Article 442-1.II of the French Commercial Code (former Article L. 442-6.I.5 °) sanctions the termination by a trader of a written contract or an informal business relationship without giving sufficient written prior notice. Over the last twenty years, this article became the recurring legal basis for all compensation actions (up to 18 months of gross margin, plus other damages) when a commercial relationship or a contract ends (totally or even partially).
How can a foreign company master the risk linked to the “sudden termination of commercial relations” set by French law?
Foreign companies doing business with a French counterpart should:
- know that this article applies to almost all type of commercial relationship or contracts, whether written or not, fixed-term or not;
- check whether its relation/contract is sufficiently long, regular and significant and whether the other party has a legitimate belief in the continuation of this relation/contract;
- give a written notice of termination or non-renewal (or even of a major modification), which length takes mainly into account the duration of the relation, irrespectively of the length of the contractual notice;
- invoke, with cautiousness, force majeure and gross negligence of the party, to set aside “sudden termination”;
- anticipate, in case of insufficient notice, a compensation which amount is the product of the average monthly gross margin per the length of non-granted prior notice.
How to master the “Sudden Termination” French rules?
When French law is applicable (see Part 2 of this post), the foreign company will face the legal regime of article L442 -1.II of the French Commercial Code (ex L442-6.II.5°) sanctioning ”sudden termination”. It is therefore important to know the headlines to manage the risks related to this rule or the possibilities to exclude or limit this risk.
As a preliminary remark, it is important to know, above all, that the implementation of the liability for “sudden termination” is the consequence of a too short notice. Thus, and contrary to what might be suggested by the claims submitted by the victims, this scheme does not lay down an automatic compensation rule. In other words, as soon as reasonable notice is given by the author of the termination, liability on that basis can be dismissed. Beyond this reminder of common sense, there are certain conditions that a foreign company must check in order to verify if and how it is subjected to this rule.
Scope of “Sudden Termination”
All contracts are covered by this legal regime, except for contracts whose regulations provide for a specific notice of termination, like commercial agency contracts and transport of goods by road subcontracts.
The prerequisite for “Sudden Termination”: an established commercial relationship
First, there must be a relationship that can be proven by a written contract or de facto, by behaviour of the parties (e.g. order and order confirmation). This relationship may be based on a succession of tacitly renewed contracts or a regular flow of business, materialized by multiple orders.
Above all, this relationship must have an established character. There is no legal definition, but this notion has been defined year after year by the Paris Court of Appeal and the Court of Cassation, which have established an objective criterion and a more subjective one. The Paris Court of Appeal (Pole 5, Chamber 4, 18 January 2017, RG No. 14/08437, Euro Media Diffusion / ITM) clearly recalled the reasoning to be followed by the judges to characterize, or not, an established business relationship:
“The application of this text assumes first of all the demonstration of the sufficiently prolonged, regular, significant and stable nature of the flow of business existing between the parties to augur the continuation of commercial relations. It is in the light of this test of the legitimate belief in the durability of the relations of the partner who claims to be ousted that it is necessary to assess whether the relationship was or was not established “.
(a) The objective criterion implies a sufficiently long, regular and significant relationship between the two parties. The duration of the relationship is the most important criterion, therefore a relationship of less than 12 months can hardly meet this criterion. The relationship must also be regular, that is, it must not have been interrupted (too often or too long). The relationship must ultimately be meaningful and represent a serious flow of business between the parties, in volume or value.
(b) The subjective test focuses primarily on the legitimate belief of the victim of the rupture in the continuation of the contract / the relationship that is based on factual elements, such as investment requests, budgets over several years, etc. It is on the basis of this legitimate belief that the victim can prove the established character of the relationship. Conversely, it is on the basis of the finding of a lack of legitimate belief in a common future that the terminating party can prove the absence of a stable character when he has resorted, on several occasions , a call for tenders (unless it is a trick).
