuring alternatives or structure of the target company?
The typical vehicle used to acquire real-estate assets is an SCI. From a tax standpoint, and provided that the SCI does not run a commercial activity, the SCI will be a pass-through entity, meaning its taxable result is not taxed at its level but at the level of its partners. With an SCI, CIT liability remains at the level of the partners at the closing date of the fiscal year. Therefore, such a vehicle allows a reduction of buyers’ tax liability. Besides, a seller is not necessarily required to grant a discount for latent tax while selling an SCI.
The acquisition of a building with a view to rent it is not a commercial activity. But the acquisition of a building with a view to shortly resell it and the rental of furnished buildings are commercial activities.
The other typical vehicle for real-estate acquisition is an OPCI. This is a vehicle that is fully exempt from CIT, provided that it distributes most of its income to its partners.
Board considerations in take-private transactions
What issues typically face boards of real-estate public companies considering a take-private transaction? Do these considerations vary according to the structure of the target?
Boards of public companies faced with a tender offer must to exercise their fiduciary duties of care and diligence. This will require the involvement of advisers (ie, investment banks and lawyers) capable of assisting the board in its assessment of the offer received, which will be contained in the prospectus that the target of a tender offer must issue in response to the bidder’s proposed takeover. In that context, the assessment of the adequacy of the bidder’s consideration is a key element, and boards may use the advice of an independent expert to confirm the fairness of such a price.
Time frame for take-private transactions
How long do take-private transactions typically take in the context of a public real-estate business? What are the major milestones in this process? What factors could expedite or extend the process?
In France, the legal regime governing the delisting of a public company is more restrictive than in other European jurisdictions. For instance, French law also requires that the bidder in a buyout and squeeze-out offer holds at least 95 per cent of the capital and voting rights of the company, while the threshold required by the European Takeover Directive is only 90 per cent.
In addition, the timeline may be longer than in other jurisdictions. For instance, in order for a buyout offer to obtain the clearance from the AMF to launch, the bidder will have to provide explanations (in the prospectus) regarding methods followed by its sponsoring bank in the calculation of the offer price, and an opinion by an independent expert confirming the fairness of such price. This requires a substantial preparation time.
After the AMF approves a buyout offer, the process accelerates: the buyout period must remain open for a minimum period of 10 days. Soon after the results of the offer are announced, and if the 95 per cent squeeze-out threshold is reached, the AMF will authorise the squeeze-out and, after the required formalities and publications are carried out, it may be implemented within a few trading days
Are non-binding preliminary agreements before the execution of a definitive agreement typical in real-estate- business combinations, and does this depend on the ownership structure of the target? Can such non-binding agreements be judicially enforced?
Parties usually sign a non-binding LoI for the direct or indirect purchase of real-estate property. Such a document is usually the first entered into in relation to a property transaction and provides for the purchase price, tax aspects, as well as the main terms and the conditions of the transaction (eg, an exclusivity period, due diligence, conditions, timing of the transaction, etc). Non-binding agreements cannot be enforced judicially.
Describe some of the provisions contained in a purchase agreement that are specific to real-estate business combinations? Describe any standard provisions that are contained in such agreements.
The purchase agreement will contain all necessary terms and conditions of the transaction, including:
- description of the real-estate asset;
- purchase price - including for share deal, price formula and procedure of determination of the final purchase price;
- list of conditions (if any);
- covenants of the seller during the interim period;
- pre-closing operations;
- closing deliveries;
- representations and warranties (R&Ws);
- indemnification; and
- guarantee deposit.
A recent trend is for the sellers to give limited R&Ws. The scope of warranties and indemnities depends and varies on the specificities of the transaction. As a minimum, the seller warrants the title to property.
Are there any limitations on a buyer’s ability to gradually acquire an interest in a public company in the context of a real-estate business combination? Are these limitations typically built into organisational documents or inherent in applicable state or regulatory related regimes?
There are certain constraints, particularly in terms of disclosure obligation bearing on the ability of a potential bidder to gradually build a stake in a listed company.
French law provides that any person, acting alone or jointly with other persons, who comes to hold more than 5 per cent, 10 per cent, 15 per cent, 20 per cent, 25 per cent, 33.33 per cent, 50 per cent, 66.66 per cent, 90 per cent or 95 per cent of the share capital or voting rights of a listed company must, within five trading days, inform the company and the AMF that it crossed such a threshold. This information will be made public by the AMF. Failure to comply with this requirement will deprive the bidder of the voting rights exceeding the relevant threshold for a two-year period following the date of actual disclosure.
