Criminal liability of legal persons under French criminal law, a sound and necessary shift in traditional case law – Option Finance January 11, 2020

Column by partner Lionel Lesur and associate Laura Isabelle Danet, from our  Corporate-M&A department, published in  Option Finance n° 1589 January 11, 2021. (Unofficial translation)

A merging company may now be convicted for criminal offences committed by the merged company before the merger by absorption occurred. If this change is rationale, it is nonetheless necessary to anticipate its consequences and its potential developments [1].

On 25 November 2020, the Criminal Chamber of the French Supreme Court for judicial matters (Chambre criminelle de la Cour de cassation), meeting in plenary session, adopted a pragmatic approach, by a decision which importance should be highlighted.

It ruled that a merging company may, under certain conditions, be held criminally liable and sentenced to any fine or seizure for a criminal offence committed by the merged company prior to the completion of the merger by absorption [2] (the “Decision”).

Double angle of the shift in traditional case law

The facts set forth in the decision are rather classic [3] but two essential contributions may be identified.

On one hand, the French Supreme Court reiterates and generalizes the consequences of the determination of fraud that corrupts everything (fraus omnia corrumpit).

The identification of fraud thus allows the judge to impose any criminal penalty, including non-material ones, applicable to legal persons provided for in Article 131-37 and, by reference, in Article 131-39 of the French Criminal Code (such as the definitive closure of the establishment which was used for committing the criminal offence, the exclusion from public procurement or even the display or circulation of the decision), on any merging company, should the aim of the merger by absorption be escaping the criminal liability of the merged company.

Although the Criminal Chamber never had the opportunity to rule on transferring the criminal liability to the merging company in case of fraud before the Decision, it considers that this Decision could not be considered as a proper shift in case law and may, therefore, be applied to any merger by absorption completed even before the Decision.

On the other hand, the judge, who identified a merger by absorption, falling with the scope with the European directive 78/855/CEE dated of 9 October 1978, consolidated by the European directive (UE) 2017/1132 (referred to as “Merger Directive”) [4], and completed after the Decision, may hold criminally liable, for a criminal offence committed by the merged company prior to the completion of the merger by absorption, and impose on the merging company a fine or a seizure.

This is a great revolution having regard to the reverse position, which has long been argued by the Criminal Chamber.

This Chamber demonstrated a real educational intention with this Decision and strictly defined materially and temporally its scope.

As a reminder, pursuant to the Merger Directive, a merger shall mean “the operation whereby one of several companies are wound up without going into liquidation and transfer to a company all their assets and liabilities in exchange for the issue to their shareholders of shares in the new company (…)”.

First, the Decision only deals with mergers by absorption of either joint-stock companies (sociétés anonymes) or, explicitly mentioned by the explanatory note issued by the French Supreme Court, of simplified joint-stock companies (sociétés par actions simplifiées) [5], which consist of transferring all of the merged company’s assets and liabilities to the merging company further to the completion of its dissolution without liquidation. The Decision should be equally applicable to partnerships limited by shares (sociétés en commandite par actions) [6].

Secondly, the Decision is precisely based on the full transfer of assets and liabilities, the very essence of the merger, to strictly circumscribe the applicable sentences to only material ones, such as fines and seizures, which result in the entry in the company’s criminal records (casier judiciaire).

Lastly, in accordance with the principle of legal predictability provided for in Article 7 of the European Convention of Human Rights and, flowing from it, of legal certainty, the Decision only applies to mergers by absorption completed after 25 November 2020.

An evolution in line with the economic nature of the merger by absorption and with European case law

Up to now, the Criminal Chamber relied upon the supremacy of the principle of constitutional value that criminal penalties shall be specific to the offender provided for in Article 121-1 of the French Criminal Code [7] whereby “no one may be held criminally liable except for his own doing”, to assert that it was not possible to hold criminally liable a merging company for criminal offences committed by the merged company prior to the completion of the merger by absorption [8].

Demonstrating legal anthropomorphism, the Criminal Chamber concluded that the completion of the merger by absorption resulted in the legal disappearance of the merged company.

This disappearance necessarily led to the expiry of criminal proceedings, just like death for private persons.

Therefore, convicting the merging company for criminal offences committed by the merged company prior to the completion of the merger by absorption was not conceivable since the dissolution of the merged company prevented the sentence to be enforced pursuant to Article 133-1 of the French Criminal Code.

As a consequence, for the merging company to be fined (without, however, being found guilty), the fine needed to be definitely set prior to the completion of the merger by absorption.

Other swathes of French law, including competition law, nonetheless quickly opposed to the French Supreme Court’s position, which was contrary to the business demands. These swathes have been relying on the concept of “undertaking” and of its obvious economic and operational continuity rather than on the concept, more static, of “company” whose regime could not, based on the proper nature of a legal person, be aligned on the regime governing individuals [9].

