France: Legal Considerations For Real Estate Lenders In France (3/4); Drafting Considerations

This is the third in a series of four articles on the legal considerations that non-French real estate lenders should examine when financing commercial real estate in France in a non-distressed context.

Our first two articles dealt with the French banking monopoly rules and certain structuring issues.

This third article contains a summary of the legal considerations relevant to the drafting of commercial real estate loan documentation in France.

We shall examine hereafter how to address clauses pertaining to:

  • interest
  • taxes, leases and insurance
  • bank accounts and waterfalls
  • insolvency and acceleration
  • unforeseen events
  • limited recourse
  • change of finance parties and powers of the agent as well as
  • choice of law and choice of jurisdiction.

Interest

Indication of the global effective rate

Article L. 313-4 of the French Code monétaire et financier (referring to articles L. 313-1 and L. 313-2 of the French Code de la consommation) requires lenders in France to indicate the "global effective rate" (taux effectif global, also referred by the acronym "TEG") to their borrowers. This must be done no later than the date of the formal facility offer or (in case of an indicative offer) the date of execution of the facility agreement, together with the "period" and "periodic rate".

The global effective rate, in a non-consumer setting, is basically an annual rate (based on a year of 365/366 days) corresponding to the borrower's borrowing cost. This includes interest and all mortgage and other costs, divided by the term of the loan, expressed as a percentage and rounded to at least one decimal, with certain assumptions especially when the rate is variable. The "period" (the interest period) and the "periodic rate" (the global effective rate times the months of the "period" divided by 12 months) must also be indicated.

It is an offence not to comply with this provision and, moreover, if the global effective rate has been miscalculated, the borrower can be discharged of any contractual interest exceeding the legal rate.

Case law of the Court of Appeal of Pau of 1 March 2001 and of the Court of Appeal of Aix en Provence of 5 May 2011 suggests that this is not compulsory where the facility is granted by a foreign bank under a foreign law to a French borrower other than a consumer. Yet in the absence of case law from the Cour de cassation, the prudent view - and predominant practice - is to have a TEG clause in the facility agreement or a TEG side letter whenever there is a French borrower.

Usury rate

When the borrower is a business or a person with a "non-commercial professional activity" (such as a property civil company), the French prohibition of usury rates does not apply unless the facility takes the form of an overdraft facility as opposed to a term loan for instance.

Many consider that nor should this prohibition apply to an overdraft facility agreement that is not governed by French law (provided that other elements relevant to the situation are located outside France), on the ground that it is not a "loi de police" (or a principle of French international public policy or a principle so fundamental that it ought to be protected by article 45 of Regulation No 1215/2012). This is because it is no longer an offence to apply usury rates in France, the sanction being that excessive interest payments are deemed capital repayments under article L. 313-5-2 of the French Code monétaire et financier.

Limitations on compounding

Pursuant to article 1343-2 of the French Code civil, owed interest can be validly compounded only if due for at least one entire year and if compounding is authorised pursuant to the relevant contract or a court decision - a clause will therefore be inserted for that purpose in any French-law term loan agreement.

In an overdraft facility, the compounding of interest on an account is however possible (the debt is deemed to be novated every interim balance date) and, in spite of the absence of conclusive case law on this topic and despite the replacement of the word "payable" for "owed" in this article effective 1 October 2016, the prohibition arguably does not concern compounding of interest that is accrued but not payable.

If the loan agreement is however not governed by French law (provided also that there are other elements relevant to the situation which are located outside France), then this French domestic public policy prohibition is unlikely to be elevated to a "loi de police" (or a principle of French international public policy or a principle so fundamental that it ought to be protected by article 45 of Regulation No 1215/2012).

Taxes, leases and insurance

Taxes

The loan agreement's conditions precedent and reiterated representations and covenants should address the payment of French taxes.  Particularly, it should cover the absence of 3% tax, which is payable where the property-owning company is directly or indirectly owned by entities located in certain countries, both for the period onwards and, in case of a share deal or of a refinancing, for the period preceding the financing within the limit of the applicable six-year limitation period.

