Member Article

Don’t close, sell

Closures of French industrial sites regularly make the news, across all sectors. To mention just a few of the most emblematic ones: Bridgestone’s Béthune site (tires, 2021, almost 900 employees), Whirlpool’s Amiens factory (tumble driers, 2017, around 280 employees), and last but not least, Arcelor Mittal’s Florange factory (steel, 2012, around 630 employees), which served as namesake to a French law obliging groups wanting to close a production site to search a buyer in order to sell the site (Law Nr. 2014-384 of 29 March 2014, “loi Florange”). But even when the search for a buyer is not mandatory, the divestment of a production site can have a lot of advantages over a closure: a new future for the factory and workforce, a quick and clean exit, no bad press…

The risks of selling

Things become less pleasant for the seller when the buyer subsequently leads the sold company to file for bankruptcy, sometimes only a few months after the sale. Besides the bad press and the public accusation of eluding obligations towards the employees or acting in fraud of creditors rights, such sales followed by a liquidation proceeding regularly lead to litigations against the seller, at the initiative of the employees, the judicial liquidator or third parties, on a variety of legal grounds, such as: - Liability claims initiated by employees under general tort law for transferring (“outsourcing”) the redundancy costs over to the buyer; - Liability claims under general tort law, for carelessly selling a company to the detriment of its creditors; - Liability claims for “organized defeasance”; - Fraud against creditors’ rights (“outsourcing” of a mass redundancy); - Claims on abusive support against the seller (former shareholder); - Extension of the insolvency proceedings for fictitiousness, - Debt relief claims against the seller (former shareholder), qualified as de facto manager for mismanagement prior to the sale contributing to the insolvency; - Specific environmental liability. While these arguments generally lack substance and are therefore unsuccessful in the great majority of cases, lower courts every now and then recognize the liability of a seller on one or several of the above grounds. In the past, employees also tried to base actions on the concept of co-employment (co-emploi) by another group entity, but a more restrictive interpretation by the Courts has significantly reduced the risk of such claims. And even with low chances of success, employees and liquidators can launch legal actions as part of a more global strategy (often coupled to PR campaigns by unionized workers), betting that international groups of companies will dig into their “deep pockets” and pay in order to avoid bad press, as well as lengthy and costly proceedings binding internal and external capacities over many years. These strategies are aided in France by virtually non-existent court fees, mostly symbolic procedural costs awarded to the winning party and provisional execution in first instance (leading to immediate payment obligations with uncertain subsequent recovery in practice).

Limiting the risks for sellers

In this context, French distressed M&A and insolvency practice have developed ways to secure such transactions and reduce claw-back risks after the divestment of a non-profitable activity, including: - Contractual undertakings to continue the business and/or inject funding (typically for a period of at least 18 months); - Contractual protection of the target against siphoning off of its liquidities/ assets by the new owner (via a cash pool, redemption of capital, management fees…), secured by a purchaser parent guarantee; - Detailed review of potential buyers’ take-over projects and their business plan, with the help of an independent audit firm; - Use of pre-insolvency proceedings (mandat ad hoc, conciliation) to structure the sale process and the review of the takeover project. The conciliation is a specific proceeding under French law giving a debtor a procedural framework to discuss with its creditors in order to find an agreement on how to restructure its debt, but also to discuss with shareholders, investors and financial partners in order to obtain new money and thereby ensure the survival of the company. In certain cases, the mission of the conciliator within the conciliation proceeding can evolve into a “pre-pack cession”, whereby the main assets of the distressed company are “pre-packed” for a sale without the debt. A creative use of the proceeding in the context of sale processes has been developed by restructuring practitioners in order to secure a sale transaction in the interest of the employees, the seller and the buyer while avoiding risks of voiding of the transaction and liability claims against the seller, especially when the seller is the main creditor of the sold company (via shareholder loans/ cash pooling). The conciliation typically leads to a validation (homologation) of a conciliation protocol relating to the sale by the competent commercial court. The validation is based on a court review ensuring that due to the validated agreement (i) the target is not anymore in a state of cessation of payment (which is grounds for opening of an insolvency under French law), (ii) the sustainability of the activity of the target is secured and (iii) the interests of other creditors (which are not party to the conciliation protocol) of the target are not infringed. While not an absolute protection, these tools allow a seller group to document and demonstrate, within the framework of a court proceeding, that it did not sell a loss-making activity carelessly, or even with the sole aim of avoiding the cost of mass redundancies, soil decontamination or financial liabilities towards third parties.

