Extraterritorial Effect of French Law on Insolvency

Cross-border insolvencies are perhaps one of the numerous consequences of the increased globalization of and recent downturns in the economy.

As we all know there is no comprehensive international law on insolvency although numerous trends and efforts push towards building adequate legal frameworks to deal with certain effects entailed by the financial distress of multinational companies: among those, the UNCITRAL model and the recent EC Regulation n° 1346 of May 2002.

France has not adopted yet the UNCITRAL model. The EC Regulation is limited in its scope: let us remind that it does not apply, among others (i) when the debtor’s COMI is located outside of the EU or (ii) in group context (opening of secondary proceedings is not planned for subsidiaries of a parent undergoing main proceedings).

Local international private law must still be applied in numerous instances. Recent efforts must be noticed in this area in particular in the US with the adoption of the [new Chapter 15 embodying the former section 304]. No such effort is visible in France which appears entirely focused these days (i) as all other EU Member States on the very much awaited clarification by the Luxembourg Court of the legitimate criteria to be used by local Courts when assessing the debtor’s COMI under the EC Regulation and (ii) more specifically, the long-awaited reform of domestic insolvency law and in particular the adoption of a Chapter 11-like proceeding (called “plan de sauvergarde”). Perhaps the future of Eurotunel S.A. will trigger new energies in this respect but let’s hope not for the numerous Eurotunel S.A.’s shareholders.

French international private law on insolvencies is unfortunately not comprehensive either. We will thus focus in this summary on certain aspects thereof which have been highlighted by certain prominent bankruptcy cases: Metaleurope Nord, Air Lib etc., in particular in respect of possible extraterritorial reach of French insolvency law.

Main French rules on Jurisdiction

• Under French international private law, the solution to conflicts of law derives in general from that of conflicts of jurisdiction. Consequently, once French Court takes jurisdiction, French insolvency law automatically applies, even for its extraterritorial effects subject to (i) the recognition of prior foreign judgments in France and (ii) the limitation to the enforceability of French judgments abroad. We will purposely exclude these imitations from the scope of this summary.

• French Courts take jurisdiction for opening insolvency proceedings against natural or legal persons exercising their business activities on the French territory as well as for all possible actions based on the French legislation that may derive or be ancillary to that opening. The French rules on jurisdiction consist of a mix of the universal competence principle and the territorial one. The actual nationality of the debtor (except through its incorporation in France) is not a significant criteria in general.

• The main criteria for justifying the jurisdiction of French Courts are as follows:

  1. localization in France of the seat of debtor’s enterprises, or, in its absence, of the main centre of its interests; in certain circumstances, the fictitious character of a legal entity incorporated outside of France can justify the jurisdiction of French Courts;
  2. the presence in France of debtor’s establishment (without legal personality) or simply of certain assets; the latter criteria may suffice in certain instances which would likely contradict with the laws of the jurisdiction where the foreign entity having assets in France is incorporated;
  3. in certain cases further to purely pragmatic reasons with the sole objective of allowing French creditors to succeed in recovery actions otherwise impossible, the mere existence of business activities or the mere ownership of assets in France were held in certain cases as sufficient to base the jurisdiction of French Courts;
  4. jurisdiction has been based on certain sections of the French Civil Code (especially articles 14 and 15).

Main extraterritorial reach of French insolvency Law

“Extension” of French insolvency proceedings

• As reminded above, French Courts take jurisdiction not only for domestic effects of insolvency proceedings opened in France but also for all possible actions based on the French legislation that may derive from that opening, whether or not these actions can hit legal or natural persons located in France or abroad. In particular, we must stress the possible “extension” of local proceedings against a designated debtor to a new debtor located abroad pursuant to section L 621-5 of the Commercial Code or to foreign managers convicted of breach of their various duties. This concept of extension has been sometimes pointed out improperly. It must be reserved to circumstances where a sing procedure already opened against a debtor is continued and enlarged to reach another natural or legal person.

• Confusion of wealth (both of assets and liabilities) is a first criterion in support of a possible extension. It can be viewed as a consequence of the abuse made of the legal nature of an entity justifying that the corporate veil be pierced. This criteria, as the fictivity one described below, is used to widen the debtor’s wealth and increase the creditors’ pie. Confusion is generally recognized by French Courts when two or several wealth are mixed up in such a manner that it is no longer possible to attribute clearly assets and liabilities to each entity concerned, thereby justifying that proceedings opened against one of them would cover the other ones as well. This theory may target legal and natural persons (for the latter, mainly managers, but in a recent ruling,1 an extension was pronounced against the debtor’s independent consultant); this criteria is usually assessed by French Courts on the basis of (i) confusion of sets of accounts or wealth overlap and (ii) abnormal financial dealings, which are alternative.

