The Real Estate Law Review: France
Introduction to the legal framework
i Ownership of real estate
Under French law, there are several common types of ownership.
Full ownership is a constitutionally protected right defined as 'the right to enjoy and dispose of property in the most absolute manner, provided that no use is made of it that is prohibited by the laws and regulations'. As an absolute right, it confers on the owner the use of the asset, the right to receive the fruits of this asset and the right to dispose of it.
Co-ownership may refer to either indivision (governed by the common rules of the Civil Code) or copropriété (governed by the Law of 10 July 1965 and its implementing Decree of 17 March 1967). Indivision refers to the situation where several co-owners jointly exercise the same right of full ownership over the same property considered as a whole (and not over a distinct share of the jointly owned property). Copropriété refers to the situation where two or more co-owners share the ownership of a property, each enjoying full rights over the private part of the property owned by it and shared rights over the common parts of the property (e.g., entrance hall, lift areas). Copropriété is generally the legal regime used for residential housing. Decree No. 2016-1167 of 26 August 2016 implementing Law No. 2014-366 of 24 March 2014 created a national registry of copropriétés where all syndicates managing copropriétés should now be registered.2 The government had been empowered (Law No. 2018-1021 of 23 November 2018) to reform, by way of Ordinance, the legal regime of Copropriété, to be implemented as from the 1 June 2020. The government actually issued Ordinance No. 2019-1011 of 30 October 2019 reforming the copropriété regime. This reform is mainly designed to simplify some of the rules applicable especially for small buildings and also to facilitate the maintenance and repair of buildings subject to co-ownership while relaxing the majority rules required to authorise works to be carried out on the building. Most of the provisions of this new Ordinance shall be applicable as from 1 June 2020.
Division en volumes is a contractual technique that consists of dividing the ownership of a property into distinct volumetric shares on different levels that may be located either above or beneath the natural ground. These shares are three-dimensionally defined and described, and no common parts exist between them. This technique is mostly used for real estate assets featuring a complex structure and organisation, in particular when there is an overlapping of surface areas, or when there are different surface areas, each with a different use (commercial, office, retail, etc.).
Long-term leases such as the bail à construction and the bail emphytéotique are entered into for a term of between 18 and 99 years. Under these leases, the tenant is granted a right in rem over the tenure itself as well as the existing property or the constructions to be erected by the tenant during the course of the lease. At the end of these leases, ownership of the new constructions is, in principle, transferred to the landlord, who will also benefit from all improvements made by the tenant by way of accession, without indemnity for the latter. Recent legislation created specific kinds of long-term leases conferring a right in rem for the purpose of developing residential housing (bail réel immobilier created by Law No. 2015-990 of 6 August 2015) or social residential housing (bail réel solidaire created by Ordinance No. 2016-985 of 20 July 2016 as modified by Law No. 2018-1021 of 23 November 2018).
Traditionally, French scholars consider that the kind of rights in rem governed by French law was subject to a numerus clausus (i.e., that French courts could only recognised those expressly provided by statutory law). A decision of the French Supreme Court put an end to a long and controversial litigation to admit that parties could create sui generis rights in rem for a limited term3 (except in the context of Copropriétés in which perpetual sui generis rights are permitted).4
ii System of registration
Real property includes land and any buildings or fixtures attached to the land, and ownership interest in them. Generally, if the same entity owns both the land and the buildings erected on it, the title is subject to one single registration, and the land and buildings are registered together. If the property is divided into units, these must be registered separately.
To be effective and enforceable against third parties, the transfer of real property ownership must be evidenced by a written deed authenticated by a French notary with a view to registering it, after its execution, with the local land registry managed by the mortgage registrar.
Note that there is no state guarantee of title, and the land registry cannot be liable for registering inaccurate information. Registration of title with the land registry by notaries allows the title holder to exercise owner's rights against third parties.
French case law held that a conflict between two persons holding the same title on a property should be adjudicated in favour of the one who registered its title with the land registry in the first place. Section 1198 of the Civil Code resulting from the reform of law of contracts enacted by Ordinance No. 2016-131 of 10 February 2016 now provides that the title holder who registered first should be preferred only if it is acting in good faith. An expert working group recently issued a report (on 12 November 2018) which recommends a simplification and a modernisation of the system of registration. A reform in this respect may occur as from 2020.
iii Choice of law
Transactions involving real estate in France are, in principle, governed by the law of the place of location of the property. All asset transactions involving a property located in France are, therefore, governed by French law.
Overview of real estate activity
French real estate investment has still been very active in 2019. Competition remains high on a large range of assets and markets resulting in very challenging cap rates on prime assets. However, in contemplation of this fierce competition on core assets, some more opportunistic investors look towards value-add transactions including a restructuring of the targeted property or of its tenancy situation. Investors' funds and public savings are channelled into the real estate market mainly through French real estate investment trusts (REITs) and insurance companies even if collection of public savings seems to slow down in real estate (may be an impact of the reduction of the scope of the French wealth tax (Impôt de Solidarité sur la Fortune (ISF) turned into Impôt sur la Fortune Immobilière (IFI)) to the ownership of real estate assets or interests). Investment funds are also active in the French market; these were still among the biggest players in 2019, together with foreign sovereign investment funds as well as pension funds or trusts, among which South Korea seemed to have taken the lead on the most competitive bids on office real estate market.