A highly illustrative case

In the case leading to the recent decision of the French Civil Supreme Court, the parties seemingly did not take any of the above precautions. On 18 October 2011, the German Prevent Dev GmbH sold 100% of the shares in its subsidiary Prevent Glass to the also German turnaround investor Erlensee for a symbolic purchase price of 1 Euro. The takeover project was based on the unrealistic idea to unilaterally increase prices towards the main customer (Volkswagen) by 30% in order to find the way back to profitability. But only one month after the sale, on 21 November 2011, a receivership proceeding was opened against Prevent Glass, stating that the company had been in a state of cessation of payments as from 31 July 2011 (months prior to the sale). The receivership was converted shortly thereafter, on 9 May 2012, into a judicial liquidation. On 30 May 2012, all employees were let go by the liquidator. 30 of the employees launched legal actions against all involved companies, in front of civil and labor courts, including against the seller, on the basis that the seller acted fraudulently and wrongfully by failing to ensure that the take-over project of the purchaser was financially and economically viable. On 27 March 2019, the first instance court of Fontainebleau decided in favor of the employees. Subsequently, the decision was annulled and rejudged by the Paris Court of appeal, which found, in accordance with the dominant case law, that there was no fault of the seller: In particular, the seller had never hidden the difficult financial situation of its subsidiary and could not be held liable for the breach by the purchaser of its contractual undertakings.

Welcome comfort for sellers

The case is the occasion for the Commercial, Financial and Economic Chamber of the French Civil Supreme Court (Chambre commerciale financière et économique de la Cour de Cassation) to state a general rule of law in a judgment published in its Bulletin and on its website (1 March 2023, n° 21-14.787). According to the judges: “There is no law, nor any principle according to which a mother company, when selling the shares it holds in the share capital of a subsidiary, has the obligation to ensure, prior to the sale, that the purchaser has a takeover project guaranteeing the economic and financial viability of such subsidiary.” By stating a rule of law in this general way, the Court draws the logical consequences from the autonomy of legal entities under French law: Even in a group of companies, no mother company has a general obligation to ensure the survival of its subsidiaries. Thus, if a subsidiary is already in a distressed situation, a sale to a third party does not legally require any specific degree of care. The principle stated by the Court can be seen as in the line of previous decisions of the Commercial, Financial and Economic Chamber of the French Civil Supreme Court, recalling that tort liability of the shareholder could only be sought in case of a fault of particular gravity having contributed to the insolvency of the sold company. Without such gravity (going well beyond bad management decisions) and causal link, no liability can be established. To be noted: the employees’ argument that the transfer was a fraudulent outsourcing of a mass redundancy was considered inadmissible by the French Civil Supreme Court, which considered (in line with previous case law) that finding such a fraud exceeded a purely legal review, as it was a factual assessment within the sole competence of the first instance and appeal courts.

Some structures remain risky

In our view, the Civil Supreme Court’s decision would not apply to a number of other configurations that can be considered by less prudent sellers, often at the request of potential purchasers of a distressed activity: - Sale of company for a negative purchase price paid to the purchaser in the form of an indemnity (rather than as a capital injection into the company) or with insufficient protection of the funds injected into the company; such schemes would be at risk of being considered fraudulent (outsourcing of a mass redundancy). - Carving out a distressed activity, which is not viable on a standalone basis from an overall profitable company and subsequent sale for a symbolic price. More generally, any undue disadvantaging of a subsidiary prior to the sale of its shares, for example by way of intragroup contracts not at arm’s length (transfer of a license for a symbolic price, providing goods and services at a loss, payment of exaggerated management fees, etc.), providing of guarantees (e.g., stock retention, pledges), termination of intragroup contracts vital to the subsidiary (contract manufacturing, distribution…) without required notice periods and generally any acts not in the interest of the subsidiary could be a basis for liability of the seller or group companies. Such acts could also be annulled during a period of up to 18 months preceding the opening judgment of the insolvency proceedings (so-called “suspect period”) of the subsidiary following a sale, by virtue of being in fraud of the rights of the creditors of the subsidiary. Accordingly, sales of assets or businesses (fonds de commerce) of a distress company have to be structured so as to minimize claw-back risks.

Risk factors to be assessed early on

In addition, it is important not to neglect remaining risk factors, such as: - Comfort letters are routinely issued by mother companies to the benefit of their distressed subsidiaries, for example at the request of the statutory auditor who has to certify the going concern situation of the subsidiary as part of the annual accounts review. French courts increasingly tend to qualify obligations under such comfort letters as obligations of result (obligation de résultat) rather than of means. Their wording needs to be reviewed carefully. - Shareholder decisions in relation to investment decisions made by a subsidiary (as reserved matters); risks exist in particular if such a decision can be construed as a shareholder direction to make an investment and/or a financing commitment. - Unilateral undertakings taken towards the employees of the divested subsidiary could have been taken by another group company. An audit of the employment situation should be undertaken before a distressed sale. - Obligations towards third parties could exist more generally, for example in the form of parent company guarantees, other securities or undertakings, etc. Such undertakings can create additional risks. They should be assessed prior to any distressed M&A transactions.

Conclusion: rejoice, but remain careful

At a time when the overall economic context, the phasing out of Covid subsidies and the upcoming deadlines for State guaranteed Covid loans may lead to the disengagement of many European and international groups from their French production activities in distress, the decision can be seen as good news for sellers. Indeed, the clarity of the principle stated by the Cour de cassation will help to bring some rogue lower courts back into line and calm the appetite of terminated employees for post-termination legal actions. Eventually, it will hopefully help to put an end to (or at least drastically reduce) the type of claims that solvent sellers of distressed companies still too often face. For now, sellers should not get overconfident: Properly assessing transaction risks and addressing them early on in the process remains highly recommended