Forced heirship: How does it matter?

Tue 25 April 2017, Philippe Ropenga Forced heirship Estate management EU Succession Regulation 650/2012

Mr. and Mrs. Jones own a house in Southern France. While enjoying lovely weather and fine wine, they start thinking about estate planning. They have read about forced heirship in French law on the Internet and are considering the transfer of the legal title to the house situated in France to a corporate entity in order to circumvent it. Mr. and Mrs. Jones will seek professional advice regarding this transfer to a corporate entity, a French Société Civile Immobilère (SCI).

Let’s see how Mr and Mrs Jones can use this company to circumvent forced heirship (1) before considering forced heirship from a different perspective (2).

1 Understanding the use of a company to circumvent forced heirship

1.1 The legal and cultural background

According to the forced heirship principle, forced heirs who are designated by law should receive a share of the estate of the deceased person, notwithstanding his or her will. A forced heir can renounce his share in the estate, but the testator cannot deprive a forced heir of his share.

1.1.1 Legal principles at stake

According to the forced heirship principle, forced heirs who are designated by law should receive a share of the estate of the deceased person, notwithstanding his or her will. A forced heir can renounce his share in the estate, but the testator cannot deprive a forced heir of his share. In France, things are divided into two categories: movables and immovables. A car moves; it is a movable. A book can be moved by hand; it is a movable. A house does not move; it is an immovable. Immaterial things such as patents and company shares are movables. Article 3 of the French civil code provides inter alia that "French law governs immovables, even those possessed by aliens¹." The law applicable to movables, in contrast, is the law of the last domicile of the deceased. This law then designates the applicable law.

1.1.2 Cultural background

Traditionally, forced heirship is used to prevent the dispersion of assets Immovables are closely related to territory and therefore are a matter of public policy. Under this traditional view, immovables are considered of greater value than moveables and therefore deserve greater attention in law.

1.2 The function of the company

1.2.1 Its role before 17th August 2015

Article 3 of the French civil code provides that immovables situated in France have to be governed by French Law. Until recently, the immovable nature of a house caused significant difficulties to its owners. To circumvent forced heirship, Mr. and Mrs. Jones could have turned the house into a movable. They could have done so by transferring the title to the house to a company. The house would have been owned by the company. Its assets would have been divided into shares, and therefore would have fallen into the movable category. Each jurisdiction applies a rule to determine the applicable law in an international context. As a result, following the relevant French conflict rule, the transfer to the company would have triggered the application of the law of the last domicile of the deceased.

Let's assume that Mr. and Mrs. Jones lived and died in a common law country before this date, the applicable law would have been the law designated by the conflict rule applicable in this country. Chances are that it would have been the law of the country where they lived and died. Here, everything would have worked fine. The house would have been turned into shares, and the applicable law would have been that of this common law country and it probably would have ignored forced heirship. Nevertheless, one has to be extremely cautious since if the law chosen by Mr. and Mrs Jones in turn designates another law, one has to make sure this law does not apply forced heirship rules.

1.2.2 Its role after 17th August 2015

On 17th August 2015, the European Union Succession Regulation² also known as Brussels IV by some Anglo-Saxon people came into effect. Mr. and Mrs. Jones have read on the Internet that they can now choose the law applicable to their succession. Can they choose a law to avoid forced heirship?

Two elements regarding the EU succession regulation have to be taken into account to answer this question: the universal application of the regulation and the optional nature of the choice of law.

The universal application simply means that any court within the EU, except the UK, Ireland and Denmark, applies this regulation notwithstanding the place of residency of the parties or their nationality. Since Mr. and Mrs. Jones own a house in France, a French court may apply the regulation to determine the applicable law to resolve a dispute regarding their succession. The choice of law is only an option. The default rule provides that if no choice has been made, the applicable law is the law of habitual residency. It may be difficult to foresee what one's habitual place of residency will be at the time of one's death. The applicable law will now govern the entire succession. It will apply to any property, be it movable or immovable. This means that the use of corporate structure to circumvent forced heirship is unnecessary. Mr. and Mrs. Jones have already lived in different places around the world and do not know what tomorrow will bring. The only thing sure is that they have the nationality of a third-party state, such as the USA. They can choose this law if they want to. They however need to make sure that the law of their nationality does not in turn designate a law they wish to avoid before they choose this law. Transferring their immovable property to an SCI still is interesting in the context of the European regulation regarding succession since estate planning is not all about avoiding forced heirship as we will see below.

2 Seeing forced heirship from a different perspective

Mr. and Mrs Jones and many other international clients are obsessed with forced heirship and tax. This post has to remain short, and tax issues are beyond its scope. Now that Mr. and Mrs. Jones know the basics of forced heirship avoidance through a company, let’s have a look at the legality of forced heirship avoidance in French law, and then at is opportunity.

2.1 The legality of forced heirship avoidance

It has been seen that a French court may have to know about Mr. and Mrs. Jones succession. How will a French judge react if he or is faced with a case of forced-heirship avoidance? As often, there is a principle and there is a practice.

2.1.1 Principle

Every case regarding forced heirship in French private international law is based on the following principle: what is fraudulent is invalid. So, what is fraud? Fraud is the use of a lawful mean to achieve an unlawful purpose. In the case of forced heirship, it is lawful to transfer the legal title to a house to a company. It however is unlawful to deprive a forced heir of the estate portion he or she is entitled to. Is it then lawful to transfer the legal title to a house to a corporate entity in order to avoid the application of forced heirship?

Case law shows how courts apply this principle in practice.

2.1.2 Practice

Until recently, the authority of the famous case involving Lesley Caron as forced heir was undisputed. The Cour de cassation (the French supreme court that deals with civil, commercial and criminal cases) held in 1985³ that changing the nature of an immovable by transferring the legal title to the property to a corporate entity in order to deprive forced heirs of their portion of the estate was fraudulent.

