The Lending and Secured Finance Review: Luxembourg
Luxembourg is generally perceived as one of the most attractive business centres in the world. With approximately 125 international banking institutions, more than €4.8 trillion of assets managed by more than 4,000 undertakings for collective investment (as of January 2020),2 a successful private equity industry and a dynamic insurance sector, Luxembourg offers a full range of diversified and innovative financial services. Luxembourg has been assigned 'AAA' credit rating by the main rating agencies.
Although the main activity of Luxembourg banks is international financial intermediation, private banking is an important pillar of the financial industry. The move towards greater consolidation in the banking sector, which surfaced in recent years, has become one of the key features of the financial landscape in Luxembourg. Market players have to deal with mergers, restructurings and closing of lines of business.
The Luxembourg lending market is characterised by a growing presence of alternative credit providers. Luxembourg has the advantage of an experienced regulatory authority, the Luxembourg Financial Supervisory Commission (CSSF), which has clarified certain exemptions for Luxembourg lending platforms.
In recent years, Luxembourg has taken major initiatives to further increase its attractiveness, such as the development of a sophisticated fintech industry, a flourishing insurance and reinsurance industry, the creation of an important offshore Chinese renminbi hub, and the furtherance of Islamic finance projects and green bonds issuances.
Recent trends and legal developments offer the Luxembourg financial sector excellent growth opportunities. Particular points of interest are the lender-friendly security interest regime, the Luxembourg Fiduciary Act 2003 (as defined below), the double Luxco structure (the Double Luxco) and the development of the fintech ecosystem.
Legal and regulatory developments
i Security interests
In the aftermath of the economic crisis and the financial markets turmoil in 2008, financial collateral arrangements have attracted considerable attention from market participants. The Luxembourg Act dated 5 August 2005 on financial collateral arrangements, as amended (the Collateral Act 2005),3 provides for an attractive legal framework for security interests, liberalised rules for creating and enforcing financial collateral arrangements, and protection from insolvency rules. It applies to any financial collateral arrangements, irrespective of the nature of secured liabilities or the status of the pledgor or the pledgee, and covers financial instruments in the widest sense as well as cash claims and receivables.
The Collateral Act 2005 was amended in 2011 with a view to enhance the attractiveness of Luxembourg as an international finance centre.4 It now confirms that the insolvency safe harbour provisions also apply to foreign law-governed collateral arrangements entered into by a Luxembourg party, which are similar to the Luxembourg financial collateral arrangements. It provides that receivables pledges are validly created among the contracting parties and are binding against third parties as from the date of entering into the pledge agreement. It also modernised the enforcement mechanism by allowing the collateral taker to appropriate, out of court, the pledged assets at a price determined after the appropriation of the asset and to direct a third party to proceed with the appropriation in lieu of the collateral taker. Finally, the number of perfection mechanisms for pledges over book-entry securities has been increased by sanctioning different change of control mechanisms set forth in the American Uniform Commercial Code as additional perfection alternatives.
ii Fiduciary Act 2003
The Luxembourg Act of 27 July 2003 on the trust and on fiduciary contracts, as amended (the Fiduciary Act 2003),5 continues to offer interesting structuring opportunities. Pursuant to fiduciary agreements governed by the Fiduciary Act 2003, a fiduciary or creditor obtains ownership of the transferred assets. These assets are not part of its personal estate and may not be seized by its creditors in that they will form part of a segregated 'fiduciary property'. The Fiduciary Act 2003 expressly states that fiduciary agreements may be used for security purposes. Fiduciary agreements are, in principle, available for all types of assets, including shares, marketable financial instruments, bank assets, equipment, raw materials and inventory, intellectual property rights, claims and receivables.
iii Double Luxco
The Double Luxco has been developed in connection with the French leveraged buyout (LBO) market to provide a response to the challenges of French insolvency laws. It is now used in LBO transactions across Europe.
Under French law, as well as in other European civil law jurisdictions, secured debt needs to be due and payable for lenders to enforce their security package. This often means that secured lenders will be required to accelerate the financing prior to enforcement. However, in this case, there is a significant risk that the borrower would apply for some form of insolvency proceeding and as result prevent the secured lenders from enforcing their security.
In this context, the aim of the Double Luxco is to shift the enforcement point towards the Luxembourg jurisdiction, which is considered to be creditor-friendly and does not require that secured debt be due and payable for lenders to enforce their security package.
In a Double Luxco, the acquisition vehicle (e.g., a French special purpose vehicle) is held by a Luxembourg vehicle (Luxco 1), itself held by another Luxembourg vehicle (Luxco 2). Each of the Luxcos will give a pledge over the shares and any other debt or quasi-equity it owns in its subsidiary as security for the repayment of the borrower debt.
The key component of the structure is to create a security interest under Luxembourg law granted by Luxco 1 over the shares in Luxco 2 that, pursuant to Article 8 of Regulation (EU) No. 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings (the European Insolvency Regulation),6 is located in Luxembourg and, therefore, remains subject to Luxembourg law. The risk that the borrower or the Luxembourg entities would file for, for example, safeguard proceedings in France on the basis that it had its centre of main interest (COMI) in France (a COMI shift), is thus mitigated. The European Insolvency Regulation, which is the recast of Council Regulation (EC) No. 1346/2000 of 29 May 2000 on insolvency proceedings, as amended,7 entered into force on 26 June 2016 and applies to insolvency proceedings from 26 June 2017. The key changes include, among others, a new definition of COMI (see Section VII.i) and the introduction of new rules to determine the location of assets (e.g., cash held in accounts with a credit institution is located in the Member State indicated in the account's International Bank Account Number (IBAN)).
