Amendments to the Luxembourg Financial Collateral Law

In July 2022, the Luxembourg Parliament (Chambre des Députés) adopted a bill proposing a reformof the Luxembourg law of 5 August 2005 on financial collateral arrangements, as amended (the Luxembourg Financial Collateral Law).¹ The reform reinforces the legal certainty of Luxembourg financial collateral arrangements by introducing a number of welcome clarifications to several frequently discussed notions and enforcement mechanisms in the law.

While the reform was primarily intended to align certain provisions of the Luxembourg law with Regulation (EU) 2021/23 of 16 December 2020 on a framework for the recovery and resolution of central counterparties (the Recovery and Resolution Regulation), the Luxembourg Parliament seized this opportunity to update the Luxembourg Financial Collateral Law and bring it in line with current market practice and case law. In particular and most importantly, clarifications have been added to the provisions regulating the enforcement of security interests by way of sale and the application of enforcement proceeds.

Recovery and Resolution Regulation

Article 2-1 of the Luxembourg Financial Collateral Law now includes a reference to the Recovery and Resolution Regulation in order to specify that the Luxembourg Financial Collateral Law applies without prejudice to the provisions of the Recovery and Resolution Regulation as well as to the provisions of Part I of the law of 18 December 2015 on the failure of credit institutions and certain investment firms, as amended, and Part IV of the Luxembourg law of 5 April 1993 on the financial sector, as amended, which includes Some derogations from the Luxemburg Financial Collateral Law in certain circumstances.

Additional clarifications about enforcement events of pledges

The Luxembourg Financial Collateral Law now contains useful clarifications with respect to the triggers for enforcement of pledges subject to that law.

The new version of the law stipulates that any event, irrespective of its nature, as agreed between the parties to a pledge agreement can serve as an enforcement event. In this respect, the law specifies that an enforcement event is a default or any other event 'whatsoever' which has been agreed between the parties by amending the definition of "Enforcement Event" in the law and in order for it to explicitly refer to "any event of default or any event whatsoever" (Fr. "une défaillance ou tout autre événement quelconque convenu entre les parties"). The introduction of this wording explicitly confirms that the agreed enforcement events entitling the collateral taker to enforce a pledge can also be events other than payment defaults, such as breaches of financial covenants or other events or circumstances which relate to either the general framework or to certain specific aspects of a transaction and irrespective of whether or not any payment obligations have become due and payable.

The Luxembourg legislator in the parliamentary works with respect to the new Luxembourg Financial Collateral Law had explicitly mentioned that the parties to the pledge should be entirely free to determine the circumstances that should lead to an enforcement event. In this respect reference was made to the non-compliance of certain financial ratios or any other elements relating to the general economy or to certain particular aspects of a given transaction.²

There had been discussions in the Luxembourg legal doctrine about the question whether any events other than typical enforcement events could indeed be agreed as constituting enforcement events of a pledge governed by the Luxembourg Financial Collateral Law. In line with the general creditor-friendly orientation of the Luxembourg Financial Collateral Law, the Luxembourg courts previously confirmed that security financial collateral arrangements can be enforced upon the occurrence of any contractually agreed enforcement trigger event (in the specific case, a breach of financial covenant), irrespective of whether a payment default occurred, or any secured obligations are due and payable. In fact, in a court decision of 22 January 2020 the Luxembourg Court of Appeal took the view that the mere violation of a financial covenant could in itself constitute an agreed enforcement event of a pledge.

The amendment of the definition of enforcement event, however, also raised the question whether the enforcement proceeds should be applied immediately against the relevant secured obligations or whether the pledgee should be required to hold these proceeds as continuing security until the secured obligations become due and payable.

The Luxembourg Financial Collateral Law now clarifies this by providing that, unless otherwise agreed by the parties, enforcements will be immediately applied against the secured obligations on enforcement. ³ This clarification also cements a position previously adopted by legal practice into the Luxembourg Financial Collateral Law.

This provision is especially helpful in circumstances where an enforcement has occurred in situations where there has been no payment default (as mentioned above) or acceleration of the underlying secured liabilities, or no contractual prepayment features will be required.

This flexibility in the structuring of an enforcement clearly is a standout feature of the Luxembourg financial collateral regime for creditors compared with other European countries.

Amendments to the enforcement methods of pledges

Furthermore, the Luxembourg Financial Collateral Law has undergone a series of amendments with respect to the various enforcement methods of pledges. These amendments relate to five main topics:

1. sale of pledged assets on trading venues;
2. appropriation of financial instruments admitted to trading on a trading venue and of units or shares in a collective investment undertaking;
3. enforcement of pledges over units or shares in collective investment undertakings;
4. enforcement of pledges over claims arising under insurance contracts; and
5. the public auction enforcement method for pledges.

However, it should be noted that parties may always agree on alternative methods of enforcement and the provisions of Luxembourg Financial Collateral Law apply only to the extent the pledgor and the pledgee have not agreed otherwise.

Sale of pledged assets on trading venues

In the past, the Luxembourg Financial Collateral Law provided the pledgee with the possibility to enforce pledged assets "by private sale on normal commercial conditions, by sale over a stoc exchange or by public auction" and by default such a public auction was to be affected through the Luxembourg Stock Exchange.