The low level of interest rates also sustains the trend for a high level of refinancing. The real estate finance market is becoming more and more borrower-friendly, with banking institutions competing to offer lower pricing and higher leverage for these transactions and also relying, where relevant, on insurance companies in club deals. This higher leverage offered by banking institutions reduced the market share of mezzanine lenders on the core assets. However, with respect to the aforementioned value-add transactions, banking institutions may not provide the full expected leverage, offering then a share to mezzanine lenders.
Hospitality and logistics assets remain highly in demand. A recent trend is an increasing demand for investment in housing, including social or lower intermediate housing, supported by institutional investors.
Foreign investment in France is subject to declaration obligations to the French authorities if certain conditions are met.
As a general rule, direct foreign investment is subject to mandatory declarations for statistical or administrative purposes to the French central bank or to the French Economics Ministry (or both); however, exemptions from such declarations may apply. For this reason, the implementation of any declaration obligations must be reviewed on a case-by-case basis.
In terms of timing, such declarations must be made within 20 days of the date of the operation or at the date of the execution of the relevant operation depending on the kind of declaration (i.e., statistical or administrative). Breach of this declaration obligations is subject to criminal sanctions (including imprisonment).
By way of exception, certain investments listed by decree are subject to prior administrative authorisations. These investments mainly concern sensitive sectors, such as national defence.
Transfer or direct acquisition of real estate, acquisition or purchase of a stake in French real estate funds (OPCIs) or in any special purpose vehicles (SPVs) made by foreign investors may also be subject to mandatory declaration. Pursuant to Decree No. 2017-932 of 10 May 2017, administrative declaration with the French Economics Ministry is not required for investment in real estate companies; statistical declaration is required for investment in real estate companies or real estate assets for value exceeding €15 million.
From a tax perspective, foreign legal entities (but not individuals) that hold, directly or indirectly, real estate located in France must pay an annual tax equal to 3 per cent of its fair market value, regardless of any acquisition debt. Such entities can, however, be exempt from this tax by complying with certain filing obligations required by the French tax authorities.
The following are automatically exempt from this tax:
- international organisations, sovereign states or one of their institutions, including legal entities, bodies, trusts or equivalent institutions that they control and have a majority interest in;
- entities whose French assets do not mainly comprise real estate;
- entities whose shares are significantly and regularly exchanged on a regulated stock exchange, including any subsidiary entities whose total shares they hold directly or indirectly; and
- entities with their registered office located in France, in an EU Member State or in a country or territory that has concluded a reciprocal tax or mutual assistance treaty with France and that:
- have a share in properties located in France representing less than €100,000 or 5 per cent of the property's market value;
- are established to manage pension funds (including partnerships between entities), or as charities with acknowledged public utility or a not-for-profit purpose, if their activity or financing justifies the ownership of the real estate assets or rights; or
- are incorporated as an OPCI (subject to the conditions it complies with certain prudential ratios and is not restricted to qualified investors), or a form regulated by similar rules in the country in which they are incorporated.
A Decree was recently published on 31 December 2019, extending the regime of prior administrative authorisations to facilities critical for strategic activities, and it remains to be assessed to what extent certain kind of real estate assets might become subject to this new regulation.
Structuring the investment
Real estate investments are usually made through SPVs incorporated as French companies, listed property investment companies (SIICs) or OPCIs.
SPVs can either be tax vehicles subject to corporation tax or transparent tax vehicles, in which case profits are determined at company level but will be taxed in the hands of shareholders.
The SIIC regime (largely inspired by the US REIT regulation) applies to real estate investment companies that:
- have a minimum share capital of €15 million;
- are listed on a French regulated market;
- have a minimum floating shareholding of 15 per cent at the date of the election for the SIIC regime (floating shareholdings are those held directly or indirectly by legal or natural persons with less than 2 per cent of the total share capital and voting rights); and
- do not have more than 60 per cent of their share capital or voting rights held directly or indirectly by one shareholder (or by different shareholders in a joint control situation) unless the shareholders are also SIIC-qualifying companies.
The SIIC regime also applies to SIIC subsidiaries subject to corporation tax that are at least 95 per cent held, directly or indirectly, by the SIIC and have the same corporate purpose.
The SIIC regime provides for a full exemption for corporation tax purposes on profits deriving from real estate investments (rents and capital gains), provided that certain distribution obligations are fulfilled (95 per cent of net rents, 70 per cent of capital gains and 100 per cent of dividends received from SIIC subsidiaries). Tax is, therefore, passed on to investors, who are subject to French personal or corporation tax if they are French residents (in this case, the distribution cannot benefit from the parent subsidiary regime if the amounts distributed correspond to tax-exempt profits), or French withholding tax if they reside abroad.
Distributions paid out of tax-exempt profits are subject to a 20 per cent levy if they are paid to corporate shareholders that hold, directly or indirectly, more than 10 per cent of the dividend rights at the time of the distribution, and that are not subject to French corporation tax or to an equivalent tax amounting to at least one-third of the French corporation tax on the distributions received. Such levy is not payable where tax-exempt profits are paid to entities that have an obligation to distribute 100 per cent of received dividends (e.g., French SIICs and OPCIs and foreign equivalents), where the shareholders of the entities that hold, directly or indirectly, more than 10 per cent of the dividend rights are subject to French corporation tax or to an equivalent tax amounting to at least one-third of the French corporation tax on the distributions received.
