When it comes to the transfer of a business, guaranteeing assets and liabilities is of crucial importance in securing the buyer’s investment. In this context, various forms of guarantees can be put in place to protect the parties involved and minimise potential financial risks. Among these, the demand guarantee (GAPD) stands out for its effectiveness and autonomous nature.
This legal mechanism, often referred to as the “queen of guarantees”, plays an essential role by offering enhanced security through its ability to ensure rapid and uncontested recovery of the amounts covered.
The “queen of guarantees”
In the context of a business transfer, it is common for the buyer to request the establishment of an asset and liability warranty (the “GAP”), designed to protect their investment by shielding them from any additional liabilities or reduction in assets following the transaction.
To ensure rapid recovery of the amounts covered by this warranty, the buyer may also require the establishment of a demand guarantee (“GAPD”).
The autonomous guarantee, defined in Article 2321 of the Civil Code since Ordinance No. 2006-346 of 23 March 2006, is “the commitment by which the guarantor undertakes, in consideration of an obligation entered into by a third party, to pay a sum either on first demand or in accordance with agreed terms“, it being specified that “The guarantor may not raise any defence relating to the guaranteed obligation“.
Two essential characteristics serve to qualify the demand guarantee:
- on the one hand, the non-opposability of defences (Art. 2321 of the Civil Code, para. 3). The assessment of this criterion is straightforward when the instrument clearly specifies that the guarantor may not invoke any circumstance relating to the underlying contract. However, the mere mention of “on first demand” does not clearly indicate the non-applicability of defences. In case of uncertainty, pursuant to Article 1190 of the Civil Code, the contract shall be interpreted “against the creditor and in favour of the debtor“;
- on the other hand, the autonomy of the subject matter of the guarantee. The essential question is whether the payment obligation relates to “a sum” or “any sum” rather than what the debtor owes. However, as soon as it involves paying “sums due” or “sums remaining due” by the debtor, the guarantee loses its autonomy (Com. 13 December 1994, 92-12.626). Nevertheless, a mere reference to the underlying contract has no bearing provided that the amount and terms of the guarantee are independent (Com. 30 January 2001, 98-22.060).
By virtue of these characteristics and its effectiveness, it is often regarded as “the queen of guarantees” because the banker cannot raise any defence drawn from the performance of the underlying contract, the beneficiary of the GAPD having, in theory, only to notify the guarantor of the calling of the guarantee in order to obtain payment.
However, the calling of the demand guarantee must follow strict formal requirements, and a lack of care on the part of the beneficiary can sometimes prove very costly.
Strict formal requirements: rigour and precision required
Given the autonomy of the demand guarantee, which is the counterpart of its formidable effectiveness, the case law of the Cour de cassation has always been very strict regarding the formal requirements stipulated by the parties. Thus, the Cour de cassation holds that the calling of the guarantee is irregular:
- where, despite its obligation, the beneficiary fails to transmit to the guaranteeing bank a copy of the written notification sent to the principal (Cour de cassation, Commercial Chamber, 22 March 2011, 09-71.690, Unreported);
- where the beneficiary fails to specify in what respect the principal has defaulted on its obligations (Cour de cassation, Commercial Chamber, 30 March 2010, 09-12.701, Published in the Bulletin);
- or where the beneficiary fails to demonstrate strict compliance with the formal and drafting requirements for the guarantee call (Cass. com., 10 Feb. 2015, No. 12-26.580, Bull. 2015, IV, No. 18);
- where the guarantee call was made by reference to the non-performance of a contract other than that referred to in the bank demand guarantee letter (Cass. com., 18 Apr. 2000, No. 97-10.160).
An illustration of mistakes to avoid
A judgment delivered by the Paris Court of Appeal on 30 May 2024 provides an interesting illustration of the mistakes to avoid in the context of a transfer of shares accompanied by an asset and liability warranty (Paris Court of Appeal, Division 5, Chamber 9, 30 May 2024, No. 23/04575).
The facts underlying the case were as follows:
On 18 December 2019, the sellers transferred to the company Belvedia the shares they held in the company JSP Finances, specialising in temporary employment. Payment for the transfer was to be made partly by bank transfer and the balance in several instalments, of which only the first was paid by Belvedia.
The parties had agreed on a price adjustment clause (based on the amount of shareholders’ equity). In addition, the sellers had provided the buyer with an asset and liability warranty, partially covered by a bank guarantee issued by the CEIDF (Caisse d’Epargne Ile-de-France).
However, in 2020, following the closing of the 2019 financial statements, an increase in liabilities under the sellers’ management was revealed.
In response, Belvedia ceased paying the remaining instalments from February 2020 onwards, informing the sellers of a significant overpayment (of more than two million euros), before bringing proceedings against them before the Judicial Court in November 2020 to obtain compensation.
Belvedia had also called the demand guarantee and the bank (CEIDF) had complied, before then calling the counter-guarantee provided by the sellers.
The sellers then brought proceedings against Belvedia and the bank (CEIDF) seeking their joint and several liability for payment of the sum called under the bank demand guarantee. The Paris Commercial Court granted their claim. Belvedia then appealed the decision.
The sellers’ arguments to defeat the implementation of the GAPD
The arguments essentially revolved around two points:
- the first argument was based on the failure to comply with the performance conditions stipulated by the GAPD which provided that ” To be valid, any call by the Beneficiary on this guarantee, whether in one or more instalments, within the limit of the amount defined above, must be made upon presentation of a written payment demand from the Beneficiary, by registered letter with acknowledgment of receipt, addressed exclusively to the Caisse d’Epargne Ile-de-France, expressly stating the amount claimed, and to which must be attached the formal demand, which has remained without effect, sent to the Guarantor by the Beneficiary in accordance with the terms and conditions of the abovementioned agreement “.
However, the sellers argued that the guarantee call had not been accompanied by a copy of the formal demand sent by Belvedia (in its capacity as beneficiary) to the guarantors.
On appeal, the judges upheld this argument, holding that “the effectiveness of the guarantee call is subject to strict compliance with the contractual provisions, including those relating to form, such compliance being the counterpart of the autonomous nature of the guarantee” and that in this case “the company X… never sent to Y… a copy of a formal demand sent to Mr and Mrs Z… invoking the asset and liability warranty. It must therefore be noted that the contractual conditions for calling the bank demand guarantee were not complied with”.
- the second argument concerned the abusive nature of the guarantee call, given that the bank demand guarantee had been called by Belvedia under a different contract (the price adjustment clause) from that referred to in the guarantee (the asset and liability warranty).
Once again, the Court of Appeal granted this claim, recalling that ” The autonomy of the guarantee does not extend to the conditions for calling the guarantee.
Thus, calling the guarantee merely requires establishing the debtor’s default, without the need to verify whether the debtor’s failure to perform is well-founded.
Furthermore, a guarantee call is considered manifestly fraudulent or abusive if the guarantee has been called under a different contract or for a different purpose from that referred to in the guarantee letter. Indeed, the demand guarantee is designed to guarantee the performance by the principal debtor of a specific obligation for the benefit of the guarantee beneficiary, so that it cannot be called in the event of non-performance of any obligation of the debtor other than that expressly specified“.
This judgment offers an interesting illustration of the fact that, although the bank demand guarantee is considered the “queen of guarantees” in the field of business transfers, it presents certain pitfalls in its implementation that both the buyer and the seller must be aware of in order to, as the case may be, secure or challenge an irregular or abusive guarantee call.
Paris Court of Appeal, Division 5, Chamber 9, 30 May 2024, No. 23/04575
