Franco British Law Society Lecture

November 19, 2001 - Edinburgh

The Director's Liability under French Law

For the purpose of this presentation, reference is made to the French Société Anonyme (SA) which is one of the corporate forms available in France with limited liability.

The management structures available for the French SA :

ð Until recently, only two types of management structure existed :

. The SA run by a board of directors whose chairman (Président Directeur Général or PDG) is both chairman of the Board meetings and the equivalent to the anglo-saxon Ceo. The PDG may be assisted by one or several General Managers (Directeur Général or DG).

. The SA run by a Management Committee (directoire) and a Supervisory Board (conseil de surveillance). Such a management structure is derived from the German model of the Aktiengesellschaft.

This two-tier system has not been very successful in France : Less than 4% of the French SA's has used it despite some famous exemples: Peugeot, AXA…

What are the reasons of such a situation? : (i) The collegiality of the Management Committee makes the decision making process more cumbersome and (ii) such a model implies more formalism as a result of the coexistence of two boards : See the legal requirements in terms of reporting between the management board and the supervisory board.

However about 20% of the listed companies belonging to the Paris Stock Exchange CAC 40 have adopted such a two-tier management structure. This may be explained by the fact that listed companies are more sensitive at dissociating the management itself and its control.

ð Since the French law dated as of May 16^th 2001 (the so-called NRE Law; Nouvelles Régulations Economiques), a new model (based on the one tier structure) is available.

Such structure mainly relies on the dissociation of the duties of the chairman of the board and of the General Manager (Directeur Général).

As a result:

. The chairman of the Board presides over the meetings of the Board and represents the Board of directors; One should also note that the corporate powers of the Board have decreased as a result of the NRE Law: It decides on the main orientations of the company and it is responsible for the control of the company's management; but the Board is no longer entrusted with the broadest corporate powers to commit the company.

. The General Manager has become independent from the Chairman: He is appointed and dismissed directly by the Board and no longer upon the proposal of the Chairman; the General Manager represents the company towards third parties and has the broadest corporate powers to commit the company.

French SAs have 18 months as from the date of the NRE Law to make a choice between this new structure and the previous one.

An evolution of the liability regime is to be foreseen as a result of the NRE Law; for instance, concerning the directors they will have less exposure as to management decisions (indeed the board is no longer entrusted with the broadest corporate powers to commit the company but, on the other hand, the directors' duties have been strengthened in terms of control of management (such duty is now provided for in the NRE Law whereas they only resulted from case law before the NRE Law).

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1. The civil liability of directors

There are more and more court decisions dealing with director's liability which logically means that there are more and more legal actions against directors.

What are the reasons for such a situation?

The civil liability of directors is one of the most appropriate legal tools available to shareholders to fight against mismanagement and it is definitively an efficient legal weapon for minority shareholders who, by essence, are not in a position to dismiss directors (such a decision requires the majority at the shareholders meeting).

Under French company law, a main distinction has to be made between the civil liability of directors towards the Company or its Shareholders (1.1) and the civil liability of directors towards third parties (1.2).

1.1 The civil liability of directors towards the company and the shareholders

The director's duties are not defined per se by French law. Such duties may be inferred from case law on director's civil liability (ie duties of care, diligence, discretion...).

1.1.1 The legal grounds for the director's civil liability :

French Company law provides that directors are liable for the following :

ð The violation of legal provisions applicable to French SAs ;

Ex. : liability of the company's directors in case of a decision taken by the Company being nullified

ð The violation of the provisions of the by-laws ;

Ex. : A Directeur Général does not comply with the limitations of his corporate powers as provided for in the company's by-laws.

ð The mismanagement ;

The concept of mismanagement relies on the concept of corporate interest = there is mismanagement whenever a director acts against the company's interest.

The Directeur Généraux are more often found liable on that basis than directors.

The Directors are usually blamed because of their absenteeism (ie: no warning in case of mismanagement by a Directeur Général).

Concerning the Directeur Généraux, it is a matter of both absenteeism (ie no accounts were prepared by them) and faulty acts (ie they decided to start some business which will then prove to be disastrous for the company).

1.1.2 The implementation of civil liability :

ð Civil liability may be sought against one director (individual liability) or against several or all of them (collective liability); in such a case the directors' liability is joint and several : the director who pays the damages (which would be decided upon by the court) has a legal recourse against the other directors (for an equal share unless the court decided otherwise).