Companies electing for the SIIC regime are entitled to step up the tax basis of their eligible assets at a reduced tax cost (19 per cent corporation tax rate instead of the 31 per cent standard rate), payable in four years.
OPCIs are fully exempt from corporation tax, but are subject to distribution obligations (85 per cent of net rents, 50 per cent of capital gains and 100 per cent of dividends received from subsidiaries exempt from corporation tax on their real estate activities). Their main business purpose must be direct or indirect investment in real estate assets with a view to carrying out rental activities.
OPCI subsidiaries that are subject to corporation tax can elect for the application of the SIIC regime described above if they are at least 95 per cent held, directly or indirectly, by the OPCI and have the same corporate purpose.
The creation of an OPCI is subject to the prior approval of the French Stock Exchange Commission.
Distributions paid out of the tax-exempt profits of SIICs and OPCIs to French UCITS,6 certain alternative investment funds or foreign equivalent entities are subject to a 15 per cent levy.
Real estate ownership
In France, the rules applying to the construction of a building or to the completion of a development operation are set at both the national and local level.
At the national level, the French Town Planning Code applies, encompassing national town planning rules (which apply in the absence of municipal town planning rules) and rules applying in specific areas, such as sea and lake areas and mountain areas.
At the local level, land use plans (PLUs) apply. A PLU is usually adopted at the city level by the relevant municipal council, but the latest legal developments favour its establishment at the inter-communal level. The PLU sets the specific rules applying in the different zones (i.e., urban zones, agricultural zones, natural zones and zones to be opened to urbanisation) of the territory it covers regarding the type and nature of admitted constructions, service road conditions and network service, setback and volume requirements, design of the buildings, landscape and environmental quality of the buildings, requirements in terms of creation of parking spaces and green surface areas.
Law No. 2014-366 of 24 March 2014 has been enacted to promote new principles of town planning with the aim of reducing the surface area used for the construction of new buildings. In accordance with these new principles, the Law prohibits the local or inter-communal authorities to provide in a PLU for a maximum ratio of constructed area to ground area.
Ordinance No. 2015-1174 of 23 September 2015 allowed the recodification of the French town planning code. The recodification included, inter alia, new features in PLU content and provided for a new definition of the various possible uses of a building.
A project's compliance with these rules is assessed by the relevant authority for the building permit.
Subject to the activity operated in the building, other authorisations may be required, such as: a specific authorisation if the contemplated building is to be used for certain activity purposes, a specific authorisation to operate a commercial activity and a specific authorisation for establishments open to the public.
Planning permission can be challenged by interested third parties before administrative courts for non-compliance with applicable rules. Most recent legislative and regulatory provisions, including Decree No. 2018-617 of 17 July 2018 and Law No. 2018-1021 of 23 November 2018 on the evolution of housing, planning and digital technology (ELAN), aim at improving the processing of claims against planning permissions. These texts provide for the acceleration of the process of request and the limitation of abuse of process through many measures such as the crystallisation of legal grounds of the claim, the obligation for the claimant to communicate the elements allowing to appreciate his or her interest to file a claim and measures encouraging the judge to allow the regularisation of irregular planning permissions whenever possible and to dismiss improper claim.
LEGAL REQUIREMENTS CONCERNING CLASSIFIED FACILITIES
A real estate asset (such as a warehouse) may qualify as a classified facility or may be served by a piece of equipment (such as an air conditioning system serving an office building) qualifying as a classified facility.
Classified facilities are defined and listed in an official nomenclature that indicates a classification level, according to the potential risks to the environment.7 Classified facilities are subject to a specific regulation codified in the Environmental Code.8
To validly operate such a facility and depending on its classification level, the proposed operator must either file a declaration or a registration or apply for authorisation (the new environmental authorisation),9 which is acknowledged or granted by the local authority. Moreover, the seller of a property where a classified facility is or has been operated must inform the purchaser of any danger or nuisance resulting from previous operations on site, to the extent that he or she is aware thereof. If the seller fails to provide this information, the purchaser can rescind the sale or obtain the reimbursement of a part of the purchase price. The purchaser may also require that the site be cleaned up at the seller's expense, when this cost remains commensurate with the purchase price.
Under Law No. 2014-366, the seller of a property located in an area identified by a public authority in an SIS (Secteur d'Information sur les Sols, to be established by the Préfet for 1 January 2019 at the latest) as having been exposed to pollution must provide the purchaser with the information pertaining to such exposure collected from the public authority. If the seller fails to provide this information, and if the ground happens to be contaminated in a manner that results in the sold property not being fit for its proposed use, the purchaser can rescind the sale or obtain the reimbursement of a part of the purchase price. The purchaser may also require that the site be cleaned up at the seller's expense, when this cost remains commensurate with the purchase price. This obligation (except for the cleaning up) is also applicable to lease agreements.
If a classified facility is operated without the above-mentioned required declaration, registration or authorisation, or if the operator does not comply with applicable rules and regulations, the operator may be held liable from an administrative, civil or criminal standpoint.
When a classified facility ceases its activities, the local authority orders the last registered operator to conduct environmental investigations and will issue an administrative order to clean up the site according to the results of these investigations.
