The sale with right of repurchase of financial securities is an old legal mechanism, provided for in the Civil Code, which offers remarkable flexibility for financing or portfolio management transactions. It is a contract of sale with a specific clause: the seller reserves the right to take back the securities sold within an agreed period, in return for repayment of the price. This tool, both powerful and subtle, can be a real strategic asset if it is mastered. However, to avoid legal pitfalls, it is essential to have a precise understanding of the conditions and effects of the sale. For a complete overview of vente à réméré, consult our detailed guide.
The essential conditions for the validity of a sale with right of repurchase of securities
For a sale with right of redemption to be valid, a number of substantive and formal conditions must be met. These set out the framework within which the parties can operate in complete security. Understand the precise legal nature of and distinctions between sale with right of repurchase and other financial transactions.
Form and formality of the agreement
The Civil Code does not impose any formal requirements for the validity of a sale with right of redemption. In theory, a simple verbal agreement could suffice. In practice, however, such an approach would be extremely unwise. A written contract is essential. This document not only makes it possible to clearly define the rights and obligations of each party (price, duration, terms and conditions for exercising the repurchase option), but also provides solid evidence in the event of a dispute. The written document formalises the common intention of the parties and secures the transaction in the eyes of third parties and the tax authorities.
The parties to the contract and the specific features of UCITS and FIAs
In principle, any natural or legal person with the capacity to contract may enter into a sale with right of repurchase, whether as seller or buyer. Ordinary contract law applies. No specific restrictions are set out in articles 1659 et seq of the Civil Code. This freedom allows great flexibility in the use of the mechanism.
However, specific regulations apply to certain players. Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Funds (AIFs) may use temporary sales of securities, a category that includes sale with right of repurchase, but within a strict framework. These transactions must serve "efficient portfolio management", i.e. aim to reduce risk, cut costs or generate additional income. In addition, the counterparties to these funds must meet specific criteria, particularly in terms of status and capital.
The object of the contract: book-entry securities and the 'thing' issue
Sale with right of repurchase can involve any type of asset, including financial securities such as shares or bonds. However, a technical issue arises in relation to so-called "book-entry" securities, i.e. securities that are dematerialised and registered in an account. Article 1659 of the Civil Code states that the seller may "take back the thing sold". How can this concept of an individualised "thing" be applied to securities that are fungible, i.e. interchangeable with other securities of the same kind?
The solution lies in the very nature of these assets. In the case of fungible securities, the obligation to make restitution is deemed to be satisfied when the buyer hands over to the seller an identical number of securities of the same class. It is not necessary for the securities to be materially the same. Legal and economic identity takes precedence over material identity, which has become obsolete with dematerialisation. The seller must simply find assets of equivalent value and nature in his assets.
The sale price: contractual freedom and price manipulation issues
The price of the sale with right of repurchase is freely determined by the parties. It does not have to correspond to the market price of the shares at the time of the transaction. It is even common for the sale price to be set at a discount, i.e. below the market value of the shares. This practice has a dual purpose: it protects the buyer against a possible fall in the share price during the transaction and encourages the seller to exercise his buyback option in order to make a good deal.
This freedom is not without limits. In exceptional circumstances, setting a price that is far from the market value could attract the attention of the market authorities as price manipulation. However, the risk is generally low for a classic sale with right of repurchase. The intention of the parties is not to deceive the market about the value of a security, but to organise a financing transaction secured by a temporary transfer of ownership.
The repurchase option: stipulation, nature and beneficiary
The repurchase option is at the heart of the repurchase agreement. To be valid, it must be stipulated in the initial contract of sale. A subsequent agreement to allow the seller to repurchase the shares would not be a sale with right of repurchase, but a simple promise to resell, with very different legal and tax consequences.
It is essential to understand that the repurchase option is an option, not an obligation for the seller. If the contract required the seller to repurchase the securities, the transaction would be reclassified as a double sale or repurchase agreement, for example. Finally, this option is reserved exclusively for the seller, as specified in article 1659 of the Civil Code. Under no circumstances may the buyer force the seller to repurchase the securities.
The duration of the buyback option: the five-year limit and its implications
The law imposes a maximum period for exercising the buy-back option. According to article 1660 of the Civil Code, this period cannot exceed five years. This rule is a matter of public policy, which means that the parties cannot derogate from it. If they stipulate a longer period, it will automatically be reduced to five years.
