Escrow of the price and asset and liability warranty in the sale of a business (fonds de commerce)

A business owner sells his business (fonds de commerce), signs the sale deed, mentally banks the price, and then discovers that his lawyer or notary will not pay him a cent for several months. On the other side, the buyer fears that a tax audit or a social security debt will emerge after signing and burden a business that he thought he had bought "clean". These two concerns come together around two mechanisms that every seller and every buyer must understand before signing: the blocking of the price with an escrow agent (séquestre) and the warranty that protects the buyer against a liability revealed after the sale.

This article explains why the price of a business remains unavailable for three to five months, how the clearing of creditors' objections and joint tax liability combine, and how to articulate escrow and an asset and liability warranty. A practical case illustrates the most feared situation: a tax reassessment that arrives once the sale has been completed.

What a sale of a business does (and does not) transfer

A business (fonds de commerce) is a set of tangible items (equipment, furniture, stock where sold separately) and intangible items (customer base, goodwill, trade sign, trade name, right to the lease, licences, related contracts). The customer base is its central element: without a customer base, there is no business.

The cardinal distinction, often poorly understood by sellers and buyers alike, is that the sale of a business is a sale of assets, not a sale of a company. The buyer takes over the elements of the business, not the legal entity that operated it. Consequently, the seller's liabilities (its supplier debts, its loans, its prior tax and social security debts) remain in principle with the seller. This is the opposite of a sale of shares, or share deal, where the buyer purchases the shares and mechanically inherits all of the company's liabilities, known or not.

This difference explains two things. First, the asset and liability warranty plays a far more structuring role in the sale of company shares than in the sale of a business. Second, although liabilities remain in principle with the seller, the law provides for formidable exceptions which place certain of the seller's debts on the buyer, or on the price. It is precisely these exceptions that justify the blocking of the price.

Escrow of the price: why the seller is not paid at signing

The escrow agent is the person to whom the sale price is entrusted on deposit, with the task of releasing it only once certain conditions are met. In practice, this is the drafter of the deed, a lawyer or notary, or a contractual escrow agent appointed by the parties. The funds are paid into a dedicated account, generally the lawyer's CARPA account (lawyers' client funds account) or the notary's office account, and remain blocked there. The cost of the drafting lawyer's work and the factors that determine it are set out in our article on lawyer's fees for the sale of a business.

This blocking is not excessive caution on the part of the adviser: it follows a precise legal logic. The drafter of the deed incurs professional liability. If he released the price too early and a preferential creditor, the tax authorities or an objecting creditor then came forward, he could be required to pay out of his own funds. Escrow therefore protects at once the seller's creditors, the buyer (who could otherwise be pursued a second time) and the professional himself.

Escrow may be contractual, arranged by a clause in the sale deed, or judicial where a dispute requires the court to order the funds to be held. In the great majority of sales of businesses, contractual escrow entrusted to the drafter of the deed is sufficient.

Why the price remains blocked for three to five months

The blocking period results from the stacking of several procedures which protect distinct interests. None can be ignored, and they do not run in parallel but largely in sequence. It is this overlap that leads to a blocking period of between three and five months, depending on the circumstances.

Publicity of the sale and creditors' right of objection

The sale of a business must be published. The deed is published in a legal notices journal and then by a notice in the BODACC (French official gazette of civil and commercial announcements), within fifteen days of the sale, in application of the provisions of the French Commercial Code on publicity of the sale.

This publicity opens the right of objection of the seller's creditors. Under Article L. 141-14 of the French Commercial Code, any creditor of the seller may, within ten days following the last of the publications, lodge an objection to payment of the price into the hands of the escrow agent. The objection does not attach the business: it blocks the portion of the price needed to satisfy the objecting creditor. The nomenclature of procedural acts set out in Annex 4-7 of the French Commercial Code moreover expressly identifies the "objection to the sale price of the business" as a separate step. From the creditor's side, the conditions and procedure for objection are detailed in our article on the time limit for objection by the seller's creditors.

For as long as an objection has not been lifted, whether by release given by the creditor or by a court-ordered limitation (cantonnement), the escrow agent retains the corresponding sums. A seller with unpaid debts therefore has every interest in settling them before the sale, failing which the price will be reduced for the direct benefit of its creditors.

Joint tax liability: the real driver of the long period

The mechanism that genuinely lengthens the blocking period is the joint tax liability under Article 1684 of the French General Tax Code (CGI). This provision makes the buyer of a business jointly liable with the seller for payment of certain taxes owed by the seller in respect of the business sold: notably income tax or corporation tax on profits made during the year of the sale and not yet taxed, as well as profits of the previous financial year not yet taxed.

