Key Aspects of Due Diligence for Cross-Border Investment in France: Identifying Material Risks

Importance of Tailored Due Diligence in France for Transactional Purposes

Engaging in robust due diligence is paramount for mitigating risks inherent in cross-border transactions. In France, this necessity is amplified by a distinct legal, regulatory, and business environment. Understanding these nuances, from intricate labor laws to specific environmental regulations, is crucial to avoid unforeseen liabilities and ensure the long-term viability of the investment. A generic due diligence approach is insufficient; it must be tailored to the specificities of the French market with the express purpose of informing the negotiation of investment terms, typically within an investment agreement, a share purchase agreement or a business transfer agreement.

Expanded Scope of Due Diligence: Focusing on French Specificities and Materiality

While the general areas of due diligence remain consistent, their application and focus require specific attention in France, always keeping in mind the materiality of the findings for the transaction at hand:

Corporate Structure and Governance

French companies, mainly family-owned businesses, often adopt complex holding structures. Due diligence in this area should verify aspects of material importance to the transaction, such as:

• Shareholder Agreements (pactes d’actionnaires): These agreements often contain crucial provisions regarding the management and transfer of shares that can significantly impact the investor's rights.

• Statutory Clauses Restricting Share Transfers: The target's articles of association (statuts) may include clauses limiting the free transferability of shares, which could affect the investor's exit strategy.

• Decision-Making Rights and Veto Powers: Understanding the allocation of decision-making authority and the existence of any veto rights held by specific shareholders is essential for assessing the investor's future control.

• Specificities of the Société par Actions Simplifiée (SAS): The SAS form offers significant flexibility in governance, but its customized by-laws require careful review to identify any unusual or restrictive provisions.

• Registration and Compliance: Examination of the target's registration with the Registre du Commerce et des Sociétés (Commercial and Companies Registry) and the adequacy of its corporate documents to ensure legal standing and identify any potential issues that could impede the transaction.

  
  

Contracts and Commercial Commitments

France adheres to the principle of “freedom of contract,” but this is tempered by mandatory rules, particularly in areas such as consumer protection and unfair terms. Due diligence should meticulously examine contracts of material significance to the target's business and the contemplated transaction, including:

• Termination and Assignment Clauses: Understanding the conditions under which key contracts can be terminated or assigned is crucial for assessing the stability of the target's commercial relationships.

• French Law–Specific Penalty and Indemnity Provisions: French law may impose specific requirements or limitations on penalty and indemnity clauses, which could impact the investor's risk exposure.

• Key Customer and Supplier Dependencies: Identifying critical commercial relationships and assessing the risks associated with their potential disruption is vital for evaluating the target's future performance.

• Contracts Governed by French Law: Special attention should be given to contracts explicitly governed by French law, as they may include obligations and legal concepts not typically found in common law systems, potentially creating unexpected liabilities.

Litigation and Regulatory Exposure

The French judicial system can be characterized by its formalistic procedures and potentially lengthy timelines. While state courts are the primary forum for dispute resolution, arbitration is increasingly common for international matters. Due diligence in this area should assess litigation and regulatory matters of material concern to the investment:

• Pending Civil, Commercial, or Administrative Litigation: Identifying any ongoing legal disputes and their potential financial and reputational impact on the target.

• Regulatory Investigations or Sanctions: Assessing any current or past investigations or sanctions imposed by French regulatory authorities that could lead to significant penalties or operational restrictions.

• Intellectual Property Disputes or Infringement Risks: Evaluating any existing or potential disputes related to the target's intellectual property rights, which could impact its competitive advantage.

• Role of Regulatory Authorities: Understanding the potential exposure to scrutiny from the active French competition authority (Autorité de la concurrence) and various sector-specific regulators that could affect the transaction or the target's future operations.

Financial and Tax Due Diligence

Financial Statements and Accounting Standards

French companies prepare their financial statements in accordance with national GAAP, known as the Plan Comptable Général, which differs from International Financial Reporting Standards (IFRS) in several aspects. Investors should thoroughly analyze financial information of material relevance:

• Recent Statutory and Consolidated Accounts: Examining the historical financial performance and position of the target to identify any significant trends or anomalies.

• Off-Balance-Sheet Commitments: Identifying any potential liabilities or obligations not recorded on the balance sheet that could materially impact the target's financial health.

• Intercompany Transactions and Related-Party Debt: Scrutinizing transactions between related entities to ensure they are conducted at arm's length and do not represent hidden liabilities.

• Audits and Management Accounts: Reviewing reports from the Commissaire aux Comptes (statutory auditor), if applicable, and internal management accounts to identify any red flags such as declining margins or cash flow concerns that could affect the investment's value.

Tax Environment and Compliance

France has historically had one of the higher corporate tax rates in the European Union, although it is currently on a gradual downward trajectory (currently at 25%). Key areas of tax due diligence with material implications include:

• VAT Compliance and Exemptions: Verifying the target's compliance with French Value Added Tax (VAT) regulations and understanding any applicable exemptions that could impact its profitability.

