A mini earthquake occurred in Italian football in July 2018. Without any sale or court decision, US-based fund manager Elliott Management announced that it had become the owner of AC Milan, which had only a year earlier been sold by Silvio Berlusconi to Chinese businessman Yonhong Li. Explaining this surprising change of hands, Elliott refers to a debt of 32 million euros which expired on 6 July and which Li, who had received this amount as a loan from the American fund for the purchase of the club, did not honour.
“This 24-hour takeover was possible because the collateral documentation relating to the financing put in place between the two companies was subject to Luxembourg collateral law,” explains Matthieu Taillandier, Partner of Finance & Capital Markets at Arendt & Medernach, “as it allows the pledge to be enforced directly in the event of default or otherwise, which is generally not so simple in other European legislation.”
In August 2005, Luxembourg’s Parliament adopted new legislation on financial collateral arrangements. The aim was to ensure the rapid transposition of a 2002 EU directive on financial collateral arrangements, which was intended to harmonise the rules on collateral. “The legislator decided to transpose the directive in the most extensive way possible by adopting a protective approach for the beneficiary or beneficiaries of the financial collateral”, observes Melinda Perera, partner Capital Markets & Banking at Linklaters Luxembourg. The law of 5 August 2005 offers extremely broad legal security in many cases, such as in the event of the insolvency of the financial collateral provider. However, only – and this is an important limitation – in cases where the financial collateral relates to assets as defined in the 2005 law (financial instruments, bank accounts or claims located in Luxembourg). Two laws – Blockchain 1 and 2 – have already been passed and a third bill was passed on 14 March by the Chamber of Deputies to come into force on 23 March. Their scope is limited to financial instruments (MiFID). Other cryptoassets will be regulated by the European MiCA regulation.
The legislator decided to transpose the directive in the most extensive way possible by adopting a protective approach for the beneficiary or beneficiaries of the financial collateral.
Structures in Luxembourg to secure the pledge
This favourable regime has seen many international creditors ensure that their clients create a Luxembourg structure for pledged assets in order to ensure they receive the full benefits of Luxembourg law in this respect. In practice, this is usually a set-up with one or two companies in Luxembourg (hence the name “Double LuxCo” in the second case). The lender, on the other hand, is not required to be based in the Grand Duchy of Luxembourg.
An important feature of this law is that the financial collateral arrangement cannot be challenged in case of bankruptcy of the collateral provider. According to the 2005 law, a pledge agreement cannot be blocked by a collective procedure. If its debtor and/or financial collateral provider goes bankrupt, the creditor who benefits from a financial collateral arrangement under Luxembourg law will always have priority to recover the pledged assets. This procedure also applies in the case of bankruptcies of companies based abroad, provided that the pledged asset is located in Luxembourg.
“The second major advantage of this law concerns the enforcement methods (how to take ownership of the pledged assets),” continues Perera. “The intervention of a third party, such as a bailiff or a court procedure, is not necessary for the two enforcement methods most used in practice, i.e. appropriation and sale. Once set out in a written agreement and upon the occurrence of the agreed event to exercise your rights, you can appropriate the pledged asset directly or decide to sell the pledged assets to an interest buyer. These two methods are quick and efficient.”
Granting loans more easily
A contract concluded under the Luxembourg law of 2005 also gives the possibility to enforce the pledge in cases other than a payment default of the borrower, with both parties free to determine the limits from which the creditor can enforce their right. This could be, for example, the occurrence of a pre-defined event as a trigger for realising the pledge. In April 2015, the British fund Intermediate Capital Group was able to take control of the French restaurant chain Courtepaille before any default. Its main shareholder, Fondations Capital, had contractually agreed not to exceed certain debt ratios, which it was unable to meet. After various phases of renegotiation, ICG finally exercised its rights over Courtepaille before the company was in even worse shape.
“This legislation, which aims above all else to protect creditors, is generally well accepted by both parties. The legal certainty it offers allows would-be borrowers to receive the amounts they need, which might not have been the case if the conditions regarding securities had been less reassuring,” highlights Taillandier.
This legislation, which aims above all else to protect creditors, is generally well accepted by both parties.
Finally, to further strengthen the regime for security interests in financial instruments, Bill 8055, which foreshadows the future Blockchain 3 Law, adopted by the Chamber of Deputies on 9 March 2023, clearly confirms that the August 2005 law will also apply to securities held in a Distributed Ledger Technology. This confirmation further strengthens the legal certainty that creditors will continue to enjoy even in the event of technological disruption.