This joint liability is subject to a double limit. It is capped at the amount of the sale price, and it is limited in time. Since the reform resulting from the Amending Finance Act for 2015, the joint liability period, historically ninety days, may be reduced to thirty days where several conditions are met: the notice of sale was sent to the authorities within the statutory period, the seller filed its results return on time, and it is up to date with its tax filing obligations. Failing that, the ninety-day period applies.

A decisive technical point: this joint liability period does not run from the sale, but from the day the seller files its results return, or from the last day of the period allowed for that filing. In the case of a sale, that results return must itself be filed within sixty days from publication of the sale (Article 201 of the CGI). In the worst case, the joint liability clock therefore starts only about two months after publication.

The concrete calculation of the period

By adding up the stages, one can see where the three to five months come from:

• publication of the sale up to fifteen days after the deed
• creditors' objection period of ten days from the last publication
• filing of the seller's results return within sixty days of publication
• joint tax liability period of thirty to ninety days running from that filing (or from the end of the filing period)

A well-run file, with an up-to-date seller and returns filed without delay, makes it possible to approach the lower end of the range. A negligent seller, late with its returns, suffers the long version. The escrow agent releases the balance of the price only once these periods have run and the absence of any objection or tax debt has been confirmed. That is why escrow on the sale of a business is a mandatory step and not a negotiable precaution.

The asset and liability warranty in the sale of a business

The asset and liability warranty on the sale of a business deserves a nuanced explanation, because its usefulness differs sharply depending on whether one buys a business or shares.

A warranty born for the share deal

The asset and liability warranty (garantie d'actif-passif), or clause warranting liabilities and restoration of assets, is a contractual mechanism by which the seller undertakes to indemnify the buyer if a liability originating before the sale comes to light after it, or if an asset recorded in the balance sheet proves overvalued or non-existent. It was designed for the sale of shares, where the buyer takes over a legal entity with all of its latent liabilities: a tax reassessment relating to a prior financial year, an unprovisioned employment tribunal (conseil de prud'hommes) dispute, a forgotten supplier debt.

In such a structure, the warranty is the logical counterpart of the transfer of liabilities: the buyer of the shares inherits the debts, and the warranty allows him to pass their economic burden to the seller for the period before the sale. The risks incurred by the buyer of company shares in the absence of such a clause are analysed in our article on the sale of shares without a liability warranty.

Its real scope in the sale of a business

In the sale of a business, the buyer does not in principle take over the seller's liabilities. One might conclude that the asset and liability warranty is useless. That would be too hasty. Several debts or obligations in fact pass through the sale and fall on the buyer or on the business:

• the joint tax liability under Article 1684 of the CGI, already mentioned
• the automatic transfer of existing employment contracts, pursuant to Article L. 1224-1 of the French Labour Code, with the employees' accrued rights
• the takeover by operation of law of certain contracts attached to the business, such as the commercial lease or insurance contracts
• debts declared by the seller but whose existence or actual amount differs from what was announced

In view of these risks, targeted warranty clauses are often preferred for businesses: a warranty on tax and social security liabilities, a warranty as to the accuracy of the turnover and profitability announced, a reinforced warranty against eviction (garantie d'éviction), and a non-compete undertaking by the seller. These clauses serve the same purpose as an asset and liability warranty but are adapted to the nature of an asset purchase.

The effectiveness of a warranty depends not only on its drafting but on its financial counterpart. A warranty with no backing, granted by a seller who will have spent the price, is worth nothing on the day the liability comes to light. Hence the value of combining the warranty with the retention of part of the price.

Practical case: a liability revealed after the sale

Take a common situation. A shopkeeper has operated a restaurant business for several years in a mid-sized town. She sells her business to a buyer who takes over the trade sign, the lease, the kitchen equipment and the two employees. The price is paid to the escrow agent, the lawyer who drafted the deed, and the buyer begins trading.

Four months after the sale, the tax authorities notify the seller of a proposed reassessment covering the year of the sale and the previous year: a significant share of cash takings had not been declared. The corresponding tax has not been paid. Under Article 1684 of the CGI, the buyer is exposed, within the limit of the price and within the joint liability period, to being called on to pay that tax.

Two scenarios then arise. In the first, the price has already been released to the seller: the buyer will have to pay the authorities, then turn against the seller under the tax warranty stipulated in the deed, hoping that she is still solvent. In the second scenario, the price has remained in escrow because the joint liability periods had not run: the escrow agent can draw on the blocked funds to clear the tax debt before any release to the seller. The buyer is protected without having to bring uncertain court proceedings.

