In Short
The Situation: For the first time ever, a court in France has examined the compatibility of the statutory netting safe harbor with the French Constitution. The French High Court of Justice (Cour de cassation) addressed the preliminary question of constitutionality in the context of an insolvency proceeding and handed down its decision on March 6, 2024.
The Result: The court declined to refer the question to the French Supreme Court (Conseil constitutionnel) on the grounds that there was no serious legal question worthy of any further analysis. By doing so, the court affirmed that the protection against systemic risk, as well as the imperatives of legal certainty and stability of the financial system, are in the public general interest.
Looking Ahead: This decision sets a major precedent, confirming the soundness of the legal basis and fundamentals of close-out netting under French law.
In December 2023, an insolvency court in France received a "preliminary question of constitutionality" (a "PQC") regarding the constitutionality of the rules protecting master agreements for derivatives and transactions involving financial instruments. The issue raised the question of what happens when one of the counterparties is the subject of insolvency or similar proceedings, which—given the numerous rules in French insolvency law—would otherwise prevent the netting from being enforceable against the debtor and its creditors, unless this safe harbor were to exist.
In brief, during a trial before any court in France, a litigator can challenge the law sought to be applied by the court, if he or she thinks that such law is contrary to the rights and freedoms guaranteed by the Constitution. This is done by submitting a "PQC," which must be examined by the court before the case goes to trial.
If all conditions are met, the Conseil constitutionnel (the French equivalent of the U.S. Supreme Court and the highest constitutional authority in France) examines the contested law and decides whether or not it conforms to the Constitution.
In order to prevent the Conseil constitutionnel from being overburdened and to avoid delaying tactics, French law provides for a filter for any such requests. Before referring any PQC to the Conseil constitutionnel, the Cour de cassation must first determine whether the question posed is of a serious or novel nature. If the Cour de cassation decides that the question is not serious, the PQC will not be referred to the Conseil constitutionnel, and proceedings resume. When a PQC is submitted to the Cour de cassation, it must be examined within three months. No appeal is possible if the PQC is not transmitted to the Conseil constitutionnel.
In the present case, the receivers of a bankrupt French company challenged the constitutionality of the French netting safe harbor. This was the first time that a French court has been asked to evaluate a PQC specifically challenging the safe harbor. The safe harbor in France derives partly from the EU Collateral Directive—partly only, because as in many EU jurisdictions, France has made a "corporate opt out" when implementing the Collateral Directive. As a result, the safe harbor for ordinary corporate companies in the French hierarchy of norms is a national law, not an EU directive incorporated into French law.
Before making its decision, the Commercial Chamber of the Cour de cassation sought the opinion of Caroline Henry, Advocate General before the Court. The court followed the Advocate General's opinion and handed down its ruling on March 6, 2024, in a very favorable development for the financial sector.
The question of constitutionality was asked as follows:
Does [the safe habor] applicable to agreements relating to financial obligations [...], which derogates from the public policy principle of continuation of ongoing contracts and from the prohibition on termination of said contracts due to the opening of collective proceedings, [...] comply with the principle of equality between creditors guaranteed by article 6 of the French Declaration of the Rights of Man and of the Citizen of 1789?
The Cour de cassation, in a short decision, refused to refer the matter to the Conseil constitutionnel, as it is empowered to do. Its reasoning was clear: "The question posed is not of a serious nature."
The court emphasized that the principle of equality of creditors does not preclude the legislator from: (i) regulating different situations in different ways; or (ii) derogating from equality for reasons of general interest, provided that, in either case, the resulting difference in treatment is directly related to the purpose of the law establishing it. The court then affirmed that the distinct treatment applied under French law to derivatives and securities financing transaction master agreements in insolvency proceedings is justified by the need for legal certainty and stability of the financial system, both being in the general public interest and directly related to the purpose of the common rules applicable to transactions in financial instruments.
Three Key Takeaways
- The court's decision is a positive, important development for French financial markets. Now that the Cour de cassation has ruled that any challenge to the constitutionality of the French netting safe harbor is non-serious, there is judicial precedent that makes it highly unlikely that the question would be asked again.
- No French court ruling has ever called into question the validity of netting in insolvency. This new decision further strengthens the legal foundations of netting agreements in France.
- This is a significant issue, given ISDA's choice of French law (and Irish law) in 2017 to govern the 2002 Master Agreement in order to provide market participants in the European Union with the unparalleled benefits conferred by the European judicial passport (i.e., immediate enforcement of court rulings throughout the territory of the Union, without any exequatur, delay, or judicial cost).
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