Extension of insolvency proceedings: commingling of assets and sham companies

The debtor company is placed in judicial liquidation, but its assets turn out to be empty: the stock, the business (fonds de commerce) and the well-funded bank accounts belong to another company in the same group, or to the manager personally. The institutional creditor, whether URSSAF (the French social security contributions agency), a bank, the French Treasury or a strategic supplier, then discovers that its proof of debt will meet only a drained estate, while the real value has been lodged elsewhere. Extension of insolvency proceedings (extension de la procédure collective) is precisely the tool that makes it possible to combine artificially separated estates into a single pool. This analysis sets out the two grounds for extension provided for by the French Commercial Code, commingling of assets (confusion des patrimoines) evidenced by abnormal financial flows, and the sham company (société fictive), and then explains how a creditor, who has no standing to act directly, can nonetheless bring about the widening of the common pledge.

The legal framework for extension: Article L. 621-2 of the French Commercial Code

Extension has its basis in Article L. 621-2, paragraph 2, of the French Commercial Code, introduced by Act No. 2005-845 of 26 July 2005, known as the business safeguard act. The text is short but structuring:

At the request of the administrator, the creditors' representative, the debtor or the public prosecutor's office, the proceedings opened may be extended to one or more other persons where their assets are commingled with those of the debtor or where the legal entity is a sham. For that purpose, the court that opened the initial proceedings remains competent.

Two lessons emerge at once. First, extension does not open a second set of proceedings: it attaches one or more persons, natural or legal, to the proceedings already opened, which become single. The initial debtor and the attached entity will be subject to a single judgment, a single representative, a single possible date of cessation of payments and, above all, a single pool of assets and liabilities.

Second, the text lays down two alternative and autonomous grounds: commingling of assets on the one hand, the sham nature of the legal entity on the other. They are not synonyms. Case law treats them as distinct routes, with their own criteria, even though a single situation may in practice combine the indicia of both. It is this duality that the law designates as the two grounds for extension of insolvency proceedings, and it is this that governs the creditor's entire litigation strategy.

Extension applies to all three procedures: safeguard, reorganisation and judicial liquidation. The territorially competent court remains the one that opened the initial proceedings, a common-sense rule that avoids conflicts of jurisdiction where the attached entities have their registered offices in different areas.

Commingling of assets: intertwined accounts and abnormal financial flows

Commingling of assets presupposes that two or more legally distinct persons behave as if they formed one and the same estate. Case law has consistently identified two alternative criteria for establishing it: inextricably intertwined accounts and the existence of abnormal financial relations. Proof of either of the two criteria is sufficient; it is not necessary to combine them.

Abnormal financial flows

The first criterion, the one most frequently invoked, rests on abnormal financial relations between the estates concerned. Abnormality is measured against the own interest of each entity: a transfer of value that has no consideration, that escapes any economic logic or that systematically impoverishes one for the benefit of the other betrays the absence of any real boundary between the estates.

Several configurations, regularly accepted by the courts, illustrate these abnormal financial flows:

• a company that settles another's debts without a mandate or agreement, or that bears its rent, salaries or social security contributions without ever being reimbursed
• repeated cash advances, not formalised by a current account agreement, unremunerated and never repaid, flowing in one direction only
• the invoicing of fictitious services, or services without real consideration, between related entities, intended to drain one of its substance
• systematic waiver of claims by one company in favour of another without economic justification, or the forgoing of contractually due royalties
• the free and lasting provision of staff, equipment or premises, without re-invoicing, for the constant benefit of the same entity

What is targeted is neither the isolated flow nor the normal cash management agreement that structures a group. It is the abnormal, systematic and unbalanced character of the movements, showing that the managers treated the two estates as a single till. A concrete example: an operating company that pays significant sums each month to a property holding company (SCI) owned by the same manager, with no written lease or defined rent, while the SCI bears no cost in return, presents the typical profile of an abnormal financial relation.