Note that when pollution is discovered on a site, the administration will require the last registered operator of the site to clean it up or, if this pollution is generated by a neighbouring facility, the last registered operator thereof. Under Law No. 2014-366, if no registered operator can be identified, the administration can order the owner of the polluted property to carry out the cleaning, to the extent it can be demonstrated that the owner has been negligent in this respect or is to some extent related to the pollution.10 The level of exposure of the owners to this new legislation will depend on whether the French courts will broadly or strictly construe these new criteria.
If pollution coming from the site's underlying ground generates damage to a third party, the third party would be entitled to initiate a civil action against the current operator or the property's owner (or both) acting as a gardien de la pollution.11 The property's owner or current operator will nevertheless be in a position to initiate a civil action against the person or operator actually liable for the pollution if identified.
Under Law No. 2014-366, upon cessation of operation of a classified facility, subject to approval of the last registered operator of the site and the relevant authority, an interested third party can substitute the former to carry out rehabilitation measures on site.12
LEGAL REQUIREMENTS CONCERNING HAZARDOUS WASTE HANDLING
Contrary to the classified facilities legislation that targets the operator of the facilities, the legislation set out in the Environmental Code13 governing the holding and handling of hazardous waste may impose obligations upon the owner of a property.
Especially where the owner of land carries out the construction of a building requiring prior excavation of polluted soil, the owner is liable for the proper handling of excavated soil that should then be directed to a special storage centre designed for the treatment of polluted soil (the selection of the storage centre depending on the nature and level of pollution detected in the handled waste). Under Law No. 2014-366, the owner of a polluted property can be held liable if it can be demonstrated that the owner has been negligent to some extent or is to some extent related to the pollution, even if the owner did not actually take part in the construction of a building on the property.
Sales of development land (i.e., land on which the buyer is allowed to erect new buildings under urban planning) and new buildings (i.e., if the sale occurs within five years of completion of the buildings) fall within the scope of VAT (the current rate of 20 per cent has been in place since 1 January 2014).
Sales of land that cannot be considered as development land and of old buildings are exempt from VAT; however, the seller can always elect to pay VAT.
Sales of buildings also trigger a transfer tax amounting to 5.81 per cent of the value of the asset. This rate can in particular be reduced to:
- 0.715 per cent if the sale concerns new buildings or development land;
- 0.715 per cent if the buyer undertakes to resell the asset within five years of the acquisition; or
- €125 if the buyer undertakes to erect or complete new buildings within four years of the completion of the sale.
With effect from 1 January 2016, an additional tax of 0.6 per cent of the value of the asset applies to the sales of offices, business premises and storage premises located in the Ile-de-France region. Sales of new buildings are not within the scope of this additional tax.
In addition, for any sale of real estate property in France, a fee amounting to 0.1 per cent of the value of the asset is due, and the notary charges a 0.814 per cent fee (which can be reduced in certain cases).
Sales of shares in real estate companies (whose assets mainly consist of French real estate) are subject to a 5 per cent transfer tax based on the sale price or, if higher, on the fair market value of the shares.
iv Finance and security
The acquisition of real estate is usually secured through a mortgage, which must be granted under a notarised agreement under French law. Depending on the purpose of the transaction, this security will be in the form of a contractual mortgage or a money purchase privilege. Both securities grant the lender the right to become the owner or resell the mortgaged real estate at public auction if the borrower defaults under the financing.
As regards the income generated by the property, the rents payable to the borrower or the indemnities payable to it in relation to the holding of its real estate (such as insurance indemnities or indemnities due under the acquisition agreement of said real estate) are usually assigned by way of security or pledged in favour of the bank.
Finally, one must stress that when the borrowing entity is an SPV, lenders very often require that the shareholders of the SPV also pledge the shares they hold in the share capital of the borrower as a security.
Leases of business premises
i Scope of statutory regime
In France, leases on property used for commercial or industrial purposes are governed by specific statutory provisions (codified under Sections L145-1 to L145-60 and R145-1 to R145-33 of the Commercial Code).
In France, the principle is that the commercial lease statute mandatorily applies to all leases entered into on premises where a business is operated (commercial offices, warehouses, factory buildings, industrial premises, shops, etc.). An essential feature of French law on commercial leases is the right of the lessee to obtain renewal of the lease upon its expiry or to obtain compensation if the lessor refuses to renew.
The commercial lease statute does not apply to leases on premises used by professionals (doctors, notaries, lawyers, etc.) for professional purposes, which are subject to a specific regime; since 2008, however, it is legally possible to subject a lease entered into with professionals to the commercial lease statute.
Law No. 2014-626 of 18 June 2014 (Law No. 2014-626) provided for a quite significant reform of the French commercial lease statutory regime. Law No. 2014-626 has been supplemented by Decree No. 2014-1317 of 3 November 2014 (Decree No. 2014-1317).
In principle, the duration of a commercial lease must be at least nine years (subject to specific exceptions), regardless of whether the lease is concluded for the first time or is being renewed: this provision is a matter of public policy. The lessee has an option to terminate a commercial lease at the end of every three-year period. Since the passing into law of Law No. 2014-626, the tenant may no longer contract out of this right, except in cases of leases pertaining to offices alone, premises constructed for one single purpose (e.g., clinics, cinemas) or warehouses (being specified that there is a debate in doctrine regarding the application of this legal provision over time). On the contrary, the tenant may always be given additional break options.
