Extract taken from 'The Lending and Secured Finance Review' – edition 5

Credit support and subordination

i SecuritySecurity 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:

  1. acceptance of the pledge by the depositary bank; and
  2. waiver and exclusion of bank set-offs and general pledge (available under general business conditions of Luxembourg banks).
Enforcement measures

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:

  1. 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
  2. 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.

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:

  1. clientele;
  2. business name and goodwill;
  3. licences;
  4. trademarks and patents;
  5. leases;
  6. furniture;
  7. materials;
  8. rolling stock and other tools; and
  9. 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.


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:

  1. 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
  2. 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:

  1. 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);
  2. the obligations of the guarantor constitute an autonomous guarantee that is not an accessory to the principal underlying obligation (e.g., a facility); and
  3. 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.

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 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.