A key question that foreign investors often ask themselves when investing in France is what consequences arise from being considered as controlling shareholder of a French entity.
The notion of “control” under French law carries significant legal and practical implications. Beyond simple share ownership, control may result from holding directly or indirectly the majority of voting rights, from the power to appoint or dismiss most board members, or even from the ability to exercise decisive influence over the company’s management and strategic decisions.
Being identified as a controlling shareholder entails specific responsibilities and potential liabilities. For these reasons, understanding how control is defined and assessed under French law is crucial for structuring an investment.
For the purpose of the below, the investing shareholder will be qualified as the “Controlling Entity” and the French entity in which it is investing the “Controlled Entity”.
The below overview is limited to non-contractual legal obligations of the Controlling Entity in its capacity as a shareholder / controller. There could be separate contractual obligations (such as under the articles of association, a shareholders’ agreement or share purchase agreement). This overview is limited only to (i) public limited companies (société anonyme – “SA”), (ii) simplified joint stock companies (société par actions simplifiée – “SAS”) and (iii) limited liability companies (société à responsabilité limitée – “SARL”), which are the most common commercial companies in France, and to the laws of France (and does not include the laws of any other country which may apply to the activities of the Controlled Entity). Accounting obligations may apply to the Controlling Entity or the Controlled Entity and will not be addressed herein.
Applicable Law for Control
Article L. 233-3 of the French commercial code provides the definition of control as follows:
“I. – Any person, whether natural or legal, is considered to control another person:
- when it directly or indirectly holds a portion of the capital giving it a majority of voting rights at general meetings of that company; or
- when it alone holds the majority of voting rights in that company by virtue of an agreement entered into with other partners or shareholders; or
- when it effectively determines, through the voting rights it holds, the decisions made at the general meetings of that company; or
- when it is a partner or shareholder in that company and has the power to appoint or dismiss the majority of the members of the administrative, management or supervisory bodies of that company.
II. – It is presumed to exercise this control when it directly or indirectly holds more than 40% of the voting rights and no other partner or shareholder directly or indirectly holds a larger share than it does.
III. – Two or more persons acting in concert are considered to jointly control another person when they effectively determine the decisions taken at general meetings.”
The concept of control must be assessed not based on the distribution of share capital, but on that of voting rights. Consequently, double voting rights must be considered and, where applicable, preference shares without voting rights, treasury shares, etc. must be excluded.
In addition, any company (and, as such, the Controlled Entity) is under the obligation to identify and declare to the Registre du Commerce et des Sociétés (the companies’ registry) who its beneficial owners are and the nature of their control. A beneficial owner is (i) any natural person who directly or indirectly holds more than 25% of the share capital or voting rights of a company, or (ii) any natural person who exercises control over the company’s management or administrative bodies or over the general meeting of shareholders by any other means, or (iii) failing that, the legal representative of the company. A company, including a foreign company, cannot itself be a beneficial owner. As such, in this scenario a company generally needs to look behind its shareholder(s) to identify any individual which meets the thresholds.
Finally, other specific definitions of “control” may exist and be relevant in different contexts (such as antitrust / foreign direct investment, accounting purposes etc.).
General Principle of Limited Liability and Notable Exceptions. In the case of (i) public limited companies (société anonyme – “SA”), (ii) simplified joint stock companies (société par actions simplifiée – “SAS”) and (iii) limited liability companies (société à responsabilité limitée – “SARL”), the principle is that the financial liability of shareholders is limited to the contributions made to the company[1].
The fact that a shareholder holds a majority (or even all) of a company’s share capital does not mean that such shareholder could be attributed liabilities exceeding its contributions. However, there are certain exceptions to this principle, a non-exhaustive list of which is provided below. Although not exhaustive, it should be noted that exceptions to this general rule are very limited.
Tortious Liability
If a Controlling Entity causes harm to a third party (in particular a co-contractor of its Controlled Entity) through the improper exercise of one of its rights, it may be liable for compensation for that harm. The Controlling Entity shall only be liable in the event of misconduct unrelated to its capacity as a shareholder, i.e., in the event of intentional misconduct of a particularly serious nature incompatible with the normal exercise of the prerogatives attached to the capacity of shareholder. Such misconduct has not been considered to have occurred in a case where a Controlling Entity voted in favour of a decision resulting in the breach of a commitment made by the Controlled Entity[2].