In addition, French companies may increase the disclosure requirement in their by-laws and require that disclosures be made for crossing thresholds between 0.5 per cent and 5 per cent of their share capital or voting rights. Such additional disclosures must be sent to the company’s shareholders but need not be disclosed to the AMF and the public.
It is also worth noting that the price at which shares are bought on the market may become a minimum price in a possible subsequent offer. Indeed, if the bidder comes to hold more than 30 per cent of the share capital and voting rights of the target, it will be required to launch a mandatory tender offer for all the shares of the target. In that case, French law provides that the price offered in such a tender offer may not be lower than the highest price paid by the bidder for shares of the target during the preceding 12 months. Such a minimum price will also become the mandatory minimum price in a subsequent buyout offer.
Certainty of closing
Describe some of the key issues that typically arise between a seller and a buyer when negotiating the purchase agreement for a real-estate business combination, with an emphasis on building in certainty of closing? How are these issues typically resolved?
The purchase process is usually divided into two main steps:
- an open bid process at the end of which an exclusivity period is granted to one candidate (sometimes an intermediate period is opened with two candidates); and
- an exclusivity period of two to four months, at the end of which a purchase agreement needs to be executed.
The French market is currently a vendor’s market, in that is there is great competition between buyers putting the vendors in a favourable situation in terms of price and negotiation. However, several issues may arise, such as the following.
The French market does not accept any condition relating to bank financing. Buyers need to provide all the evidence that they have the financial capacity to pay the purchase price.
Buyers have to be able to complete the purchase process in a very short time period (eg, due diligence and negotiations are usually completed within two to four months). This timing may be extended depending on the negotiation, the quality of the information provided by the seller or any other reasons.
Limited representations and warranties
Buyers have to be very pragmatic and efficient in negotiating the R&Ws.
Who typically bears responsibility for environmental remediation following the closing of a real-estate business combination? What contractual provisions regarding environmental liability do parties usually agree?
In France, responsibility for environmental remediation may be borne by different persons depending on the situation.
If a regulated facility (ICPE) has been or is currently operated on the sold property, the last operator (or its beneficiary) of the facility that caused the pollution has the administrative obligation to remediate the site upon termination of activities to ensure its compatibility with a set use. An industrial use will be taken into account most of the time.
If the sale of an operated site entails a change of operator of the facilities, the new operator is liable for future environmental remediation, provided that such remediation is related to the taken over activities.
Finally, if environmental remediation is required because of a change of use of the site, the person responsible for the change of use will also be responsible for the corresponding environmental remediation.
If no regulated facility has been operated on the site, the waste producer that contributed to the origin of soil pollution or the waste holder whose fault contributed to such pollution will bear the remediation obligation.
In all cases, the landlord may have residual liability when the above-mentioned primarily responsible persons have disappeared and if the landlord is proven to have been negligent or if they contributed to the pollution of the site.
The administrative environmental remediation obligation may only be transferred, under specific conditions, through an administrative procedure implying among other things prior authorisation from the prefect and the constitution of financial guarantee. It should be noted that, even if the administrative environmental remediation obligation cannot be contractually transferred, specific remediation cost repartition may be agreed between the parties.
Other typical liability issues
What other liability issues are typically major points of negotiation in the context of a real-estate business combination?
The seller of a property (asset deal) must provide the purchaser with two warranties, different in scope, covering the risks of eviction and hidden defects in the building sold. In practice, clauses are often inserted into contracts that limit the seller’s warranty or even exclude it altogether. Such clauses are invalid if they emanate from a seller who is a professional, unless the purchaser too is a professional, specialising in the same field as the seller. Recent laws have imposed a requirement to append various schedules either to the pre-contract or to the notarised deed of sale which relate to the risks attached to the property, such as termites, lead or asbestos.
Warranty against eviction
This warranty against eviction is a guaranty granted by law and which covers the risk of eviction (ie, by third parties or by the seller him or herself).
The seller first guarantees the purchaser against any direct claims to his or her property, such as seeking to evict him or her on the grounds of adverse possession or claiming rights in rem to the building, such as usufruct or building lease.
The seller also guarantees the purchaser against any indirect actions against his or her property, such as selling the property to a third party before the first sale is registered.
Warranty covering hidden defects
After the sale, the purchaser may discover that the building sold contains a hidden defect. This is defined by the Civil Code as a defect that makes the building sold unfit for the purpose intended by the purchaser, or impairs this to such an extent that the purchaser would not have acquired it, or would have offered a lower price for it, had he or she have known about the defect.
The purchaser is then entitled to apply for annulment of the sale accompanied by a refund of the price paid, or to receive a reduction in this price. The seller is not required to issue warranties covering any apparent defects. The extent to which a defect is deemed to be not apparent depends primarily on the extent of the purchaser’s experience in detecting such defects. The purchaser may first seek the annulment of the sale. However, he or she may also apply to the courts for a reduction in the price of the property.
