Usual Luxembourg security package
Luxembourg is one of the leading domiciles worldwide for international investment portfolio acquisition vehicles.
Acquisition financing are usually secured against the assets and cash flows of the target company as well as of the buyout vehicle.
In practice, given that a Luxembourg holding company generally does not have any operational activities, shares, receivables and cash on bank are the most important assets to cover.
Pledges are the common form of security for such movable property. They are governed by the Law of 5 August 2005 on financial collateral arrangements, as amended (the Financial Collateral Act), which transposed Directive 2002/47/EC of 6 June 2002 on financial collateral arrangements (the Collateral Directive) into national law.
Methods of enforcement of security
One of the innovations of the Financial Collateral Act has been to facilitate the enforcement of pledges. It offers to the secured creditor the opportunity to enforce pledges without having to give a prior notice to the pledgor. It further provides for the following enforcement procedures (in addition to the right to receive dividends and vote the pledged shares):
- private sale at arms’ length conditions (conditions commerciales normales)
- appropriation at a value as determined by an independent auditor
- sale by public auction
- attribution in court.
Upon the occurrence of an event of default as agreed between the parties, the main methods used by secured creditors to realise or appropriate the collateral are the enforcement by means of private sale or the appropriation of the pledged assets.
- No liability of the pledgee: Where shares are pledged, the private sale of such assets has the specific advantage that the pledgee does not become owner of the Company and does hence not have to assume any liability, even for a short period of time.
- No valuation required as a matter of law: The law does not required proceeding to a valuation of the pledged assets. The pledgee may conduct a full marketing process to demonstrate that the pledged assets have been sold at arm’s length conditions. The pledgee would then have to contact several potential buyers and sell the pledged assets to the highest bidder. Reasons of certainty and prudence command however that an independent valuation is obtained to reduce the risk of challenge.
- Vagueness of the term "arm’s length conditions": The main disadvantage of enforcement by means of a private sale is the vagueness of the term "at arm’s length conditions" (conditions commerciales normales). As a guidance, a private sale would meet the "normal commercial test" when 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, accept to pay to a willing seller.
- No intervention of formal authority (court or exchange): The appropriation is an out-of-court enforcement procedure. Considering that there is no formal authority to intervene, an appropriation is a cost efficient method.
- Valuation can be performed afterwards: The appropriation can be made either after or before the valuation has been completed.
- Appropriation can be made by a designated third party: The pledged assets can be appropriated by the pledgee himself or by a third party (eg. a special purpose vehicle wholly owned by the lenders).
- Intervention of an independent auditor in case of appropriation of collateral: According to the Financial Collateral Act, the secured creditor can appropriate the pledged assets at a price determined pursuant to the valuation method agreed upon between the parties.
In order to reduce the risk of challenge, it is recommended to obtain an independent valuation. The secured creditor would have to appoint an independent external auditor (réviseur d’entreprises agréé), who is registered with the Luxembourg Institut des Réviseurs d’Entreprises. The auditor will determine the value of the collateral on the basis of (i) the valuation method agreed upon between the parties and (ii) the latest published annual accounts of the Company or other recent or appropriate finance documentation. The secured creditor will need to ensure the availability of this documentation. Upon determination of the value of the pledged collateral, a set-off against the secured debts will be made (just as in a credit-bid process).
Disapplication of the insolvency rules
One consequence of the policy underlying the Financial Collateral Act's aim to enhance certainty for secured parties is the disapplication, in relation to the granting and the enforcement of security, of both Luxembourg and other jurisdictions' laws relating to bankruptcy, liquidation, reorganisation or similar measures.
Article 20(4) of the Financial Collateral Act provides that pledges are valid and enforceable against third parties, receivers, liquidators or similar persons notwithstanding a reorganisation, winding up proceedings or similar national or foreign proceedings. The assets subject to the pledge do not form part of the estate of the insolvent company.
Article 24 of the Financial Collateral Act further gives an extraterritorial effect to article 20(4) of the Financial Collateral Act by extending the insolvency remote effect provided by said article to financial collateral arrangements governed by laws other than Luxembourg law, at the sole condition that the provider of the financial collaterals is established in Luxembourg.