Pursuant to Section L145-12 of the Commercial Code, the duration of a renewed lease is nine years unless the parties agree otherwise. A lease entered into for more than 12 years shall be published.
iii Termination and security of tenure
In principle (and apart from specific situations, such as amicable termination or termination by court order), French commercial leases may only be terminated by a termination notice, which has to be issued by a court process server or, since the entry into force of Law No. 2014-626 and at least when delivered by the tenant pursuant to Law No. 2015-990 of 6 August 2015, notified by registered letter with an acknowledgment receipt at least six months in advance (subject to local usage) and contain specific provisions.
Under French law, the lessor may always refuse to renew the lease upon expiry and terminate the lease, but in these cases (as a result of the implications regarding security of tenure) the landlord will have to pay compensation for eviction in an amount equal to the loss suffered by the tenant as a result of the lease not being renewed. Limited circumstances allow the landlord to terminate the lease upon expiry without compensation (non-performance by the lessee of its material obligations, the building posing a health hazard or safety risk, denial of the right for the lessee to benefit from commercial lease law, regaining possession of premises for residential purposes, etc.).
iv Rent review and rent indexation
Subject to several exceptions (e.g., leases with variable rents determined on the basis of a percentage of the tenant's turnover), the commercial lease statute provides for a three-year review arrangement whereby each party may seek a rent review so that the rent corresponds to the rental value of the premises. In principle, the increase (or decrease) of the rent is capped by the variation of the statutory index selected by the parties, unless a change in the rental value exceeding 10 per cent and triggered by a material alteration of the local commercial conditions can be demonstrated.
The provisions governing the revision of the rent amount under a commercial lease have been amended to include an absolute cap that would be applicable to any judicial revision. Accordingly, the implementation of the rules governing the judicial rent revision may no longer result in an annual increase of the rent exceeding 10 per cent of the most recently passed rent of the lease.
The parties may agree that the rent be indexed on an annual basis, although such provisions do not override the three-year review stipulated by law. The Construction Cost Index (ICC Index) is no longer available for rent revision under a commercial lease: instead, the Commercial Rent Index (ILC Index) is available for commercial activities, and the Tertiary Activities Rent Index (ILAT Index) is available for tertiary or professional activities or warehouses. Moreover, Section L145-39 of the Commercial Code provides that any party to a commercial lease agreement may request a judicial review of the rent at the current market value of the premises provided that the commercial lease agreement provides for an indexation clause and that, as a result of the clause, the rent has increased or decreased by at least 25 per cent since its most recent contractual or judicial setting. The same absolute 10 per cent cap as that applicable to a judicial review triggered by a change in the rental value is also applicable to that kind of revision.
v Rent upon renewal
Pursuant to Section L145-33 of the Commercial Code, the rent of the renewed lease shall be set at the market value; however, the variation between the rent under the initial lease (whose duration is no more than nine years) and the rent under the renewed lease cannot exceed the variation of the statutory index selected by the parties over the period of the lease (unless one of the parties can provide evidence of a significant change in one of the elements that served as the basis for the initial setting of the rent). In any event, even in the case of significant change in the above-mentioned elements, the 10 per cent cap shall be applicable to the rent upon renewal. Accordingly, the implementation of the rules governing the determination of the rent upon renewal may no longer result in an annual increase of the rent exceeding 10 per cent of the most recently passed rent of the renewed lease.
Pursuant to the provisions of Section L145-34 of the Commercial Code, where a commercial lease is entered into for a term of more than nine years, the rent of the renewed lease may be uncapped upon renewal and set at the rental market value.
The provisions governing the rent determination upon renewal are not mandatory and may be agreed otherwise by the parties. The provision of a variable rent (based on the tenant's turnover) is regarded as setting aside the statutory provisions but French case law recently held that, when the rent consists of a fixed component and a turn over based variable component, the parties could validly refer the determination of the fixed component to the judge upon renewal pursuant to Section L145-33 of the Commercial Code.
vi Mandatory limitation on rechargeable service charge
The Civil Code provides some rules with respect to the allocation of service charges, and works and repairs obligations, between landlord and tenant. These rules are applicable to all types of leases (i.e., they are not specific to commercial leases) but are not mandatory: parties may agree otherwise on such allocation.
Law No. 2014-626 (supplemented by Decree No. 2014-1317 on this matter) changes the above-mentioned principle for commercial leases, and lists some service charges and repairs that can no longer be rechargeable to commercial tenants. This mandatory limitation is a revolution in French market practice, where triple net investors' leases had previously been drafted and negotiated under the assumption that tenants should bear all charges and repair costs. The cost of heavy repairs (within the meaning set forth in Section 606 of the Civil Code), property management fees and some taxes levied on the owner (subject to exceptions such as land tax) can now no longer be recharged to tenants.
vii Assignment of a commercial lease
The basic principle under the French commercial lease statute is that the lessee may assign its lease right to the purchaser of the business operated in the rented premises. To prevent the tenant from being deprived of its option of assigning its business, any agreement that prevents the tenant from assigning the lease right to the purchaser of its business undertaking will be declared null and void; however, the initial lessee (assignor) may remain jointly and severally liable for the fulfilment of its assignee's obligations under the lease.