Inextricably intertwined accounts

The second criterion concerns accounting commingling itself. The entities' accounts are so mixed that it becomes impossible to determine, item by item, what belongs to one and what belongs to the other. This is referred to as inextricable intertwining of assets and liabilities.

This intertwining shows itself in a single set of books kept for several companies, joint bank accounts fed indiscriminately, stock that is not individualised, or the absence of any inventory making it possible to attach an asset to a given estate. Here the judge looks not for an imbalance of value but for a material impossibility of separation. Where the chartered accountant or the representative can reconstitute the respective estates only at the cost of an impossible disentangling exercise, commingling is established.

In practice, the two criteria often overlap. A business that organises abnormal flows frequently ends up muddying its accounts. The applicant for extension nonetheless has every interest in characterising the criterion invoked precisely, because the burden of proof is not identical: abnormal flows are proved by bank statements and targeted entries, intertwining by an overall finding of inextricability.

The sham company: the façade legal entity

The second ground for extension is the sham nature of the legal entity. Here the reasoning changes in nature. The point is no longer to find that two real estates have been commingled, but to show that the legal entity never had a genuine existence: it is a shell, a screen, a legal appearance masking the action of a third party, most often the manager or a parent company.

A sham company is recognised by the absence of the constituent elements of a partnership contract. The central criterion is the lack of affectio societatis, that is, the absence of a genuine intention to collaborate on an equal footing in a common venture. Several converging indicia found the characterisation:

• nominee shareholders, with no real contributions or any decision-making power, fronting for a single master of the business
• no functioning of the company's organs: no general meetings, no resolutions, no effective corporate life
• an economic activity that is non-existent or entirely dictated by a third party who decides alone, collects and disposes of the funds
• fictitious or token contributions, share capital never paid up, or the absence of any operating means of its own
• a registered address, a manager and a clientele entirely merged with those of another entity

The classic illustration is a company created to ring-fence valuable assets or to receive cash, but which carries on no real activity and whose statutory manager is merely an agent of the real master of the business. The sham nature then leads the court to disregard the corporate screen and to combine the façade's estate with that of the entity in proceedings.

The distinction from commingling of assets has practical consequences. The sham nature goes to the very existence of the legal entity and requires proof of a simulation. Commingling goes to the separation of estates between entities whose existence is not itself disputed. A prudent creditor will often put its claims principally on one of the grounds and in the alternative on the other.

Extension and groups of companies: where the boundary lies

Extension in a group of companies is the most delicate terrain, because it collides with a cardinal principle of business law: the financial autonomy of each legal entity. Membership of a group does not, in itself, entail any joint liability or any commingling. A parent company and its subsidiary, a holding company and its shareholdings, remain distinct legal subjects, holding separate estates. The particular situation of partners of a SNC (French general partnership) in the face of the company's insolvency proceedings, in light of their unlimited and joint liability, is examined in our dedicated article.

A requirement of rigour follows: the normal flows in the life of a group do not establish commingling. A duly concluded and remunerated cash management agreement, a management fees agreement corresponding to real services, an intra-group surety, centralised purchasing or the pooling of support functions are not abnormal in themselves. They fall within ordinary asset management, accepted provided that they rest on consideration and serve a group interest.

The shift to extension requires crossing the threshold of abnormality or of sham nature. The judge examines whether the group logic served as cover for a systematic stripping of the company in difficulty, or for the creation of screen entities. This is why mere identity of managers, a community of economic interests or commercial dependence, on their own, are never sufficient. The applicant must establish either concrete abnormal financial relations or the real non-existence of one of the companies. This requirement protects structured groups and confines extension to abusive arrangements.

How an institutional creditor can bring about extension

This is where the strategic interest of the subject lies. A reading of Article L. 621-2 reveals a decisive limit: the creditor is not among the persons with standing to request extension. The text reserves the initiative to the judicial administrator, the creditors' representative, the debtor and the public prosecutor's office. A creditor, even an institutional one of the first rank, therefore cannot directly summon the third-party entity for extension. Its application would be declared inadmissible for lack of standing.