This reasoning had been validated by the French Constitutional Council stating that the principle according to which criminal penalties shall be specific to the offender shall be modulated by the aim of the sentence, relying, in particular, upon “the mutability of legal forms used to do business” [10].

The French Supreme Court for administrative matters (Conseil d’Etat) also admitted this principle for tax and financial regulation matters, long before the French Supreme Court for judicial matters did [11].

It was, therefore, necessary to reassess the French Supreme Court’s historic position, which was difficult to endure any longer in terms of economic considerations.

Indeed, it did not take into consideration the distinctiveness of legal persons, which can freely transform into other legal forms without being liquidated, thus ignoring the economic reality.

On 25 November 2020, the Criminal Chamber showed pragmatism while drawing the necessary conclusions from Article L. 236-3 of the French Commercial Code whereby the merger by absorption of a company results in its dissolution, not its liquidation. It disappears transferring all of its assets and liabilities to the merging company.

The latter hence entirely supersedes the merged company in all its assets, rights and obligations. The merged company appears to economically and operationally survive within the structure of the merging company.

Therefore, the latter could not be considered as a proper “third party” pursuant to Article 121-1 of the French Criminal Code. Without this transfer of all the assets and liabilities, the legal person would disappear, its criminal liability being, in any case, terminated.

With this Decision, the Criminal Chamber finally complies with the position taken by the Court of Justice of the European Union (ECJ) and the European Court of Human Rights (ECHR) after having, for many years, resisted the call.

According to the ECJ, it clearly appears that a merger falling within the scope of the Merger Directive results in the transfer of the criminal liability of the merged company to the merging company and, mechanically, of the obligation to pay the penalty definitely imposed further to the completion of the merger, while the criminal offence was committed prior to this completion [12].

The disappearance of the merged company is not being denied by the judges in Luxembourg. However, their decision emphasizes that the assets and liabilities (patrimoine) of the merged company transferred to the merging company due to the merger, which have no global definition, do include its criminal liability.

This interpretation contributes, in particular, to protect the interests of third parties in accordance with the Merger Directive, as these third parties shall not be prejudiced by the dissolution of the merged company.

As a consequence, a merging company may be held liable for criminal offences committed by the merged company prior to the completion of the merger by absorption.

This Decision has not, however, on its own, allowed the French Supreme Court to develop a different position than its traditional position, it being specified that the French Supreme Court is required to interpret national law in accordance with EU Law. However, this interpretation shall not have a direct effect on individuals.

The cornerstone of this shift operated by the French Supreme Court is, actually, the decision of the ECHR dated 24 October 2019 [13].

It infers from the principle of economic continuity between the merging and the merged companies that imposing a civil fine on a merging company for restrictive competition practices committed by the merged company prior to the completion of the merger does not violate the principle according to which criminal penalties shall be specific to the offender.

This decision provided the Criminal Chamber with an ideal opportunity to adopt an economic approach which complies with the EU Law and admit a potential criminal conviction of the merging company for criminal offences committed prior to the completion of the merger by absorption by the merged company.

The acceptation of the economic realities in the context of a merger by absorption calls for clarifications and encourages an increased vigilance

The Decision condemns, explicitly and either way, the art of dodging consisting in evading Article 121-2 of the French Criminal Code while completing a merger, used as a sham in order to avoid any potential criminal conviction.

The Criminal Chamber, refusing this manipulation, shows itself as being a part of a wider process aiming at moralizing business life.

Insofar, this position generates as many questions as it raises uncertainties.

This Decision indeed only refers to “existence of a fraud in law”.

However, it does not specify whether the fraudulent aim shall be exclusive of any other aim or whether the judge is allowed to hold liable the merging company for criminal offences committed before the completion of the merger by absorption by the merged company should he consider that the merger by absorption is devoid of any economic rationality or that its completion was rushed.

Aside from such consideration, the Decision obviously faces the difficulty to prove the existence of fraud, both for detecting and appreciating it.

The fraudulent intent is, very often, astutely covered by other causes which may be either economic, strategic or financial.

More broadly, questions raised by the Decision are regrettably, not strictly restricted to the sole hypothesis of fraud.

Because the Criminal Chamber only applies its shift in case law to mergers falling within the scope of the Merger Directive, the articulation between the Decision and the provisions of the French Commercial Code which indiscriminately cover the mergers between all business companies (sociétés commerciales) might inevitably be questioned.

Furthermore, the scope of the operations, once they imply the final disappearance of the legal person which was criminally liable (such as the dissolution of a company pursuant to Article 1844-5 of the French Civil Code, the merger by absorption completed while setting up a new company or the carve out of a company [14]), and of criminal offences likely to be ultimately covered remains uncertain.

