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Be Careful When Terminating Contractual Relations In France – Sylvie Gallage-Alwis and Déborah Azerraf

By Sylvie Gallage-Alwis , DeborahAzerraf

Partner Sylvie Gallage-Alwis and Associate Déborah Azerraf discuss the difference in maintaining and ending contractual relations for businesses in the UK and France.

Sylvie and Déborah’s article was published in Law360, 23 July 2019, and can be found here. Articles on this topic was also published in Le Monde du Droit, 15 July 2019, and Lawyer Monthly, 13 August 2019, and can be read here and here respectively.

The article was also published in Global Banking and Finance Review, 22 October 2019, and can be found here.

When professionals enter into contractual relations, it is permissible to consider that the contract will be the binding law between the parties. While this is true in the U.K., without the option of exemption, as a professional doing business in France or having concluded contracts under French law, you should be aware that it is not possible to terminate established business relations whenever you want or whenever you think you are contractually able to do so.

The notice period determined in the contract will not necessarily be enforceable. Indeed, whether or not there are contractual relations between the parties, the party wishing to terminate them will have to respect a certain period of time depending on the duration of the business relations and the economic dependency between the parties. If the applied notice period does not comply with the above, the victim will be able to claim damages on the ground of the sudden termination of business relations.

Beware, French courts will not hesitate to enforce a much longer notice period than the one you have signed for by contract, the idea being that the weaker party is the one which wants to remain in the contractual relations and needs protection in order to get organized. While one could have first understood the spirit behind the French courts’ approach, case law became wild and French companies have learned how to use this rule to escape from a strict application of the contracts they have signed. Indeed, sudden termination of contractual relations is a tort law claim which can in most circumstances be heard by French courts even if you have chosen another applicable law and did not choose French courts in your jurisdiction clause.

What are established business relations?

To be established, business relations must be stable and continuous. Indeed, stability is an essential prerequisite to establish business relations within the meaning of Article L. 442-1 II of French Commercial Code. This means that the relations must not only have started long before, but only stable business relations whose existence cannot be doubted will be considered as established. Note that even if the contract is recent, French courts will look at whether or not an earlier starting point exists (through successive purchase orders for instance).

What is sudden termination?

Under French law, business relations can be stopped provided they are not ended in an abusive way. It will be considered abusive or sudden for any person with production, distribution or service activities to terminate, even partially, the business relations without providing enough notice period. Therefore, the termination is considered to be sudden if the party at its origin has not complied with the usual notice period: either the duration of the notice period is insufficient, or the notice period does not exist. In such a case, the party alleging sudden termination can claim damages, which would amount to the loss of contribution margin during the notice period it should have been granted. Note that there can be no sudden termination if a fixed-term contract has been concluded between the parties.

What type of damages will be granted?

The company alleging that there has been a sudden termination of commercial business relations can claim for damages which would correspond to the loss of contribution margin (i.e. difference between the turnover from which the victim was deprived after deducting the expenses that were not incurred as a result of the decline in activity resulting from the termination). The appropriate method of calculation of the damages is as follows:

[(The monthly average turnover over the last two or three years preceding the termination x the number of additional months’ notice that should have been granted) x margin rate)].

The number of years (two or three) for the calculation of the average turnover depends on what happened during the two previous years. If the turnover was stable for the past two years, courts will use two years as the basis for their calculation. If there has been a sudden drop of turnover the last year before termination, courts will look back at three years for the calculation so that the result is not too much impacted by a drop of activity generally due to the upcoming termination.

For instance, for companies which have been in a business relationship for more than 20 years, and for which contribution margin amounted to 40%, if the court believes that a 12 months’ notice period should have been granted, the court will assess the damages as follows: [(€50,000 (i.e. monthly average turnover over the last two years preceding the termination) x 12 months) x 40%] = €240,000.

How to avoid sudden termination of commercial business relations?

In France, disputes related to the sudden termination of business relations represent a significant part of disputes brought before commercial courts. Left to the discretion of the judges, the duration of the notice period has been for a long time associated with legal uncertainty. Indeed, a high number of companies were imposed much longer notice periods by French courts — up to 24 months — than the periods mentioned in their contracts, when applicable, or the periods they considered to be reasonable.

The standard 90-day notice period would never be enforced and always deemed insufficient. Believing, in this respect, that contracts are binding between the parties and that the freedom to enter into business relations prevails was a careless attitude when looking at case law applying Article L. 442-6-1 of the French Commercial Code.

This French specificity, which has long been criticised and misunderstood by foreign companies, has been reconsidered by Order 2019-359 of April 24, 2019, reforming Title IV of Book IV of the French Commercial Code on transparency, restrictive competition practices and other prohibited practices. Indeed, this order has considerably amended the provisions of the French Commercial Code relating to restrictive competition practices. More specifically, the new provisions of Article L. 442-1 II on the sudden termination of established business relations should reduce the number of litigation cases in this area.

While the legislator has extended the number of parties likely to be held liable in the event of the sudden termination of business relations, he has also significantly limited the cases in which the party at the origin of the termination may be held liable. Indeed, this article now provides that an 18-month notice period would allow businesses to avoid liability. This period is presented as a maximum, beyond which it will no longer be possible to hold the party at the origin of the termination liable. This exemption from liability if the parties comply with an 18-month notice period is intended to apply, regardless of the duration of the business relations. This is particularly interesting in the scope of very long business relations, as until now companies faced a risk of having to comply with a notice period of more than 18 months.

While such an evolution can be welcomed as it will certainly have the effect of facilitating the amicable settlement of disputes that may arise in the event of the termination of business relations, there is a risk that this cap will be analysed as a reference period with no more case-by-case analysis of the economic dependency and the duration of the business relations to determine if a shorter period would be more reasonable. This reform aims at making France more attractive to foreign investments by limiting the legal uncertainty around the enforcement of contractual provisions, which is a positive step. However, it must not become the ground for automatic liability should less than 18 months be applied as a notice period by a foreign company to a French one.

Conclusion

In addition to the rules on the sudden termination of business relations, which have undergone major changes, Order 2019-359 of April 24, 2019, has also led to a number of changes, in particular with regard to the control of significant imbalance in business relations. Indeed, Title IV of Book IV of the French Commercial Code codifies the ability for a professional victim of significant imbalance to request the nullity of unlawful clauses or contracts and to request the restitution of undue advantages.

While this order is not revolutionary, the changes it brings about raise a number of questions, particularly with regard to their application over time and their understanding by the courts. We can therefore only advise companies doing business in France to stay prudent and not to assume that French courts will enforce the contract as it is. Their will to protect French small businesses is stronger than their will to protect the binding effect of contracts.

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