Introduction to representations, warranties and indemnities under French law & practice

1. Introduction to representations, warranties and indemnities under French law & practice 18 February 2013 Presentation to the Supreme Commercial Court of the Russian Federation

2. Contents • A limited legal protection • Absence of any specific provision governing private sale of shares • General regime applicable to sale of goods • General regime applicable to formation of contacts • The traditional French “balance sheet warranty” • Trigger: increase of liabilities or decrease of assets • Consequences: indemnity • The influence of the anglo-saxon full “R&W” protection • Detailed list of specific representations & warranties • General indemnity • Main terms of contractual protection • Types of warranty/indemnity provisions • Beneficiaries • Limitations

3. Summary • French law does not specifically address the protection of a buyer of shares (in a private sale). • Protection is based on general regime governing sales of good and formation of contracts. • Most usual applicable sanctions are nullity or rescission. • However contractual freedom under French law allows an extensive and fully enforceable protection. • The current practice is a combination of a traditional French approach focusing solely on balance sheet warranty and the anglo-saxon approach covering a wide range of detailed representations and warranties.

4. 1. A limited legal protection • Absence of any specific legal remedy to protect the buyer of shares in Civil or Commercial Codes. • A specific regime only exists for listed securities resulting mainly from market abuse regulations (price manipulation, false information, insider trading) • Two sources of protection for buyers (in a private sale): • mandatory legal rules: legal regime applicable to sales of goods and to formation of contracts • optional contractual arrangement: freedom of contract and enforceability of protective provisions

5. Legal regime: sale of goods 1.Warrantyagainst dispossession (garantie d’éviction) Article 1626 of the French civil Code: “Although no warranty was contractually provided at the time of the sale, the seller is required by law to warrant the purchaser against acts of dispossession which may affect whole or a portion of the thing sold, or against encumbrances affecting that thing, and not disclosed at the time of the sale.” • Limited scope of protection. • It warrants the existence and quiet enjoyment of the shares. In practice mostly applies where the seller did not own or was otherwise not entitled to sell the shares. • It also applies to limited circumstances where the seller’s acts, after the sale, notably competition initiatives, completely prevents the purchaser from pursuing the company’s business purpose. • It also covers acts of third parties (such as supervisory administration or authority).

6. Legal regime: sale of goods (continued) Examples: Successful dispossession: Cass., Civ 1ère, January 24, 2006, M. Laurent Paudex c/ M. Jean-Michel Mazue: • Facts: a partner in a professional partnership sold his shares to a purchaser, before restarting a practice in the same field in a nearby area. • Decision: seller intentionally attracted the company’s patients to its own practice. As a result, the share purchase was purposeless, and the court granted relief to the purchaser (i.e. rescinded the contract) based on a breach of the warranty against dispossession. Unsuccessful dispossession: Cass., Com., January 21, 1997, Sté Eridania Beghin Say c/ Ducros: • Facts: the founders of a company manufacturing spices and dehydratedaromatic herbs had sold their company, and had then restarted another business of frozen aromatic herbs. • Decision: purchaser failed to show that the seller’s new business was attracting the company’s customers and prevented it to pursue its own business. As a result, the purchaser’s claim for breach of the warranty against dispossession was rejected.

7. Legal regime: sale of goods (continued) Sanctions: • Rescission (termination of contract with retroactive effect). • In addition to rescission, purchasers can obtain: • A total or partial reimbursement of the purchase price; • Damages; and • Purchasers can also obtain in summary proceedings, that the seller be enjoined by a court order to cease his competition, if they can show that such court order is urgently needed to prevent an illicit damage.

8. Legal regime: sale of goods (continued) 2.Warrantyagainst hidden defects (garantie des vices cachés) Article 1641 of the French civil Code: “A seller is liable for the hidden defects of the product sold when such defects make it unfit for the use for which it was intended, or when they impair that use in such fashion that the buyer would not have acquired the product, or would have paid less, had he known of them.” • This protection covers defects that were unknown to the purchaser before the sale and that significantly impair the purchaser’s ability to use the goods as intended. • Again, as for dispossession, the scope of protection is very limited and the conditions are strictly applied by courts: • The rule only protects the purchaser when the relevant hidden defects are such that the company is prevented from pursuing its business purpose. • No protection is offered when the defect only decreases the value of the company, or makes it simply harder to pursue the business in the conditions expected by the purchaser. • Accordingly, the defect must be fundamental, prior to the sale and unknown of the buyer. • In practice, to our knowledge, relief has only been granted under that theory in the case of sale of business rather than sale of shares.

