CMS Expert Guide to cash pooling in France

a) Introduction

In France, the legal framework pertaining to cash pooling is essentially two-pronged, consisting in a set of rules mainly defined by both banking regulations and by company law.

b) Banking regulations: an exception to banking monopolies

French law defines banking services under article L. 311-1 of the French Monetary and Financial code (Code monétaire et financier - "MFC") as including:

• granting of credits;
• receiving deposits; and
• providing banking payment services.

The carrying out of such banking services is restricted to credit institutions (and financing company as the case may be) under French law under notably sanction, in case of noncompliance and without the benefit of an exemption, of criminal penalties (the "Banking Monopoly").

Amongst ancillary services to banking services, article L. 311-2 of the MFC lists "7. Payment services of section II of article L. 314-1 of the MFC". The said article provides for a list of activities related to payment operations through a payment account. The carrying out of such payment services is also restricted to regulated entities such as credit institutions or payment services providers under sanction, in case of noncompliance and without the benefit of an exemption, of criminal penalties (the "Payment Monopoly").

To this general prohibition (article L. 511-5 of the MFC), the MFC provides notably a specific exemption both to the Banking and Payment Monopolies for intra-group activities (article L. 511-7 3. of the MFC): Banking and Payment Monopolies do not prevent a company from “carrying out treasury transactions with companies that have direct or indirect capital ties with it, giving one of the related companies effective control over the others”.

Whilst space does not permit a full analysis of this provision here, disputes in relation to the application of this provision have been rare in recent years.

c) Company law requirements: corporate capacity, corporate interest, transactions with related parties

Three main requirements arising from French company law are usually considered in connection with cash pooling agreements.

The first is corporate capacity. A French company must have the power under its corporate objects to enter into a cash pooling agreement. In practice, French companies usually have rather broad objects, allowing nearly all kinds of activities. In this view, it may be difficult to imagine this issue giving rise to litigation in connection with a cash pooling arrangement.

The second is corporate interest. The cash pooling agreement must comply with the corporate interest of the participating French companies. This is a matter which must be carefully assessed, because it both (i) requires a case-by-case analysis and (ii) can give rise to the civil liability of managers (see below). The difficulty associated with establishing a corporate interest has been eased by relatively recent case law acknowledging the concept of a “group interest”.

The third is related parties transactions proceedings. Here, it is necessary to assess whether entering into the cash pooling agreement would require approval of the relevant corporate body as a “regulated agreement”.

For instance, in a société anonyme, the company’s board of directors would have to give prior approval in accordance with section L. 225-38 of the French Commercial Code (Code de Commerce). This section provides that “every contract entered into directly or through an intermediary between the company and its general manager, one of its delegated general managers, one of its administrators, one of its shareholders holding a proportion of voting rights higher than 10% or, where it is the matter of a shareholder company, the company controlling it within the meaning of section L. 233-3, must be subject to the prior consent of the board of directors.” The scope of concerned persons and the relevant corporate body depends on the type of company, but this is the general idea.

Only current agreement concluded on normal terms would escape this procedure. For instance, a cash pooling agreement will be entered into under normal terms if the participating companies receive interest at the market rate on cash which they transfer to the pool. If the cash poured into the cash pool does not generate any interest, the agreement may not have been concluded under normal terms. 

More broadly, the question whether cash pooling agreements are per se qualified as current contracts tends to find a positive answer in case law, but there is still some scope for doubt.

d) Risk of insolvency and compulsory winding-up

The mixing of funds in a cash pool can cause a risk of uncertainty as regards ownership of such funds and can ultimately lead to insolvency proceedings instigated against one company being extended to other members of the group. 

Obviously, the existence of a cash pooling arrangement does not automatically generate such uncertainty. Such uncertainty will generally only arise where the flow of funds between participants in the pool is affected by a significant number of unusual transactions or circumstances (for example, default on repayments or debt waiver).