Criminal Liability
A Controlling Entity may be held criminally liable in the event of fraudulent overvaluation of a contribution in kind during the formation of the Controlled Entity or during a capital increase[3].
De facto director (“Dirigeant de fait”)
A de facto director is “any individual who, directly or through an intermediary, has in fact exercised the management or administration of a company under the cover of or in place of its legal representatives”[4]. This concept falls within the sovereign power of judges, who will examine the facts to determine whether or not a de facto director exists. They will have to characterize a set of indicators, as there is no single criterion that can be used to formally identify a de facto director. These indicators are of various nature. For example if the Controlling Entity manages the business activities of its Controlled Entity, signs bank documents, signs commercial and administrative documents, signs essential acts such as a commercial lease, this person could be determined to be a de facto director. In addition, if all or almost all decisions made by the legal representative of the Controlled Entity must be approved by a board (or equivalent body) in which the majority of members are representatives of the Controlling Entity, the board members could be determined to be de facto directors. In such case, the de facto director would be considered an appointed legal representative and could be held liable to the same criminal penalties.
Insolvency
Should a Controlled Entity enter an insolvency process, the general principle is that the Controlling Entity will not be liable for its obligations absent a contractual agreement to the contrary (such as a parent company guarantee or indemnity). However, the director of a Controlled Entity in judicial liquidation who has committed mismanagement acts (“faute de gestion”) that has contributed to an insufficiency of assets may be ordered to make good all or part of the shortfall in assets[5]. This applies to all de jure or de facto director, including a Controlling Entity that would be considered a de facto director. In addition, the liquidation proceeding may be extended to the de jure or de facto directors of the Controlled Entity when they made a confusion between their assets and those of the Controlled Entity[6]: e.g. (i) confusion of accounts between the insolvent Controlled Entity and its Controlling Entity (where it is not possible to know to which entity some assets are attached), (ii) abnormal financial relationships between the insolvent Controlled Entity and its Controlling Entity, (iii) payment of the debts of a Controlling Entity by the insolvent Controlled Entity (and vice versa) with no consideration for the paying company, (iv) absence of invoicing for services rendered by a company to another company. French case law is particularly restrictive. Confusion of assets is not easily recognized and implies very serious accounting or financial irregularities. A group which functions on a normal basis should not in principle be threatened by such a proceeding. The conditions for an extension of proceedings become particularly difficult, if not theoretical, in the case of de jure or de facto directors (e.g. shareholders) which have no establishment in France.
Tax
All de jure or de facto directors who, through fraudulent manoeuvres or serious and repeated failure to comply with tax obligations, have made it impossible to collect any taxes and penalties owed by a company may be held jointly and severally liable for the payment of such taxes and penalties[7]. The tax liability of directors may be incurred even if such directors are also subject to legal proceedings to make good the shortfall in assets. Consequently, a Controlling Entity that acts as a de facto director and commits such manoeuvres could be held jointly and severally liable for the payment of taxes and penalties of a Controlled Entity.
Conclusion
Before investing in France, a foreign investor should understand the consequences of control under French law to ensure compliance with applicable obligations and assess the liabilities to which it is subject. With a global network of over 40 offices, Squire Patton Boggs is a full-service law firm that can assist investors in considering the legal constraints applicable to the Controlling Entity and the Controlled Entity in their respective jurisdictions.
[1] Article L. 225-1, L. 227-1 and L. 223-1 of the French commercial code for, respectively, a SA, a SAS and a SARL.
[2] Cass. com. 18-2-2017 n°12-29.752
[3] Article L. 241-3, L. 242-2 and L. 244-1 of the French commercial code for, respectively, a SARL, a SA, and a SAS.
[4] Article L. 241-9, L. 246-2 and L. 244-4 of the French commercial code for, respectively, a SARL, a SA, and a SAS.
[5] Article L. 651-2 of the French commercial code.
[6] Article L. 621-1, L. 631-7, L. 641-1 of the French commercial code.
[7] Article L. 267 of the French book of tax procedures