9. Legal regime : sale of goods (continued) • Sanctions: • Either • Reimbursement of the purchase price and return of the shares to the sellers; or • Reimbursement of a portion of the purchase price; and • Damages: • When sellers were aware (or should have been aware) of the hidden defects, they must identify all direct damages caused to the purchaser by the defects; • When sellers were not aware (and were under no duty to be aware) of the hidden defects, the indemnification is limited to the fees incurred by the purchaser in connection with the sale.

10. Legal regime: sale of goods (continued) Examples: Defects that have led to indemnity of buyer (of a business, not of shares): Non compliance with security regulation for a business open to a large public; unexpected termination of a key contract (a licence agreement with Renault for a car business) Defects that have NOT led to indemnity of buyer: Cass., Com. December 12, 1995, Hôtel de l’Esplanade c/ Meyer Amar • Facts: after the sale the purchaser realized that it could not operate the company's business without undertaking substantial work, as it was non-compliant with administrative safety requirements. • Decision: because the operation of the business was still possible, provided additional expenses were incurred, the non compliance with administrative requirements did not constitute a “hidden defect” of the shares purchased. Cass., Com., November 16, 2004, Sanidis c/ Mariotte • Facts: a company purchased filed for bankruptcy four months after the sale • Decision: there was no evidence that the company was insolvent already at the time of the sale, and it was able to pursue its business during several months (4) after the sale; as a result, there was no hidden defects impairing the use of the shares.

11. Legal regime: formation of contracts • Invalid consent theory (théorie des vices du consentement): a contract is not validly formed if the consent of a party has been altered, either by a mistake (erreur), or as a result of the deceptive behavior of the other contractual party (dol). • article 1109 of the French civil Code: “There is no valid consent, where the consent was given by mistake, or where it was extorted by duress or obtained by deception.” • Mistake (erreur) Article 1110 of the civil Code: “Mistake is a ground for annulment of an agreement only where it relates to the substance of the thing which is the subject matter of the agreement.” • A contract can only be voided, i.e. held null, under the rules on mistake when such mistake relates to: • the substance, or the substantial characteristics, of the contract’s subject matter, and • an element so material for the party, that it would not have contracted if it had been informed of the true characteristics of such element. • Mistake must also be excusable: absent of any precise legal provision, courts generally consider that each party has some “basic” obligations. Hence, the seller owes some disclosure duties and the buyer is expected to make limited but reasonable diligence. A professional would be expected to carry out a more comprehensive due diligence. • Mistake can not be alleged when the true characteristics of the company that are discovered by the purchaser after the sale only decrease the company’s value, even if such decrease is significant. French courts apply this rule only if the purchaser can demonstrate that the company purchased was not economically viable, already at the time of the sale. • Sanction: nullity.

12. Legal regime: formation of contracts (continued) Examples of mistakes: Accepted mistake: Cass., Com., October 1, 1991, SNV Quille c/Gasquet and others • Facts: purchaser discovered after the sale that almost all of the assets of the company he had bought for a significant price had been sold by the seller a few weeks before the sale. • Decision: the sale of substantially all of the assets of the company before the sale had made it impossible for the company to pursue its business. The purchaser was mistaken by this, and the contract was voided by the court. Rejected mistake: Cass., Com., February 28, 2006, Duflot c/Czabania • Facts: A company was sold at a time where it was already insolvent, and files for bankruptcy a short time after the sale. • Decision: the court rejected the mistake argument based on the fact that (i) the purchaser had been provided with information on the financial situation of the company before the sale, and (ii) the filing for bankruptcy did not necessarily imply that the company was not economically viable. Cass., Com., February 4, 1997, Phommachan c/Soumpholphakdy • Facts: a company purchased filed for bankruptcy three months after the sale. • Decision: the disproportion between the price paid and the actual value of the company is a “mistake as to the value” and not a “mistake as to the substantial characteristics” of the shares. The claim for error is therefore rejected. Finally, motivation and reasons for a transaction do not caraterize a mistake.