This case illustrates the complementarity of the two mechanisms. Escrow is a security in fact, immediately available for as long as the funds are blocked. The asset and liability warranty, or liability warranty, is a security in law, available afterwards, but its value depends on the seller's solvency. The buyer's maximum security presupposes that the contractual warranty period and the period for which a portion of the price is retained overlap.

Combining escrow and warranty to genuinely secure the price

Understanding that these two devices answer different logics makes it possible to negotiate the deed better. Escrow protects primarily the seller's creditors and the tax authorities; it releases the price once the statutory periods have run. The warranty protects the buyer against liabilities revealed after those periods, sometimes months or years later.

Several negotiating levers exist to combine these protections:

• provide for a retention of part of the price as security, a portion of the price kept by the escrow agent beyond the tax clearance period alone, released progressively according to a schedule or on expiry of the warranty
• back the liability warranty with security (bank guarantee on first demand, independent guarantee, pledge) so as not to depend solely on the seller's future solvency
• set a clear trigger threshold (de minimis) and a clear cap, in order to avoid disputes over minor liabilities
• calibrate the duration of the warranty on the authorities' reassessment periods, in particular the tax and social security reassessment period, which is longer than the joint liability period under Article 1684 of the CGI

For the seller, the stakes are symmetrical: settle its debts before the sale, file its returns on time to benefit from the reduced joint liability period, and negotiate a staggered release of the price rather than an indefinite blocking. A seller that is up to date with its obligations recovers its price faster.

Conclusion

The blocking of the price for three to five months is neither administrative heaviness nor excessive caution on the part of the adviser: it is the mechanical consequence of the overlap between the creditors' right of objection and the joint tax liability under Article 1684 of the French General Tax Code, whose clock starts only after the seller files its results return. To seek to get round this period is to expose the buyer to paying twice and the drafter of the deed to incurring liability.

The position to adopt is clear: escrow and warranty are not opposed, they complement each other. The first covers the immediate risk over the statutory period, the second covers the deferred risk over the authorities' reassessment period. A well-constructed deed makes the end of the escrow coincide with the warranty coming into full effect, leaving no window of uncovered risk. Before signing, have your lawyer check that the period for which the price is retained, the exact scope of the warranty and the security backing it form a coherent whole: it is by this articulation, and not by the headline amount of the price, that the real security of the transaction is measured.

Frequently asked questions

Why is the sale price of a business blocked with the escrow agent? The price is entrusted to an escrow agent, often the drafting lawyer or notary, to protect the seller's creditors and the tax authorities. Until the creditors' right of objection (Article L. 141-14 of the French Commercial Code) and the joint tax liability (Article 1684 of the CGI) have run their course, the escrow agent cannot release the funds without risking liability and exposing the buyer to double payment.

How long exactly does the blocking of the price last? In practice, three to five months. The period combines publication of the sale (up to fifteen days), the creditors' objection period (ten days), filing of the seller's results return (sixty days from publication under Article 201 of the CGI) and then the joint tax liability period of thirty to ninety days, which runs only from that filing.

What is the joint tax liability under Article 1684 of the CGI? It is the mechanism that makes the buyer of a business jointly liable with the seller for certain taxes linked to the business sold, notably tax on profits for the year of the sale and for the previous financial year not yet taxed. This joint liability is capped at the amount of the price and limited in time, which justifies keeping the price in escrow during the period at risk.

Is the asset and liability warranty mandatory in a sale of a business? No, no law requires it. It is more common in the sale of shares, where the buyer takes over the company's liabilities. In the sale of a business, the buyer does not in principle take over the seller's liabilities, but targeted warranty clauses (tax and social security warranty, warranty as to the accuracy of turnover) remain strongly advisable to cover exceptions such as joint tax liability and the transfer of employment contracts.

What happens if a liability is revealed after the sale of the business? If the price is still in escrow, the escrow agent can draw on it to settle the debt before any release to the seller. If the price has already been paid, the buyer must rely on the warranty stipulated in the deed and turn against the seller, which presupposes that the seller is solvent. Hence the value of backing the warranty with security and providing for a retention of part of the price.

How can a seller recover its price more quickly? By settling its tax, social security and supplier debts before the sale, and by filing its returns within the statutory periods. Compliance with these obligations makes it possible to benefit from the joint tax liability period reduced to thirty days instead of ninety, and avoids creditors' objections that would block part of the price.

What is the difference between contractual escrow and judicial escrow? Contractual escrow is arranged by a clause in the sale deed, which designates the drafter or a third party to hold the price: this is the most common situation. Judicial escrow is ordered by a judge, generally in the event of a dispute between the parties or with a creditor, in order to freeze the funds until the dispute is resolved.