France: Introduction of Preferred Shares in French Law

Last Updated: 7 September 2004
Article by Marine Guyon-Godet

The French government took advantage of the Ordonnance on securities reform of June 24, 2004 to introduce a new category of securities called actions de préférence, or preferred shares. This type of instrument, now valid under French law, is a well-known device in international finance.

There has long been a lack of a French legal instrument to meet the conditions of a typical round of financing in which Anglo-Saxon standards, particularly those of California, have prevailed. Even more disadvantageous to French companies was the fact that English, Dutch and Israeli laws, among others, were familiar with this type of instrument. While many companies are seeking capital, investors favour simplicity: They select the investment option that looks the most familiar. Under the pressure from CroissancePlus (a nonprofit lobbying association), later joined by the Association Française des Investisseurs en Capital and the MEDEF as well as a few others, the government has chosen preferred shares as its response to the expectations of the private equity markets.

The preferred shares phenomenon is not totally new in France, since mechanisms allowing shareholders to benefit from special rights (priority shares - actions de priorité, priority shares without voting rights - actions à dividendes prioritaires sans droit de vote, certificats d’investissements…) already existed. However, the new Articles L.228-11 to L.228-20 of the French commercial code introduced by the Ordonnance have the merit of framing and harmonizing those practices, as well as giving them the flexibility that, paradoxically considering their number, they lacked. By creating preferred shares and authorizing their conversion to ordinary shares, preferred shares of another category or even buy-back under conditions set forth in the by-laws, the government obviously is intending to reinforce the appeal of the Paris private equity market and place French companies on an equal footing with foreign companies to attract capital.

Preferred Shares

In Anglo-Saxon practice, preferred shares include, in addition to traditional shareholder rights, certain governance and financial rights. The "governance rights" guarantee investors access to privileged information, management participation or control, and the right to approve (or be consulted on) certain decisions. The financial rights, on the other hand, provide preferential rights to the proceeds in the event of a liquidation. These rights also protect investors against the consequences of a later round based on a lower purchase price, thanks to a ratchet mechanism that adjusts the number of shares to be held by the investors.

The new French preferred shares combine the possibilities offered by already existing categories of French securities. They are similar to the actions de priorité with regard to the advantages granted, and to the actions à dividendes prioritaires and the certificats d’investissements regarding the voting rights organization. Indeed, preferred shares may be issued without voting rights or with specifically tailored voting rights (which was prohibited for the actions de priorité).

Actions de priorité (priority shares), long recognized under French law, allowed liquidation preference rights reduced to the actual winding up or bankruptcy of the company and governance rights. They did not, however, meet investors’ needs regarding preferential rights to the proceeds in the event of a sale or merger of the company, or regarding price protection (the investor’s valuation of the company). In fact, with respect to the latter, the price paid by the investors at their first entry into the company’s capital is to be reduced in the event of a subsequent down round, using one of the following methods: (i) the "full ratchet," which adjusts the post-conversion price to the level of the lowest valuation, (ii) the "weighted average ratchet," which adjusts the post-conversion price to an average of lower valuations during a given period, and finally (iii) the "pay to play," which limits the investor’s protection, regardless of the ratchet chosen, in relation to the investor’s participation in the subsequent rounds. Without a simple instrument, the practice of attaching warrants to the investors’ shares has developed to allow the issuance of a number of shares at par value, so that the average purchase price per share is adjusted to the appropriate level.

Regarding the preferential liquidation rights, practitioners up to now have not found a simple approach: Liquidation preference rights in case of winding up or bankruptcy are generally incorporated in the by-laws via actions de priorité, while liquidation preference rights in a sale or merger of the company are more often the subject of particular provisions in the shareholder agreement.

Are Preferred Shares the Solution?

Will preferred shares allow all of these rights to be embodied in a single instrument?

There is no doubt that it will serve the purpose for liquidation preferences or management rights protection. Preferred shares replace actions de priorité and allow everything formerly allowed by actions de priorité.

As for price protection, the ratchet may now be included in the preferred shares to determine its rate of conversion to ordinary shares. Nevertheless, the drafters of the Ordonnance did not specify how the conversion would work. In a previous article, we had suggested that the shares, issued at par as a result of the conversion of the preferred shares, should be paid up using the issuing premium paid for the existing shares, therefore within the limits of the issuing premium. Unfortunately, nothing has been provided in the Ordonnance to this effect. This could mean that, at times where the mere existence of the notion of capital is questioned by the law (cf. possibility under French law to incorporate a SARL with 0.02 euro of capital only), it is possible to imagine shares issued for free. Or else, as the by-laws no longer have to mention a nominal value and the law therefore allows the par value of ordinary shares to vary, the par value of the shares would vary with the successive conversions of the shares. The quantity of "guillotine" nullifications contained in French company law, which the authors of the Ordonnance did not wish to delete, will most likely lead to prudence at first.

