Have you considered this for the enforcement of a Luxembourg pledge over shares?February 2023 update
In multijurisdictional financings, taking pledges over shares in a Luxembourg company can boost businesses’ access to fresh and cheap money. And it’s one of the things that makes the Grand Duchy so attractive.
We (Joris Reinert and I) first wrote on this topic in November 2021 when the global health situation had weakened many companies and state aid repayments were due, accelerating the scrutiny of financial covenants. But the markets remained strong, and enforcements of security were limited until late 2022.
the recent geopolitical events, interest rates peaks and investors’ loss of faith in some countries have changed the panorama. Financial and liquidity disruption is a reality for businesses, and defaults have increased more than ever in the toughest environment since the 2008 financial crisis, leading to a rise in enforcements of Luxembourg share pledges. We’re at a defining moment for credit providers, who are trying to square several circles when looking at the financials of the debtor, so we thought it was important to update our 2021 article.
Luxembourg’s magic comes from its well-established, reliable and credible collateral framework. It’s a quick, easy and efficient legal environment for the creation of a pledge over shares in a Luxembourg company, its perfection and enforcement. The parties simply need to agree on the event that will trigger the exercise of rights by the security taker, be it the exercise of voting rights or the enforcement of the security, in accordance with the Luxembourg law of 5 August 2005 on financial collateral arrangements, as amended (the Collateral Act) and the provisions of the pledge agreement itself.
In this article, we’ll talk more about more strategy than substance around an enforcement. Don’t let guesswork weaken your position and reflect on the following before “pushing the (enforcement) button”.
A few reminders
The Collateral Act has made enforcements easier by offering secured creditors the possibility to exercise their rights in circumstances freely (emphasis added!) determined by the parties in the pledge agreement. The Luxembourg courts have ruled on this, and it’s now set in stone. Not even a prior notice (mise en demeure) before taking action is legally required, though security takers tend to inform the debtor side in advance, probably out of caution.
The appropriation (of the collateral) is the most common enforcement method because of its speed, cost-effectiveness and flexibility (although enforcements through private sales are not rare). It’s based on a valuation carried out, before or after the appropriation, at a price determined by the valuation method agreed upon by the parties. The Collateral Act also allows appropriation by the security taker itself or, more often (to limit the risks relating to contamination, consolidation, potential liabilities or adverse tax consequences), by a third party.
Additionally, the right to take over the shares in accordance with the pledge agreement is protected by the Collateral Act, so the enforcement documentation does not need to be (extremely) complex.
Before launching the enforcement by appropriation
An enforcement requires preparation, so a lender and/or security taker should:
- identify the parties to be informed of the enforcement (even if not legally required), and form and times of the notifications;
- verify the validity of the share pledge and the completion of the perfection formalities (which vary depending on the form of the company);
- verify the existence of any shareholders, investment or joint-venture agreement;
- verify the conditions of the trigger event under the pledge agreement and/or the main contractual documentation (focusing on the credit agreement and other intercreditor arrangements);
- identify the specificities relating to the enforcement of a pledge over a general partner share/unit, a collective investment vehicle, or a listed vehicle;
- verify the activities of the “target”, the need of specific personnel or licenses, and assess if clearances from prudential authorities are needed;
- check the legal, tax and accounting considerations of the appropriation structure;
- prepare the legal documentation for the appropriation and the exercise of (voting) rights to change the management, the registered office or the delegation of powers;
- collect / analyse data (financials, business plans, licenses, change of control clauses) pertaining to the “target” and its group;
- plan the post-enforcement phase (how will you manage the “acquired” business?);
- appoint an enforcement team (eg bailiff, valuer, new directors, accountants and even a PR agency to ensure effective communication after the enforcement, especially when the “target” is in sensible space);
- prepare filings and registrations with the Register of Commerce and Companies or the Register of Beneficial Owners; or
- expect the unexpected, such as (lack of) cooperation of the debtor side, collection of the company’s books, records or data, COMI shift, or insolvency proceedings started by the company before the enforcement.
