In the sale of a French SME, the parties pour their energy into the warranty and indemnity clause, the garantie d’actif et de passif, and far too little into the four documents or clauses that actually decide the fate of the deal: the letter of intent, exclusivity, the earn-out and the seller’s non-compete undertaking. Badly drafted, they turn a successful sale into litigation two years later. French contract law as reformed in 2016 and the case law of the commercial chamber of the Cour de cassation nonetheless provide fairly precise guideposts. You still need to know them before signing the first page.
The founder of an industrial maintenance company near Nantes, with 60 employees, sells 100% of his shares to an investment fund. The price has a fixed portion of 9 million euros and an earn-out of up to 3 million, calculated on EBITDA for the following two financial years. The seller stays on as managing director during the transition. Eighteen months later, the new shareholder imposes group management fees, pushes two large projects into the next financial year and dismisses the seller for “strategic disagreement”. Reference EBITDA falls below the trigger threshold. The earn-out is worth zero, and the seller discovers that the contract says nothing about the management rules applicable during the calculation period.
1. The letter of intent: what it really binds you to
The letter of intent, or lettre d’intention, sets out the broad lines of the deal: scope, price range, timetable, conditions (due diligence, financing, authorisations). In principle it does not bind the parties to complete the sale, but everything depends on its wording: if it records an agreement on the business and on the price with no real reservation, a French judge may treat it as a completed sale or as a promise to sell. That is the trap. The confidentiality, exclusivity and costs clauses, for their part, are binding by nature.
During negotiations, article 1112 of the French Civil Code imposes good faith. Breaking off talks is not wrongful in itself, but an abrupt, late or unjustified withdrawal makes its author liable. The Code does, however, cap the damages: they cannot compensate the loss of the benefits expected from the contract that was never signed, nor the loss of a chance to obtain those benefits, so that only the costs incurred and, where relevant, harm to reputation are recoverable. Article 1112-1 also requires each party to disclose any decisive information it knows of and that the other party is legitimately unaware of, and article 1112-2 sanctions the use of confidential information obtained during the negotiations.
2. Exclusivity: useful, provided it has an end date
A buyer who pays for due diligence demands an exclusivity period, during which the seller agrees not to negotiate with anyone else. It must have a precise end date, usually six to twelve weeks, extendable by written agreement, and a clear sanction. An exclusivity clause with no end date becomes a weapon against the seller, who can neither sell to someone else nor force the buyer to close.
Breach of exclusivity gives rise to damages, sometimes fixed in advance by a penalty clause, which the judge may reduce if it is manifestly excessive (article 1231-5 of the French Civil Code). It does not, however, allow anyone to force the seller to sell. It is protection, not a means of enforcement.
3. The earn-out: write the rules of the game
The earn-out, or complément de prix, bridges the gap between optimistic sellers and cautious buyers. Legally, the price must be determinable on the day of the sale: the formula must therefore rest on objective elements that do not depend on the will of one party alone. In practice, the risk lies not in the validity of the clause but in its performance, because the buyer holds the pen on the accounts from which the earn-out will be calculated.
A sound clause defines the reference metric (revenue, gross margin, EBITDA) with the adjustments allowed and excluded, sets the applicable accounting methods, lists the management decisions that are prohibited or subject to the seller’s consent during the calculation period (group recharges, transfers of business, changes in revenue recognition), grants the seller access to information and provides for disputes to be settled by an expert within the meaning of article 1592 of the French Civil Code, whose decision binds the parties. It also deals with what happens to the earn-out if the seller, who manages the company during the transition, is removed or dismissed without fault: this is the point most often forgotten, and it is the one that cost the Nantes founder 3 million euros, because a buyer who controls management, the accounts and the project schedule at the same time can, without falsifying anything, shift profit from one year to the next, and the only remedy left is then a claim for bad-faith performance of the contract (article 1104 of the French Civil Code), which is slow, expensive and uncertain, when a few lines of drafting, negotiated while the seller still held all the cards, would have been enough.
4. The seller’s non-compete
Even without a clause, the seller owes the statutory warranty against eviction, the garantie d’éviction (article 1626 of the French Civil Code): he cannot take back the customers he has sold. A non-compete clause goes further and must be proportionate. It is limited in time, in space and in the activities covered, and it must be justified by the protection of the buyer’s legitimate interests, meaning the value of the customer base and know-how acquired. A term of three to five years, a territory matching the company’s actual area of business and a precise definition of the prohibited activities usually withstand judicial review.
Where the seller remains an employee, two undertakings must be kept apart. The clause tied to the sale requires no financial consideration. The clause in the employment contract, by contrast, is valid only with financial consideration, under the settled case law of the social chamber of the Cour de cassation. Confusing the two exposes the buyer to the nullity of the more useful undertaking. That mistake is expensive.
5. Prior notice to employees
In companies with fewer than 250 employees, the sale of a stake representing more than 50% of the shares requires employees to be informed no later than two months before the sale, so that they can make an offer (articles L. 23-10-1 et seq. of the French Commercial Code, and L. 141-23 et seq. for the sale of the business as a going concern, the fonds de commerce). Failure to inform no longer voids the sale, but it exposes the seller to a civil fine. The deal timetable must build this in from the letter of intent onward.
6. What about the warranty and indemnity clause?
It remains essential, but it protects only the buyer. For the seller, protection lies in the clauses above: dated exclusivity, a well-framed earn-out, a proportionate non-compete. The Nantes founder eventually obtained a settlement for half of the earn-out, after a forensic accounting review revealed that the two projects had been shifted. He could have obtained the full amount with an ordinary-course-of-business clause and an acceleration clause in case of forced departure. Every seller should take note.
Selling or acquiring a company in France
The firm advises sellers and buyers, from the letter of intent to the warranty and indemnity clause, and acts in price disputes. See our page on company sales and acquisitions, and our article on the shareholders’ agreement and the effectiveness of its clauses. For an initial discussion: contact.
Further reading: Majority abuse, minority abuse and management audits: a French shareholder’s weapons; Nullity reform in French company law: the six points that decide the fate of your corporate resolutions.
Frequently asked questions
Does a letter of intent commit the seller to sell?
In principle no, if it expressly reserves the signing of the final agreement. But if it contains a firm agreement on the business and the price, a French judge may treat it as a sale. Its confidentiality and exclusivity clauses, however, are binding.
What can be claimed when negotiations are broken off abusively?
The costs incurred and, where relevant, moral or reputational harm. Article 1112 of the French Civil Code excludes compensation for the loss of the gains expected from the contract that was never signed and for the loss of a chance to obtain them.
How can an earn-out be secured?
By precisely defining the calculation metric, the accounting methods, the management decisions restricted during the reference period, the seller’s access to information, recourse to an expert in case of disagreement and what happens to the earn-out if the seller leaves.
How long can the seller’s non-compete last?
The clause must be limited in time and space and proportionate to the buyer’s interests. Three to five years over the company’s actual area of business is a commonly accepted term.
Must employees be informed before the sale?
Yes, in companies with fewer than 250 employees, when more than 50% of the share capital or the business itself is sold, no later than two months before the sale. Failure to do so is sanctioned by a civil fine.
On the same subject: removal of a company director, just cause and compensation, the shareholders’ agreement and setting up a foreign company in France.