Some additional features have been built into the Double Luxco structure that allow the beneficiaries of a share pledge to vote on certain matters as if it were a shareholder without having to enforce the share pledge.
iv Alternative credit providers
According to the Luxembourg Act dated 5 April 1993 relating to the financial sector, as amended (the Banking Act 1993), any person granting loans on a professional basis must hold a licence of a credit institution or a professional in the financial sector carrying on lending activities in Luxembourg. In particular, Article 28-4 of the Banking Act 1993 defines professionals carrying on lending operations as professionals whose activity consists of granting loans to the public for their own account (without calling on public savings to refinance themselves). Article 28-4 not only covers the origination of loans8 (on a primary basis), but also the acquisition of undrawn or partially drawn loans (on a secondary basis) by a Luxembourg entity. Financial leasing and factoring activities also fall under Article 28-4.
Nonetheless, in certain instances lenders will be able to benefit from an exemption from licensing requirements under Article 28-4 of the Banking Act 1993. For instance, securitisation transactions are expressly excluded from its scope. There are also exemptions (by way of interpretation and administrative practice) that are granted by the CSSF (the CSSF Exemptions) insofar as loans are not granted to the public. The CSSF describes the notion of 'public' in a negative way and considers that a 'limited circle of persons previously known to the lender' does not fall within the notion of public. To assess the meaning of 'restricted circle of persons previously known to the lender', the CSSF applies two cumulatively criteria:
- the number of persons concerned must be limited (though the CSSF does not set a cap for the number of people above which the restricted circle no longer exists); and
- the persons concerned must be identified or identifiable in the sense of an existing relationship or a relationship that is in the process of being built on the basis of objective predetermined criteria (before the granting of the loans).
Furthermore, the requirement under Article 28-4 to hold a licence for carrying on lending activities only applies to the extent that loans are granted 'on a professional basis'. In other words, the granting of loans must be a regular occupation or a business activity. The reference to the professional character of the lending activity implies that it is performed repetitively and that unique or one-off lending operations are subject to neither Article 28-4 nor the Banking Act 1993 in general. In the same vein, the acquisition of fully drawn loans would normally be exempted from licensing requirements, as this would not be regarded as the granting of a loan. Where partially drawn or undrawn loans are concerned, or where the transfer concerns loans that have been entered into simultaneously or immediately prior to the transfer of the loans, it is likely that Article 28-4 will kick in (unless one of the CSSF Exemptions is available).
i Withholding tax
Interest payable under, or with respect to, Luxembourg law or foreign law loan agreements or security arrangement agreements may, in principle, be made free and clear of, and without withholding or deduction for or on account of, withholding tax in Luxembourg,9 provided that:
- all payments and transfers made by, on behalf, in favour or for the account of, the Luxembourg company under such agreements, are made on an arm's-length basis and are in accordance with market practice;
- the Luxembourg company is not, is not deemed to be and, as a result of entering into and performing such agreements, will not be, over-indebted in light of the current practice of the Luxembourg tax administration; and
- none of the parties to such agreements will have any relation with the Luxembourg company other than that of an independent third party acting in the normal course of its business or will maintain any particular economic relation with the Luxembourg company, other than that contemplated by such agreements.
ii Registration duties
There are, in principle, no stamp, registration or similar taxes, duties or charges under the laws of Luxembourg payable in connection with the execution, performance and enforcement by the relevant parties of Luxembourg law or foreign law loan agreements, or security arrangement agreements, except security interests that must be registered with public authorities in Luxembourg (such as mortgages over real estate property, aircraft or ships, general business pledges, pledges over IP rights), subject to the following.
The registration of any such agreements with the Luxembourg Registration Duties, Estates and VAT Authority in Luxembourg will be required if any such agreements are physically attached to a public deed or to any other document subject to mandatory registration, in which case either a nominal registration duty or an ad valorem duty (e.g., 0.24 per cent of the amount of the payment obligation mentioned in the document so registered) will be payable depending on the nature of the document to be registered. While the Luxembourg pledge agreements governed by the Collateral Act 2005 (as defined below) are not subject to registration pursuant to Article 26 of the Collateral Act 2005, if they are voluntarily registered with the Luxembourg Registration Duties, Estates and VAT Authority in Luxembourg on a voluntary basis, a nominal registration duty will be payable.
Credit support and subordination
Security interests governed by the Collateral Act 2005
The Collateral Act 2005 is regarded as one of the most creditor-friendly legal frameworks for security interests globally. It contemplates liberalised rules for creating and enforcing financial collateral arrangements and shields financial collateral arrangements from insolvency proceedings. The Collateral Act 2005 expressly provides that financial collateral arrangements (including pledges) are valid and enforceable, even if entered into during the pre-bankruptcy period (the 'hardening' or 'suspect' period), against all third parties including the insolvency receiver, liquidators and other similar persons irrespective of any insolvency, liquidation or other situation affecting anyone of the parties (except in the case of fraud).
The Collateral Act 2005 applies to any financial collateral arrangements, regardless of the status of the pledgor or the pledgee and of the nature of secured liabilities, and covers financial instruments in the widest sense as well as cash claims and receivables. Accordingly, pledges over shares, book-entry securities, intra-group loan receivables and pledges over bank accounts may benefit from this attractive framework.
The Collateral Act 2005 also provides for transfers of title by way of security and recognises the right of the pledgee to re-hypothecate the pledged assets. It enables the pledgee to use and dispose of the pledged assets. Contractual arrangements allowing for substitution and margin calls are expressly recognised by the Collateral Act 2005 and are protected in insolvency proceedings (in respect of which, security interests other than those covered by the Collateral Act 2005 and granted during the pre-bankruptcy suspect period can be challenged).
Creation and perfection requirements
The Collateral Act 2005 provides for a liberalised set of rules for creating and perfecting securities. As such, pledges over shares will be validly created and enforceable against third parties (depending on the type of company whose shares are pledged) by the execution of the pledge agreements or the registration of the pledge in the shareholders' register of the company concerned in the case of registered shares; the effective transfer of the shares to the pledgee (or a third party appointed by the pledgee) in the case of shares in bearer form; or by the registration of the pledge in the register of the depositary in the case of immobilised bearer shares. Other rules apply in the case of shares in book-entry form.
A pledge over intra-group loans or receivables governed by Luxembourg law or owed by a Luxembourg obligor is validly created and enforceable against third parties by the execution by the pledgor and the pledgee of the pledge agreement, and binding against the debtor upon the debtor having knowledge of the creation of the pledge. Future intra-group loans or receivables may be pledged, provided that they are determinable at the time the pledge is granted. Depending on the nature of receivables, the practice is to cover new receivables by establishing lists of receivables on a regular basis and servicing notices accordingly.
A pledge over bank accounts held with a credit institution in Luxembourg typically covers cash and book-entry securities. The pledged account can be either blocked or operated pursuant to the parties' agreement. The pledge will be notified to the depositary bank or, as applicable, consent will be obtained from the depositary bank as to:
- acceptance of the pledge by the depositary bank; and
- waiver and exclusion of bank set-offs and general pledge (available under general business conditions of Luxembourg banks).
Under the Collateral Act 2005, pledgees can benefit from enforcement measures that are generally viewed as creditor-friendly. A pledgee may enforce a pledge, without the obligation of prior notice to the pledgor, in its absolute discretion and in the most favourable manner provided by it.
In the case of a pledge over shares, the pledge may generally be enforced by the pledgee by way of:
- out-of-court appropriation of the shares at a price determined pursuant to a valuation method agreed upon by the parties in the pledge agreement (i.e., typically, a valuation to be carried out by an independent auditor or an investment bank chosen by the pledgee at the time of enforcement); or
- out-of-court private sale on arm's-length commercial terms (i.e., the sale must be made at a price that a well-informed independent willing buyer would normally, under relevant market conditions and taking into account the information available at that time, be prepared to pay to a willing seller).
The pledge agreement will typically provide for the possibility to enforce the pledge agreement by way of appropriation before the valuation has been commenced or completed, which may allow for the pledge to be enforced by the pledgee overnight. However, the pledgee may decide, depending on the particular circumstances and to reduce the risk of post-enforcement liability proceedings, to wait for the valuation to be completed before enforcing the pledge.
Under the Collateral Act 2005, the parties are free to determine the trigger event for enforcing a security interest. This can be an event of default of a non-payment type or any other event agreed upon by the parties, the occurrence of which will entitle the pledgee to enforce the security. However, an enforcement of a pledge triggered by an event of default other than a payment default may raise practical difficulties that will need to be carefully assessed on a case-by-case basis.
Comparable attractive enforcement methods exist for pledges over accounts or receivables. Furthermore, a pledge over an account and a pledge over receivables may generally be enforced by the pledgee by requesting payment to it by the bank where the account is held of the pledged assets or by the debtor of the pledged receivables, in and towards full payment and discharge of the secured liabilities.
Enforcement measures under the Collateral Act 2005 may undoubtedly be considered highly attractive to lenders. Therefore, and to the extent possible, market practice in Luxembourg consists of bringing a security package within the scope of the Collateral Act 2005.11
Other security interests
Luxembourg also has a trial-tested and relatively creditor-friendly security interest regime outside the Collateral Act 2005, and security interest can normally be taken over a wide range of assets.
Mortgages over real estate property, aircraft or ships located in Luxembourg
A mortgage may be taken over real estate property or aircraft and must be drafted in the form of a notarial deed. A mortgage over ships may be constituted by a private written agreement or a notarial deed. The mortgage agreement or deed must specify the assets covered precisely and must be registered at the mortgage registry of the judicial district in which the real estate property is located, in the maritime registry or in the registry for aircraft mortgages, as the case may be, to be valid and enforceable against third parties. Registration is subject to ad valorem taxes and translation requirements, and is valid for 10 years (renewable). The mortgage may be granted only to secure a sum of money that is certain and determined. The mortgage does not cover rentals and insurance policy proceeds, which must be separately pledged.
Pledges in respect of proceeds from insurance policies
A pledge can be granted in respect of proceeds from insurance policies. The pledge will be subject to similar rules as for a pledge over receivables.
Pledges over intellectual property rights
A pledge can be granted over patents. Pledges over copyrights (and, to a certain extent, over trademarks and models or designs) are subject to debate and require a case-by-case analysis. For validity and enforceability between the parties and against third parties, pledge agreements relating to patents, trademarks and models or design must be registered with the appropriate national or international intellectual property registration authorities.
