The main legislative provisions applicable to private equity operations in France are set forth in the Commercial Code, the Monetary and Financial Code and the Civil Code.
The Civil Code's provisions on contract law were substantially amended in 2016, which has important implications for M&A practice in general, including private equity.
For instance, the new Article 1124 of the Civil Code has reinforced the binding effect of unilateral promises to buy or sell by establishing the ineffectiveness of the revocation of such a promise by the promisor. As result, the withdrawal of a promise during the period within which the beneficiary may exercise the option no longer prevents the formation of the promised contract. Therefore, beneficiaries are now entitled to seek enforcement of the relevant promise against the defaulting promisor, pursuant to new Articles 1221 and 1224 of the Civil Code.
In practical terms, such developments have enhanced the effectivity of mechanisms often used in private equity transactions, such as put and call options and tag-along and drag-along rights, which are all based on unilateral promises to buy and sell under French law.
As Europe's second largest private equity market, France provides a safe and stable legal environment for investors. Indeed, France has developed a solid legal framework, with effective standards for investor protection. Having dealt with such matters for years, French courts are quite familiar with private equity litigation and enforcement. Therefore, private equity investors investing in France can rely upon an effective and affordable judiciary system, providing concrete solutions to their disputes.
Depending on the nature and size of the deal, the following authorities may have a role to play:
French Competition Authority (FCA): Under French law, transactions meeting the following three conditions (other than transactions in retail businesses, where lower thresholds may apply) are subject to merger control:
Where such conditions are met, an application for review must be filed with the FCA, which will assess the competition implications of the intended transaction and can either prohibit or authorise (with or without conditions) the operation.
Minister for the economy and finance: Under French law, some foreign investments are subject to the minister's compulsory prior approval.
Operations falling within the scope of prior authorisation are investments:
The minister can either reject or approve (with or without conditions) the intended transaction.
In France, private equity transactions are also subject to certain labour law requirements.
Prior to the conclusion of a binding agreement, the target's social and economic committee (CSE) (if any) must be informed and consulted on the intended transaction. In France, only companies with more than 50 employees are required to have a CSE. The CSE's opinion is not binding and therefore cannot impede the transaction. However, failure to comply with consultation obligations could delay the transaction and may expose the target's management to criminal sanctions. For instance, the Paris Court of Appeal recently confirmed the suspension of Suez's takeover by Veolia (CA Paris, Pôle 6, 2e ch., 19 nov. 2020, n° 20/06549), on the grounds of failure to comply with prior consultation obligations.
Additionally, if the intended transaction implies the transfer of 50% or more of the target's share capital, the Hamon Law requires small and medium-sized companies (ie, companies with fewer than 250 employees and an annual turnover of up to €50 million) to notify the intended transaction to all employees individually prior to completion. Such notification is intended to allow each employee to make an offer to purchase the relevant shares. Stakeholders are not entitled to perform the operation unless all employees have waived their right to make an offer. In case of non-compliance with such rules, stakeholders risk a penalty equal to 2% of the purchase price paid upon completion.
In most private equity deals, the investment fund set up a special purpose vehicle (Newco), created specifically for the purpose of effecting the intended transaction. Thus, all private equity investors are gathered under a single corporate body. In general, the funds required for purchasing the target are raised at the level of Newco.
When managers invest alongside the private equity fund, a second special purpose vehicle (Manco) is usually formed. The idea is to bring all key managers together, with the aim of ensuring a successful transition once the acquisition has been completed (especially in the context of a takeover by private equity investors).
The respective rights and obligations of Newco and Manco in relation to the target are set forth in a shareholders' agreement. As for the contractual relationship between sellers and special purpose vehicles, such parties are usually bound by execution of an acquisition agreement.
Newcos and Mancos are usually incorporated as a société par actions simplifiée (SAS), which is the most flexible corporate form under French law.
The main advantage of the SAS is that the company's bylaws can be tailored to fit investors' needs, as French corporate law does not contain any significant organisational requirement applying to this type of corporation. Another key advantage of this form of business entity is that the SAS has very low capital requirements (the minimum share capital required to incorporate a SAS is equal to €1). Furthermore, the SAS allows investors protect their personal wealth, since shareholders' liability is limited to the amount of their initial investment. Therefore, the SAS is very popular among foreign investors.
Despite these many advantages, private equity investors must bear in mind that French corporate law prohibits SAS companies' access to capital markets and therefore their shares cannot be listed on a stock exchange. As a result, the SAS must be transformed in a société anonyme before any listing.