Pursuant to French case law, clauses providing that the assignment is subject to certain conditions (e.g., good faith of the assignee) are deemed valid, provided the various restrictions do not make it impossible in practice for the tenant to assign its business.
On the other hand, a mandatory pre-emption right is conferred upon the tenant under a commercial lease in the event of a sale of the rented premises pursuant to Law No. 2014-626, but only where the rented premises are used for retail.
viii Authorised use of the premises
French commercial law does not offer the lessee any specific option to modify the leased premises without the lessor's consent. The French commercial lessee is entitled, however, under certain circumstances, to extend or change the scope of the activities it is contractually authorised to operate in the rented premises. If the landlord refuses, the lessee can apply to the courts to seek such authorisation.
Developments in practice
i Reform of French law of contracts
The draft Ordinance we referred to in the previous edition of The Real Estate Law Review has been enacted into Ordinance No. 2016-131 of 10 February 2016 providing for a large reform of the provisions of the Civil Code governing the contracts, the regime of obligations (whether contractual or not) and the rules of proof.
The Ordinance came into force on 1 October 2016. Even if to some extent, the intent of the French government was to embody into the Civil Code a large set of previous rulings of the French case law, the Ordinance, however, provides some innovative solutions. It is rather challenging to try to summarise the main provisions of this reform within the framework of this chapter; some of the main new rules that shall impact the real estate practice are as follows. Some articles of the Ordinance have been recently amended by Law No. 2018-287 of 20 April 2018 ratifying the Ordinance (Ratification Act), which is applicable, unless otherwise stipulated, since 1 October 2018.
MANDATORY DUTY TO PROVIDE PRE-CONTRACTUAL INFORMATION
Section 1112-1 of the Civil Code provides that whenever a party knows information that is of critical importance for the consent of the other party, the former should made the latter aware of that information where the latter party legitimately ignores this information or relies on the former party. This duty does not apply to the value of the services or obligations. The duty to inform is mandatory.
PREFERENTIAL RIGHT TO CONTRACT
Section 1123 of the Civil Code sets forth the regime of any preferential right to contract as this regime has been drawn by previous French case law. In particular, in the event of breach of this preferential right, its beneficiary can apply for nullity of the contract entered into with a third party and for its substitution for the third party provided that the beneficiary can evidence that the third party knew the existence of the preferential right to contract and the intention of its beneficiary to exercise it.
UNILATERAL PROMISE TO CONTRACT
Section 1124 of the Civil Code is reversing the controversial though continuing French case law as to the enforceability of a unilateral promise to contract. So far, if the promisor was retracting its promise before the beneficiary exercises its option to contract, the latter could only be awarded damages but could not apply for specific performance. The rule is now that a retraction by the promisor shall not prevent the beneficiary from exercising its option to contract and then the promised contract from being entering into.
GENERAL CONDITIONS OF NON-NEGOTIATED CONTRACTS
Section 1110 of the Civil Code provides for a distinction between those contracts that have been actually negotiated between parties (contrats de gré à gré) and those whose general provisions, determined in advance, have not been subject to a negotiation between parties (contrats d'adhésion). The Ratification Act has recently amended the definition of this latter kind of contract, which is now defined as a contract containing a set of non-negotiable clauses, determined in advance by one of the parties.
Regarding the applicable sanction in this respect, Section 1171 of the Civil Code further provides that, for contracts executed (1) before 1 October 2018, any clause that appears to be significantly unbalanced shall be regarded as null and void, and (2) as from 1 October 2018, any non-negotiable clause, determined in advance by one of the parties and which creates a significant imbalance between the rights and obligations of the parties shall be regarded as null and void.
Definition of contrats d'adhésion has already raised some controversy, and the practice of general and often non-negotiable terms in commercial leases (in shopping centres for instance) should no longer be recommended.
UNFORESEEABLE CHANGE IN CIRCUMSTANCES
Section 1195 of the Civil Code adopts a rule that had been banned a long time ago in private contracts by the French Supreme Court (whereas the French Administrative Supreme Court admits it in administrative contracts). A significant change in circumstances resulting in the performance of a contract becoming excessively onerous for a party that did not accept assuming this risk shall entitle the party to a renegotiation of the contract and, failing reaching an agreement with the party, it may apply before the court for a revision or a termination of the contract. The new rule (as most of those resulting from the reform) is not, however, mandatory, and the parties can accordingly agree otherwise.
CONNECTION BETWEEN CONTRACTS
Section 1186 of the Civil Code provides that a contract may cease to exist and to be enforceable if its performance is rendered impossible by the disappearance of another contract.
PRE-EMPTIVE EXCEPTIO NON ADIMPLETI CONTRACTUS
Section 1220 of the Civil Code provides that when it becomes obvious that a party shall not be in a position to perform its obligations, the other party, even before the breach actually occurs, may suspend the performance of its own obligations.
RESTRICTIONS TO SPECIFIC PERFORMANCE
Curiously, Section 1221 of the Civil Code governing the contractual remedies both acknowledges that the specific performance is now the principle compared to damages and provides for a restriction to this principle where specific performance would trigger for the debtor costs manifestly not commensurate to the interest for the creditor. Alternatively, Section 1223 of the Civil Code provides that, (1) for contracts executed prior to 1 October 2018, the creditor of an obligation that has not been properly performed by the debtor may, following a formal notice, apply for a price reduction if it has already paid the service and if not, notify to the debtor its intention to reduce the price, and (2) for contracts executed since 1 October 2018, if the creditor has already paid the service, failing agreement between the parties, it may only request a judicial price reduction, and if no payment has been made, it must obtain the prior written consent of the debtor to apply for a price reduction.