Whatever course of action he or she chooses, the purchaser must act no later than two years as from the date on which they discovered the defect.
Sellers’ representations regarding leases
In the context of a real-estate business combination, what are the typical representations and covenants made by a seller regarding existing and new leases?
Investment in property tends to be for commercial or office use. A lease agreement for this use will fall into the scope of the commercial leases regulations.
The main purpose of the French regulation is to grant the lessee the right to renew their lease in order to ensure the continuation of their business and to secure their clients.
French rules relating to commercial leases are very strict and has to ensure a real-estate-related business combination that all the requirements are respected in the lease agreements. The minimum term of a commercial lease agreement is nine years. However the parties can provide for a longer term. Unless otherwise agreed, the tenant may terminate the lease at the end of each three-year period by giving at least six months’ prior notice.
The parties can provide for a longer term (such as a 12-year term). The lease agreement shall be prepared as a notarial deed if its term exceeds 12 years. In such cases, the lease shall be registered with the Mortgage Registry and is subject to the payment of registration duties.
A tenancy schedule indicating the rent level and break options, is part of a seller’s R&Ws. Representations may cover ancillary costs that have wrongly been charged to the tenant. As a strict case law limits restrictions of the legal indexation of the rent, issues are frequently to be found in such indexation clauses, therefore R&Ws are frequently discussed with the seller.
Legal due diligence
Describe the legal due diligence required in the context of a real-estate business combination and any due diligence specific to a real-estate business combination. What specialists are typically involved and at what point in the transaction are the various teams typically brought in?
Before issuing a firm offer letter, the purchaser will usually carry out an extensive due diligence on the real-estate asset and/or the target company. The legal due diligence (eg, review of titles, zoning searches, review of building authorisations, review of leases, corporate and tax aspects, etc) will be conducted by notaries and lawyers, it being specified that the notary will review the title to property more than 30 years, deeds creating easements and legal compliance with obligatory documents (eg, asbestos, termites, Legionella bacteria and energy performance reports).
Technical and environmental surveys of the real-estate asset will also be carried out.
How are title, lien, bankruptcy, litigation and tax searches typically conducted? On what levels are these searches typically run? What protection from bad title is available to buyers and does this depend on the nature of the underlying asset?
Searches are conducted in the framework of a virtual data room where all documentation concerning the transaction is made available to the bidders.
All documents relating to the ownership of a property are published at the Land Registry. Notaries are therefore able to verify title to property more than 30 years, easements, etc, by conducting additional searches. No transaction will occur if the notary is not in a position establish title to property over a 30-year period. No legal opinion or insurance will give protection against bad title.
Commercial courts can provide bankruptcy certificate or certificates regarding encumbrances and liens over the company and the business.
Representation and warranty insurance
Do sellers of non-public real-estate businesses typically purchase representation and warranty insurance to cover post-closing liability?
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Review of business contracts
What are some of the primary agreements that the legal teams customarily review in the context of a real-estate business combination, and does the scope vary with the structure of the transaction?
The main lease issues are those mentioned under question 22 (ie, term of the leases, break options, rent levels and indexation clauses), whereby the legal focus generally remains on the lease situation.
The public notary is responsible for reviewing title deeds in France. Even in a share deal, it is common practice for a notary to be involved in this regard.
As the broker fees are usually to be borne by the seller, such agreements are not analysed in an acquisition due diligence.
Ancillary agreements (ie, all other agreements linked to the real estate, such as maintenance agreements) are reviewed during the due diligence phase, in order to determine their conditions and whether it is worthwhile for a purchaser to pursue them.
In addition to real-estate issues, in share deals, other important aspects have to be considered (eg, management of past liabilities and calculation of purchase price).
Breach of contract
Remedies for breach of contract
What are the typical remedies for breach of a contract in the context of a real-estate business combination, and do they vary with the ownership of target or the structure of the transaction?
Remedies depend on the nature of the purchase agreement and the moment of the breach. In most cases, there are two options to consider:
- that the contract still needs to be executed. Therefore, a party has the right to enforce the execution of the purchase agreement against the other party in breach; or
- that the contract is terminated with the possibility to claim for damages (around 10 per cent of the purchase price).
How does a buyer typically finance real-estate business combinations?
A mix of equity and indebtedness typically finances the acquisition of a real-estate asset.
The level of equity and debt in real-estate assets’ financing depends in particular the bank indebtedness conditions (which will take into account the property’s use, its location, its vacancy and the quality of the borrower). Banks’ policies also usually require an indebtedness level to not exceed 50 per cent (or less) of the value of the real asset (much lower than before the subprime crisis).