Regarding the preferential liquidation rights, it is now possible to convert preferred shares into ordinary shares (or into another category), using the price of the sale or merger of the company as a reference. Some were already using warrants (bons de souscription) to this effect, thus allowing a given investor to increase the percentage of share of capital held by it to the level of the percentage of the price that it was agreed the investor would receive. The numerous practical problems that were encountered in the exercise of the warrants continue to exist for conversion rights of the preferred shares. The Ordonnance provides for the fate of the preferred shares in the event of merger, thereby appearing to acknowledge the complexity of the problem and to provide a solution. Nevertheless, the use of the qualifier "equivalent" for substitution rights in the event of a merger makes the law unclear. As regards a sale, we have always held that the allocation of the sale price is ultra vires, and therefore falls outside the realm of corporate powers. Furthermore, the mere complexity of today’s sales (partial payment in shares, partial payment in cash, earn out provisions, etc.), makes it difficult, to say the least, to use any type of security. The existence of preferred shares does not change the situation. Again, the "guillotine" nullifications probably will result in the current by-laws/shareholders agreement distinction being maintained, and in our opinion for the better.

Finally, the Ordonnance authorizes the company’s buy-back of its preferred shares, which opens the door to the redemption of the shares. However, as the protection of creditors has not been waived, the buy-back may place beneficiary companies in opposition to their creditors and, in any case, slow performance will be the rule.

Flexibility

The regime applicable to the preferred shares is very flexible, at the moment of their creation as well as in the course of their management. The rights pertaining to the preferred shares are set forth in the by-laws or in the issuing agreement (contrat d’émission) and can be of all kinds. The functioning of the preferred shares is flexible as well; their preferences may be temporary or permanent, and they may also be terminated. However, preferred shares with no voting right cannot represent more than half of the share capital (or more than a quarter in the case of a listed company), without risking invalidation of the issuance.

The introduction of preferred shares under French law has opened the way to a wide range of possibilities. The new article L.228-20 of the French commercial code even permits the distinguishing between the place where the right is exercised and the place of its issuance, in the case of subsidiaries that are directly or indirectly 50% controlled. A subsidiary will be able to issue shares, the rights of which will be exercised in the parent company or vice versa. This ability did already exist under French law but only in one direction (the issuance of rights by the subsidiary giving the right to shares of the parent company). This feature is well known in the United States, where even triangular mergers are allowed, a possibility that is not yet available in France.

In addition, French law, similar to US law, now allows tracking shares (actions reflets ou traçantes), the attached financial rights of which depend on the performances of one of the company’s particular activities. A company can now issue shares that give the right to a dividend calculated on the basis of the results of a subsidiary or of the parent company. Thus, preferred shares could provide means of additional financing by attracting investors that are interested in the activity of a specific company.

The legislator thought it necessary to require the procédure des avantages particuliers "when these shares are issued for the benefit of one or several shareholders designated by name." This procedure, which already applied when the preferences associated with actions de priorité were linked to the individual as opposed to the share, implies that an auditor, independent from the issuing company, files a report on the value of those benefits. The procedure applies to any issue of any preferred share reserved to shareholders of the issuing company, regardless of whether or not it is tied to the shareholder or to the share. This reporting requirement is useless, first because it seems to us that it is time to consider shareholders as competent, capable and responsible persons, and second because experience shows that the auditor’s report almost always concludes that it is impossible to appraise the benefits that constitute preferential rights.

Finally, the new law allows preferred shareholders to request from the issuing company’s auditor a report on compliance with the particular rights associated with preferred shares. With all due respect to auditors, entrusting an accountant with the mission of verifying the compliance with the rights attached to preferred shares is questionable. It is true that the August 2003 financial security law paved the way by entrusting the auditor to write a report on the chairman of the board’s report on corporate governance. But what authority will the opinion of an accountant on legal compliance have? An expert designated by the commercial court would be the most appropriate solution. The cost of the expert’s mission should be borne by the requesting shareholder so that this right be exercised without excess.

But let us not be negative. Practitioners have awaited this step forward for too long for us to turn up our noses now. Let us use this new law for the future of our companies, be they industrial, technological or commercial. Let us allow this practice to be implemented and trust that the lobbyists and legislators will polish the language in the near future.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions