Josée Weydert Margaretha Wilkenhuysen November 25 2011 Insolvency protection of creditors and collateral takers NautaDutilh | Insolvency & Restructuring - Luxembourg Josée Weydert, Margaretha Wilkenhuysen Insolvency & Restructuring Constitution and perfection of collateral arrangementsInsolvency aspects of collateral arrangementsBeneficiary of collateral Remedy for potential conflict with depository Rights attached to the collateral Other insolvency protectionThe Act of May 20 2011 implements EU Directive 2009/44/EC (amending the EU Settlement Finality Directive and the EU Collateral Directive), and amends the Collateral Act of August 5 2005. The Collateral Act has always been a lender-friendly implementation of the Collateral Directive. Most of its provisions have not changed and in general, the Collateral Act remains favourable to creditors in insolvency situations and other contexts. Constitution and perfection of collateral arrangements According to the new Article 2 of the Collateral Act, a written list of claims, transmitted to the collateral taker (ie, the pledgee) is sufficient to ensure perfection of the collateral arrangement over claims and to make them effective in respect of third parties and debtors. Separate notification to individual debtors is no longer required in order to enforce such arrangements in respect of the debtor or a third party, facilitating the taking of collateral.Article 2(3) of the act provides that the security granted to the pledgee will not be affected by: the substitution or withdrawal right on surplus assets given as security in favour of the pledgor; the right of the pledgor to collect products from assets until further notice; and the right of the pledgor to give instructions in relation to pledged assets. A new Article 2(5) allows an original debtor to waive a right of set-off and other rights against the creditor and any transferees of the claim. A new Article 2(6) allows parties to a financial collateral arrangement to agree that in the event of enforcement of the collateral arrangement, the pledgor waives its right of recourse against the original debtor.Article 11 of the act has been changed in order to improve enforcement rights. Before the amendments, a pledgee could appropriate the collateral at a price determined by an agreed valuation method, but it was unclear whether this could happen after - or only before - the price was determined. The amendments allow both techniques to used, direct appropriation being allowed before finalisation of the valuation.Insolvency aspects of collateral arrangements According to Article 20(1) of the act, financial arrangements and the enforcement of events are valid and enforceable against third parties, commissioners, receivers, liquidators and other similar persons, notwithstanding reorganisation measures, winding-up proceedings or similar national or foreign proceedings.Reduction of annulment risk in insolvency procedures Article 20(4) provides that Luxembourg insolvency and pre-insolvency rules are excluded in respect of collateral arrangements. With some minor exceptions, the provisions on annulment that apply to certain types of transaction - in particular, payments, transfers of ownership and grants of collateral - during the hardening period(1) or following the cessation of payments(2) and, more generally, national or foreign provisions on reorganisation measures and insolvency proceedings do not apply (from a Luxembourg perspective) to Luxembourg financial collateral instruments and netting arrangements, and thus cannot block their enforcement. Similarly, such provisions do not apply to waiver clauses (with respect to Articles 2(5) and (6) of the act). However, the exclusion from annulment does not apply in cases of fraud.Article 20(4) provides for a specific protection regime in favour of the pledgee, whereby the pledgor's insolvency procedure affects neither financial collateral instruments nor set-off and close-out netting clauses agreed between parties in collateral arrangements. Thus, a collateral arrangement and its clauses remain effective in respect of parties and third parties, even in the event of insolvency proceedings.Article 24 of the act has also been modified in order to clarify its scope and improve the position of the pledgor. Under Article 24, immunity from annulment risk in insolvency procedures applies neither to collateral arrangements governed by the act nor to similar collateral arrangements governed by foreign law, provided that the collateral provider is established or resident in Luxembourg.Public policy aspectsAccording to the preparatory works relating to the amendments, Article 20(4) must be considered a mandatory rule that protects collateral arrangements from collective proceedings and their effects.In 2009 a Luxembourg court injunction(3) was issued to the effect that the protective measures described above are protected from the rules on Luxembourg collective proceedings, but that general contract law and consumer protection rules are nonetheless enforceable in respect of financial collateral arrangements. However, in its November 3 2010 decision in Landsbanki the Court of Appeal interpreted Article 20(4) differently in light of the EU Collateral Directive. The court found that Article 20(4) is a policy rule and therefore mandatory.(4)Effectiveness in case of opening of insolvency proceedings Pursuant to Article 21, financial collateral arrangements are valid and enforceable against third parties, commissioners, liquidators, receivers or other similar persons, even if they are concluded on the day on which winding-up proceedings are to be commenced or at the beginning of a reorganisation measure, but before the court issues its decision on the opening of such proceedings or the reorganisation measure becomes effective.However, Article 21(2) provides that even if financial collateral arrangements are concluded after the court ruling on the opening of such proceedings, but before the reorganisation measure becomes effective, such arrangements may be effective and enforceable against third parties, commissioners, receivers, liquidators and other similar persons if the collateral taker can prove that it did not know (and could not reasonably have been expected to know) that the proceeding had been opened or that the measures had been taken.In view of these provisions, the district court has ruled that a collateral arrangement is invalid if it is concluded after the opening or entry into effect of collective or reorganisation proceedings.