This finding does not condemn the creditor to passivity. Several indirect routes allow it to steer the proceedings towards extension and thereby to widen its pledge.

The first is to approach the creditors' representative. The representative acts for the collective interest of the creditors; it has standing to bring extension proceedings and every interest in rebuilding an impoverished estate. An institutional creditor holding probative material, such as bank statements showing one-way transfers, invoices without consideration or asset ring-fencing arrangements, has an interest in bringing it to the representative's attention by a detailed report, documenting precisely the abnormal financial flows or the indicia of a sham company. A solid body of evidence significantly increases the likelihood that the representative will bring the action.

The second route is through the public prosecutor's office. The prosecutor has its own standing to request extension and plays an active role in insolvency proceedings, in particular where indications of fraud, organised insolvency or a fraudulent arrangement appear. A creditor may send it a documented report, particularly relevant where the facts have a criminal dimension, such as fraudulent bankruptcy (banqueroute) by misappropriation of assets or fraudulent organisation of insolvency. On the use by the creditor of fraudulent bankruptcy and management bans against a manager who organises his or her own insolvency, see our analysis of this criminal lever.

The third route, the most operational, is the application to be appointed as supervisor (contrôleur), on the basis of Articles L. 621-10 et seq. of the French Commercial Code. The supervisor assists the representative in its task and monitors its action. Above all, where the representative remains inactive, the law allows a supervisor to bring certain actions, in default, in the collective interest of the creditors, after a formal notice that has gone unanswered. Supervisor status gives the creditor access to information on the proceedings, a right of oversight over the representative's strategy and a lever to spur on the extension action. Public creditors, such as URSSAF or the tax authorities, are frequently appointed supervisors and actively use that position.

The combination of these three levers, a report to the representative, referral to the prosecutor's office and taking up supervisor status, constitutes the real strategy of the institutional creditor wishing to widen its pledge. It turns an apparent procedural inadmissibility into a real capacity to influence the outcome of the case.

One point on time limits deserves attention. Case law holds that an extension action for commingling of assets or sham nature is not subject to a limitation period inherent in its nature. This absence of limitation gives the creditor and the representative time to gather evidence, which is often lengthy to assemble where concealed flows must be reconstructed. It nonetheless remains prudent to act without delay, because the dispersal of assets and the disappearance of accounting records make proof harder with time.

The effects of extension on the creditors' pledge

Extension produces a radical and immediate effect: the unity of the proceedings. The attached estates are combined into a single pool, managed by a single representative, under a single procedure. It is this combination that is the central benefit for the creditor.

In practical terms, the assets of the attached entity swell the creditors' common pledge. Assets that had been lodged in the sham company or in the entity that benefited from the abnormal flows become realisable for the benefit of all the creditors in the proceedings. A creditor who had only an empty shell in front of it finds a substantial asset base again. Symmetrically, the liabilities of the combined entities are merged: the creditors of the attached entity enter the proceedings, which may reduce the benefit for an original creditor. The final balance depends on the ratio between the assets recovered and the liabilities absorbed, hence the importance of a forward-looking analysis before launching the action.

Unity entails other technical consequences. The court may set a common date of cessation of payments, which widens the suspect period applicable to the attached entity. The nullities of the suspect period, provided for in Articles L. 632-1 et seq. of the French Commercial Code, may then strike at the abnormal acts performed by the combined entity, further strengthening the reconstitution of the assets. Proofs of debt, relief from time-bar and the whole procedural regime apply in a unified manner.

In this respect extension differs from the other mechanisms for reconstituting assets. It is neither an action to make up the shortfall (comblement de passif), now the action for liability for insufficiency of assets under Article L. 651-2, which presupposes a management fault by the manager, nor an action for nullity of the suspect period, nor an action paulienne (action to set aside acts in fraud of creditors). Extension does not penalise a fault: it records a financial reality, namely that the separation of the estates was only apparent. This difference in nature explains why it does not require proof of loss or of an intention to harm, but only objective criteria of commingling or sham nature. The conditions and risks of the action for liability for insufficiency of assets brought against the manager in liquidation are set out in our article on Article L. 651-2.