Section 1226 of the Civil Code provides that, in the event of breach of contract, the non-defaulting party may unilaterally terminate the contract at its own risk by sending a simple formal notice to the defaulting party, even if there is no specific termination clause provided in the contract.
ii Indexation in commercial leases
NEW INDEX ON COMMERCIAL LEASES APPLYING TO OFFICES AND LOGISTIC WAREHOUSES
Commercial leases usually contain an indexation clause under which the rent is automatically reviewed and calculated every year on the basis of variations (formerly in the ICC Index) in the ILC Index or the ILAT Index, which are both published quarterly by the National Institute of Statistics and Economic Studies.
The ILAT Index was created on 17 May 2011. Its implementing decree was enacted on 29 December 2011 and sets out the rules for the composition and calculation of the ILAT Index, which may be used for tertiary activities other than commercial and craft activities, as well as renting of office space for activities run by professionals (such as lawyers and doctors) or in logistics warehouses.
NEED FOR CLARIFICATION ON RENT INDEXATION CLAUSES
In recent years, the application of some indexation clauses included in commercial leases has been challenged by tenants on the basis of their non-compliance with public policy regulations applying to indexation clauses in general. A legal clarification of the indexation regime is expected to put an end to this situation of legal uncertainty.
To mitigate the consequences of a massive increase of the ICC Index on the level of commercial rents in recent years, cap and floor limitation mechanisms have been agreed upon in commercial leases. In the absence of clear-cut case law from the Supreme Court, there is a risk that some of those mechanisms could be considered null and void and in breach of general public policy regulations on indexation.
The Paris Civil Court also handed down two contradictory decisions on 5 January 2010 and 13 January 2011 on the validity of indexation clauses allegedly contravening the provision of the Monetary and Financial Code that rules that 'any clause in a successive performance contract, including all kinds of leases and rental agreements, which provides for the application of an index variation period longer than the interval between each review, is deemed void'.
However, two much-anticipated decisions of the Paris Appellate Court rendered on 4 April 2012 have reversed these controversial decisions of the Paris Civil Court that challenged the validity of such indexation clauses by ruling that, even if the drafting of the clause was not literally compliant with the above-mentioned provision of the Monetary and Financial Code, the clause should nonetheless be held valid if its implementation did not have adverse financial consequences for the tenant. The appellate court ruling was upheld by the French Supreme Court in a decision rendered on 11 December 2013.
On the top of that, in an important decision dated 14 January 2016, the French Supreme Court finally held that the upwards only indexation was not valid. Since then, lower courts have rendered a significant number of decisions that tend to expand the scope of prohibition of any indexation formula not strictly keyed to the variations of an authorised index.
iii Growing focus and attention on environmental issues
Environmental matters have become a key issue for participants in the French real estate market further to the Environment Round Table forum. This forum comprises a set of political meetings held in France between September and October 2007, which were aimed at making long-term decisions in the areas of environment and sustainable development and which have given rise, over recent years, to the enactment of two pieces of legislation.
The Grenelle 1 Law of 3 August 2009 provides for a comprehensive set of targets relating to building and energy, public transportation, biodiversity and agriculture, health and environmental risk prevention, waste treatment and governance (information and training). The Grenelle 2 Law of 12 July 2010 on the national commitment to environment (supplementing the Grenelle 1 Law) provides for actual implementation of the following objectives:
- energy performance for buildings and the harmonisation of tools in terms of urban planning;
- public transportation that is more respectful to the environment while ensuring mobility needs;
- reduction of energy consumption and carbon emissions;
- biodiversity preservation;
- implementation of new green governance; and
- environmental risk monitoring, waste treatment and health preservation.
The Grenelle 2 Law contains or consolidates numerous provisions that affect real estate transactions. In particular, it provides for the following:
- sellers must now provide certain information regarding, inter alia, mandatory communication of an energy consumption diagnosis for the sale of any real estate asset;
- landlords must convey certain information to the tenant regarding risks of ground pollution, energy consumption diagnosis, radon and a natural and technological risk statement for any real estate asset leased – called ERP (Etat des Risques et Pollutions) since an Order of 13 July 2018; and
- energy efficiency works must now be carried out for buildings used for tertiary activities or public services within eight years of 1 January 2012.
The decree of 30 December 2011, supplementing the Grenelle 2 law, is also aimed at creating a green lease legal regime. It introduces an obligation to attach an environmental annex to a lease with respect to office or commercial space of more than 2,000m². Such an annex must contain information regarding the features of the facilities and systems of the building and leased premises, their actual water and energy consumption and the quantity of waste generated. It must also mention each party's obligation to undertake to complete a programme of actions with a view to improving the energy and environmental performance of the building and leased premises.