General business pledges
A general business pledge is available under Luxembourg law and covers the following:
- business name and goodwill;
- trademarks and patents;
- rolling stock and other tools; and
- 50 per cent of the value of the inventory.
Receivables, securities and cash must be expressly included to be covered by the pledge (although there are no Luxembourg court precedents to confirm the validity of such inclusion). The general business pledge is only available over industrial or commercial business conducted in Luxembourg and can only be granted to credit institutions (and, for historic reasons, breweries) authorised specifically by the Luxembourg government to that end.
For validity and enforceability against creditors, the pledge must be registered at the mortgage registry of the judicial district in which the business is located. Registration is subject to ad valorem taxes and translation requirements and is valid for 10 years (renewable).
Satellites, rights to orbital slots and customer contracts
For assets such as satellites, rights to orbital slots or customer contracts, it may be difficult to obtain a valid Luxembourg law security interest and it would accordingly be preferable to restrict transfers of such assets to companies in Luxembourg.
Under Luxembourg law, contracts providing for reciprocal obligations of the parties may not be pledged as such. A pledge may, however, be granted over the monetary or restitution claims resulting from the contracts. An analysis of the customer contracts, as well as of the contractual documentation relating to satellites and rights to orbital slots, may be needed to determine whether Luxembourg security interests over those assets would be appropriate.
A possible alternative could be to subject those assets (according to the lex rei sitae rule) to foreign law security interests, provided that those laws allow for such security interests and that the assets, though owned by the Luxembourg companies, are not located (or deemed to be located) in Luxembourg.
ii Guarantees and other forms of credit support
Besides security interest rights, Luxembourg law also provides for security in the form of personal guarantees such as a suretyship, an independent or demand guarantee, or a letter of comfort. In addition, the new regime of professional guarantee of payment has been proposed under a recent draft bill.
A suretyship is an agreement made between the surety and the debtor whereby the surety undertakes to pay the debtor's debt if the debtor is unable to make the payment. It is subject to the validity of the underlying obligation (e.g., a facility) and to all the defences that apply to the underlying obligation, which means that the surety may use all exceptions available to the debtor against the beneficiary of the suretyship.
If the suretyship is granted by a natural person, pursuant to Article 2016 of the Luxembourg Civil Code:
- if a creditor who benefits from the suretyship does not inform the natural person at least once a year about the evolution of the guaranteed claim and its accessories, the creditor will no longer be entitled to the claim's accessories (including interest), costs and penalties; and
- a professional creditor is not entitled to rely on a suretyship agreement entered into by a natural person whose commitment was, at the time of the entry into the suretyship agreement, obviously disproportionate to this person's assets and income, unless at the time the surety is called, this person's estate enables him or her to comply with the related payment obligation.
Although there is, to the authors' knowledge, no Luxembourg (published) case law on this point, it cannot be excluded that a Luxembourg court would hold Article 2016 of the Luxembourg Civil Code to be a point of international public policy that would set aside the relevant foreign governing law.
A suretyship is generally considered to provide for some level of comfort to a creditor under Luxembourg law depending on the particularities of the transaction, although lenders usually require more robust types of guarantees.
Independent or demand guarantee
An independent or demand guarantee is a commitment of an autonomous nature, which shall expressly set out that:
- it is a demand guarantee and not a suretyship (although despite the expressed common intention of the parties to this effect, the guarantee could be construed by the relevant competent court as a suretyship);
- the obligations of the guarantor constitute an autonomous guarantee that is not an accessory to the principal underlying obligation (e.g., a facility); and
- the guarantor agrees that any invalidity relating to the underlying obligation would not cause the demand guarantee to be null and void.
While being in a stronger position than in the suretyship, the beneficiary of the demand guarantee will not be protected in the case of bankruptcy of the guarantor, and its claim will rank pari passu with the other creditor of the guarantor.
Letter of comfort
A letter of comfort is a document generally issued by a bank or a parent company that provides for an assurance as to the debt of the debtor. The legal force of the letter will depend on the exact terms therein. It should therefore be drafted in a way that the issuer undertakes an obligation of results. However, in the case of default, even with a firm letter of comfort, the issuer could not be forced to perform the debtor's obligation but only to indemnify the creditor for any (proven) damage.
Professional guarantee of payment
On 22 April 2020, the Luxembourg government introduced a draft of law No. 7567 before parliament, aiming at introducing a new regime on the granting of personal guarantees in a professional context (the Bill). This regime is aimed at increasing contractual freedom of personal guarantees while strengthening their legal certainty. The Bill purports to achieve for personal guarantees what the Collateral Act 2005 achieved for security interests.
The traditional choice currently offered by the Luxembourg legal regime of personal guarantees between the suretyship (which is governed by Articles 2011 and following of the Luxembourg civil code) and the autonomous guarantee (which has been developed by legal practitioners and recognised by case law) suffers from inherent limits in terms of structuring possibilities, especially in the context of sophisticated financial transactions. Indeed, such transactions often require the parties to make adjustments to these two types of personal guarantees to achieve the desired outcome for such guarantee. These adjustments sometimes raise a risk of requalification, and the legal uncertainty resulting therefrom makes the autonomous guarantees and suretyships unfit to meet the various needs of market participants. The Bill is aimed at introducing, next to these two regimes of personal guarantees, a third regime, which will provide increasing contractual freedom of guarantees while strengthening their legal certainty, making such guarantees more adequate to complex financial transactions.
Definition of professional guarantee of payment
The Bill is aimed at introducing a new act on professional guarantee of payment (the Act). According to the Act, a professional guarantee of payment is defined as being any undertaking pursuant to which a person, the guarantor, undertakes towards another person, the beneficiary, to pay upon demand of that beneficiary (or any other person agreed between the guarantor and the beneficiary) an amount of money determined pursuant to the terms agreed between the guarantor and the beneficiary, in connection with one or more receivables or the risks associated with such receivables.
Conditions for the application of the new regime
Pursuant to the Bill, in order for the Act to apply, the following cumulative conditions need to be met:
- an express reference must be made to the Act in the professional guarantee of payment (which, for the avoidance of doubt, must be governed by Luxembourg law);
- the professional guarantee of payment must be evidenced in writing, it being understood that such writing may be in electronic form or on other durable media; and
- the guarantor cannot be a natural person.
As regards the first condition above, the explanatory memorandum of the Bill clarifies that the Act may also apply to guarantees which have been entered prior to the entry into force of the Act provided that the parties to any such guarantee agree to make the guarantee subject to the Act (either by way of an amendment of the guarantee or by a designation in any other manner to the Act).
Key differences with the autonomous guarantee
The Act expressly provides that the purpose and terms of the professional guarantee of payment and in particular the amount of the guarantor's payment obligation under the guarantee may be freely contractually agreed by the parties. The parties may expressly refer to the guaranteed receivables or risks for the determination of the amount, terms and duration of the professional guarantee of payment. This feature embedded in the Act clearly distinguishes the professional guarantee of payment from the existing regime of autonomous guarantees.
Key differences with the suretyship
The Act expressly provides that, where the professional guarantee of payment is governed by the Act, the provisions of Articles 2011 and following of the Luxembourg civil code relating to suretyship may not impede the application of the terms of the guarantee agreed between the parties. In particular, the Act offers increased flexibility to the parties, by providing that, except if the parties agree otherwise:
- the guarantor shall not be able to raise any exception arising from the guaranteed receivables or risks;
- after payment, the guarantor has a recourse against the underlying debtor and is subrogated in the rights of the beneficiary in respect of the guaranteed receivables to the extent of the amount paid by the guarantor; and
- the guarantor shall remain liable to the beneficiary for the full amount of its obligations under the professional guarantee of payment even if the underlying debtor of the guaranteed receivables is subject to a reorganisation measure, a liquidation procedure or any other national or international competition situation including resolution, reorganisation and winding-up measures of credit institutions and investment firms, or any other domestic or foreign measure affecting the rights of creditors generally, including where the guaranteed receivables are or have been the subject of a debt rescheduling measure, reduction or conversion into capital or any other instrument, in each case without prejudice to the application of the provisions of the act of 8 January 2013 on the over-indebtedness.
Similarities with the Collateral Act 2005
Similar to the Collateral Act 2005, the Act further provides that:
- the professional guarantee of payment may be called upon the occurrence of any circumstances or events that have been contractually agreed by the parties, including in circumstances where there is no breach of performance under the guaranteed receivables or where the guaranteed risks have not materialised; and
- the professional guarantee of payment may be granted in favour of a person acting on behalf of beneficiaries of the professional guarantee of payment, a fiduciary or a trustee, to guarantee receivables of third-party beneficiaries, present or future, provided that such third-party beneficiaries are determined or ascertainable. Persons acting on behalf of beneficiaries of the professional guarantee of payment, the fiduciary or the trustee have the same rights as those of the direct beneficiaries of the professional guarantees of payment referred to in the Act, without prejudice to their obligations towards third parties benefiting from the professional guarantee of payment.
iii Priorities and subordination
The validity of certain clauses and provisions pertaining to subordination and priorities is not entirely settled under Luxembourg law, and the possibility that such clauses would be voided on public policy grounds cannot be entirely excluded.
There are no general Luxembourg law provisions or regulations on contractual subordination (other than under Luxembourg banking, insurance and securitisation legislation), no Luxembourg well-established (published) case law, and only little legal literature on the validity and enforceability (under Luxembourg law) of contractual subordination. Contractual subordination would be upheld by Luxembourg courts, even in the event of insolvency proceedings affecting the Luxembourg party concerned (although there is uncertainty as to whether an insolvency receiver of a Luxembourg party debtor would accept the hierarchy between senior and subordinated creditors of this Luxembourg party). To assess contractual subordination in general, Luxembourg courts would mainly turn to Belgian case law and legal literature, which seem to admit the validity and enforceability of a provision whereby a party agrees to subordinate its claim to the claim of another (senior) creditor.
It is also generally held that a junior creditor may agree to subordinate his or her claim, whether or not secured, to that of a senior creditor by agreeing to turn over (transfer) proceeds of the junior claim and its security to the extent necessary to pay the senior claim. Notice to the common debtor is not necessary for the validity of the turnover against creditors of the junior creditor. However, from a Luxembourg law perspective, turnover provisions might be regarded as a mere contractual mechanism and would not give the senior creditor a proprietary claim on the insolvency of the junior creditor. If a junior creditor has been paid before a senior creditor and bankruptcy proceedings are instituted against the junior creditor before the amounts so paid to the junior creditor have been paid and distributed to the senior creditor, it is uncertain whether the senior creditor would be able to claw back these amounts from the junior creditor. There is uncertainty regarding whether a Luxembourg insolvency receiver of a debtor subject to Luxembourg insolvency proceedings would, where applicable, accept the hierarchy between senior and subordinated creditors of this debtor.