  1. wealth overlap: the imbrications must be such that they render a dissociation between and allocation among the two companies impossible; although several judgments refer to that criteria it is seldomly retained by Courts; there are different degrees that may be assessed and the threshold above which the overlap is synonym of confusion is not clearly established; only the objective criterion of confusion of accounts seems solidly established;
  2. abnormal financial dealings; every abnormal financial dealing does not reveal a confusion of wealth and such a scenario must be distinguished clearly from fraudulent conveyance of company’s assets; it appears that only the repetition of dealings and the willingness to create a confusion may be characterized by Courts as abnormal financial dealings; abnormality is underlined in instances where there is no counterpart to a particular transaction; this must be immediately nuanced in the presence of a group context; indeed, French Courts when faced with intra-company transactions in a group context, are accepting to take into account necessary group constraints such as the narrowness of the relationships and the relative dependence of a company towards another; in AOM AIR Liberté for example,2 the Paris Appeal Court considered that the conditions of a confusion were not met despite a massive cancellation of indebtedness (more than 100 million EUR) from the parent, Holco, at the benefit of the French subsidiary; in a similar context in the Cocoon decision the Appeal Court of Toulouse has admitted that cash flow centralization at the holding level was perfectly licit: the counterpart of abnormal dealings was the membership to the group and the vocation of each entity to benefit from that membership or to undergo its necessary effects;

  the Appeal Court of Douai in the Metaleurope Nord case3 ruled in favour of the extension to the foreign parent of the proceedings opened against the subsidiary based on confusion: in that case, the management of foreign exchange risk had been entrusted to the parent and the strategy pursued by the latter was deemed disastrous; human resources were indicative of a confusion: although an employee of the parent acted as manager of the subsidiary, he had not been appointed neither as employee nor as manager of the latter; the Appeal Court underlined also that the subsidiary had been in a very delicate situation and that its solvency had been depending on financial means (cash and credit) from the parent: in short, the subsidiary had been in a situation of dependence whether for its decision making process or financing.

• Fictivity is the second criterion that may allow French Courts to pierce the corporate veil of a French subsidiary to reach its parent. What are targeted here are dummy companies having no autonomous decision-making power in particular in respect of their decision for survival or winding-up. The fictivity is an application of the notions of simulation or fraud in particular when the key components of the affectio societatis are missing. In the Metaleurope Nord case, where the faith of 830 employees was at stake, the Appeal Court of Douai upon petition from the liquidator and the public prosecutor, in a first interlocutory judgment4 reviewed the various criteria pursuant to which the French subsidiary could be deemed as fictitious. Two criteria were distinguished: (i) the existence of a principal (“maître de l’affaire”) who under the cover of the incorporation acted in his own interests (own interests does not equal to group interests the latter being deemed usually to correspond, ex ante, to the interest of all companies of the group), and (ii) the absence of decision-making autonomy of the debtor and the immixion of other persons in its management (degree of subordination of the subsidiary and correlative autonomy of the parent): the Court reminded that economic interdependence within a group cannot base the extension of the proceedings even when certain functions notably the accounting or administrative ones are centralized; the Court also added that it is necessary to measure the actual autonomy of the subsidiary in its appropriate economic sphere (be if production, marketing, or financing activity); the Court appointed an expert to appreciate if the subsidiary had the financial, material and human means necessary for the achievement of its corporate purpose. In its second decision referred to above, the same Court confirmed its decision by adding though that the fictivity of a subsidiary arrangement can be deducted from a deceitful intention to avoid a responsibility or to defraud creditors; after issuance of the expert report, the Court finally decided that the fictivity was not proven but nevertheless decided to extend the proceedings against the foreign parent based on the confusion of wealth rather than on fictivity grounds.

• French Courts deny generally the unity of company theory, where collaboration in economic or commercial purposes is linked to the achievement of a community of interests; although the group has no legal personality under French law, the community of interests and economic links are not inevitably the sign of a confusion or of fictivity; French Courts do recognize that proceedings cannot be extended to another company of the same group solely based on inter-coporate shareholding, identity of managers, complementary in their corporate purposes, common clientele, existence of permanent business connections notably the existence of a treasury pool, interdependence and the completeness of activities.

• The above issues should not be confused with possible rulings against French entity by foreign Courts on the basis of the location of their COMI outside of France pursuant to the EC Regulation. This confusion made by some commentators came in light in furtherance of the Daisytek case.