Anticipating a “Sudden Termination” claim
(a) The termination may be total or partial
The total rupture is materialized by a complete stop of the relations, for example ending the contract, stopping the sending of orders by the purchaser or the recording of orders by the supplier, or in the event of a very significant change in the prices applicable between the parties or the volume of promised benefits.
But the most complicated situation to deal with is the so-called partial rupture that will be deduced from a modification of elements that partly impacts the relationship but does not reduce it to nothing. For example, a relative price increase or decrease, a change in the terms of payment or delivery.
(b) The termination must be subject to a reasonable written prior notice
The notice must be notified in writing. The absence of written notice is already a breach in itself. The notification must clearly reflect the willingness of a party to sever the relationship in whole or in part, which must be clearly identified and the notice must be clearly stated. The party wishing to terminate a contract must clearly distinguish between the letter of formal notice for default and the subsequent notification of the breach, giving notice (if applicable). As regards the implementation – for the first time – of a tendering procedure / call for tenders, it is the notification informing the current partner of the future tendering procedure which is deemed to be a rupture, therefore a notice period must be respected.
The duration of the prior notice to be respected is not defined by French law which did not pose precise rule until the reform of April 24, 2019.
The Court of Cassation (Com 20 June 2018, No. 16, 24163) recalled the principle for determining the length of notice that should have been respected. It is necessary to analyse “in a concrete way the commercial relation, taking into account its duration, the volume of business realized and the notoriety of the customer, the sector concerned as the seasonal character of the product, the absence of state of economic dependence of the supplier and the time required to find another partner, granting, in accordance with the law, the minimum notice period determined by reference to the usages of the trade “.
If several criteria are stated, it should be noted that the most common criterion is the duration of the relationship. It also takes into account the share of turnover achieved by the victim, the existence or not of a territorial exclusivity, the nature of the products and the sector of activity, the importance of the investments made by the victim especially to the relationship in question, and finally the state of economic dependence.
The length of the notice given by the judges is very variable. The appreciation of notice is made on a case-by-case basis. It is very difficult to give a golden rule, even though roughly for each year of relationship, a month’s notice might be due (to modulate up or down depending on the other criteria in the relationship).
The Ordinance of April 24, 2019 limited to 18 months the period of notice reasonably due under Article L 442-1.II. But much of the litigation will remain uncertain since only relations of exceptional longevity (+/- more than 20 years) or particularly sensitive, could have led to the allocation of a notice higher than 18 months. However, by capping the 18-month notice, the objective of this reform seems to level, indirectly, from this ceiling, downwards, the other notices.
As this rule is of tort nature and is of public order (in international matter, see Part 2 of this post) judges are not bound by the contractual notices stipulated in the contract. But if the author of the breach also violated the terms and conditions of termination provided for by contract, including the contractual notice, the victim may seek the responsibility of the author both on the tort basis of the sudden rupture but also on the basis of the breach of a contractual obligation (but reparation for the same damage cannot be cumulated).
The duration of the notice is assessed on the day of the notification of the rupture so that even if the victim of the break finds another partner or other outlets faster than the theoretical notice, compensation on the basis of this theoretical notice is still due. It goes without saying that during the period of notice, the parties must fully comply with all contractual conditions (unless the contract provides for derogations during this notice, for example the loss or limitation of territorial exclusivity or modification of the terms of payment).
Cases in which “Sudden Termination” is ruled out
The legal regime provides for two cases, and the case-law seems to have imposed others.
(a) The two legal exceptions are Force majeure (very rarely consecrated by the courts) and the fault of the victim of the termination, case-law having added that it must be a serious violation (“faute grave”) of a contractual commitment or a legal provision (such as non-respect of an exclusivity, a non-compete, a confidentiality or a change of control duty). The non-payment of the amounts due contractually can constitute a serious fault justifying a termination without notice, but it is a question of fact where the judge takes into account the importance of the sums involved, the duration of the late payments, their reiteration and reactions of the creditor who must obviously not have tolerated these non-payments and have put his debtor on notice.