The trend of judges in France, and particularly those of the French Supreme Court (Cour de cassation), is to set a high standard for compliance in respect of the aforesaid provisions.

II. Liability risks

a) Risks of directors’ liability – Civil liability

i.) General scope

A director or manager may be held liable for the following categories of breaches towards the company, shareholders and third parties:

• General: any act or omission of the directors or managers which may cause a damage/loss to be suffered;
• Negligence (duty of care):
  • mismanagement; or
  • misrepresentation of annual accounts;
• Company law:
  • breaches of the law and regulations applicable to companies; or
  • breaches of the articles of association;
• Breach of loyalty (duty of care):
  • not acting in the best corporate interest of the company; 
  • not acting in the best interest of the company's shareholders (when it aligns with the corporate interest); or
  • unfair competition with the company. 
• Bankruptcy liability: in the event of bankruptcy, a specific action may be brought against directors or managers who may be ordered to pay off all or part of the company's debts.

Directors or managers are personally liable towards third parties who are not shareholders only if the breach of their duties committed by them is an intentional and serious one, qualifying as not intrinsically connected with the performance of these duties. A director or manager is only liable if the breach he/she has committed has caused personal damage to the victim. Directors may be liable individually or jointly depending on whether a director individually, or several directors collectively, have breached their directors' duties.

Liability suits brought against directors or managers by third parties suffering damages, by shareholders acting individually or on behalf of the company (lawsuit ut singuli) lapse 3 years from the commission of the harmful act.

ii.) In the context of cash pooling agreements

Here, the main issue is the above-mentioned duty of care of managers in handling payments, security commitments and financial flows of the company.

First, should the company's financial balance situation become compromised due to payments made in the context of the cash pooling that materially exceed the company's capacity, or if the manager knew beforehand that such payment could or would not be refunded through the cash pooling, the company could be held financially liable and the manager's civil liability could be brought forward on the ground of negligence or, worse, if the action was deliberate, on the ground of mismanagement.

A corollary ground for liability could be if the manager of the company would commit the company to an unlimited payment guarantee, i.e. exceeding the company's part in the cash pooling and that the triggering of such guarantee would jeopardise or even bankrupt the company.

Another ground of liability is the risk of failing to provide the market with requisite information Whilst there is little case law on this point, the Court of Appeals of Paris ruled in a decision dated 2 March 2004 that a cash pooling agreement could have the effect of masking a state of financial dependence of a subsidiary on its parent company. In the judgment, the court reproached the director of the subsidiary for having breached its duty to provide exact, precise and sincere information to the public by failing to disclose the true situation.

b) Risks of directors’ liability – Criminal liability

i.) General scope

Managers and directors may also be held criminally liable for offences committed during the exercise of their duties. In addition to general criminal offences (theft, murder, etc), managers may be liable for certain specific offences such as:

• Governance:
  • misuse of company property in the personal interest of the manager;
  • misuse of powers in the personal interest of the manager; or
  • infringement on the mission of the statutory auditor; 
• Finance:
  • breach of Banking Monopoly;
  • breach of Payment Monopoly;
  • presentation of false corporate accounts 
  • distribution of fictitious dividends; or
  • insider dealing;
• Compliance:
  • bribery;
  • anti-trust; or
  • environmental hazard;
• Labour law:
  • health and safety/security; or
  • infringement of employee representatives’ right to be informed or consulted.

As outlined above, the manager, in his capacity as legal representative of the company, would have responsibilities linked to the company's general management function, including his responsibility as employer and person in charge of health, safety and environment. Failure to comply with the relevant regulations on these matters may trigger criminal liability for the manager, even in the case that such failure was caused by an employee.

ii.) In the context of cash pooling agreements

Here, one of the main issues for a cash-pooling participant is to stay within the limits of the above-mentioned exemptions to the Banking Monopoly and to the Payment Monopoly. If such limits would be exceeded, both the company and its managers could be held criminally liable. The Banking Monopoly is protected by criminal law and punishments are rather heavy.