More generally, green labels and certifications (HQE, BBC, BREAM standards, etc.) have become a pre-eminent valuation criterion of real estate assets. This is reflected in the market practices. Among other examples, the granting of labels and other environmental certifications is now viewed, in real estate development projects, as fully incorporated in the definition and scope of the building to be erected. It is now also market practice that the price is not paid in full by the purchaser until the developer has obtained these labels and environmental certifications.
iv Introduction of EU Directive on Alternative Investment Fund Management (the AIFM Directive)14 into French law
A set of laws, including Law No. 2014-1 of 2 January 2014, introduced and implemented the principles of the AIFM Directive into French law.
An alternative investment fund is an entity that does not qualify as a UCITS, and is designed to collect equity from various investors with the purpose of investing such equity in a predetermined investment strategy implemented by a management company. Many investment vehicles set up to invest in real estate property or in real estate debt may fall within the scope of this rather broad definition.
Some criteria that need to be tested to determine whether the AIFM regulation is applicable to an investment vehicle are still to be clarified (e.g., what level of discretion is given to the management company in making investment decisions to qualify the vehicle as an alternative investment fund?). Companies running an industrial or commercial activity are exempted from the AIFM regulations; however, the question remains as to what extent a real estate activity can be regarded to be a commercial activity.
The French regulator, the Financial Markets Regulator (AMF), has already provided some guidelines to construe the new legislation, but to date no specific cases or litigation have been brought before the AMF or French courts.
There is some expectation as to what the interpretation of the above-mentioned criteria by the AMF and French courts will be to really understand the extent to which the AIFM regulations will now govern real estate investment business, which has so far been rather accustomed to developing in a non-regulated environment.
v New mortgage financing practice and issues
The entry of insurance companies and debt funds into the mortgage financing markets brought about some changes in the practice of mortgage financing for either legal or financial considerations.
The regulatory law for insurance gives insurance companies the benefit of an exemption to the banking monopoly, allowing them to provide, under certain leverage conditions, mortgage financings. However, this exemption does not confer the status of banking institutions on insurance companies, with the result that they cannot be granted a Dailly Law security assignment of receivables against the borrower; the Dailly Law assignment is one of the key security interests in real estate financing. Insurance companies can only be granted a pledge of receivables, which is ultimately regarded as a less robust security than a Dailly Law assignment. This may lead to complicated negotiations in the case of a mixed pool of lenders (with banks eligible to receive Dailly Law assignments and insurance companies not eligible). Pursuant to Ordinance No. 2017-1432 of 4 October 2017, which came into force on 3 January 2018, certain qualified debt funds may now be eligible to benefit from Dailly Law security assignment. Surprisingly though, insurance companies have not been retained as eligible.
The insurance company assault on the mortgage financing market has also favoured the development of a hitherto unusual practice in real estate financing: financing by bonds issuance. The financing providers are buying bonds issued by the borrower instead of providing straightforward loans. This has an impact on the investment structuring of the borrowers, as some corporate forms of companies (French SCI, SNC and, to some extent, SARL) are not eligible for bonds issuance. This also offers the real estate debt market the prospect of flexibility to structure real estate debt between senior lenders and mezzanine lenders.
Financial considerations also weigh on the negotiations of the financial terms of financings. As insurance companies regard real estate financing as an alternative to investment of public savings in long-term fixed-income products, they can provide financings of longer duration (10 years) than the banks, but they impose tougher early repayment clauses on borrowers (computing break-costs until final maturity rather than the end of the current interest period).
Deals involving mezzanine lenders have also raised some new challenging structuring issues in the world of real estate financing, such as when the mezzanine lenders' rights are subordinated to those of the senior lenders' rights as to the enforcement of common security (including mortgages) conferred upon both categories of lenders.
Additionally, Law No. 2019-486 of 22 May 2019 (the PACTE Law) has been enacted and empowers the government to reform the French security law by way of an Ordinance with the aim of modernising and rendering it more attractive to business.
Outlook and conclusions
The recovery of growth of the French economy is boosting the leasing transactions market, especially for offices and logistics, increasing the expectations of real estate investors on rental values. French real estate (including residential and housing real estate now) continues to be seen as a very attractive investment in Europe, and the combination of close-to-zero interbank interest rates and lower spreads makes credit even cheaper and encourages higher pricing of assets and lower yields on prime assets.
Besides, the aforementioned ELAN Law (Law No. 2018-1021 of 23 November 2018) is intended to foster housing developments. The aforementioned PACTE Law was eventually enacted on 22 May 2019, simplifying French company law and turning it into a more business-friendly set of rules.
1 Pierre Gebarowski and Alexandre Blestel are partners at De Pardieu Brocas Maffei.
2 This registration obligation is only applicable for residential housing.
3 Decision of the third Division dated 8 September 2016 (see also decisions of 31 October 2012 and 28 January 2015).
4 Decision of the third Division dated 7 June 2018.
5 In particular, OPCIs with simplified rules.
6 UCITS or 'undertakings for the collective investment in transferable securities' are investment funds regulated at European Union level.
7 This encompasses a wide variety of equipment or premises ranging from air-conditioning systems to warehouses and factories whose operation involve handling hazardous substances.
8 Section L511-1 et seq.
9 Section L181-1 et seq.
10 Section L556-3 II 2.
11 Literally, 'keeper of the pollution'.
12 Section L512-21.
13 Section L541-1 et seq.
14 EU Directive 2011/61/EU of 8 June 2011 on Alternative Investment Fund Management.