The judges consider themselves, of course, not bound by a termination clause defining what constitutes serious misconduct. In any case the party who terminates for serious misconduct must clearly notify it in its letter of termination. Above all, it is important to bear in mind that serious misconduct leads to a lack of notice, therefore, if the terminating party alleges serious misconduct but grants notice, whichever it may be, judges may conclude that the fault was not serious enough.
(b) In recent years, case-law has added other cases of liability waiver. This is the case when the rupture is the consequence of a cause external to the author of the rupture, such as the economic crisis, the loss of its own customers or suppliers, upstream or downstream. In this case, judges endeavour to check whether the perpetrator of the rupture himself suffered this external event and could not control it.
Judges have also excluded “sudden termination” in the hypothesis of the end of the first period of a fixed-term contract, whatever its duration (e.g. 10 or 15 years, with or without a clause of tacit renewal)and its nature (e.g. with exclusivity). In this case, courts decide that the faculty of opposing the non-renewal, at the first renewal of this contract, constitutes a foreseeable event for the victim of the rupture, which excludes the very notion of brutality; but once the contract has been renewed at least once, judges can subsequently characterize the victim’s legitimate belief in a new tacit renewal.
Compensation for “Sudden Termination”
Judges only compensate for the detrimental consequences of the brutality itself of the breach but do not compensate, at least in the context of article L442 -1.II, for the consequences of the breach itself.
The basic rule is in principle very simple: it is necessary to determine the length of the notice which should have been granted, from which the notice actually granted is deducted. This net notice is multiplied by the average monthly gross margin of the victim. But judges are often led to use now a different concept which is the margin on variable costs (especially if the relationship involves services), excluding costs disappearing with non-performance of the contract/relation.
In general, the base of the average monthly margin consists of the last 24 or 36 months. French judges can be quite satisfied with the accounting information provided by the victim’s accountant, so defendant should not hesitate to ask for the full accountancy evidences, especially to identify (lower) margin rates for the goods or services in question, or even a judicial expertise on those accounting elements.
The compensation calculated on the average margin is, in general, exclusive of any other compensation. In all cases, the victim must prove that it has suffered other losses as a consequence of the brutality of the rupture. Judges may thus award compensation for dismissals which are the direct cause of this brutality: depreciation of investments made recently by the victim, especially when asked by the terminating party, or damage to the brand image when other market players (partners, banks, customers) are informed of a termination without notice which can create a negative image to the detriment of the victim.
Some practical tips about “Sudden Termination”
Even though the legal regime is still ambiguous and the case-law terribly casuistic which prevents to release strong guidelines, here are some practical tips when a company plans to terminate a relationship / contract:
- in the case of a fixed-term contract renewable tacitly, the notification of non-renewal must be anticipated well in advance of the beginning of the contractual notice in order to avoid being in a situation where it is necessary to choose between not renewing the contract with a notice that is not sufficient or agree to see the contract renewed itself for a new term;
- commercial teams must be made aware of the risk of partial sudden termination when they change the conditions of execution of a commercial relationship / contract too radically;
- in some cases, it may be useful to send a pre-notice of termination with a “notice proposal” in order to try to validate this notice with the other party;
- it may also be useful, in certain relationships, to notify the end of the relationship with different lengths of notice depending on the nature of the product lines;
- Finally, the best way is to conclude an end-of-relation protocol, fixing the duration of the notice as well as, if necessary, the progressive decline of the orders, the whole within the framework of a settlement agreement which definitively waives any claim, including “sudden termination”.
As we have just seen, sudden termination regime shall be taken into consideration when entering into the final phase of a duration relationship: the way in which the contract (or de facto relationship) is terminated must be carefully planned, in order to manage the risk of causing damages to the counterparty and being sued for compensation.
Since sudden termination regime is also applicable to cross-border relations, in the next post we will see how a foreign company can avoid the application of this regime or, at least, manage it in the best possible way, by setting aside not only French law but also French courts.