(5)Beneficiary of collateral The act offers great flexibility with regard to the beneficiary of collateral arrangements. It does not require that the beneficiary of a security interest be the party to which the debt or obligation is owed.Pursuant to Article 2(4) of the act, collateral may be provided in favour of a party that acts for the beneficiaries of the collateral, a fiduciary or a trustee in order to secure the claims of existing or future third-party beneficiaries, provided that such third-party beneficiaries are determined or determinable. They enjoy the same rights as beneficiaries of the collateral arrangement. Remedy for potential conflict with depository Parliamentary Document 6461/7, containing the European Central Bank's position of November 5 2010 on the draft bill to amend the act, highlighted a possible conflict as to the ranking position between the pledgee and the depository of financial instruments.Article 5(2) of the act, as amended, now provides that if a depository of financial instruments is validly dispossessed of the financial instruments inscribed, it is deemed to have waived its privileged ranking position. Such dispossession is facilitated under the amended act by: the conclusion of the collateral arrangement (if the depository is also the collateral taker); an agreement reached between the depository, the pledgor and the pledgee, or between the pledgor and the pledgee, and which is notified to the depository, whereby the depository acts under the instructions of the pledgee, not the pledgor; the registration of the financial instruments in an account held by the pledgee; or the registration of the financial instruments in a special account in the name of the pledgor or a third party, provided that the existence of the pledge is specifically noted. Rights attached to collateral Article 9 of the Collateral Act (as amended) provides that distribution and exercise of the rights attached to financial instruments (including voting rights and other rights) subject to financial collateral are governed by the parties' agreement. In situations where no provision in the collateral arrangement governs this issue, and except where the pledgee has a right of use over the collateral, the pledgor exercises these rights. When financial collateral is provided to a security agent, a fiduciary or a trustee on the beneficiary's account, the latter holds and exercises such rights, unless otherwise agreed.Most Luxembourg collateral arrangements provide that voting rights are held by the pledgor unless an event of default occurs, in which case voting rights are transferred to another party (normally when there is an event of default) in accordance with the collateral arrangement.Other insolvency protectionLuxembourg fiduciary structuresThe Act on Trusts and Fiduciary Agreements (July 27 2003, as amended) provides that a fiduciary agreement enables the transfer of the legal ownership of assets to a fiduciary. The fiduciary estate is segregated from the personal estate of the fiduciary (ie, it is off balance sheet). The assets of the fiduciary estate can be attached only by creditors whose rights arise from the fiduciary estate. In the event of the fiduciary's liquidation or bankruptcy, such assets are not included in the fiduciary's estate.Securitisation vehicles The Securitisation Act (March 22 2004) provides for a specific insolvency protection regime by recognising the validity of non-petition, limited recourse and subordination clauses. Moreover, it allows for the segregation of assets by means of a compartment structure; this also allows for the separate liquidation of assets and liabilities. In accordance with Article 61 of the act, for security interests granted by the securitisation vehicle no later than the date of issuance of the securities or the conclusion of agreements secured by such security interests, the provision for annulment included in Article 445(4) of the Commercial Code (on voidance of security interests for previously contracted debt) is expressly excluded.(6) Securities depositoriesUnder the Law of August 1 2001 on fungible securities a depositor of financial instruments held with a professional depository is guaranteed the same rights as it would enjoy if the financial instruments were held by the depositor. The depository is required to record the financial instruments in its books separately and off its balance sheet.In the event of insolvency or similar proceedings affecting the depository, the depositor retains a right of restitution over financial instruments of the same nature as those deposited with, or held by, the depository (including any sub-depositories). If the financial instruments held by the depository are insufficient to satisfy all of the depositor's rights, any financial instruments of the same nature that the depository holds on its own books may be added to the instruments to be restituted until the depositor is fully satisfied.Mortgage-backed securities Investors may acquire lettres de gage issued by credit institutions and thus benefit from attached preference rights. Defined as debt securities guaranteed by a cover pool of assets specifically allocated to this type of security, Luxembourg lettres de gage are issued by specialised credit institutions under Article 12-1(1) of the Finance Act. Article 12-1(3) identifies three types of lettre de gage: mortgage lettres de gage (Article 12-1(1)(a)); public lettres de gage (Articles 12-1(1)(c) and (d)); and movable lettres de gage (ie, those based on loans secured by real movable rights) (Article 12-1(e)). The two first traditional types of Luxembourg lettre de gage, which existed before the Act of November 21 1997, are based on loans secured by rights in, or security interests over, real estate, or are secured by a public authority. Movable lettres de gage, introduced by the Act of October 24 2008, are based on loans guaranteed by rights in, or security interests over, movable assets (eg, ships, aircraft and boats). Regardless of the form of instrument, such covered bonds give their holders preferential claims. Articles 12-8 (1) and (2) provide for preference rights and seniority for these bondholders, ensuring the payment of their claims. Furthermore, Article 12-8(4) sets out the segregation of assets principle, whereby such covered bonds fall outside the group of assets governed by the issuer's insolvency or liquidation proceedings. Similarly, bondholders shall not be considered members of the body of creditors during such proceedings. Thus, bondholders are deemed to hold senior claims, and are paid in priority of unsecured creditors.These provisions strengthen the protective measures and secure the position of creditors and investors that hold lettres de gage from insolvency or liquidation proceedings against the issuer.For further information on this topic please contact Josée Weydert or Margaretha Wilkenhuysen at NautaDutilh by telephone (+352 26 12 29 1), fax (+352 26 68 43 31) or email ([email protected] or [email protected]).Endnotes(1) For further details please see the "Overview".(2) As provided for in Articles 445 to 447 of the Commercial Code.(3) Luxembourg injunction, December 4 2009, 879/2009, 123551.(4) Luxembourg Court of Appeal, November 3 2010, 35824.(5) Luxembourg District Court, November 19 2008, 1409/08.(6) This carve-out does apply to Luxembourg law and foreign law security interests.