If you don’t want this to slip through the cracks, it’s important to have a clear roadmap. For instance, on enforcement, the ownership of the shares will be transferred. If the shares of, say, a société anonyme are being appropriated, is the register handy to evidence such a transfer, to make it enforceable towards third parties? If not, there are some ways to overcome that practical complication (eg to launch a summary proceedings (actions en référé)), but your plans and timing will be compromised.
The valuation method of an enforcement by appropriation is freely determined by the parties. Usually, it’s deferred to an independent auditor or an investment bank. But the question is: who should appoint the valuer, the lender itself or the security agent? The pledge agreement is probably silent on this, so you should look at the terms of the underlying finance documentation, which, if LMA style, will probably provide an answer. It’s important to check there’s no conflict of interest of the valuer with the debtor group or, even, depending on the circumstances, the creditors or the security taker themselves.
The process may take some time (six to ten weeks generally), depending mostly on the available information on the “targeted” group, the complexity of the structure and the asset class. Most of the pledge agreements state that the valuation must be at fair (market) value. This is commonly taken as the estimated best obtainable value of the asset (given the market conditions), based on information available at the date of valuation and that would be paid by a willing buyer to an unaffiliated willing seller in an arm’s length transaction. The term “market” is in brackets as what would happen if there were no “market” for the assets?
The contractual provisions may affect the transferability of the shares and, as a result, the position of the security taker on enforcement. For instance, if only a minority stake in the company is subject to the pledge, the pledgee (or its delegate) may be caught by the provisions of an existing shareholders’ agreement on enforcement. In this respect we’ve seen situations where an upfront discount of the value of the shares has been applied.
Once the valuation has been completed, the value to retain is to be set in the range proposed by the valuer. Some say that opting for the mid-point of the range is prudent, unless exceptional circumstances have occurred that cause the security taker, acting reasonably, to believe there’s a reason to choose a different figure in the range. Others consider that the concept of “fair value” should be determined in accordance with the International Private Equity Valuation guidelines commonly accepted in Luxembourg. Definitely, there’s no one single method, but remember the appropriation value should be determined as at the date of the actual enforcement.
Even if legal proceedings have been started in Luxembourg, or elsewhere, in connection with a dispute on the main finance documentation (usually on the existence of the event of default), there’s no obligation to stop the valuation process.
In any event you can rely on one of the pillars of the Collateral Law, which lies on the limited grounds available to challenge a valuation if carried out in accordance with the terms agreed by the parties in the pledge agreement. Unless it can be demonstrated that there had been a manifest error or a fraud.
Application of proceeds and rights of recourse
The enforcement aims at discharging the secured liabilities to be calculated as at the date of the appropriation. So lenders and borrowers have to be prepared to face two situations at that moment:
- If the value of the collateral is lower than the secured liabilities, the creditor is entitled to exercise other remedies in the finance documents (eg enforcement of any another security or guarantee); or
- If the value of the collateral is higher than the secured liabilities, the creditor can keep the proceeds without incurring any liability (generally up to the amount of the secured liabilities) and then remit any surplus to the security grantor. On this point, parties generally argue on two points when the pledged assets are not liquid: when should this excess be transferred back to the security grantor, and should it be in cash and/or in kind? And should there be a financial support commitment from the lenders for the benefit of the appropriation vehicle to cover any surplus to be paid back?
No matter what the situation is, we won’t discuss here the consequences if the rights of recourse have not been (properly) waived but one should consider these.
Challenge of the enforcement
Luxembourg courts have repeatedly pushed back on any attempt to challenge an enforcement. Though it’s still possible in cases of clearly established fraud or abuse of right (abus de droit) from the lender side.
Nothing is foolproof, and there’s a certain breakpoint above which things can get complicated, so make an educated decision before “pushing the button”.