Luxembourg law neither contains a specific legal provision that expressly recognises limited recourse provisions nor is there any Luxembourg (published) case law or well-established legal literature dealing with such clauses. Nonetheless, Belgian case law (to which Luxembourg courts often turn in these instances) seems to admit the validity and enforceability of a provision whereby contractual arrangements are established in conformity with contact law to the extent that they do not grant to a particular creditor a better rank in the distribution of the debtor's assets. The principle of pari passu treatment of creditors (according to which contractual arrangements, entered into prior to the opening of insolvency proceedings and designed to unfairly benefit one creditor to the detriment of other creditors by giving it a preferential right not provided for by law, are unlawful) aims only at protecting the rights of all the creditors, and as such is public policy. In other words, the debtor may not, by an arrangement with one of its creditors, impair the rights of the other creditors. Nothing, however, prohibits one or more creditors to limit, derogate from, or even renounce their rights in the sense that they dispose of their own rights without altering other creditors' rights.
Non-petition clauses (a clause whereby one or more parties waive ab initio their right to institute bankruptcy proceedings against their debtor) are likely to not be recognised under Luxembourg law. Although there is no specific Luxembourg case law or legal literature, Belgian case law does not recognise the enforceability of a non-petition clause because it violates public policy.
Legal reservations and opinions practice
Luxembourg law generally upholds the principle of legal and contractual certainty, and legal reservations may be less intrusive than other continental European jurisdictions. Nonetheless, its civil law heritage means that lenders will have to take into account certain public policy considerations.
i Financial assistance and corporate benefit
Assuming the grantor of a guarantee is a private limited liability company or a public limited liability company (which is typically the case for Luxembourg holding companies), some guidance as to the granting of guarantees and guarantee limitation is necessary. However, guarantee limitations would normally not apply where the security grantor grants financial collateral governed by the Collateral Act 2005 or other security interests.
A company may give a guarantee provided the giving of the guarantee is covered by the company's corporate objects and in the corporate interest of the company. In other words, a group guarantee must comply with the principle of speciality (the Corporate Objects Test) and company law (the Corporate Benefit Test).
As regards the Corporate Objects Test, the giving of a guarantee does not necessarily fall within the scope of a company's corporate objects. This point must be analysed on a case-by-case basis in light of the guarantor's corporate objects clause in its articles of association.
As regards the Corporate Benefit Test, the managers or directors of a company must act in the best interest and for the corporate benefit of the company. The giving of a guarantee in support of a third party's indebtedness is not necessarily ultra vires if the transaction furthers, even indirectly, the corporate purpose of each guarantor. The test is whether the company that provides the guarantee receives some consideration in return (such as an economic or commercial benefit) and whether the benefit is proportionate to the burden of the assistance. Accordingly, a guarantee that could adversely affect the creditors of the company is not necessarily, per se, against the company's best interest. However, a guarantee that substantially exceeds a guarantor company's ability to meet its obligations to the beneficiary of the guarantee and to its other creditors would expose its directors to personal liability. It is, therefore, prudent (for upstream or cross-stream guarantees) to limit the guarantee to a percentage (normally between 80 per cent and 100 per cent) of the company's net worth (or similar reference value) so that, at least in accounting terms, the guarantee does not adversely affect the creditors of any of the guarantors.
It follows that a Luxembourg company may, in principle, provide a guarantee for the benefit of other group companies if it can be demonstrated that:
- the company belongs to a group of companies that has a real structure and is organised in the view of a common economic, industrial and commercial policy;
- the company derives a benefit from giving the guarantee; and
- the guarantee amount is not disproportionate to the company's financial means.
For an upstream or cross-stream guarantee, the insertion of limitation language will generally be required by the company acting as a guarantor. The same limitations do not apply for downstream guarantees.
If the assistance is deemed contrary to the interest of the company by the courts, its directors may be held liable for action taken in that context. Further, under certain circumstances, the directors of the Luxembourg company might incur criminal penalties based on the concept of misappropriation of corporate assets (Article 1500-11 of the Luxembourg Act dated 10 August 1915 on commercial companies, as amended (the Companies Act 1915)). Article 1500-11 of the Companies Act 1915 makes it a criminal offence for the directors and managers of a Luxembourg company, whether having been officially appointed or being de facto directors or managers (which might include legal persons), if, acting in bad faith, they have made use of corporate assets or of corporate credit for uses other than those required by the interests of such company, and for their own personal benefit or for the benefit of companies or enterprises in which they have a direct or indirect interest. It cannot be excluded that, if the relevant transaction were to be considered as a misappropriation of corporate assets by a Luxembourg court, or if it could be evidenced that the other parties to the transaction were aware of the transaction not being for the corporate benefit of the Luxembourg company, the transaction might be declared void or ineffective based on the concept of illegal cause. Also, depending on the factual circumstances, a liquidator, an insolvency receiver or creditors of the assisting company could seek the liability of the banks (e.g., where the guarantee trigger has caused the insolvency of the assisting company or has caused a wider consequential loss to the creditors of such company).