ð The applicable statute of limitation is 3 years as from the date on which the faulty act is committed or as from the date it is known if it is concealed.

ð Such rules are applicable to a prejudice suffered by the Company or to a prejudice suffered by a shareholder.

1.1.3 Two types of prejudice :

ð On the one hand, the damage/prejudice may be suffered by the company itself : this is the corporate prejudice ("préjudice social").

Ex. : A tax reassessment due to a director's misbehaviour or the material decrease of the company's profits.

In such a case the so-called "ut singuli" action is available : Any shareholder (acting individually or through a "shareholders' association" (holding more than 5% of the company's share capital) may act on behalf of the Company. As a result of such action, the possible damages are to be paid to the company.

ð On the other hand, the damage/prejudice may be suffered by a shareholder : this is the individual damage ("préjudice individuel").

In practice such a situation (where a shareholder acts for its own account) is rare.

Ex. : a DG would misappropriate a dividend, a shareholder was entitled to.

But according to case law the decrease in value of the company's stock due to mismanagement does not constitute an individual damage (since it does not constitute a damage different from the corporate damage).

1.2. The Civil liability toward third parties

ð Third parties have to start their legal actions against the Company and not against the directors themselves unless the director's faulty act could be disconnected from the duties of such director.

ð Actually the director's fate, in that respect, will mainly depend on the financial situation of the Company.

Two situations have to be considered :

1. The Company is "in bonis"

When the Company is able to face the financial consequences of its director's faulty acts, French courts are rather indulgent with the directors. Indeed it is difficult, in such case, to evidence that the faulty act can be disconnected from the director's duties. For instance, case law does not consider it is the case whenever a Directeur Général exceeds his corporate powers as defined in the by-laws.

Does this mean that the director of a French SA will never be found liable ?

. Not exactly : As seen previously, the Company or the shareholders may start legal actions against the directors ; such legal actions are usually commenced by minority shareholders or by the replacing corporate managers.

. Moreover, in case the director committed a criminal offence, the victims may request the court to condemn the directors themselves to pay damages. Indeed under criminal law (and contrary to civil law) it is not required that the wrongful act (constituting the criminal offence) be disconnected from the director's duties.

2. The Company is bankrupt

When the company is unable to pay its creditors (ie insufficiency of assets), the court may decide, in accordance with French bankruptcy law, that the Company's liabilities be borne, totally or partially by the corporate managers ("action en comblement de passif social").

Two conditions must be met :

First a mismanagement has to be evidenced and second the link between the mismanagement and the company's insufficiency of assets.

In such a case, mismanagement is understood by courts in a broader sense (e.g. the decision to make inappropriate investment or the failure of monitoring appropriately the Company's senior employees).

Such legal action may be started by the judicial receiver or the representative of the company's creditors (both of them being appointed by the bankruptcy court), the prosecutor or the court itself.

There is a 3 year statute of limitation applicable to this action (starting as from the court order deciding on the judicial sale of the company's assets or the judicial liquidation of the Company).

2. The criminal liability of directors

It is noteworthy that, since a 1994 law, French legal entities (themselves as opposed to their directors or corporate managers) can be held criminally liable for the criminal offences which are committed for their account by their legal representatives. The company's criminal liability is not extended to any criminal offence provided under French criminal law: It has to be expressly provided for by the relevant legal provision. However the director's own criminal liability may still be sought together with the Company's.

The most common criminal offences retained against directors are the following :

- The misuse of corporate assets

A directors, acting in bad faith would use the company's assets for a purpose which is contrary to the company's interest and for a personal purpose.

Ex : a director would have the company buy a sailing boat for the personal use of such director.

- Other criminal offences

. distribution of fictitious dividends

. presentation of untrue accounts

. other criminal offences as provided under labour law, environmental law...

3. The tax liability of directors

Pursuant to Articles 266 and 267 of the Tax Procedure Code, the directors and the Company are jointly liable for any tax claim that the directors would have decided not to pay.

Such provisions may be implemented against the directors only if the Company is unable to pay the tax. It's precisely when the Company faces financial difficulties that the directors may be tempted either to delay or simply not to pay the company's tax.

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