For instance, articles L. 511-5 and L. 571-3 of the MFC provide for and punish infringement of this monopoly through the criminal offence of illegal practice of the banking profession. Here are the main penalties incurred: up to three years of imprisonment and a fine of up to EUR 375.000 for natural persons, and a fine of up to EUR 1.875.000 for legal persons. Additional and ancillary penalties are also provided for.

Another main ground for criminal liability in a financial company is payments concurring in: tax evasion, bribery, etc. The risk is higher for cross border payments.

A main risk for directors of French companies participating in a cash pooling agreement is potential liability for “abuse of corporate property”, i.e. use by the directors of corporate property or funds in bad faith in a way which they know is contrary to the company’s interests. This is a risk which particularly concerns French directors, due to the heavy sanctions which can be imposed – namely imprisonment for up to five years and a fine of up to EUR 375,000.

This raises the question of whether the director of a subsidiary who approves the transfer of funds by such subsidiary to another group entity under a cash pooling scheme is guilty of abuse of corporate property. If only the individual interests of each participating group member are to be considered, the criminal risk is significant since the transfer of funds to another entity is made in the interests of the other participating group companies. On the other hand, the operation may appear perfectly lawful if one takes into account the interests of the group as a whole.

Case law has developed a number of criteria to be considered in this respect. In the well-known Rozenblum case, the French Supreme Court (Chambre Criminelle de la Cour de Cassation) set out three criteria to be considered when deciding whether cash advances between companies within the same group constitute an abuse of corporate property:

• cash advances between companies within the same group must be remunerated with a sufficient rate of interest and permitted within the framework of a policy developed in respect of the group as a whole. However, this must be a genuine group and it is necessary that the group should comply with these requirements in practice;
• it will not suffice that such requirements are only fulfilled “on paper”;
• further, it is essential that any financial detriment incurred by one company for the benefit of another must have been incurred for the economic, corporate and financial interests of the group as a whole, for the purposes of preserving the balance of the group and the continuation of the policy developed for the group as a whole;
• finally, a company cannot incur a financial detriment for the benefit of another if, in incurring such detriment, the existence or the future of the company is threatened.
  The French Supreme Court has followed this precedent in all subsequent cases on this matter.

As a general rule of thumb, besides criminal offences related to the management of any company (commingling of assets, etc), the main grounds for criminal liability stem from the same source as for civil liability: the duty of care of managers in handling the funds and ascertaining the scope and final purpose of any financial operation of the company. If this duty is reasonably discharged, the ground for liability will be rather limited.

c) Liability of shareholders

In most cases, the liability of shareholders who are not managers will be limited to the amount they own in the share capital. However, specific situations may arise.

First, the confusion of the assets and liabilities of various companies of a group may be established by the court during bankruptcy proceedings, when the existence of abnormal financial relations or financial flows between them is noted.

Second, the abuse of majority and its consequences. A contract can be declared void for “abuse of majority” if it becomes contrary to the interests of a company. This annulment of a decision of a general meeting can give rise to a claim for damages on behalf of the minority shareholders against the majority shareholders who originated the operation. Any compromised manager could also be held liable. However, finding examples in case law of contracts declared void on these grounds remains difficult.

Last but not least, if the company is an unlimited liability company (such as a société en nom collectif), in case of bankruptcy, the shareholders would have to compensate the full loss. If it could be proved that such loss could at least in part have been caused by the manager through careless or wrongful management, the shareholders would be entitled to sue the manager for damages.

a) Apportioning the liability

A means of limiting the liability in relation to huge undertakings/guarantees taken under the cash pooling would be to apportion such commitment to the part of the company in the cash pooling to prevent a creditor from suing the company for the whole of a loss on the account.

b) Choosing a centralising entity

There are several options in relation to the choice of a centralising entity.

The centralising entity could be the parent company. The disadvantage of this is that the interests of this company may appear excessively enhanced in comparison with the interests of other entities. This solution is likely to significantly strengthen the position of the parent company.

