This article was first published in the Magazine des Affaires.
It is finally here: after several years of consultations, punctuated with drafts from various eminent legal specialists and a preliminary draft from the Justice Ministry in February 2015, on 10 February 2016 the government published regulation no. 2016-131 aimed at reforming contract law. A whole portion of our law has now been amended - or rather modernised - through the incorporation of various solutions into the Civil Code, in particular those sanctioned by case law.
This article is not aimed at addressing the contents of the reform as such, which has been the subject of numerous comments since its publication, but rather to look at one provision introduced into the Civil Code that might burden the exit processes for various capital investment operations.
New article 1171 of the Civil Code thus states that: "In a subscription contract, any clause creating a significant imbalance between the rights and obligations of the parties to the contract will be deemed not written. The determination of significant imbalance will relate neither to the main purpose of the contract nor to the appropriateness of the price to the service". The aim of the reform simply reiterates the tendency for increased protection of the supposedly weaker party that is enshrined in the Consumer Code, whereby non-professionals are protected by law from significant imbalances that might be imposed upon them by professionals: this is the well-known notion of "abusive" clauses.
At first sight, upon reading the new article 1171 of the Civil Code, we might think that the concept of subscription contract is foreign to the world of private equity, where the vast majority of agreements are intensively negotiated by the parties and their respective counsels and where the protection introduced by the Civil Code of the "unknowing" party, or of that considered to be the weaker, has no relevance to this type of operation, where the parties by their very nature have sufficient knowledge to prevent the imposition without negotiation of the conditions of the agreements that bind them.
However, upon closer inspection, the subscription contract is in practice not so unusual in capital investment: for example allocations of stock options for enterprise start-ups (bons de souscription de parts de créateur d'entreprise or BCE) where the employees or company officers benefiting from such options must accept the terms and conditions of a shareholder agreement to which they must be party in order to be able to benefit from their options; or level 2 or 3 managers in a LBO who, so as to take part in the operation, become party to agreements that they do not (and cannot) negotiate. Worse still, this practice has seen the wide-ranging inclusion of "Instruments of Subscription" as annexes to shareholder agreements: under the terms of such instruments, if potential shareholders wish to achieve shareholder status and thus benefit from the associated rights and obligations, they must comply with the terms of an agreement that they have by definition not negotiated and, in the vast majority of cases, cannot envisage negotiating without destabilising their participation in the operation.
And what is the position of companies? Without following the rules governing public offerings of financial securities, their share capital is nonetheless open to a large number of shareholders or partners - investors, level 1, 2 or 3 managers, etc., historical investors, employees. It is not possible to imagine that each of these will take an active part in negotiating the documentation concerning their investment without introducing a major risk factor into the operation. Consequently, most partners merely sign up to instruments negotiated by others that impose the conditions to which they will have agreed.
While this concept of the subscription contract is thus not so unusual in the world of private equity, such contracts nevertheless create a significant imbalance between the parties: to reiterate the provisions of the Civil Code, determining these imbalances may relate neither to the main purpose of the contract nor to the appropriateness of the price of the service. It is at this stage difficult to prejudge what the courts might for example make of the concept of significant imbalance in a shareholder agreement. Nevertheless, it should be noted that there are many possible outcomes, meaning that there are many possible court rulings on various cases in practice. Could a liquidity process organised between just some of the shareholders be regarded as a significant imbalance? Will differing financial or political rights between partners or partner categories be regarded as significant imbalances and thus as an abuse? In this respect the safeguarding of an alignment of interests between the various participants in an operation or an ab initio balancing of shareholder rights, in particular according to their investment in the operation, will probably be the best protection against such uncertainty.
This question is all the more important because, if such clauses are held to represent a significant imbalance, the Civil Code provides for heavy penalties: the clauses will be deemed not written. The effect desired by the parties during negotiations could thus become null and void, preventing operations from going ahead. As underlined in the report to the President of the Republic relating to the regulation of 10 February 2016, this penalty is a matter of public policy, and it is thus not possible to derogate from it by simply waiving the provisions of said article 1171.
As we have outlined, the concept of significant imbalance is vague: nevertheless, prudence (indeed moderation) is advisable in the negotiation and drafting of shareholder agreements. The risk relates more to the legal effectiveness of the stipulations contained in the contract than to the significant imbalance (and actual abusiveness) of the clauses. It may offer a weapon to some that would force others to grant them more rights, as in the possible case of a shareholder who disputes and refuses an exit on the grounds that the liquidity clause or the conditions for the drag-along were imposed upon him. Is this not rather a form of pressure allowing him to negotiate more favourable conditions - or cause the failure of the process - by means of an action aimed at establishing the abusive character of certain clauses of the agreement, for example? Admittedly the notion of good faith in the performance of contracts, reaffirmed as a basic principle by the regulation, will always be a safeguard against this type of demand, but it can only be judged a posteriori by the courts.
Let us be reassured, this is simply futurology: while shareholder agreements signed before the regulation is introduced, i.e. 1 October 2016, will remain subject to the unmodified provisions of the Civil Code and will thus not be affected by the concept contained in new article 1171, after this date prudence is advisable.
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.