French Court of Cassation, 19 January 2010 (No. 08-19.376)

‍The Dispute

A majority shareholder sold his shares to a purchaser under a share purchase agreement (SPA) that included an earn-out mechanism, calculated by reference to the company’s future financial performance. Payment of the earn-out was also conditional upon the seller remaining in a management role until a defined trigger date.

Prior to that date, the purchaser exercised its contractual right to revoke the seller from his position. The seller initiated proceedings to annul the SPA, arguing that the earn-out clause was void on the basis that it constituted a condition potestative.

Under French law, a condition potestative is a contractual condition whose fulfilment depends solely on the will of the obligor. Pursuant to Article 1304-2 of the French Civil Code (formerly Article 1174), such conditions are null and void.

Judicial Decisions

Decision of the Court of Appeal

The Court of Appeal dismissed the seller’s argument. While it acknowledged that thepurchaser, as majority shareholder, had the ability to revoke the seller ad nutum, it concluded that this discretion did not render the earn-out condition void. It reasoned that under former Article 1178, a condition is deemed fulfilled if its performance is prevented by the obligor in bad faith. Accordingly, the court found that the clause was not potestative, as the seller retained the ability to invoke the clause if revocation had been exercised abusively.

Decision of the Court of Cassation

The Court of Cassation partially quashed the decision, including to the extent that the Court of Appeal had rejected the claim for annulment of the earn-out.

The Court found that the appellate court had failed to apply the correct legal test for determining whether the clause was potestative. Specifically, it should have assessed whether the condition for payment of the earn-out was effectively subject to the purchaser’s sole discretion, by virtue of its unilateral revocation power. The mere existence of a remedy for bad faith did not negate the fundamental imbalance created by a clause whose fulfilment could be rendered illusory by one party alone.

The case was therefore remitted to a different Court of Appeal for reconsideration.

Key Point

To avoid the risk of an earn-out clause being declared void for potestativité, parties must ensure that its fulfilment does not rest solely on the purchaser’s discretion. Objective criteria - such as clearly defined revenue thresholds, EBITDA targets, or other measurable indicators - should underpin the payment condition. Where management tenure is a factor, safeguards must be in place to prevent its manipulation, particularly through discretionary revocation.