We can also envisage the use of an Economic Interest Grouping, a structure of cooperation which is more egalitarian.

Whatever the choice of centralising entity, the involvement of a bank in the cash pooling arrangement is advisable, since a bank will be able to provide real-time information about the balances on the subaccounts of the various companies participating in the cash pooling arrangement.

c) Formalising the cash pooling agreement in a written agreement

It is generally considered that, for evidence reasons, the rights and obligations of the companies participating in a cash pooling arrangement should be set out in a written cash pooling agreement. In the absence of a written document, it may be difficult to provide evidence of the participating companies’ respective rights and obligations.

There are precautions to be taken in drafting such a written agreement. As mentioned above, the cash pooling agreement must specify that interest is payable to the companies contributing funds to the cash pool.

In addition, a cash pooling agreement should clearly state its duration and include provisions governing the ability of each French company to withdraw from the agreement if participation in the cash pool ceases to be in such company’s interests. Finally, it is important that the circumstances in which a company will be-come automatically excluded from the cash pooling operations are defined.

d) Delegating liability

Managers can delegate part of their responsibilities to some employees through a power of attorney under certain conditions. If these conditions are met, civil and criminal liability on the delegated matter are transferred to the delegate.

e) Insuring the risk for managers

Civil liability may be covered by insurance, through specific contracts (police d'assurance de responsabilité civile des mandataires sociaux - RCMS). Liability insurance covers the costs of defending and appearing before civil, criminal and administrative courts, as well as damages due to victims, including damages paid to civil parties in a criminal trial. Although it covers managers, it is taken out on their behalf by the company. We advise subscribing to such an insurance policy.

Last but not least, in most cases, ensuring criminal liability per se (i.e. the penalty itself – the fine – not the damages to civil parties) is illegal.

a) Interest deductibility

Interest payments made by cash pool members that are in a debtor position are deductible subject to standard interest deduction limitations on loans to shareholders’ and related parties (interest rate limits) and the general limitation of the deductibility of net financial expenses (resulting from the transposition of ATAD 1). 

However, some exceptions from the interest deduction limitation rules apply to French entities centralizing the cash pooling activities for the interest paid to the cash pool members insofar as they do not act on their own behalf but on behalf of the cash pool members.

For the same reason, the French tax authorities make a moderate application of the principle according to which advances made by a company to its shareholders are presumed to represent profit distributions.

b) Transfer pricing

According to general transfer pricing principles cash pool members that are in a credit or debit position should ensure that an arm’s length interest rate is applied. Companies with a cash surplus must obtain a return at least equal to that which they could obtain by placing their cash directly with a bank or financial institution. On the other hand, companies with cash deficits should not bear a higher interest rate than they could if they borrowed directly.

The cash pool leader must receive an arm’s length remuneration for the services it provides to the cash pool members.

The cash pool members should receive adequate remuneration for guarantees they may provide to other members of the cash pool.

c) Withholding tax

Under French tax law, interest payments to non-resident entities are exempt from withholding tax, unless they are paid to NCSTs. However, in certain cases, interest payments may be qualified as deemed distributed income, falling within the scope of the French domestic dividend withholding tax when paid to non-resident recipients, subject to the applicable tax treaties.

d) Corporation tax

The interest payments received or deducted by French cash pool members are taken into account in their taxable income subject to corporate income tax at the standard rate.

e) VAT rules

For VAT purposes, a distinction must be made according to whether the core company acts as a borrower-lender or as an agent.

In the first situation of borrower-lender, the core company carries out loan transactions with its subsidiaries. The interest received in return for these loans is exempt from VAT. 

In the second situation, that of an agent, the core company carries out operations to manage the loans that the subsidiaries grant to each other. The commissions received in return for these operations are subject to VAT at the standard rate. 

The different cash pooling methods may thus have an impact on the deduction coefficient of the core company.

N/A