Modernisation of the Luxembourg Financial Collateral Law
Since its adoption, the Luxembourg law on financial collateral arrangements, dated 5 August 2005 (the Financial Collateral Law), has been the key to facilitate, accelerate, and ensure the enforcement procedure of financial collateral arrangements, and to help preserving financial stability in Luxembourg.
The Financial Collateral Law is generally regarded as the most efficient and attractive legal framework in the EU for creditors in financing transactions. Since its adoption, Luxembourg has developed a strong practice in structuring cross-border and domestic financing, refinancing, and restructuring transactions.
Luxembourg proved to be a strategic jurisdiction for the finance parties with respect to enforcement of security interests, as its Financial Collateral Law offers, amongst others measures, bankruptcy remote security instruments, and a broad range of efficient and out-of-court enforcement procedures in the most secured creditor and protective manner in Europe.
On 7 July 2022, the Luxembourg Parliament (Chambre des Députés), adopted the draft law 7933 (the Law), amending, amongst other laws, the Financial Collateral Law.
The Law aims to reinforce contractual flexibility between parties and legal certainty to the benefit of secured lenders. It codifies certain existing market practices and jurisprudential positions as regards enforcement options and methods, and as well as modernises the regime of public auctions of the pledged assets.
Those improvements can only be welcomed, being in line with the spirit of the Financial Collateral Law and reinforcing its creditor-friendly position to support and further boost the lending activity in Luxembourg.
The Law entered into force on 24 July 2022. The main amendments to the Financial Collateral Law are as follows:
Enhanced legal certainty regarding enforcement events
The Financial Collateral Law already provided for a definition of “enforcement event” being an event of default, or any event, as agreed between the parties, i.e. including events other than payment defaults.
In the past, the Luxembourg jurisprudence also confirmed the creditor-friendly orientation that the mere breach of a financial covenant could itself trigger the enforcement of a pledge governed by the Financial Collateral Law[1].
The Law now reinforces and clarifies this flexibility in the contractual structuring of an enforcement event that already constituted one of the most attractive features of the Financial Collateral Law compared to other European countries. It does so by adding the term “whatsoever” (“quelconque”, in French) to the range of events that could trigger an enforcement. An enforcement event means an event of default, or any other event whatsoever, as agreed between the parties on the occurrence of which, under the terms of a financial collateral arrangement, or the relevant financial obligation agreement or by operation of law, the collateral taker is entitled to realise or appropriate financial collateral or a close-out netting provision comes into effect.
The Law thus emphasises the concept that non-repayment is not required to allow enforcement, and strengthens the concept of freedom of contract by which the parties can freely provide that any event agreed between them (e.g. the breach of a contractual representation or covenant) will be recognised as an enforcement event.
Following and in-line with the amendment to the definition of enforcement event described just above, the Law now clarifies that when the financial obligations secured are not due and payable at the time the pledge is enforced (i.e. in the context of an enforcement of a security interest with no payment default), the proceeds of the enforcement shall be applied in discharge of the underlying secured obligations, unless otherwise agreed between the parties. This welcomed clarification removes any doubt present in the past as to whether the enforcement proceeds, in a scenario where the underlying secured obligations have not yet become due and payable, could be applied immediately in discharge of such secured obligations or should be held as continuing security.
Modernised enforcement methods
Public auctions
In the past, the Financial Collateral Law provided the pledgee with the possibility to enforce pledged assets, amongst other enforcement methods, “by private sale on normal commercial conditions, by sale over a stock exchange or by public auction”.
Under the previous version of the Financial Collateral Law, public auctions were, by default, required to be effected by and at the Luxembourg Stock Exchange (the LuxSE) based on a specific governmental license. The reference to the LuxSE has become outdated as its status has changed (i.e. by operation of a law of 2007, the LuxSE has become one of the many private professionals of the financial sector). Thus, following the entry into force of the Law, public auctions will now be executed by default by a Luxembourg bailiff or sworn notary, based on a new detailed procedure introduced by the Law. The Law provides that the parties may still agree to deviate from the procedure set out therein for public auctions. This amendment may resuscitate the interest for this enforcement method that was rarely, if at all, used in the past being preferred to other more efficient, more expedited, and less costly enforcement methods as the appropriation or the private sale.
Sale on a stock exchange of financial instruments admitted to trading
In respect of the enforcement by way of sale of collateralised financial instruments admitted to trading, the Law has replaced the reference to the “sale over a stock exchange” with the “sale over a trading platform”. This grants the flexibility that the enforcement - by the sale of such pledged assets - can be effected on a platform on which they are admitted to trading. Assets admitted to trading to multilateral trading facilities (MTF) or organised trading facilities (OTF) may now be disposed of, by way of enforcement, on the platform where they are admitted to trading.
Appropriation of units or shares in a collective investment undertaking
An additional new feature introduced by the Law in the Financial Collateral Law relates to the determination of the value at which pledged units or shares in a collective investment undertaking can be appropriated.
The Law distinguishes between units or shares of a collective investment undertaking that:
- are admitted on a trading platform that can be appropriated at market price.
- are not admitted on a trading platform that can be appropriated at the price of the last net asset value published by or for the collective investment undertaking, provided that the last publication of the net asset value is not older than a year.
Redemption of units or shares in a collective investment undertaking
The Law introduces an additional enforcement method regarding the pledged units or shares issued by a collective investment undertaking. By inserting a new paragraph to Article 11 of the Financial Collateral Law, the Law provides the pledgee with the possibility to request the redemption of these units or shares at the redemption price determined in accordance with the constitutional documents of the relevant collective investment undertaking. Such request of redemption constitutes a new available enforcement method introduced by the Law, alternative to appropriation and private sale, and which does not require the involvement of a third-party buyer. It could be particularly beneficial to pledgees that may not be able to appropriate the pledged units or shares because of regulatory or internal-policy reasons.
Insurance claims
Regarding pledges over insurance claims deriving from insurance contracts, the Law now clarifies that the pledgee may exercise all rights resulting from the relevant insurance contract, including the exercise of the repurchase right or demand payment from the insurance company for any sums due under the insurance contract. This amendment is particularly well received as it also removes any doubt arisen in the past as to the qualification of insurance contracts as financial collateral and the consequent applicability of the Financial Collateral Law to pledges over insurance contracts.
Other Notable Amendments
The Law clarifies that a transfer of title for security purposes can be also granted to a person acting on behalf of the beneficiaries (e.g. a security agent), a fiduciary or a trustee. If the transfer of title for security purposes is carried out on a fiduciary basis, the transferee must be a professional of the financial sector. In this regard, the Law clarifies that payment institutions and electronic money institutions qualify as professionals of the financial sector and are therefore eligible under Article 13 of the Financial Collateral Law to act as agents, fiduciaries, or trustees holding the security for beneficiaries.
Furthermore, the Law clarifies that the insolvency remoteness of set-off arrangements and security interests applies to national and foreign law insolvency procedures.
The Law also clarifies that confiscation measures (“séquestre”, in French) do not prejudice financial collateral arrangements or set-off arrangements and set-off measures (including their enforcement).
In the aim of increasing the legal certainty around security over fungible precious metals, the Law clarifies that pledges over the fungible precious metals that fall within the scope of the Luxembourg Grand Ducal Regulation dated 18 December 1981 on the deposit of fungible precious metals are also governed by the Financial Collateral Law, unless the Grand-ducal regulation of 18 December 1981, as amended, provides for a specific regime or when the nature of the precious metals does not allow it.
[1] Luxembourg Court of Appeal, 22 January 2020, No 6/20 IV-COM, roll No CAL-2017-00004.