13. Legal regime: formation of contracts (continued) 2. Deceptive behaviour (dol) Article 1116 of the civil Code: “Deception is a ground for annulment of a contract where the acts of deception used by one of the parties are such that it is obvious that, without them, the other party would not have entered into the contract. It may not be presumed, and must be proved.” • A contract can be voided when a seller or a third party (including the agent of the seller or of the buyer acting on its behalf) has induced the purchaser in entering into the contract by using deceptive measures. • The purchaser must demonstrate that he would not have contracted, had the deceptive measures not been used against him. • Deceptive measures include notably intentionally concealing material information to the purchaser, intentional lies, communication of false documents. • In most cases where positive acts of deceit can be shown, the contract can be voided even if the purchaser’s negligence is also responsible for its mistake. • Sanctions: nullity and/or damages.

14. Legal regime: formation of contracts (continued) • Case where deceptive behavior was successfully asserted against the seller: Cass., Com., November 3, 2004, Berlioz c/ Berlioz • Facts: after the sale, purchaser discovered significant liabilities that had not been disclosed to him, and falsifications of the accounts with respect to inventories and certain invoices. • Decision: purchaser was not negligent in failing to review about 200 pages of documents only provided to him on the very signing day. In addition, purchaser sufficiently showed that the information with respect to certain invoices and inventories had been falsified. As a result, purchaser’s consent was deceived and the contract was held null and void. • Case where deceptive behavior was unsuccessfully asserted against the seller: Cass., Com., October 20, 1998, Allain c/ Lièvre • Facts: purchaser discovered after the sale that the fixed assets and the benefit of the company at the time of the sale were significantly lower than the figures indicated in the financial statements provided before the sale, and alleged that seller had failed to disclose a report prepared by an expert on these financial statements that would have revealed these discrepancies. • Argument: purchaser alleged that this non-disclosure was a deceptive behavior and that had he been provided with the information in that report, he would not have consented to the purchase. • Decision: the court considered that the undisclosed report was based on accounting data that were available to the purchaser, and that the report’s analysis of these data was simple and could have been made by the purchaser if he had conducted ordinary verifications. The claim for a nullity of the contract based on a deceptive behavior was therefore rejected.

15. Legal regime: freedom of contract/enforceability Parties freely define the contents of their obligations • Article 1134 of the French Civil Code: “Agreements legally entered into are the law of those who entered into them. They may be revoked only by mutual consent, or for causes authorized by law. They must be performed in good faith”. • The parties are free to take any undertaking (subject to French public order rules). • Parties are therefore free to take the kind of undertaking that are typical in representations and warranties arrangements, and are legally bound by such undertakings. • French courts can however freely seek the true intent of the parties, whenever the meaning of any provision is unclear, or when the contract is silent on a particular question. Limits to the parties’ contractual freedom: French public order • Article 6 of the French Civil Code: “Statutes relating to public order and morals may not be derogated from by private agreements”. • Parties are prohibited from taking commitments conflicting with a number of rules in various areas such as morality, public safety, economic rules, tax etc. These rules are generally not relevant to the issues at stake in representations and warranties arrangements. Accordingly, representations and warranties arrangements generally do not conflict with any French public order rules. Parties’ duties to perform their obligations in good faith • Article 1134 of the French civil Code provides that “Agreements must be performed in good faith”. • The difficult balance between the seller’s duty to disclose and the purchaser’s duty to investigate, duty of care and/or loyalty (the degree of which varies depending, inter alia, on (i) the behavior of the parties, (ii) the “sophistication“ and (iii) the general availability of the information.

16. Legal regime: contract (continued) Examples: • Implied disclosure obligation: • In cases where a seller has concealed material information with respect to the company, purchasers can sometimes show that seller’s silence is a breach of an implied disclosure obligation, based on article 1134. • Such implied disclosure obligation only exists to the extent the purchaser’s duty to investigate the company does not outweigh the seller’s duty to disclose information. • Duty of loyalty: • Cass., Com., February 27, 1996, Vilgrain: • Facts: the manager of a company had entered into an agreement to sell its own shares to a third party at a defined price. In the meantime, he negociated a subsequent sale. The manager decided to purchase those shares, at a price significantly lower that the price he had negotiated with the third party, before reselling them at the highest price a few days later. • Argument: the minority shareholder alleged that the manager was liable of deceptive behavior since he did not disclose his intent to immediately resell the shares to a third party at a higher price. • Decision: the Court decided that the manager breached a duty of loyalty he owed to the shareholders (and which was nowhere provided) and therefore that his behavior was deceptive. The court ruled that the manager had to pay the shareholder the difference between the price he sold the shares at to the third party and the price he bought the shares at from the minority shareholder.

