Have you considered this for the enforcement of a Luxembourg pledge over shares?

This article was originally published in Agefi Luxembourg, November 2021 and is reproduced with permission from the publisher.

In multijurisdictional financings, taking pledges over shares of a Luxembourg holding company has been key for the attractiveness of the Grand Duchy.

The magic derives from the flexibility of their implementation and the efficiency of their enforcement and takeover of a group upon the occurrence of the eventfreely agreed upon by the parties (subject of course to the compliance with the Luxembourg law of 5 August 2005 on financial collateral arrangements, as amended (the “Collateral Act”) and the pledge agreement itself).

With the current global health situation having weakened many groups and state aids failing due for repayment i several countries, it is likely that defaults will escalate, leading to a rise in enforcement of Luxembourg pledges. Perhaps what will be developed below is more strategy than substance, but you will certainly need confidence-building measures and you will have to consider some elements for an enforcement by appropriation. Don’t let guesswork weaken a well-established, predictable and robust legal framework.

A few reminders

The Collateral Act has greatly facilitated enforcements by offering the secured creditor the possibility to exercise its rights in circumstances freely (emphasis added!) determined by the parties in their agreement. This has been clearly ruled by Luxembourg courts and may be set in stone soon. Not even a prior notice (mise en demeure) is legally required, but security takers tend to inform the debtor side, probably in an abundance of caution.

The appropriation of the pledged assets is probably the most commonly used enforcement method due to its rapidity, cost-effectiveness and flexibility, with a valuation to take place before or after the appropriation at a price determined pursuant to the valuation method agreed upon by the parties. The Collateral Act also allows an appropriation by the security taker itself or, more frequently, by a third party.

Additionally, the right to take over the shares derives from the Collateral Act, so the relevant documentation does not need to be (extremely) complex.

Before launching the enforcement

Before launching the enforcement, you may consider a few elements beforehand, among which:

• identification of the parties to inform of the enforcement (although not legally required);
• verification of the validity of the share pledge and fulfilment of the perfection formalities;
• verification of the conditions of the trigger event under the pledge agreement and/or
• structure and tax considerations of the appropriation vehicle;
• preparation of the legal documentation and exercise of (voting) rights;
• appointment of the enforcement team (eg bailiff, valuer, new directors, accountants); and
• collection / analysis of financial data pertainingto the “target” and its group.

If you do not want this to slip through the cracks and ensure that the process is as smooth as possible, it’s worth gathering these components as soon as possible. For instance, everybody knows that, upon enforcement, ownership will be transferred. If the shares of, say, a société anonyme are being appropriated, is the register handy to evidence such a transfer? If not, there are some ways to overcome that practical complication (eg to launch a summary proceedings (actions en référé).

Valuation process

The valuation method of an enforcement by appropriation is freely determined by the parties. Typically, it is agreed that the valuation is carried out by an independent auditor. In practice, the question would arise as to who appoints the independent auditor, the lender itself or the security agent? The pledge agreement is probably silent on this, so it’s worth verifying the terms of the underlying finance documentation, which, when based on the LMA standards, will provide the answer. In any event it’s important to verify the absence of a conflict of interest with the debtor group or, even, depending onthe circumstances, the creditors or the security taker themselves.

The process may take some time (between six to ten weeks generally), depending mostly on the information available, the complexity of the structure and the asset class. Most of the pledge agreements state that the valuation shall be at fair (market) value, which is commonly construed as the estimated best obtainable value of the collateral (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 reader will appreciate that the term “market” is in brackets as what would happen if there is no “market” for the assets so appropriated?

Once the valuer has finished its work, what’s the value to retain in the proposed range? Some say that the mid-point of the range is generally taken, unless exceptional circumstances have occurred such as to cause the security taker, acting reasonably, to believe there is justification for a different figure in the range to be selected. Others consider that the concept of “fair value” should be as defined in the International Private Equity Valuation guidelines commonly accepted in Luxembourg. Definitely there is no single method, just keep that element of complexity in mind.

Also note that, despite any legal proceedings pending in another jurisdiction in respect of the main finance documentation, there is no obligation to stop the valuation process in Luxembourg.

In any event you can rely on one of the pillars of the efficient framework of the Collateral Law, which lies on the limited grounds available to challenge a valuation if it was 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.

Application of proceeds and rights of recourse

The initial purpose of the pledge is to secure the obligations owed under the main finance documentation. The enforcement of the pledge naturally aims at discharging those obligations and two situations may occur as a result:

• the value of the pledged assets is lower than the secured obligations. In such a case the creditor should be entitled to enforce any other security or call any other guarantee to satisfy the secured obligations (if the finance documents permit); or
• the value of the pledged assets is higher than the secured obligations. The creditor shall then retain the proceeds up to the amount of its secured obligations and remit any surplus to the security grantor, without incurring any liability. The question is when this excess should be transferred back?

No matter what the situation is, we won’t discuss here the consequences if the rights of recourse have not been (properly) waived as it could set alarm bells ringing.

Challenge of the enforcement

Luxembourg courts have repeatedly pushed back on any attempt to challenge an enforcement in Luxembourg (although it’s possible in case of clearly established fraud or abuse of right (abus de droit)). Nothing is foolproof here, but let’s make an educated decision before pushing the button.