The Alteco / Mag Import case
As security for the performance of their obligations under a facility agreement, two Spanish holding companies, Alteco Gestión y Promoción de Marcas, S.L and Mag Import, S.L (the Borrowers), granted a pledge over a securities account held in Luxembourg and on which shares in Gecina S.A, a French real estate company, were credited.
The pledge was subsequently amended so as to be enforceable upon default of payment and not only upon early termination as initially stated therein. Said amendment occurred during the claw-back period set out under Spanish insolvency law.
Following default of payment upon maturity, Spanish bankruptcy proceedings were opened against the Borrowers.
At the request of the Spanish receivers, the Spanish court decided to suspend the enforcement of the pledge in order to allow the receivers to challenge the amendment made to the Luxembourg security agreement during the claw-back period.
The secured creditors in turn brought an action before the Luxembourg district court to order that the Spanish provisional measures cannot interfere with the enforcement.
In its decision dated 29 January 2014, the Luxembourg court held that legal actions cannot be used to delay or frustrate the enforcement process of Luxembourg security interest even upon insolvency events.
By doing this, the Luxembourg court re-affirmed the position taken in previous case law whereby article 20(4) of the Financial Collateral Act must be regarded not only as a mandatory legal provision, but as a true loi de police which aims at “sheltering financial collateral arrangements against any challenges, therefore giving to lenders a fully secured legal framework” (Chamber of council of the district court of Luxembourg, 14 October 2010).
Enforcement of a Luxembourg share pledge as restructuring method
Company’s contracts, including security agreements, can be affected by insolvency procedures if they were concluded during the suspect/hardening period (période suspecte) and the preceding 10 days.
The suspect period starts from the moment the company stopped paying its debts (cessation des paiements), though the exact date is fixed by the court (a maximum of 6 months before the start of the insolvency procedures).
The following contracts are automatically null and void when concluded during the suspect period:
- contracts entered into by the insolvent company, if its obligations are significantly more onerous than the obligations of the other party
- any payment made by the insolvent company in respect of debts that are not yet due
- any payment made by the insolvent company in respect of debts that are due, unless it was paid in cash or made by bills of exchange
- any security granted over an asset of the insolvent company to secure obligations contracted before the security contract was entered into
Additionally, any contract or payment can be annulled by the court if the other party had personal knowledge that the company was insolvent.
If made during the suspect period, out-of-court restructuring arrangements are thus at risk to be declared null and void.
Pre-pack sale is a commonly used restructuring tool in the UK. It entails the sale of a company's business and/or assets which has been arranged in advance of the company entering into administration and will be closed shortly after the appointment of an administrator over the company.
The benefits of this method are, inter alia:
- the possibility to avoid – as much as possible – loss of value of the company’s business and assets
- the ability to realise a sale of the company’s business and assets within a short period
- the confidentiality of the prepared sale through pre-pack administration
- the involvement of a receiver at an early stage as a result of which the receiver is in a better position to collect as much information as necessary
- the possibility for potential buyers to have more opportunities to perform due diligence
- a successful sale through a pre-pack will generally result in the preservation of jobs and value as much as possible
- the value of the company as a going concern will be significantly higher than the sale of the company’s business and assets in regular insolvency proceeding.
Because of the execution risk resulting from the application of Luxembourg claw-back rules during a restructuring process and due to the fact that in Luxembourg, an administrator cannot be appointed out of court by a debtor and/or its creditors, it is not possible to pre-agree a sale of business in advance in insolvency proceedings in Luxembourg.
As mentioned above, financial collateral arrangements covered by the Financial Collateral Act are valid and enforceable, even if entered into during the pre-bankruptcy suspect period.
An effect similar to the UK pre-pack sale could then be obtained by implementing a "quasi pre-pack" through the enforcement (by way of private sale or out-of-court attribution) of a Luxembourg pledge agreement over the shares of the holding company. Even though untested at this stage, this possibility could prove useful for the implementation of loan-to-own strategies in Luxembourg.