Conclusion

Extension of insolvency proceedings is not an ancillary weapon: it is often the only instrument capable of yielding a dividend to a creditor faced with an entity drained of its substance. The two grounds respond to different logics that must be handled with discernment. Commingling of assets penalises abnormal financial flows or an inextricable intertwining of accounts between entities whose existence is not disputed. The sham company, for its part, brings down the screen of a legal entity that never genuinely existed. In the context of a group, the boundary is demanding: financial autonomy remains the rule, and only established abnormality or proven sham nature justifies breaking it.

The position taken in this analysis is clear: the institutional creditor is not condemned to endure the inadmissibility that Article L. 621-2 sets against it. It has a real power of initiative, provided that it exercises it through the right channels and builds, in advance, a methodical body of evidence. Proof of abnormal flows or of sham nature is prepared, not improvised at the hearing.

Before any report, a prudent creditor should have an audit carried out of the flows between the debtor and the suspected entities, map the movements lacking consideration, and apply for appointment as supervisor in order to gain access to the documents in the proceedings. It is as a supervisor, with a documented file in support, that it will effectively influence the decision of the representative or the prosecutor's office to bring the extension and widen the common pledge.

Frequently asked questions

Can a creditor directly request extension of insolvency proceedings? No. Article L. 621-2, paragraph 2, of the French Commercial Code reserves the request for extension to the judicial administrator, the creditors' representative, the debtor and the public prosecutor's office. A summons issued by a creditor would be inadmissible for lack of standing. The creditor must go through the creditors' representative, refer the matter to the public prosecutor's office by a documented report, or obtain appointment as supervisor in order to act where the representative is in default.

What is the difference between commingling of assets and a sham company? Commingling of assets presupposes that two entities, whose existence is not disputed, have mixed their estates, either through abnormal financial relations or through an inextricable intertwining of their accounts. A sham company is a legal entity that never had a real existence, lacking affectio societatis and effective functioning, serving as a mere screen. The first ground finds a commingling between real estates, the second the non-existence of an autonomous estate.

Is membership of a group of companies enough to justify extension? No. The financial autonomy of each legal entity is a protected principle. The normal arrangements of a group, remunerated centralised cash management, management fees with real consideration, intra-group sureties, do not establish commingling. Extension in a group of companies requires proof of either abnormal and systematic financial flows or the sham nature of one of the entities. Mere identity of managers or economic dependence is not enough.

What is an abnormal financial flow justifying commingling of assets? It is a movement of value between two estates lacking economic consideration and contrary to the own interest of the entity that is being impoverished. Examples frequently accepted: bearing another company's debts without reimbursement, repeated cash advances never repaid, invoicing of fictitious services, unjustified waivers of claims. It is the systematic and unbalanced character of the flows, and not an isolated transfer, that reveals the absence of a boundary between the estates.

Which court has jurisdiction to rule on extension? Article L. 621-2 of the French Commercial Code provides that the court that opened the initial proceedings remains competent for the extension, even if the attached entity has its registered office in another area. This rule avoids conflicts of jurisdiction and concentrates the litigation before a single court, generally the commercial court (tribunal de commerce), or the tribunal judiciaire for debtors who are not traders.

Is the extension action subject to a limitation period? Case law holds that an extension action based on commingling of assets or sham nature is not subject to a limitation period inherent in its nature. It nonetheless remains advisable to act quickly, because the dispersal of assets and the gradual disappearance of accounting records make it harder, with time, to prove abnormal flows or sham nature.

What is the effect of extension on the creditors' pledge? Extension combines the estates into a single pool managed by a single representative. The assets of the attached entity, property and cash lodged in the sham company or in the beneficiary of the abnormal flows, swell the common pledge. In return, the liabilities of the entities are merged and the creditors of the attached entity enter the proceedings. The net benefit for a creditor therefore depends on the ratio between the assets recovered and the liabilities absorbed.