Over the past few years, private debt funds have also become an importance source of liquidity for private equity deals. However, bank loans nonetheless remain a common source of funding. In general, bank loans are borrowed by Newco, which will also be the recipient of immediately available funds provided by private equity investors.
As an alternative source of funding, shareholders' loans (typically in the form of bonds or convertible bonds) are also frequently used in order to finance part of the target's purchase price and other expenses associated with the acquisition.
In terms of regulatory constraints, Article L 225-216 of the Commercial Code prohibits ‘financial assistance' from a company for the acquisition of its own shares by a third party. Consequently, a target:
Non-compliance with this prohibition may give rise to criminal sanctions and financial penalties.
The main advantage of a bank loan is that capitalised interests are tax deductible under French law.
With respect to shareholders' loans, debt holders are generally offered a higher return on their investment than investors holding common stock (ie, sweet equity).
When it comes to cross-border deals, special attention should be paid to compliance with foreign investment control procedures under French law (for further details, see question 2.1). Failure to comply with such requirements may have important consequences, such as exposing investors to financial and criminal sanctions. French authorities may also declare the relevant transaction void. Tax structuration is also an important part of cross-border transactions.
The major challenge posed by a private equity transaction involving multiple investors is managing to align the interests of each fund and reaching an equilibrium in terms of shareholders' rights, depending on the amount invested by each such party.
When it comes to veto rights on reserved matters, investors must first reach a consensus on the specific list of management decisions qualifying as reserved matters. The question then arises of which kind of majority will be required to approve or veto such reserved matters.
With regard to investors' liquidity, the key issue will be defining how and by who the exit process can be launched.
All these matters must be addressed in the shareholders' agreement and will typically give rise to intense negotiations.
The investment process is usually launched when the private equity investors submit a non-binding letter of intent to the target's shareholders. The letter of intent outlines some of the basic fundamental terms of the intended transaction, sets out a provisional schedule for its completion, and generally contains confidentiality and exclusivity provisions.
Once the letter of intent has been accepted by the sellers, due diligence reviews are conducted by the private equity fund together with some negotiation. On average, this process can take from one to three months, depending on the seller's responsiveness to information requests and the scope of such reviews.
If the results of due diligence reviews are satisfactory, a binding acquisition agreement is negotiated and executed by the shareholders and the private equity investors, usually in the form of a share purchase agreement (SPA). This step is generally referred to as the ‘signing'.
The length, depth and scope of due diligence reviews depend on several factors, such as:
Most of the time, due diligence investigations cover a wide range of areas, including intellectual property, commercial contracts, insurance, claims and ongoing litigation, human resources, real state, taxation, corporate documentation and financial statements.
To better assess the legal consequences of the intended transaction, it is very important to identify change-of-control provisions in any contract or agreement entered into by the target.
Documents required for due diligence investigations are usually disclosed through virtual data rooms. Such documents may contain sensitive information about the target and/or its operations. Therefore, it is very common that sellers require prospective buyers to sign non-disclosure agreements before granting them (or their counsel) access to such data room.
Following the contract law reform enacted in 2016, new Article 1112-1 of the Civil Code imposes on sellers a general obligation of information based on good faith. Henceforth, sellers have a duty to disclose to buyers any information of significance relating to the object of the sale (other than an estimation of its value) before the contract is signed or formed. In case of non-compliance, the seller may be liable to pay damages to the buyer or the contract may be declared void. This is why it is so important to provide or obtain (as the case may be) complete and accurate information during the due diligence process.
In general, it is very common for both investors and sellers to appoint lawyers and financial advisers (eg, investment bankers) to assist them throughout the investment process.
The primary role of such advisers is to assess the fairness of the terms of the proposed transaction and provide guidance to their respective clients to improve the outcomes of negotiations.
Both the locked box and closing accounts mechanisms are commonly used in private equity transactions. The use of locked box mechanisms has increased lately. The reason for this is that over the past few years, French private equity deals have been predominantly seller friendly. The price retained in a locked box deal is usually based on the target's last audited accounts. Under this scenario, the buyer assumes the risk or reward of the target group's performance from the locked box date (ie, before completion). This mechanism is usually favoured by sellers in highly competitive business sectors, as it provides greater certainty to the seller, can speed up negotiations and can thus reduce the transaction's costs.
When the agreed completion date is too far away from the date of execution of the acquisition agreement, the completion accounts price mechanism is usually preferred. In this case, the price is estimated at closing and is subject to post-closing adjustments based on completion accounts. This closing mechanism is generally considered to be more buyer friendly, as the final price will reflect the target group's performance more accurately. In practice, this mechanism is more likely to generate post-closing litigation.