Investors have also made major fundraising during the past years in the real-estate asset sector and have to invest their equity. This will impact the level of equity injected.
If it is at the property level, the bank indebtedness will usually finance the property’s acquisition price or works on the property. In case of share deal, the purpose will be to refinance the existing indebtedness of the target company.
What are the typical obligations of the seller in the financing?
At the acquisition date, the real-estate asset and its revenues (and the borrower’s shares in case of senior line indebtedness) shall be free any privilege and the seller shall provide the purchaser with the relevant release agreement. The seller shall also provide the purchaser with all information usually required within the context of an acquisition of real-estate assets, such information being communicated to the bank and its advisors. The seller shall also authorise the banks and a real-estate expert to visit the property.
What repayment guarantees do lenders typically require in the context of a property-level financing of a real-estate business combination? For what purposes are reserves usually required in the context of property-level indebtedness?
The banks usually require guarantees to:
- cover any borrower’s cash shortfall in case of vacancy or rent-free periods;
- cover a specific issue that shall be financed with equity or excess cash (eg, capital expenditure costs, tenants’ improvements, repairs, leasing or taxes); and
- cure a soft financial ratio.
In case of default or breach of financial ratio upstream payments will be forbidden and any excess cash will be put into a reserve (either transferred to a cash collateral account or retained to the operating account) or allocated to the repayment of the indebtedness.
What covenants do lenders usually insist on in the context of a property-level financing of a real-estate business combination?
The main covenants in real-estate finance usually are:
- information covenants with respect to the borrower (eg, annual accounts, by-laws, etc) and the property (eg, rent roll, unpaid rents, occurrence of any damage, etc);
- financial covenants (such as the loans-to-value ratio, the interest coverage ratio and the debt service coverage ratio); and
- covenants relating to the property, such as:
- the borrower undertaking to properly manage the property and entering into property management and asset management agreements on terms or with a counterparty that may be prior approved by the agent);
- that the property shall be properly insured; and
- the type of leases the borrower is authorised to enter into.
Typical equity financing provisions
What equity financing provisions are common in a transaction involving a real-estate business that is being taken private? Does it depend on the structure of the buyer?
Financing documentation imposes strict controls on upstream payment and some compulsory equity injection requirements.
Upstream payments shall be subordinated to the debt, limited to the excess cash available to the borrower and cannot occur if a default (or a breach of financial ratio) has occurred and is continuing.
Equity injection provisions may be required to cure a covenant (eg, financial ratios, repayment obligations) or to solve a specific issue (eg, works financing, etc).
Collective investment schemes
Are real-estate investment trusts (REITs) that have tax-saving advantages available? Are there particular legal considerations that shape the formation and activities of REITs?
To qualify as a French REIT (a SIIC), a company must comply with the following conditions on a continuous basis:
- be listed on a regulated stock exchange;
- have a share capital of at least €15 million; and
- 60 per cent or more of its capital (or voting rights) must not be held, directly or indirectly, by one or more shareholders acting in concert (unless, under certain conditions, the shareholders are themselves SIICs).
The corporate purpose of the SIIC must predominantly be the acquisition or construction of real-estate assets in a view to renting them or the direct or indirect holding of shares in entities (tax transparent or subject to CIT) with an identical corporate purpose.
SIICs may carry out ancillary activities that do not correspond to their main corporate business, provided that the value of assets allocated to other activities, such as property dealers or properties development, must not represent more than 20 per cent of the gross value of the SIIC’s assets.
An election for the SIIC regime is necessary to benefit from the tax-favourable regime. The election for the SIIC regime entails the consequences of a ceasing of business and notably the payment of an exit tax of 19 per cent computed on the latent capital gains on the assets.
After election for the SIIC regime, the SIIC benefits from a tax exemption on the rental income, capital gains on the sale of building and dividends of the subsidiaries subject to SIIC regime, subject to distribution requirement of, respectively, 95 per cent, 60 per cent and 100 per cent.
Income from ancillary activities remains liable to CIT at the standard rate and is not subject to the distribution requirements of the SIIC regime.
Private equity funds
Are there particular legal considerations that shape the formation and activities of real-estate-focused private equity funds? Does this vary depending on the target assets or investors?
As regards to the formation of such a fund, legal considerations will depend on the type of investors and for instance:
- whether they are foreign or domestic investors or a mix; and
- whether they are regulated or not.
Some activities are regulated and the capacity to invoice fees needs, in some cases, to receive prior approval from the AMF or another French administration. Some activities must be registered, and some specific legal requirements apply, such as for the managing of a real-estate asset (a property manager).