• Transfer Pricing Documentation and Practices: Assessing the target's policies and documentation related to the pricing of transactions between related entities to ensure compliance with French transfer pricing rules and avoid potential penalties.

• Withholding Taxes on Dividends, Royalties, and Interest: Understanding the applicable withholding tax rates on payments made to non-residents, which could affect the investor's returns.

• Local Taxes: Reviewing the target's obligations regarding local taxes such as the Contribution Économique Territoriale (CET), which can represent a significant cost.

• Ongoing Audits and Tax Rulings: Ensuring full disclosure of any ongoing tax audits or any specific tax rulings obtained from the French tax administration, as these could have a material impact on the target's tax liabilities.

Labor and Employment Due Diligence

French labor law is notably employee-centric and characterized by a strong presence of labor unions. Investors undertaking due diligence should focus on aspects of material impact on the transaction:

• Review All Employment Contracts: Pay particular attention to the terms and conditions of employment contracts, especially those of executive-level staff, as these can have significant cost implications.

• Understand Applicable Collective Bargaining Agreements (conventions collectives): These agreements often set out detailed rules regarding working conditions, wages, and benefits that are legally binding on the employer and can significantly affect labor costs.

• Assess Accrued Employee Benefits: Quantify accrued liabilities related to employee benefits, such as paid leave, bonuses, and severance rights, as these can represent significant financial obligations.

• Employee Representative Bodies (Comités Sociaux et Économiques, or CSEs): Recognize that CSEs have significant consultation rights in transactions that may affect the company's structure or employment. Failure to properly consult with the CSE can lead to delays or even the invalidation of a transaction, representing a material risk.

Real Estate and Environmental Considerations

Whether the target company owns or leases property in France, investors must verify aspects of material concern:

• Title Deeds, Encumbrances, and Zoning Restrictions: Ensuring clear ownership, identifying any mortgages or other encumbrances, and confirming compliance with local zoning regulations, as these can significantly impact the value and usability of the property.

• Environmental Audits: Conducting thorough environmental audits, particularly for industrial sites, to identify any potential contamination or environmental liabilities that could lead to significant remediation costs.

• Compliance with Building and Safety Codes: Verifying that the properties comply with all applicable French building and safety regulations, as non-compliance can lead to operational restrictions or costly upgrades.

• Environmental Remediation Obligations: In certain sectors, French law may impose obligations to remediate environmental damage, even if the damage was caused by previous owners, representing a potentially material liability.

Foreign Investment Screening in France

France has significantly reinforced its foreign investment control regime under the Code monétaire et financier. Non-EU investors must obtain prior authorization from the Ministry for the Economy (Direction Générale du Trésor) when acquiring control or a significant influence in companies operating within “sensitive” sectors. This requirement represents a material consideration for the transaction timeline and feasibility. These sectors include:

• Defense and national security

• Energy and water

• Transport and telecommunications

• Artificial intelligence, semiconductors, and space technologies

• Healthcare and biotechnology (with heightened scrutiny since the COVID-19 pandemic)

The review process typically takes between 30 to 75 days. Engaging legal counsel for pre-filing discussions with the relevant authorities is strongly advised to navigate this potentially material hurdle efficiently.

Compliance and Anti-Corruption

France actively enforces anti-corruption measures through the Sapin II law. Due diligence must confirm aspects of material importance related to compliance:

• Has Appropriate Internal Compliance Procedures: Assessing the existence and effectiveness of internal policies and procedures designed to prevent and detect corruption, as a lack thereof can expose the investor to significant legal and reputational risks.

• Maintains Accounting Records in Compliance with French Law: Ensuring that the target's accounting records are accurate and comply with all relevant French legal requirements, as discrepancies can lead to penalties.

• Has No Exposure to Domestic or International Corruption Investigations: Identifying any past or present investigations or allegations of corruption involving the target company or its personnel, which could have a material adverse effect.

• GDPR Compliance: Due diligence should also assess the target's compliance with the General Data Protection Regulation (GDPR), including procedures for data transfers and the adequacy of cybersecurity protocols, as non-compliance can lead to significant fines.

Conclusion: Informing Transactional Negotiations through Focused Due Diligence in France

Conducting comprehensive and meticulously tailored due diligence, focused on identifying potential risks and liabilities of material importance, is not merely a recommendation, but a fundamental necessity for any cross-border investment in France. The insights gained from this process are crucial for informing the negotiation of key investment terms, including the purchase price, the scope of representations and warranties provided by the seller, and the necessity for specific indemnities to cover identified risks. Engaging experienced legal and financial advisors with specific expertise in the French market is strongly advised to navigate these complexities and ensure a successful and secure investment in France.

Please note that this due diligence report is not intended to summarize all legal issues relevant to the target. It aims only to highlight those legal issues regarding the target that we consider sufficiently material to be brought to the investor's attention in the context of the contemplated Transaction.