Obtaining finance is a frequent and often essential stage in the life of a business. For banks and other creditors, lending money means ensuring future repayment. Pledging a business is one of the most common and effective ways of securing a business loan. This security allows the trader to guarantee his debt with his business tool, without being dispossessed of it and thus being able to continue his business. It is a powerful legal mechanism, but its implementation is governed by strict rules. Understanding how it works, its scope and its consequences is essential for any company director, craftsman or farmer. This mechanism is a special application of the fundamental principles of pledging under french lawadapted to the realities of business life.
Pledging a business: a key guarantee for the business
The pledge of a business is a contract by which the owner of a business (the debtor) pledges it as security for the payment of a debt to a creditor. Introduced by a founding law of 17 March 1909, and now codified in articles L. 142-1 et seq. of the French Commercial Code, this system was designed to reconcile two imperatives: to provide a solid guarantee to the lender and to allow the borrower to continue to run his business to generate the income needed to repay the loan.
The special feature of this security is that there is no dispossession. Unlike a traditional pledge, where the asset is physically handed over to the creditor, the merchant retains full use of his business. The creditor, known as the "pledgee", does not acquire ownership of the business, but rather a set of rights that protect him in the event of non-payment. This security is therefore purely legal and relies on a system of publicity to ensure that it is enforceable against other creditors and potential purchasers of the business.
The advantage for the creditor is that it provides a guarantee based on the debtor's main asset. For the trader, it is a way of accessing credit without paralysing his business. They can continue to use their equipment, welcome their customers and exploit their brand, all of which together constitute the value of their business.
Components of the business that can be pledged
One of the points to watch when pledging a business is the precise determination of the basis of the pledge, i.e. the items that will actually be covered by the guarantee. The Commercial Code sets out a list of items that may be included, while excluding others by default.
Tangible and intangible items: the legal basis for pledging
Unless expressly and precisely designated in the deed of pledge, the guarantee covers only the intangible items listed by law. Article L. 142-2 of the French Commercial Code refers to: the business name and sign, the leasehold rights, the customer base and goodwill. These components form the core of the value of the business.
However, the parties may agree to extend the pledge to other items. Industrial property rights such as patents, trademarks and designs can be included. Similarly, the equipment and tools used to run the business can be included in the collateral, provided they are listed in detail in the deed. This is essential to avoid any subsequent disputes. It should be noted that certain intangible assets, such as film or software rights, may be covered by the guarantee. very specific pledges which are governed by independent regimes.
However, certain items are systematically excluded from the basis for pledging a business. This is the case with goods. Stock is intended to be sold in the normal course of business and cannot therefore constitute stable collateral. Buildings are also excluded, even if they are owned by the trader and are used in the business, as they are subject to property security arrangements such as mortgages. Lastly, the merchant's receivables and debts do not form part of the business and are therefore not included in the pledge.
The concept of small business and rural business: extensions to the system
The success and relevance of the mechanism for pledging business assets led the legislator to extend it to other forms of economic activity. The Act of 5 July 1996 created the craft business, which can be pledged under conditions almost identical to those for a business. This enables craftspeople to benefit from the same credit facilities by offering their work tools as collateral.
More recently, the Agricultural Policy Act of 5 January 2006 introduced the agricultural fund, defined in article L. 311-3 of the French Rural and Maritime Fishing Code. This fund can also be pledged to secure debts. The basis of assessment includes items specific to agriculture, such as live and dead livestock, stocks, payment entitlements and planting rights. Here again, the system is largely modelled on that for business assets, with a disclosure system tailored to ensure the security of creditors.
Formalities for establishing and publicising the pledge of the business
To be valid and produce its effects, particularly with regard to third parties, the pledge of a business must comply with a precise set of formalities. If any of these steps are omitted, the pledge may be null and void, with potentially disastrous consequences for the creditor.
The pledge deed: a condition of validity and enforceability
The pledge must be set out in writing. The law requires that this deed be either an authenticated deed, i.e. drawn up by a notary, or a private deed that has been registered with the tax authorities, failing which it will be null and void. This document is the cornerstone of the security. It must precisely identify the creditor, the debtor, the amount of the secured debt (principal, interest and ancillary costs) and, of course, describe the items of the fund that are pledged.
The purpose of requiring a written document and its registration is to ensure the legal certainty of the transaction. It gives the deed a definite date and prevents fraud. A poorly drafted or incomplete deed could be challenged, depriving the creditor of its guarantee when it is most needed.