The period begins on the day the sale is completed. The seller must declare his intention to repurchase the shares before the expiry of this period. If he fails to do so, he forfeits his right: the repurchase option disappears and the buyer becomes the definitive and irrevocable owner of the securities. This is one of the main risks for the seller. The parties may agree to a period shorter than five years and even extend it, provided that the extension takes place before the expiry of the initial period and that the total duration does not exceed the legal limit.
Conditions for exercising the repurchase option: declaration and return of the price
Once the contract is in place, the seller's right to repurchase must be exercised in accordance with specific procedures. This is a decisive step that triggers the cancellation of the sale.
Form and deadline for the declaration of intent
The law does not prescribe any particular form for the declaration by which the seller informs the buyer of his decision to exercise the repurchase option. For reasons of proof, notification by registered letter with acknowledgement of receipt is strongly recommended. In financial circles, a written confirmation (e-mail, for example) often follows an oral agreement.
The imperative element is compliance with the deadline. The declaration must be received by the buyer before expiry of the agreed term (or the legal five-year period). A late declaration would have no effect, and the sale would become final. Once the declaration has been accepted by the buyer, the seller is committed and can no longer withdraw. He is then obliged to refund the price.
Price refunds: calculation, costs and limits
The exercise of the repurchase option is conditional on the buyer returning the "principal price", as stated in article 1659 of the Civil Code. However, the parties may agree that the repurchase price is different from the initial sale price. It may be higher, in particular to include remuneration for the buyer, equivalent to interest on the funds he has made available. This practice is accepted by the courts.
The seller must also reimburse the "fair costs of the sale" incurred by the buyer, such as any registration fees. The main limit to the increase in the purchase price is the risk of the transaction being reclassified as a usurious loan if the buyer's remuneration is deemed excessive. The price clause must therefore be carefully drafted to reflect the economics of the transaction without falling foul of such a prohibition.
The legal effects of the sale with right of repurchase for the parties and third parties
A sale with right of redemption produces complex legal effects, which change between the time it is concluded and the expiry of the redemption option. It is essential to distinguish between them in order to understand the rights and obligations of each party. Considering the tax consequences of the transaction is just as important, as they can influence its profitability. Analyse the specific tax implications of sale and repurchase to optimise your operations.
Effects during the term of the sale: rights of the seller and the buyer
Throughout the term of the agreement, the parties are in a unique position. The seller no longer owns the shares, but retains a right to recover them. This right is an asset that can be sold. However, he cannot sell the shares themselves a second time, as he no longer owns them.
The buyer, for his part, becomes the full owner of the shares, although his ownership is subject to a resolutory condition. As such, they exercise all the rights attached to the securities: they receive dividends or interest and exercise voting rights at general meetings. They may even dispose of the securities, i.e. sell, lend or repurchase them. If he does so, however, he takes a risk: if the seller exercises his right of repurchase, the buyer will have to obtain identical securities in order to return them.
Effects on expiry of the repurchase agreement: cancellation or consolidation
There are two possible scenarios at the end of the period. If the seller exercises his right of repurchase, the effect is radical: the sale is cancelled retroactively. Legally, everything happens as if the sale had never taken place. The seller is deemed to have always been the owner. He recovers the shares (free of any encumbrances that the buyer may have placed on them) and returns the agreed price. The buyer is deemed never to have been the owner.
Conversely, if the seller does not exercise his right within the stipulated period, the resolutory condition is not fulfilled. The sale is then consolidated. The buyer becomes the definitive and irrevocable owner of the securities. The seller loses all rights to them. This situation represents the main risk for the buyer if the securities have depreciated significantly, as he finds himself the owner of an asset that is worth less than the price he paid.
Enforceability against third parties and specific issues
Article 1673 of the Civil Code protects the seller who exercises his right of redemption by allowing him to take back the property "free of all charges and mortgages" created by the buyer. While this rule is clear in real estate matters thanks to land registration, it is much more difficult to apply in the case of cashless financial instruments.
In the absence of a publicity system for sales with right of redemption of securities, it is very difficult for the seller to assert his right against a third party in good faith to whom the buyer has resold the securities. Similarly, if the buyer has pledged the securities to a creditor, the latter could oppose their return. The seller retains an action for compensation against the buyer who cannot return the securities, but his real right to the securities themselves is weakened. The structuring of the contract must anticipate these difficulties.
The sale with right of repurchase of securities is a complex legal instrument that requires rigorous analysis and tailor-made contractual drafting. The financial and strategic stakes fully justify the use of expert support. Our experts in banking and finance law can help you secure all your complex transactions.
Sources
- Civil Code, articles 1659 to 1673 (sale with right of redemption).
- Monetary and Financial Code (provisions relating to financial instruments and UCITS/FIA transactions).
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