In view of the present COVID-19 situation, we are likely to witness increased use of closing accounts in private equity deals in the months to come.
While not forbidden by French law, break-up fees are very uncommon in practice. In general, break-up fees are payable if either party decides not to proceed with the intended transaction for reasons not imputable to the other party.
Punitive damages are currently prohibited under French law. Thus, if the stipulated amount of break-up fees exceeds the actual damage, a judge may be entitled to reduce the amount payable to the injured party.
It is common practice for the seller to assume risks prior to closing. Therefore, risks subsequent to closing are usually borne by the purchaser.
The specific question of determining who shall bear the known and unknown risks disclosed in the data room during the due diligence process is often sensitive and, as such, gives rise to long discussions.
When they act as buyers, private equity investors tend to ask for wide representations and warranties (including business representations) from the sellers and the managers. However, in the context of a secondary buyout, private equity investors in a selling position are generally reluctant to provide representations and warranties other than minimal representations relating to the ownership of their shares in the target and to their personal capacity and authority to make such representations.
In most cases, inaccurate representations and warranties and damages arising from such an inaccuracy may give rise either to the payment of an indemnity to the purchaser and/or the target. In order to ensure the effectiveness of such compensatory mechanisms, it is very common that private equity investors request sellers to provide some form of security, typically in the form of a bank guarantee payable on first demand. Alternatively, a portion of the purchase price can be placed in an escrow account.
The use of warranty and indemnity insurance was not very common in France, mainly because of the extra costs involved; but it has become increasingly popular nowadays, especially in larger deals. The French warranty and indemnity insurance sector is growing fast in France, with many major insurers entering the market.
As already mentioned in question 3.1, key managers are usually offered the opportunity to invest in the target alongside the private equity investors, through a newly created Manco. On average, Manco's investment represents 10% to 15% of the target's share capital, but may vary from deal to deal. Such investment generally takes the form of a sweet equity package, ordinary shares, fixed-rate instruments and eventually a ratchet mechanism (less commonly used because of the tax risks associated with these mechanisms for managers). The idea is to offer managing shareholders a higher return on their investment. A comprehensive tax analysis is always required in the management inventive schemes (see below).
In general, managers perform a dual role within the target, as they are both shareholders and employees (or service providers). Because of that, French tax authorities tend to consider gains derived from management packages as part of managers' wages rather than as capital gains. As a result, managers are denied tax advantages normally applicable to capital income. This mainly occurs when securities are awarded to managers on preferential conditions, without any financial risk taking.
In order to mitigate tax exposure, managers must acquire their securities at a purchase price equal to fair market value. Ideally, such purchase price should be determined by a neutral expert. Allocation of free shares should also be avoided as much as possible.
In general, manager shareholders have no special statutory rights deriving from their management position. However, they are bound by certain obligations specifically linked to their status as managers. For instance, manager shareholders are usually subject to non-compete and non-solicit obligations which are usually set forth in the shareholders' agreement and reiterated in the service agreement or employment contract of each manager.
In case of departure (ie, when a manager is laid off, is dismissed from the board or no longer provides services to the company), manager shareholders are usually required to transfer their shares back to the target or to sell such shares to the private equity investors. To this end, each manager must enter into a call option in benefit of the private equity investors, either contained in the shareholders' agreement or established as a separate contract.
A manager is typically considered a ‘good leaver' when his or her departure is caused by death, mental or physical incapacity, or has been approved by the investors. In this case, the manager's shares will be transferred at fair market value.
In most cases, a ‘bad leaver' is defined as anyone who is not a ‘good leaver'. Where a more restrictive definition is used, a manager is deemed to be a ‘bad leaver' when his or her departure results from gross negligence or serious misconduct, poor performance or breach of the shareholders' agreement. In this case, the manager's shares will be transferred at price lower than their fair market value.
Governance arrangements are generally laid out in the shareholders' agreement, which is confidential under French law.
In most cases, investors do not wish to take part in the company's day-to-day management. Instead, they prefer to perform a supervisory role, which has the advantage of limiting their liability in relation to the management of the target and, more broadly, of the group. Consequently, a supervisory board is usually established within the portfolio company and investors are granted the right to appoint one or more representatives to the board. In practical terms, the main role of such representatives consists of monitoring business performance and authorising some extraordinary management decisions, which in general are restrictively listed in the shareholders' agreement and eventually reiterated in the company's bylaws.
When putting forward nominees to the board, investors must ensure that the potential candidates have full legal capacity to act and serve as corporate directors.