Leases

The loan agreement's covenants regarding leases should be adapted to the French mandatory provisions applicable to commercial leases (minimum nine years, renewable...).

Insurance

The loan agreement's clauses regarding construction insurance must be adapted to the French insurance requirements, including ten-year construction liability insurance and construction defect ("dommages-ouvrage") insurance policies.

As regards to property damage insurance, upon notification to an insurer that the insured property is mortgaged, the insurer is required by law to pay damage insurance proceeds directly to the secured parties, not the insuree. The facility agreement must therefore specify when and how these insurance proceeds are to be released for paying the repair costs of the relevant asset, taking into consideration French building permit procedures. Please note that "loss of rents" insurance proceeds are not concerned by this mechanism; they must be security assigned (or pledged or delegated) as any other receivable.

Bank accounts and waterfalls

It is less common in France than in the U.K. to have operating (rent) accounts controlled only by the facility agent, who does not want to be troubled by potential allegations of de facto management of the company if the latter subsequently goes bankrupt.

This being said, it is common to have waterfall provisions varying according to whether a default is continuing or not, with the lenders being authorised to "block" the operating account pursuant to the bank account pledge provisions. The question of what expenses can be paid with the rent and insurance proceeds while the loan is in default but not accelerated must be addressed. Moreover, waterfalls and subordination agreements must allow mandatory minimum distributions in OPCIs and SCPIs (offset with new subordinated intra-group debt if a default is outstanding).

Insolvency and acceleration

Insolvency clauses must be adapted to the various French insolvency and pre-insolvency proceedings:

  • the appointment of an ad hoc administrator
  • the conciliation proceeding
  • the safeguard proceeding
  • the accelerated safeguard proceeding
  • the judicial recovery proceeding; and
  • the judicial liquidation proceeding

It has become standard to assimilate to an insolvency event the commencement of alert proceedings by statutory auditors where they have reached a certain phase without being satisfactorily resolved.

These are generally listed as events of default, though they cannot have all the consequences attached to events of default because a lender would actually be prevented from accelerating a loan merely:

  1. because safeguard or judicial recovery proceedings have been commenced (article L. 622-29 of the French Code de commerce provides that, "The opening judgement does not render payable receivables that were not payable on the date it was rendered. Any clause to the contrary shall be deemed not to have been written") or
  2. because an ad hoc administrator has been appointed or because conciliation proceedings have been commenced (article L. 611-16 of the French Code de commerce).

This is why the acceleration clause is generally qualified with a reference to the rules of Book 6 of the French Code de commerce.

Unforeseen events

Pursuant to the new article 1195 of the French Code civil, introduced as part of the reform of the law of obligations effective 1 October 2016, contracts can be reviewed by a judge if "a change of circumstances that was unforeseeable at the time of execution of the contract makes its performance excessively onerous for a party that did not accept to assume this risk". Lenders may therefore want to insert a clause excluding the application of article 1195 of the French Code civil, without prejudice to the material adverse change and new circumstances clauses of the loan agreement availing only to the lenders. Such exclusion clause should be valid given that this article has a "suppletive" character according to the report to the President of the Republic pertaining to this ordinance (J.O. 11 February 2016).

Limited recourse

Because some French companies like SCIs and SNCs are unlimited liability companies, it is expected to include a limited recourse clause in the facility agreement protecting their shareholders... unless this feature is intentionally relied on for cross-collateralisation purposes (see the second article in our series).

Change of finance parties and powers of the agent

Change of finance parties

Since 1 October 2016, the regime of the assignment of receivable has been simplified - a notification by huissier of the debtor is no longer a condition to the effectiveness erga omnes of the transfer - but completed by specific regimes for assignments of contracts and assignments of debts, two notions that were not clearly recognised by French law earlier.

Given the new regime of assignment of contracts (and the new regime of assignment of debts, which is very similar), a clause should be inserted in any French-law facility agreement whereby (i) the borrower "agrees" in advance to the assignment of contract resulting from any transfer of participation to a new lender or substitution of an agent so that such assignment of contract will be effective against the borrower upon simple notice pursuant to the new article 1216 of the French Code civil and (ii) the borrower further "expressly agrees" that in this case the exiting lender or agent shall be discharged from all obligations pursuant to the new article 1216-1 of the French Code civil (although some authors have raised the issue whether such consent could be granted in advance given that the words "in advance" appear only in article 1216 not in article 1216-1).

