Sale of Shares or Disguised Sale of Real Estate: The Implied Warranty Against Hidden Defects Applies

Imagine: you buy a flat in Biscarrosse, near the lake, to use as your second home. The seller offers you to buy the shares of an SCI that holds the property. This seems simple, quick, and you avoid notary fees. But a few months later, a persistent damp smell appears. The walls turn black. You discover old infiltrations that the seller knew about. Who must pay for the repairs? The seller tells you: "You bought shares, not a building. No warranty!" Is that true?

This question was answered by the Court of Cassation in a famous judgment of 5 May 1981 (No. 79-17.115). It held that when the transfer of shares is merely a marketing technique — a disguised sale of real estate — the sellers are bound by the implied warranty against hidden defects provided for in Article 1641 of the Civil Code. In other words, the law cannot be circumvented by changing the legal form of the sale.

In this article, I will tell you the facts of this case, dissect the judges' reasoning, and give you practical advice to avoid pitfalls. Whether you are an owner, buyer, or property professional in Dax or elsewhere, what you are about to read may save you a lot of trouble.

The Facts: A Story Like Many Others

In this case, a property company (SCI) had been set up to build and sell units in a building. The shareholders of the SCI — the sellers — transferred their shares to buyers. But in reality, this transfer of shares was a scheme: each transfer resulted in an immediate winding-up of the SCI, with a specific unit being allocated to each buyer. The "shareholders" never truly had the status of shareholders: they became owners of their unit upon signing.

Mr X, an owner in Biscarrosse, was one such buyer. After the sale, he discovered hidden defects (probably construction defects, such as infiltrations or cracks). He sued the sellers for compensation. They responded: "You bought shares, not a building. The implied warranty against hidden defects does not apply."

The Court of Appeal ruled in favour of Mr X. The sellers then appealed to the Court of Cassation. Their argument: the transfer of shares is a sale of corporate rights, not a sale of real estate. Therefore, the rules on the sale of real estate, including the implied warranty against hidden defects, do not apply. The Court of Cassation dismissed the appeal. It confirmed that the sellers were liable under the implied warranty against hidden defects because the transfer of shares was merely a device.

The Court's Reasoning — Dissected

The Court of Cassation relied on Article 1641 of the Civil Code. This article provides that the seller is bound to warrant the buyer against hidden defects that render the property unfit for its intended use or so diminish its use that the buyer would not have acquired it, or would have paid a lower price, had they known of them. In short, if a non-apparent defect existed at the time of the sale and is serious, the seller must compensate.

But the sellers argued: "This is not a sale of real estate, so Article 1641 does not apply." The Court responded: "Since it is conclusively found that the SCI was merely a marketing technique, that the transfer of its shares was only a legal form devoid of real effect, that the transferees were never shareholders because the transfer deed entailed an immediate winding-up with allocation of units to the buyers, and that, finally, under the guise of share transfers, sales of completed buildings were carried out, the sellers are bound by the implied warranty against hidden defects."

In other words, the judges looked at the economic and legal reality of the transaction, not just its outward form. It does not matter that the contract is called a "transfer of shares" if in fact it is a sale of real estate. This is known as "recharacterisation": the court can reclassify an act according to its true nature. This principle is fundamental in law.

This decision is not a departure: it confirms earlier case law. But it is particularly clear on the point that form must not mask substance. The judges also noted that the share transfers resulted in an immediate winding-up of the SCI, which proved that the parties' intention was indeed to sell units.

What This Means for You — Practically

For buyers, this is an essential protection. If you are offered to buy a home via SCI shares and you discover a hidden defect, you can take action against the seller as if you had bought the building directly. You benefit from the legal warranty, even if the contract says otherwise. But beware: you must prove that the defect existed before the sale and was hidden. An apparent defect (visible during the viewing) does not entitle you to a warranty.

For sellers, this is a warning. You cannot escape your obligations by using an SCI. If you sell units in the form of shares, you remain liable for hidden defects, unless there is a valid exclusion clause (but such clauses are strictly regulated). For example, a developer in Dax who sells flats through an SCI cannot hide behind the corporate form to avoid liability.

Take a concrete example: in Biscarrosse, a buyer purchases a studio via an SCI for €150,000. A year later, they discover infiltrations requiring €20,000 in repairs. If the defect is hidden and pre-existed the sale, the seller must pay. Without this case law, the buyer would have had no recourse.

If you are in this situation, you must act quickly. An action for hidden defects must be brought within two years of discovering the defect (Article 1648 of the Civil Code). Do not delay: gather evidence (photos, expert reports, witness statements) and consult a lawyer.

Four Tips to Avoid This Type of Dispute

• Have the property inspected before buying: Whether you buy shares or the property directly, hire a building expert. For €500 to €1,500, you can detect hidden defects before the sale. That is little compared to the cost of a lawsuit.
• Require contractual warranties: In the share transfer deed, include a clause whereby the seller declares no knowledge of any hidden defects and undertakes to warrant defects discovered within five years. Even if the law protects you, a clear clause facilitates recourse.
• Verify the reality of the SCI: If you are offered to buy via an SCI, ask to see the articles of association, accounts, and ensure the company has a genuine activity. If the SCI only holds one building and shares are transferred with immediate winding-up, that is a red flag.
• Keep all documents: Retain technical surveys, emails, photos of the condition of the property. In the event of a dispute, these elements are crucial to prove that the defect pre-existed.

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Further Reading: Related Case Law and Developments

The 1981 decision is part of a consistent line. For example, the Court of Cassation held in 1993 (Civ. 3e, 10 March 1993, No. 91-12.642) that the sale of shares in an SCI whose sole purpose was to hold a building should be recharacterised as a sale of real estate if the transfers were made to third parties. Similarly, in 2005, it applied the same reasoning to transfers of shares in a joint venture (Civ. 3e, 21 September 2005, No. 04-12.449).

The trend is clear: courts look at economic reality. In recent years, they have become even more vigilant against schemes using SCIs to circumvent protective rules for buyers (such as pre-emption rights, construction standards, etc.).

Going forward, expect courts to continue recharacterising transactions whenever the legal form does not match reality. If you are considering a sale via an SCI, seek advice to avoid an unpleasant surprise.

Checklist Before Taking Action

FAQ – Frequently Asked Questions

1. Can I take action against the seller if I bought SCI shares and discover a hidden defect? Yes, if the share transfer was in reality a disguised sale of real estate. You benefit from the implied warranty against hidden defects. But you must prove that the defect existed before the sale and was hidden.
2. What is the time limit to act? You have two years from the discovery of the defect. After this period, you lose any recourse. Do not delay consulting a lawyer.
3. What if the seller refuses to acknowledge the defect? Have the defect officially recorded by a court-appointed expert (you can request a preliminary injunction for preservation of evidence without waiting for the trial). Then sue the seller for breach of warranty.
4. Can the seller exclude liability by a clause? In principle, the implied warranty against hidden defects is a matter of public policy: it cannot be waived in advance. However, a non-warranty clause may be valid if the seller is a private individual not acting in a professional capacity and the buyer is a professional aware of the risks. In your case, if you are a private individual, the clause will likely be deemed unfair.
5. How much does a procedure cost? Legal fees and expert costs can range from €3,000 to €10,000, but if you win, the seller may be ordered to reimburse them. A preliminary consultation with a lawyer (€45 with Maître Zakine) allows you to assess your chances.

Are you in a similar situation? A 30-minute initial consultation with Maître Zakine (€45) could save you months of litigation — and often much more. Book an appointment →