On the 11th May 2016, the Paris Court of Appeal has decided a case regarding the Jarre Family trust⁴. The trust was created for the benefit of the surviving spouse. The spouses were the trustees. The entire estate of Mr. Jarre was held on trust. On 3rd March 1995, the legal title to a Parisian immovable was transferred to a société civile immobilière. On 31st May 1995, the title to shares was transferred to the trust. Some heirs argued that the only purpose of the creation of the company followed by the transfer of shares was to avoid the application of forced heirship. Their point was that the major reason for holding shares of a company that owned an immovable instead of holding the immovable itself on trust was forced-heirship avoidance.

The Court of Appeal dismissed the argument. It stated that a transfer of legal title to an SCI was fraudulent when it happened in haste, shortly before the owner's death. The Court then looked at the facts and noted that the transfer took place fourteen years before the owner's death. It was part of a well-defined plan designed to give everything to the wife. The Court then noted that the estate plan was also conceived for economic, fiscal, and commercial reasons and therefore held that it was valid.

Does it mean that forced heirship does not matter anymore? Forced heirship still is an important principle that always applies to internal French cases but one can avoid it.

Does it mean that any foreign citizen can do whatever he or she wants with his or her estate? Certainly not. This case has not been decided by the Cour de cassation. It may be confirmed since the French ministry of justice does not seem interested in promoting forced heirship⁵. Furthermore, according to the Paris Court of Appeal, there are principles that are protected by French international public policy "such as principles of non-discrimination regarding sex, religion or the type of filiation." This gives a clear indication about the current state of law: forced heirship is not an essential principle. Case law is forged by more than one court. Nevertheless, the current trend is in favour of forced-heirship avoidance.

Anglo-Saxon lawyers know very well that it is fairly easy to highlight a difference in treatment in order to plead a cause as a case of discrimination. We can imagine the following case based on sex discrimination. The deceased thought that his daughter would squander all his estate and decide to avoid forced heirship in order not to leave anything to his daughter. She probably will argue later that the purpose of this estate planning was to discriminate her. If the father mistrusted the daughter with money during his lifetime, the wisely-advised daughter probably would have gathered evidence to comfort her case.

In brief, the case ruled by the Court of Appeal does not necessarily means that French courts will promote testamentary freedom as much as the Anglo-Saxon ones. They may well intervene as much as they do now on different grounds.

2.2 The opportunity of forced-heirship avoidance

2.2.1 A nice decoy

If you do not have a headache by now, you have already noticed that this brief description of a common technique of forced-heirship avoidance required more than a thousand words. In real life, this means a lot of drafting and thus high fees. Is it worth it?

2.2.2 Other important things

Among the two other important things, one is overestimated while the other tends to be disregarded.

Tax issues

The issues are well-known and answers to the questions they raise depend on Mr. and Mrs. Jones' situation. French tax administration considers that a SCI is fiscally transparent. The SCI is a company with a legal personality that is distinct from that of its shareholders, but the fiscal administration treats the income produced by the SCI as the personal income of its shareholders. Mr. and Mrs. Dupond are French and live in France. They run a SCI that owns empty flats. Rents are treated as their own income, and they do not have to pay any tax regarding profits made by the SCI. Mr. and Mrs Jones have to be extremely cautious as their tax administration may consider the SCI as an opaque structure, and tax profits made by the SCI before taxing Mr. and Mrs Jones. Furthermore, France is not only famous for its wine but also for its wealth tax.

Management issues

Clients tend to underestimate management issues. Consider the following two very common situations:

Situation 1: Frédéric Martin has five brothers and sisters. He is the director or gérant of the SCI that owns the family home in Bordeaux. All six of them are equal shareholders of the SCI. His sister Alice is married and her husband Alain, who has nothing to do with the SCI, constantly tells Marc that he does not know anything about real estate and that he should leave the management of the SCI to others. Since Alice does not want to intervene in the dispute, she does not wish to make any decision regarding the property. Bernard thinks that he should be the gérant and therefore always contradicts Frédéric and votes against his plans regarding the company. Cédric lives in Tahiti. Daniel lives in Canada. They never cared about the management of the family home. Évelyne always supports Frédéric.

Since Frédéric is the gérant and has large powers, he can make decisions despite Bernard's hostility and the lack of engagement of the others. None of them, except Bernard, wishes to replace him. The value of the property is maintained over time.

Situation 2:Facts are the same except that there is no SCI. Everyone is an equal co-owner of the legal title to the house. Bernard does not have the power to make important decisions. No one, except Évelyne and Bernard, wants to make any decision since it could mean supporting Fréderic against Bernard or Bernard against Frédéric.

The property decays; taxes are not paid. It will require long and expensive court proceedings to solve the different issues that will arise. One can now understand why the French tax administration treats the SCI as a fiscally-transparent structure: It allows better management. The SCI primarily is a management tool, that can be used to circumvent forced heirship.

Conclusion

If Mr. and Mrs. Jones spend a lot of time and money on avoiding forced heirship, they probably will find a professional able to conceive the most exciting estate plan they have ever seen. They will however feel frustrated when they discover that this plan does not meet their needs in real life and does not facilitate the transfer of the assets to the next generation.

In brief, forced heirship may be a problem, but it can be easily circumvented in the vast majority of cases involving Anglo-Saxon clients. It therefore is not wise to focus on forced-heirship avoidance. One should also consider management issues that really are thorny in practice. The same difficulty occurs with trusts: it is not easy to find the right trustee and the right lawyer to look after the family property over time. Devoting time to think about future management issues sounds less exciting than drafting audacious estate plans, but it is crucial.

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