Investors are usually granted veto rights over crucial decisions affecting the organisation, structure or performance of the portfolio company. In general, such decisions include:
These governance arrangements are generally set out in the shareholders' agreement. Although it is technically possible for investors to exert veto rights directly as shareholders, in most cases veto rights are exerted indirectly, through members representing the private equity investors on the company's supervisory board.
In addition to veto rights over crucial corporate decisions, private equity investors are usually granted information and audit rights. This generally implies that the target's management has a reporting obligation towards the investors, who are entitled to receive financial reports on a monthly or quarterly basis. As part of their audit rights, investors are allowed to access the target's premises and can inspect the company's books and records, either on their own or with the assistance of external counsel.
Private equity investors usually expect to get a return on their investment in the short to medium term (in general, four to seven years after closing). Although there are many exit strategies allowing investors to achieve this goal, the most common exit channels in France are secondary buyouts, trade sales and initial public offerings (IPOs).
The French Financial Markets Authority (FMA) exerts significant control over IPOs. A company cannot conduct an IPO unless the FMA has approved its prospectus. In general, the overall IPO process can be completed in approximately six months.
Deal structuring in private equity transactions is always driven by tax considerations. Careful planning is therefore crucial to avoid unnecessary tax costs and to optimise investors' return. In practical terms, investment structures are always designed with a view to:
From a tax perspective, value added tax (VAT) on some acquisition costs incurred by companies involved in a private equity transaction (other than underwriting and commitment fees or upfront fees) may be recoverable.
However, this requires that the company which bears the expenses carries out an activity subject to VAT. It is thus necessary for the companies involved in the transaction to provide some services (eg, risk management services) to the other group companies, so that they can recover input VAT incurred upon the acquisition.
Appropriate material means and human resources must be made available to the companies involved in the transaction for this purpose, so that the French tax authorities cannot challenge the reality of the services rendered to other group companies.
As a consequence, to the extent that the acquiring company provides management services subject to VAT to each of the acquired companies, the acquiring company should be entitled to deduct input VAT incurred upon the acquisition subject to the VAT taxation ratio, and any dividends received by such acquiring company should in principle have no impact on its VAT recovery rights.
French tax law currently provides for several incentive mechanisms, mostly in the form of tax savings, aimed at boosting investment in unlisted companies. For instance, French corporations and their 95%-owned domestic subsidiaries are eligible to form a consolidated group for taxation purposes. Tax integrated groups are required only to file a single tax return and therefore pay corporate tax on their aggregate income. This allows for losses to be offset against profits and intra-group transactions to be neutralised. In the context of a private equity investment, this regime makes it possible to offset the interests on acquisition debt against the target's profits. It is also worth noting that dividends paid within a tax consolidated group are eligible for a 99% tax exemption.
Fundraising activity in France has been very dynamic over the past three years, with most deals taking place in the small and mid-cap segments (according to CFNews, 50% in companies with a market capitalisation of less than €20 million and 25% in companies with a market capitalisation of less than €150 million). Thus, France is currently Europe's second largest private equity market. One reason for this is that Macron's presidency has consistently pursued a pro-business economic programme. This, coupled with Brexit, has undoubtedly increased France's economic appeal. The impact of the COVID-19 crisis on the whole economy is an obvious challenge, but opportunities may also arise from the crisis as the price of targets, which was quite high, may become more reasonable and thus generate activity in the M&A and private equity sector. We are in fact very pleased to notice that private equity deals have progressively resumed since the first lock-down.
In the context of the COVID-19 pandemic, the French government has tightened control over foreign investments in companies operating in sensitive sectors.
On the one hand, biotechnologies were included on the list of ‘sensitive businesses' that fall within the scope of the minister for the economy and finance's prior authorisation (for further details on foreign direct investment (FDI) control, please see question 2.1). On the other hand, the threshold triggering FDI control was lowered from 25% to 10%. Consequently, the purchase by a non-EU investor of more than 10% of the voting rights of a sensitive or strategic company is now subject to the minister's prior approval.
These exceptional measures are expected to end on 31 December 2020; however, given the ongoing sanitary crisis, an extension of such restrictions cannot be excluded.
Before taking part in a private equity transaction, legal advice should always be sought, especially in the case of overseas investors who are unfamiliar with French law or the local market's particularities. Additionally, special attention should be paid to red flags raised in due diligence reports, since they constitute precious tools that allow investors to address potential problems upstream. From our perspective, this is the best way to avoid unnecessary risks and to achieve successful deal outcomes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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