In the case of a public limited liability company, parties will have to take into consideration specific financial assistance rules. According to Article 430-19 of the Companies Act 1915, a public limited liability company is prohibited from granting loans, guarantees or advancing funds to a third party for the acquisition of its own shares unless a 'whitewash' type of procedure is followed.
ii Insolvency proceedings and hardening period rules
Insolvency situations are governed by a set of rules that have been elaborated by courts and legal literature around the cardinal principle of pari passu ranking of creditors. Under applicable Luxembourg law, it is possible for a company to be insolvent without necessarily being bankrupt. If a company fails to meet the two cumulative tests of bankruptcy – namely the cessation of payments and the loss of creditworthiness – it is not deemed bankrupt. The judgment declaring the bankruptcy, or a subsequent judgment issued by the court, usually specifies a period not exceeding six months before the day of the judgment declaring the bankruptcy. During this period (the suspect period), the debtor is deemed to have been already unable to pay its debts generally or obtain further credit from its creditors or third parties. Payments made, as well as other transactions concluded or performed, during the suspect period, and specific payments and transactions during the 10 days before the commencement of that period, are subject to cancellation by the Luxembourg court upon proceedings instituted by the Luxembourg insolvency or bankruptcy receiver.
iii Enforcement of foreign judgments
A final and conclusive judgment in respect of agreements obtained against a Luxembourg company in an EU Member State court would be recognised and enforced by Luxembourg courts without re-examination of the merits of the case subject to and in accordance with the Regulation (EU) No. 1215/2012 of the European Parliament and of the Council of 12 December 2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (recast).12 This is provided that the judgment in question qualifies as a judgment (as defined therein) or, as the case may be, is subject to and in accordance with Council Regulation 805/2004 of 21 April 2004 creating a European enforcement order for uncontested claims, provided that the judgment in question has been certified as a European Enforcement Order (as referred to therein).13
A final and conclusive judgment in respect of agreements obtained against a Luxembourg company in an Icelandic, Swiss or Norwegian court would be recognised and enforced by Luxembourg courts without re-examination of the merits of the case subject to the applicable enforcement procedure and conditions of the Convention on Jurisdiction and the Recognition and Enforcement of Judgments in Civil and Commercial Matters signed at Lugano on 30 October 2007.
A final and conclusive judgment in respect of agreements obtained against a Luxembourg company in another foreign court than the courts referred to above would be recognised and enforced by Luxembourg courts subject to the applicable enforcement procedure (as set out in the relevant provisions of the Luxembourg New Civil Procedure Code). Pursuant to present Luxembourg case law, the enforcement of such judgment is subject to the following requirements:
- the foreign judgment must be enforceable in the country of origin;
- the court of origin must have had jurisdiction both according to its own laws and to the Luxembourg conflict of jurisdictions rules;
- the foreign proceedings must have been regular in light of the laws of the country of origin;
- the rights of defence must not have been violated;
- the foreign court must have applied the law that is designated by the Luxembourg conflict of laws rules or, at least, the judgment must not contravene the principles underlying these rules;
- the considerations of the foreign judgment as well as the judgment as such must not contravene Luxembourg international public policy; and
- the foreign judgment must not have been rendered as a result of or in connection with an evasion of Luxembourg law.
iv Legal opinion practice
The nature of legal opinion practice in Luxembourg is characterised by a certain level of flexibility, and a legal opinion may be given by either creditor counsel or debtor counsel as the case may be. Legal opinions are typically addressed to the finance parties, but disclosure to certain advisers such as auditors or regulators is generally accepted. In the case of primary syndication, it is market practice to allow any lender joining the syndication within three months of the opinion being issued to rely on the legal opinion.
Most of the loan trading transactions in Luxembourg are carried out by inbound financial and credit institutions, and these transactions are normally governed by the law with which the institutions are most familiar (i.e., English or New York law). So far as the loan transfer and its effects are governed by English law, the choice of law is recognised in Luxembourg pursuant to Regulation (EC) No. 593/2008 of the European Parliament and the Council of 17 June 2008 on the law applicable to contractual obligations, except in limited circumstances. The choice of New York law would equally be recognised, except in limited circumstances.
However, to the extent that it relates to Luxembourg assets, in most cases the security package will be governed by Luxembourg law, and market participants regularly seek advice on ensuring that secondary market purchasers obtain the benefit of Luxembourg security or guarantees (if any) after a loan transfer (the transfer).
If the security arrangement is a pledge or a suretyship, it will be transferred automatically together with the underlying main obligation (the pledge and the suretyship each being an accessory to the main obligations (Article 1692 of the Luxembourg Civil Code)). If the transfer is effected through a novation, the pledge or suretyship in question would lapse unless expressly reserved or confirmed, respectively, by the parties concerned.
If the security arrangement is a transfer of title by way of security (which is not an accessory to the underlying main obligation), the new transferee would require an express confirmation of the transfer from the transferor (as security provider). The same applies to autonomous independent personal guarantees.