In respect of the private sale of financial instruments admitted to trading, the reference to "stock exchange" has now been updated and clarifies that the sale of the pledged assets can generally happen on the platform on which the pledged assets have been admitted to trading, which does not necessarily need to be a regulated market only. Furthermore, assets which have been admitted to trading on any unregulated market can be directly disposed of on the same market. Such markets now also include any Luxembourgish, European or third country regulated markets, multilateral trading facilities (MTF) or organised trading facilities (OTF).

Appropriation of financial instruments and of units or shares in a collective investment undertaking

Another additional new feature of the Luxembourg Financial Collateral Law is the introduction of provisions regarding the value at which financial instruments admitted to trading on a trading venue, and units or shares in collective investment undertakings, can be appropriated.

The Luxembourg Financial Collateral Law now clearly distinguishes between (i) an appropriation of financial instruments admitted to trading on a trading venue (which appropriation can, unless the parties have otherwise agreed, be made at the market price of such financial instruments), and (ii) an appropriation of units or shares in a collective investment undertaking, which can, unless the parties have otherwise agreed, be made either at their market price, provided that such units or shares are admitted to trading on a trading venue, or at the price of the last net asset value published by, or for, that collective investment undertaking, provided that the latest publication of the net asset value is not older than one year.

This addition to the Luxembourg Financial Collateral Law follows an evolution in market practice where a similar approach on appropriation of fund units has become increasingly common.

Enforcement of pledges over units or shares in collective investment undertakings

The new version of the law also explicitly clarifies that with respect to units or shares in a collective investment undertaking the collateral taker can enforce the pledge by requesting the redemption of the pledged units or shares at their redemption price in accordance with the constitutional documents of the relevant collective investment undertaking.

Enforcement of pledges over claims arising under insurance contracts

Furthermore, an additional item covering insurance contracts and listing all accepted enforcement procedures ⁴ has been included in the relevant provision of the Luxembourg Financial Collateral Law. The Luxembourg Financial Collateral Law now offers a new, specific enforcement method for these types of claims by providing that a pledge over such insurance contracts can be enforced by requesting the repurchase of the contract or demanding the payment of all sums due under the insurance contract in satisfaction of the secured obligations.

This new rule on the enforcement of pledges over claims arising under insurance contracts should be likely to assuage the doubts that have been raised in the past by certain legal authors questioning the applicability of the Luxembourg Financial Collateral Law to pledges over insurance contracts. In this respect it is, however, important to note that a pledge over a Luxembourg life insurance contract still needs to comply with articles 116 and 117 of the Luxembourg law of 27 July 1997 on the insurance contract. This law has not been amended by the reform of the Luxembourg Financial Collateral Law. Specific rules in this respect provide that, among other things, a life insurance contract may be pledged only by an endorsement signed by the policyholder, the collateral taker and the insurer and, where the benefit of a life insurance contract has already been accepted, with the consent of the beneficiary.

New public auction enforcement regime

Finally, the Luxembourg public auction regime has been amended and updated and thus no longer refers to the Luxembourg Stock Exchange as the mandatory public auction entity. The public auction regime prior to the reform of the Luxembourg Financial Collateral Law was based on a law dated 1 June 1929 and stemmed from the fact that the Luxembourg Stock Exchange used to benefit from a specific governmental concession. However, as a result of the Luxembourg law of 13 July 2007 on markets in financial instruments, the Luxembourg Stock Exchange has become an ordinary professional body in the financial sector among many others and thus the Luxembourg legislator did not consider it appropriate to burden it any longer with the role of a national public auction entity. ⁵ Consequently, an entirely new procedure which involves the participation of a Luxembourg notary or bailiffs has been included in the new Luxembourg Financial Collateral Law and which applies unless parties agree otherwise. The new law also foresees specific rules with respect to situations in which any authorisations or lack of opposition from a particular public authority is required for the realisation of a tender in the auction process. If such approval cannot be obtained in a timely manner, the pledgee has the right to prolong the relevant period during which the approval can be achieved or, as the case maybe, to initiate a new public auction procedure.

Interestingly, the Luxembourg Financial Collateral Law now provides that assets can be acquired in a public auction through any payment method, including set-off against the obligations secured under the relevant security arrangement. Although this amendment to the law should be welcomed, it ought to be noted that the public auction procedure is not used very frequently as pledgees tend to prefer the shorter and less expensive appropriation and private sale mechanisms.

The changes introduced by the new Luxembourg Financial Collateral Law have brought about helpful clarifications and answers to the above discussed legal aspects, without changing the overall substance of the law. In this respect the reform has undoubtedly reinforced the law's strong creditor-friendly position and will further enhance Luxembourg's position as a prime financial centre for all types of financial transactions requiring collateral arrangements.

_{1. Projet de loi N°7933, 20.12.2021.}

_{2. Comment to article 9, page 16 of bill of law N° 7933.}

_{3. Article 11(5) of the Luxembourg Financial Collateral Law.}

_{4. Article 11(1)g) of the Luxembourg Financial Collateral Law.}

_{5. Comment to article 10, page 18 of bill of law N° 7933.}

Authors: Fabien Debroise, Partner; Katia Fettes, Counsel; Anna Kozakiewicz, Associate