17. 2. The traditional French “ balance sheet warranty ” The “balance sheet warranty” is the clause whereby the seller undertakes to hold the purchaser (and/or the company) harmless in the event of (i) an increase of the net liabilities or (ii) a decrease of the assets of the company, based on its most recent balance sheet, and resulting from an event that is revealed to the purchaser after the sale, but that originates prior to the date on which the date of the most recent balance sheet. Historically, balance sheet warranties were the first type of warranties used in M&A transactions in France, starting about 50 years ago. Initially, they were restricted to liabilities warranties (i.e. warranties protecting the purchaser against increases of the company’s liabilities, but giving no protection in the event of a decrease of assets). Liabilities warranties were then combined with asset warranties, protecting the purchaser against both an increase of liabilities and a decrease of assets. Example: “The Seller undertakes to hold the Purchaser harmless from any increase of liability or decrease of any assets that were not disclosed in the Reference Balance Sheet, and that is caused by or originated from, an event, a fact or an operation occurring prior to the date on which the Reference Balance Sheet were prepared, and that has not been or has been insufficiently provisioned in this Balance Sheet”.

18. The influence of anglo-saxon practice of R&W • In the Anglo-Saxon practice, the seller makes a large number of specific representations and warranties relating notably to the assets, the liabilities, the management, the conduct of the business of the company etc. The inaccuracy of those representations and warranties can lead to indemnification, if such inaccuracies cause a damage to the buyer. Exceptions to the representations and warranties are usually described in the exhibits attached to the share purchase agreement. • The main representations and warranties include: ownership of the shares, capacity to enter into the contract, legal organization of the various entities sold, compliance with law, absence of insolvency proceedings, title to assets, title to intellectual property rights, compliance with applicable permits, sufficiency of assets, absence of undisclosed material liabilities, absence of environmental liabilities, absence of labor law liabilities, absence of material litigation, absence of tax liabilities, etc. • Representations and warranties are given at the date of the signing, and are very often reasserted on the closing date, thereby protecting the purchaser against risks originating before the date of the reference accounts, and until the closing date. • French practitioners now generally use combined forms of warranty undertakings, i.e. warranties that include both a balance sheet warranty clause and representations and warranties. • These combined warranties are accepted by French courts and are enforceable.

19. Main terms of contractual protection and related issues • Type of warranty: • Balance sheet: the seller undertake to compensate any increased liability or any decreased asset • Value: the seller undertake to adjust the purchase price • R&W • Beneficiaries: • The buyer: refund/decrease of the purchase price, usually capped at such price • The company: indemnification of the company, arguably unlimited, unless otherwise provided • The benefit of the warranty may be transferrable (pursuant to an ordinary contract assignment mechanism) to a new purchaser of the company, or not. Courts will generally require a specific provision to that effect. • Limitations: some “reps” can be moderated by using a seller’s knowledge qualifier: • The “seller’s knowledge” is usually defined by reference to a group of key employees in the company. • The seller’s knowledge qualifier may, alternatively or through combinations, refer to the seller’s actual knowledge, attributed knowledge or actual knowledge following due enquiry. • Example: “Where any statement set out in Section [●] (Warranties) is expressed to be given or made "to the Seller's Knowledge", such statement shall be deemed to refer to the actual knowledge of the persons listed in Schedule[●], following due enquiry by such persons”. • When a seller’s knowledge qualifier is provided, purchaser must not only show the inaccuracy of the representation, but also that the key employees were aware of that inaccuracy. • The warranty may provide that any payment made pursuant to it to the purchaser will be treated as a decrease of the purchase price, or may provide that such payments are indemnities (unless the warranty is expressly provided to benefit to the purchaser and not to the target companies). • When the target is a beneficiary of the warranty, it can enforce its right pursuant to the third party beneficiary theory (stipulation pour autrui) provided in the French civil Code. • Seller is not liable to indemnify the purchaser when the information had been disclosed in the disclosure letters. When no disclosure was made, but the seller can still show that the purchaser know the information, the seller remains liable to indemnify the purchaser, unless specifically provided otherwise. • The amount of the indemnity is determined pursuant to the representation and warranties provisions.

20. Contacts Pierre Clermontel Managing Partner T:+33 1 40 73 12 42E:pclermon@debevoise.com 4 place de l'Opéra 75002 Paris