In view of the importance the Criminal Court gave to its Decision, its scope may evolve with every opportunity given to the French Supreme Court  [15] or under the leadership of the French lawmaker.

The Decision is also part of a wider rationalization of business law, which encourages legal prosecutions of legal persons, more creditworthy than individuals.

This trend increases even more the development of a French transactional Criminal Law driven by an increasing effectiveness of criminal penalties.

It is, for instance, illustrated by the introduction of the mechanism of the judicial convention of public interests (convention judiciaire d’intérêt public) in accordance with the law dated of 9 December 2016 [16] (referred to as “Loi Sapin II”). Its scope of application is still restricted to identified offences, including corruption and tax evasion. However, it may be usefully widened based on the Decision.

Finally, preliminary consequences shall be drawn from the Decision in order to increase economic players’ awareness.

A specific attention shall be paid to intra-group restructuring, in particular based on corresponding financial and reputational risks, in the light of the obvious refusal of the French Supreme Court to manipulate the merger by absorption.

It is becoming complicated, for a group, further to this shift in case of law, to implement a scorched earth policy, merely wiping the subsidiaries’ criminal slate clean through the completion of a merger by absorption.

Aside from this consideration, the criminal risk shall be strictly assessed in the context of the process of an acquisition.

Due diligences on the target (and more, specifically, of its liabilities), which precedes the purchase, shall thus be subject to special vigilance, especially if the target recently received all the assets and liabilities of another company.

If it appears difficult to detect, in the strict context of an acquisition audit, criminal offences committed by companies which merged with the target (including tax offences, environmental damages or corruption), due diligences may no longer settle for browsing through this significant risk but will have to further evaluate it (ideally, while conducting targeted searches in emails and/or interviews of the relevant operational staff members of the target).

For this reason, due diligences shall also take into consideration the potential risk of recidivism as regards any next similar offence potentially committed by the merging company.

In any event, it may also be appropriate to proceed with, further to the completion of the acquisition, a deeper audit of the then purchased target in order to precisely map the risks incurred and try to remediate damage, in particular, should the target evolve in sensitive sectors or maintain business relationships with risk countries.

In view of this issue, which is also related to the tight schedule of any M&A transaction, the impact of the Decision should be revealed at the stage of the negotiations of the target’s sale and purchase agreement rather than on the determination of the purchase price.

Representations and warranties given by the seller(s)/warrantor(s) should indeed necessarily take into consideration the criminal risk, which may be potentially significant, whether identified or not, during the conduct of due diligences.

It may also speed up the development and the widening in scope of the “warranty and indemnity insurance”.

This insurances aims at compensating the reluctance of the seller(s) to grant the required guarantees, including in terms of cap, duration and risk of civil liability resulting from the criminal risk identified in the sale and purchase agreement.

Accepting the principle of a potential criminal liability of the merging company should, therefore, only be considered as a first step. The Criminal Chamber is likely to quickly clarify its regime.

[1]        The authors wish to thank Michel Sapin, Senior Advisor in the law firm Franklin for his valuable contribution.

[2]        Cass., crim., 25 Nov. 2020, No. 18-86.955.

[3]        « Responsabilité pénale de la société absorbante pour des faits commis par la société absorbée », Dalloz, J. Gallois, 10 Dec. 2020.

[4]        European Directive 78/855/EEC of 9 October 1978 based on Article 54 (3) (g) of the Treaty concerning mergers of public limited liability companies, codified by the European directive (UE) 2017/1132 of the European Parliament and of the Council dated 14 June 2017.

[5]        « Note explicative relative à l’arrêt n° 2333 du 25 novembre 2020 (chambre criminelle) », 25 Nov. 2020 by the French Supreme Court for judicial matters.

[6]        Pursuant to Article L. 226-1 of the French Commercial Code, partnerships limited by shares is only a form of joint-stock companies.

[7]        Cons., const., 16 June 1999, No. 99-411 DC.

[8]        Cass., crim., 25 Oct. 2016, No. 16-80.366.

[9]        Cass., com., 21 Jan. 2014, No. 12-29.166.

[10]      Cons., constit., 18 May 2016, Decision No. 2016-542 QPC.

[11]      CE, 23 July 2014, No. 359902.

[12]      ECJ, 5 March 2015, C-343/13.

[13]      ECHR, 24 Oct. 2019, Carrefour France c. France, No. 37858/14.

[14]      This decision is unlikely to apply to the partial division of a company, as it does not result in the dissolution of a company.

[15]      Cass., civ. 3ème, 26 Nov. 2020, No. 19-17.824.

[16]      Law No. 2016-1691, 9 Dec. 2016, Official Journal 10 Dec. 2016.