Entry in the special register: ranking and enforceability
A deed is not enough. For the pledge to be enforceable against third parties, i.e. to be effective against other creditors or a potential buyer of the business, it must be published. This publication takes the form of an entry in a special register held at the registry of the commercial court within whose jurisdiction the business is operated.
This registration must be made within thirty days of the date of the pledge deed. Compliance with this time limit is essential: late registration would render the pledge null and void. The registration preserves the creditor's lien for ten years and must be renewed before it expires if it is not to lose its effect. It is the date of registration that determines the rank of the pledgee in relation to other creditors who may also have a security interest in the same assets. The principle is simple: first registered, first served.
The effects of pledging a business: rights of the pledgee
Once validly constituted and published, a pledge confers on the creditor a set of prerogatives designed to protect his claim. Although powerful, these rights are specifically defined and limited by law.
Preferential right: ranking in relation to other liens
The preferential right is the pledgee's main advantage. It enables them to receive priority payment from the sale price of the business in the event of compulsory realisation. If the debtor fails to repay his debt and the business is sold, the secured creditor will be able to recover his claim from the proceeds of the sale before the unsecured creditors (those who have no particular guarantee).
However, this preferential right is not absolute. The secured creditor may be overridden by other creditors considered to have priority by law. These include wage creditors (the "wage superprivilege"), the Treasury for certain taxes, and the legal costs incurred in bringing about the sale of the business. The ranking of the pledged creditor is therefore a key element to be analysed in any recovery situation.
Resale right and purge procedure
The resale right is the essential corollary of the preferential right. It means that the security "follows" the business, even if it is sold to a third party. The creditor can therefore enforce his rights over the business against any successive buyer. In other words, selling the business does not cause the pledge to disappear.
For the purchaser of a business, the existence of a pledge constitutes a major risk. This is why the law provides for a procedure for "purging" registrations. The purchaser can free himself from the right of pursuit of pledged creditors by offering to pay them the purchase price directly. The creditors may accept this offer or, if they consider the price insufficient, request that the business be put up for public auction, offering to purchase it for a price one-tenth higher. This complex procedure requires the assistance of a lawyer to secure the transaction.
No right of retention and no judicial attribution
It is important to highlight two rights that the pledgee does not have. First, he has no right of retention. As there is no dispossession, he obviously cannot retain the funds until payment is made. Secondly, and this is a major difference from other security interests, he cannot request the judicial allocation of the fund in payment of his claim. The only means of realisation is by compulsory auction.
Enforcement of pledges and insolvency proceedings
The purpose of a guarantee is to be able to be enforced when the debtor defaults. The terms and conditions of this "realisation" are strictly regulated, and the situation becomes even more complex when the company enters collective proceedings.
Enforcement of the security: forced sale of the business
If the debt is not paid on the due date, the secured creditor can enforce its guarantee. The procedure begins with a formal notice to pay sent to the debtor. If the notice remains without effect for eight days, the creditor may apply to the Commercial Court for the compulsory sale of the business.
The court will then order the sale by public auction. The proceeds of the sale will be divided among the creditors according to their rank, with the secured creditor exercising his preferential right over the price obtained, after payment of any creditors who have priority over him.
Pledging in the event of insolvency proceedings: fate of the lien
The opening of safeguard, reorganisation or liquidation proceedings against the debtor has a direct impact on the rights of the secured creditor. As soon as proceedings are opened, the creditor can no longer take individual legal action to obtain payment of his claim or the sale of the business. They must declare their claim and their pledge privilege to the judicial representative.
Under a reorganisation plan, payment of his claim will be subject to the deadlines and discounts imposed by the court. In the event of compulsory liquidation, his preferential right will be exercised over the sale price of the business, but always after the preferential creditors of the proceedings (legal costs, salaries, subsequent "useful" claims). Resale rights are also paralysed during the proceedings. The management of a pledged claim in a context of business difficulties is technical and requires a perfect command of the interactions between security law and insolvency law.
The creation and management of a pledge on a business, craft or farm is a legal act with far-reaching consequences. To secure your financing or defend your rights as a creditor, precise drafting and expert analysis are essential. Our team of lawyers with expertise in securities and guarantees is available to support you.
Sources
- French Commercial Code, in particular Articles L. 142-1 et seq.
- Civil Code
- Code rural et de la pêche maritime, in particular article L. 311-3
- Intellectual Property Code
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