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29 July 2015
On May 12 2015 the Court of Cassation – the highest judicial civil court in France – held that a parent company cannot be held liable for failing to provide a subsidiary with equity commensurate to cope with transferred liabilities in a spin-off, with a few narrow exceptions. Transferring an asset or activity to a subsidiary is common before the transfer of a division; in the case at hand the subsidiary had been set up for the sole purpose of owning a branch of the parent's assets in preparation for its transfer. While it is possible that a parent company may be liable in those circumstances, the facts of this case failed to reach that threshold. The court's decision illustrates and clarifies – although not completely – the extent and limits of that potential liability.
Rhodia, a French producer of specialty chemicals, was the result of a spin-off from its parent company (now Sanofi) in 1998. Rhodia alleged that Sanofi was tortiously liable by failing to transfer enough equity to account for future charges stemming from existing environmental and retirement liabilities in the transferred assets – charges which were ultimately more significant than originally accounted for.
The Court of Cassation held that, considering the financial structure and warranties of the spin-off (neither of which envisioned Sanofi providing for future liabilities), Sanofi could not be held responsible for them.
The court found that Sanofi was not at fault as neither the allocation of equity nor Rhodia's overall financial structure as created in the spin-off was negligently constructed or otherwise lacking in diligence or care. Sanofi provided Rhodia with an initial capital increase of €610 million and then a second capital increase of €1.52 billion, and agreed to waive the €650 million debt of Rhodia's US subsidiary: a total of €2.78 billion.
In addition, while the environmental and retirement liabilities were considerable, the court determined that Rhodia's strong performance following the spin-off demonstrated that there was no obvious relation between a potentially insufficient capitalisation or a financially imbalanced structure and the company's commercial prospects. In the years following the spin-off, Rhodia became a leader in the chemical market after a friendly takeover by a foreign company and launched a successful initial public offering. Further, its financial difficulties began in the early 2000s, years after the spin-off and the capital increase, making the link between the spin-off and Rhodia's performance too tenuous for legal liability.
A fundamental tenet of the parent-subsidiary relationship is the legal independence of the two entities; theoretically, the liability of the subsidiary cannot lead to the liability of the parent. While that remains the general principle, there are a number of exceptions – for example, where:
Further, when the separate legal personality of the two companies is confused by their actions or is a sham or a facade, courts will treat their legal personalities, including assets and liabilities, as one. Nevertheless, the Court of Cassation found no such exceptions in this case.
While the court's decision provides valuable insight when strictly confined to the facts, it also contains broader implications for the parent-subsidiary dynamic. First, if the liabilities of the transferred assets in a spin-off eventually surpass what was originally envisioned, the parent cannot be held liable on that basis alone. However, the court stressed that in this case, the financial imbalance created by the increased liabilities was insufficiently severe to require compensation by the parent company, implying that there could be cases where a sufficiently egregious imbalance would necessitate redress. Such cases will likely be rare, as the specific facts of the present case create a high, precise standard. Rhodia also pursued a theory of liability predicated on deeming Sanofi a de facto director: under the precise conditions set out in Articles L651-2 and L225-251 of the Commercial Code, that standard, too, will be confined to a narrow set of cases, conforming to a specific set of facts.
Second, and more generally, the court's decision could also indicate that for a subsidiary in financial distress, intra-group financial support cannot be implicitly assumed.
Ultimately, future parties are still left with some reliable legal guidance. The decision provides a framework for a parent company approaching a spin-off, as the court established that the parent will not be held responsible for an unforeseen increase in liabilities unless a specific – and high – threshold is reached. Nonetheless, while the court gave some indication of the factual considerations that will be taken into account, the definitive standard for liability remains unclear.
For further information please contact Alain Levy or Gwenaëlle de Kerviler at AyacheSalama by telephone (+33 1 58 05 38 05) or email (email@example.com or firstname.lastname@example.org). The AyacheSalama website can be accessed at www.ayachesalama.com.
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