It is of course possible for the borrower's consent to be conditional on the new lender's meeting certain qualities including - in case of assignment of an undrawn commitment - in terms of solvency minimum rating requirements. Guarantees and security interests granted by third parties should also contain a clause whereby they will survive a novation and (to be on the safe side until an ambiguity in the wording of the new article 1216-3 of the French Code civil has been lifted) an assignment of contract.

Assignments of litigious receivables remain subject to article 1699 of the French Code civil authorising the assigned debtor to discharge himself or herself by paying the discounted price, interest and costs to the assignee.

A related issue is the right to disclose confidential information in case of syndication. Article L. 511-33 of the French Code monétaire et financier, which saddles credit institutions with an obligation to keep client information confidential, contains some exceptions for enabling syndications and hedging, but it is recommended to insert appropriate confidentiality clauses in the loan agreement as the above legal provisions may not apply to all situations.

Powers of the agent

French-law finance documentation may contain provisions whereby the finance parties appoint a facility agent and a security agent. A security agent is however not akin to a security trustee, despite the addition in 2008 by the French legislator of an article 2328-1 in the French Code civil purporting to enable creditors to appoint, in the loan agreement, a person empowered to create, manage and enforce security interests on their behalf. In case of finance documentation governed by the laws of a country that recognise trusts, French courts will however recognise that a security trustee may act in its own name (cf. the Belevedere decision of the Cour de cassation of 13 September 2011).

Since 1 October 2016, it is recommended to insert a clause in French-law loan agreements authorising expressly the facility agent and the security agent to execute finance documents on behalf of two or more finance parties at the same time or in its own name and on behalf of one or more finance parties, by derogation to the new provisions of article 1161 of the French Code civil.

Choice of law and choice of jurisdiction

Choice of law

Choice of law clauses pointing to the law of a foreign jurisdiction will generally be given effect by French courts, pursuant to applicable French conflict rules, namely those set out in Regulation (EC) No. 593/2008 on the law applicable to contractual obligations.

Choice of jurisdiction

Furthermore, a judgment rendered in a foreign country against a French company pursuant to a clause granting jurisdiction to the courts of that country will generally be recognised in France, despite the poor drafting of Regulation (EU) No. 1215/2012 of 12 December 2012 when it comes to the issue whether domestic conflict rules continue to apply to judgements from non-EU countries (cf. the "reflex" theory).

Please note, however, that the Cour de cassation held on 26 September 2012, albeit in a case where the borrower was an individual, that a clause compelling one of the parties to bring actions in a specific jurisdiction but authorising the other to choose any jurisdiction (a one-sided jurisdiction clause) was not valid on the ground that it was "potestative" (discretionary), hence allowing a French court to ignore it and hear the claim brought by the French party.

Amidst criticisms, the Cour de cassation however changed its approach to one-sided jurisdiction clauses in more recent decisions. In a decision of 15 March 2015, it suggested a one-sided jurisdiction clause could be valid if it "permitted the identification of the jurisdictions before which an action could be brought with respect to the performance of the contract".

In a decision of 7 October 2015, it considered a choice of jurisdiction clause that required one of the two parties to seize the court of a specific country (the other party's country of incorporation) and authorised the other party to choose among the courts of the country of incorporation of either party or of any country where it had suffered a prejudice. It ruled that "the court of appeal was right to consider that this clause, which enabled one to identify the jurisdictions that could hear a litigation between the parties in connection with the performance or the interpretation of the contract, met the predictability requirement which choice of jurisdiction clauses must satisfy" (though wrong to apply it in a dispute about anti-competition practices in the absence of an express reference to such disputes in the clause).

Our next article will examine the legal considerations relevant to the negotiation and execution of commercial real estate loan documentation in France as well as post-closing considerations.

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.

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