Recovery of assets

• Pursuant to Section L 624-3 of the Commerce Court, French Courts could seek to extend local insolvency proceedings against statutory or de facto managers of that business (whether living in France or abroad) were a breach by those managers of their duty of care has contributed to the incapacity of the French company to pay off its debts due with cash and cash equivalent assets. A mere negligence or imprudence might be sufficient. This ground is often called “action en comblement de passif.” This qualification is usually given upon exercise in total independence and freedom, continuously and regularly, of positive management and direction actions biding upon a company. Courts can sometimes make a very broad interpretation of what is meant by de facto manager. In a recent domestic case5 (but the reasoning of which could easily be extended to a cross-border situation), once the breach of the duty of care was established, the fact that two white-collar employees of a bank were acting in reality as the bank representatives at the Board of a distressed company has justified action (for EURO 44 million) against the bank pursuant to L 624-3 in the framework of the proceedings opened against the distressed company. This ruling has been criticized extensively, one of the reasons behind that the employees were already statutory Board members of the distressed company; the Court took the view from different factual evidence that the “official” office carried out by the Bank’s employees was actually totally subject to instructions from the Bank

  If is not excluded that the above management capacity be found with other legal entity, for instances, parent shareholders located abroad. Consequently, these foreign parents can be drawn pursuant to section L 624-3 into what at the beginning looks like a purely domestic proceedings; excessive continuation of a distressed (i.e., loss making situation), insufficient shareholders’ equity or even strategic errors could constitute the necessary breach of duty and, consequently, serve as appropriate prerequisite to the extension of proceedings.

  In a recent ruling6 French Court precisely decided to extend the proceedings opened against a French subsidiary against a Belgian parent found guilty of mismanagement.

  Once all the conditions of L 624-3 are met, Courts may decide that all or part of the debts of the bankrupt company be supported, jointly or not, by all company’s managers or certain of them. What is even more remarkable is that one manager (again be it an individual officially appointed in that capacity or a parent company deemed as having acted as de facto manager) can be condemned to support 100% of the debts even when it is established that his breach only contributed partially to the insufficiency of assets or only caused a portion of the debts. However, the total amount of the condemnations imposed against legal or de facto managers may not exceed the excess amount of liabilities over the assets. Any proceeds collected from the managers under the above legal ground shall be integrated into the assets of the distressed company and be affected under the recovery plan.

Personal insolvency

• Pursuant to Section L 624-5, I of the Commerce Code, if proceedings are opened against a legal entity, Courts may at their discretion open different proceedings against statutory or de facto managers thereof, whether paid or not, if either (or any combination) of the following instances is met:

  • holding the legal entity and making use of its assets as personal property;
  • carrying out of commercial activities under the cover of the legal entity but for one-self interest;
  • making use of the credit of the legal entity or of its assets against its company interest for personal purposes or to favour another legal entity or enterprise in which they have an interest;
  • the abusive continuation of a irrecoverable loss-making situation in their personal interest;
  • the holding of fictitious accounts or the removal of accounting documents from the company or the fact of not holding accounting according to the regulation at the first place;
  • the embezzlement or concealing of any or all of the company’s assets or the deceitful increase of its liabilities; and
  • keeping obviously incomplete or irregular accounting.

Universality principle

• In a largely commented ruling,7 the Supreme Court seems to have made a praetorian application of that principle. It must be stressed that the set of facts submitted to the Court occurred before the entry into force of the EC Regulation (but the same solution could be applied today in instances not covered by that Regulation). Proceedings were opened by a French Court against a couple of individuals who own assets abroad. The Worms Bank, acting as creditor, engaged into enforcement action on part of their assets located in Spain. The Appeal Court of Versailles ordered the bank to withdraw. The French Supreme Court did approve the Appeal ruling on the visa of the universality principle: the French judgment should produce its effects in any jurisdictions where the debtors had assets subject to limitations, if any, imposed by the foreign jurisdictions. By opening a redressement judiciaire against the couple, the French Court did ordered an automatic stay against the debtors and such stay had to be enforced abroad; the means of enforcing was through an injunction in persona (inspired probably from Anglo-Saxon model) against French creditors seeking to realized certain of their assets located in Spain.

Conclusions

We have tried to show largely by cherry picking (we have not for example reviewed the regime of the “personal insolvency” (“faillite personnelle”) that can also be imposed by French Courts under certain conditions as sanction on foreign (de facto or statutory) managers pursuant to Sections L 625-1 and 2 of the Commerce Code), that foreign managers and shareholders of French subsidiaries should become increasingly aware of the tools made available to French Courts to seek to extend local insolvency proceedings abroad in almost any cross-border instances not covered by the scope of the EC Regulation. This might help them at thinking to take appropriate steps at non suspected times in order to structure their presence in France properly and to avoid the above-mentioned classical pitfalls.