The new professional payment guarantee – Luxembourg reinforces its legal toolkit (ahead of Brexit)

This article was originally published in Agefi Luxembourg, November 2020 and is reproduced with permission from the publisher.

Introduced by a law dated 10 July 2020 (PPG Law), the professional payment guarantee (PPG) is the result of an accelerated legislative process made possible by the alignment of both professional and public demands for a new type of guarantee in a context marked by the COVID-19 pandemic and the looming Brexit.

In the context of Brexit, some European institutions as well as Luxembourg financial institutions initiated a gradual transition away from English law to other continental European laws, especially Luxembourg law, which is known for its pragmatic, agile and reliable approach. While the Law on financial collateral arrangements of 5 August 2005 (Financial Collateral Law) introduced a modern, efficient and business oriented system of rules for security interests, the existing legal framework on guarantees was not so appealing and did not offer adequate options for international financial transactions, or even for the Luxembourg government in its efforts to provide financial relief to the sectors of economy affected by the consequences of the pandemic.

The traditional common guarantee, the suretyship (cautionnement) had several limitations: only payment obligations could be guaranteed, its enforcement was possible only in case of a payment default and it could not be granted to a security trustee, requiring the use of complex structures, such as parallel debt mechanisms.

The other type of existing guarantee, the first demand or independent guarantee (garantie à première demande/garantie autonome), had the advantage of addressing most of the suretyship's shortcomings. By essence, first demand or independent guarantees imply a complete separation between the guarantee and the guaranteed obligations and thus a waiver of all defenses from the guarantor. However, it was not suitable for the guarantee of portfolio or ongoing obligations and any interaction with the underlying guaranteed obligations was excluded. Furthermore, contrary to other jurisdictions (such as France) , the Luxembourg legal regime was not based on legislation, but only on case-law and legal usages and thus lacked the level of legal certainty which suretyships had. Affected also by the perpetual risk of requalification into a suretyship, the first demand guarantee was only a partial solution for guarantees on transactions for which Luxembourg law was a potential choice.

The objective of the introduction of the PPG was to eliminate most of the limitations of the existing types of Luxembourg guarantees and introduce in the Luxembourg legal arsenal a tool equivalent to the guarantees which could be granted under English law but also German law (Bürgschaft auf erstes Anfordern). There are very few limitations as to the issuers of the guarantee. Natural persons may grant it if they act in their professional capacity (excluding thus consumers), as well as all types of companies (including those without legal personality), located in Luxembourg or abroad, public or international organisations and institutions, or investment funds (including common funds - FCP). There are no restriction as to the beneficiary and the granting of the guarantee in favour of representatives of creditors (such as security trustees and security agents) is expressly permitted by the PPG Law. Future beneficiaries can also be designated, to the extent the guarantee includes the criteria for their determination. To facilitate the spread of the professional payment guarantee, the PPG Law allows parties to decide to submit their existing guarantees to the new regime.

Formal requirements are limited. A written or electronic form is required, although an express reference to the application of the PPG Law must be inserted into the guarantee agreement.

The PPG has even more important advantages on substantive aspects. The designation of the guaranteed obligations is no longer limited to payment obligations and can also cover obligations to deliver (livrer), to perform (faire), to refrain from doing certain actions (ne pas faire), to deliver financial instruments or other assets or hedging obligations in respect of any type of underlying claims or assets. This very broad and diverse range of obligations will be appreciated by financiers and practitioners.

The trigger event for calling the guarantee is no longer limited to a payment default in the case of the PPG. The parties can freely agree to use other triggers, such as a breach of credit ratios by the guarantor or the debtor, or the breach of a prudential mandatory ratio applicable to the beneficiary of the guarantee.

Furthermore, the extent of the waiver of the rights of recourse of the guarantor is also left to the parties' discretion. The key innovation of the PPG Law lies in the presumption that the guarantor has waived the right to raise any defenses it may have against the beneficiary in relation to the guaranteed obligations. Unlike the first demand guarantee, the PPG Law provides that the existence of a reference to the guaranteed obligations in the guarantee itself does not lead to a risk of requalification into a suretyship and thus to an invalidation of the waiver. The PPG Law further expressly allows the waiver by the guarantor of the personal recourse against the originator of the guarantee (donneur d'ordre) and its subrogation rights against the beneficiary.

Another key benefit of the new PPG Law is the enforceability of the guarantee in the context of insolvency or similar proceedings, similar to the Financial Collateral Law. The PPG would remain enforceable against the guarantor even if the parties involved in the guaranteed obligations are subject to any such proceedings. The alignment with the Financial Collateral Law is however only partial – the PPG Law stops short of upholding the enforceability of the guarantee in case of insolvency of the guarantor itself. Such extraterritorial effect was possible under the Financial Collateral Law, based on the location in Luxembourg of the assets subject to the security interest created thereunder, whereas the PPG remains a form of personal security, with the main Luxembourg nexus being the choice of the governing law of the guarantee. The PPG may also be a useful tool before an insolvency, to the extent its enforcement does not require the acceleration of the guaranteed obligations. This flexibility recommends the use of the PPG as a part of indirect economic support measures which Luxembourg or European financial institutions may wish to implement in the context of market liquidity crisis.

Due to its benefits and facility of use, the PPG is destined to be widely used on finance, M&A, hedging, securitisation and, more generally, commercial transactions, enhancing the ability of the Luxembourg legal toolkit to efficiently respond to the financial markets' needs. A new way for Luxembourg to shine and weigh in on cross-border transactions!