In addition, Luxembourg market practice typically recommends 're-perfecting' the Luxembourg law-governed security arrangement following the transfer. For pledges over registered securities, the re-perfection is achieved by a new registration of the pledge in the securities register. For pledges over bank accounts (cash or securities), the re-perfection is achieved by notice to the Luxembourg account bank relating to the identity of the new pledgee; and for pledges over receivables, the 're-perfection' is usually achieved by notice to the debtor of the pledged receivables relating to the identity of the new pledgee. In all those instances, the relevant pledgor should arrange for the re-perfection or notification to be implemented. Timing will depend on the cooperation of the counterparty, where necessary. So far as personal autonomous guarantees and transfers of title by way of security are concerned, the guarantor or the new transferor's (as security provider) consent would have to be obtained.
Additional steps would be required in the case of general business pledges, mortgages and pledges over intellectual property rights, patents, trademarks and copyrights.
If loan trading transactions are carried out through alternative funds (such as alternative debt funds) the following would occur:
- additional requirements would derive from Directive 2011/61/EU of the European Parliament and of the Council dated 8 June 2011 on alternative investment fund managers and amending Directive 2003/41/EC and 2009/65/EC and regulations (EC) No. 1060/2009 and (EU) No. 1095/2010 (the Act on Alternative Investment Fund Managers (AIFMD)),14 and the Luxembourg Act dated 12 July 2013 on alternative investment fund managers implementing the AIFMD;15 and
- the obligations arising for the parties to such agreements would be subject to the AIFMD.
Outlook and conclusions
The financial markets turmoil of 2008 created a wave of consolidation in the banking sector and substantially reshaped the financial landscape in Luxembourg.
The enforcement of financial collateral arrangements, in the wake of the economic and financial markets turmoil of 2008, raised a number of issues that led to closely watched proceedings before Luxembourg courts. The general success of lenders in defending actions against enforcement has strengthened the legal security and attractiveness of financial collateral arrangements governed by Luxembourg law. Moreover, the Luxembourg legislator has recently further strengthened the appeal of the Collateral Act 2005 by confirming that the insolvency safe harbour provisions also apply to foreign law-governed collateral arrangements, which are similar to the Luxembourg collateral arrangement.
Regulatory changes have also had a significant impact on many market participants. The multitude of European and international legislative initiatives that were aimed at closing gaps in regulation and supervision that might adversely affect the stability of the international financial system have also created increasing capital and reporting requirements.
In an uncertain regulatory environment, Luxembourg authorities have clearly aimed to differentiate themselves from their foreign counterparties by quality of service, responsiveness and approachability. In particular, the CSSF has in the past shown a desire to strike the right balance between increased supervision and the need for the financial sector to breathe and develop. While there is undoubtedly an international trend towards a common supervisory culture and a harmonised application of a single rule book, the CSSF seems committed to continue to advocate for a consensus-based model of supervision.
Luxembourg authorities have also taken considerable steps to promote Luxembourg as the premier international renminbi hub in the euro area and to solidify its position as one of the leading Islamic finance centres in Europe. As a result of these efforts, Luxembourg is now the leading European financial centre in terms of renminbi loans and deposits.
The Luxembourg government proposes to introduce a private foundation, as well as a structure of trust similar to the English law trust, into the Luxembourg legal framework, with a view to strengthen, among others, the Luxembourg wealth management and financial sectors. It is also currently being contemplated to overhaul the current Luxembourg insolvency regime and to put into place mechanisms that would help companies that are in difficulty to avoid bankruptcy proceedings.
1 Henri Wagner is a partner and François Guillaume de Liedekerke is counsel at Allen & Overy.
3 Mémorial A – No. 128 of 16 August 2005.
4 Act of 20 May 2011 on the business of electronic money institutions, Mémorial A – No. 104 of 24 May 2011.
5 Mémorial A – No. 124 of 3 September 2003.
6  OJ L 141/19.
7  OJ L 160/1.
8 On 9 June 2016, the CSSF updated its FAQ concerning the Luxembourg Act dated 12 July 2013 on alternative investment fund managers, which includes FAQ 22 relating to alternative investment fund managers and alternative investment funds (AIFM/AIF) engaging in loan origination, or loan participation or acquisition. This FAQ is available at: www.cssf.lu/fileadmin/files/AIFM/FAQ_AIFMD.pdf.
9 This remains subject to the application of Luxembourg law of 23 December 2005, as amended, introducing a withholding tax of 20 per cent on payments of interest or similar income made or ascribed by a paying agent established in Luxembourg to or for the benefit of an individual beneficial owner who is a resident of Luxembourg.
10 For further information on this topic, refer to 'Enforcing financial collateral arrangements in the new world – challenging times!', Henri Wagner and François-Guillaume de Liedekerke, Bulletin Droit et Banque, No. 47, April 2011.
11 A number of closely watched court decisions have recently strengthened the legal security and attractiveness of financial collateral arrangements subject to the Collateral Act 2005. For example, the decision of the Court of Appeal sitting in summary proceedings, No. 35824, 3 November 2010, which confirmed that the enforcement of a pledge agreement made in accordance with the terms of the pledge agreement may in principle not be challenged and that only action for liability may potentially be taken against the pledgee. Luxembourg courts have also limited the possibility to appoint a receiver or administrator in the context of enforcement procedures of financial collateral arrangement as long as enforcement measures comply prima facie with the conditions provided for in the pledge agreement (Court of Appeal sitting in summary proceedings, No. 346743, 3 June 2009, and Luxembourg District Court sitting in summary proceedings, 11 February 2010).
12  OJ L 351/1.
13  OJ L 143/15.
14  OJ L 174/1.
15 Mémorial A – No. 119 of 15 July 2013.