Michel Molitor
Molitor Avocats à la Cour, Luxembourg
michel.molitor@molitorlegal.lu

Laurent Henneresse
Molitor Avocats à la Cour, Luxembourg
​​​​​​​laurent.henneresse@molitorlegal.lu

A recent decision handed down on 22 January 2020 by the Luxembourg Court of Appeal^[1] is relevant for banking and finance practitioners as it concerns the attempts made by a pledgor to overturn the enforcement of pledges. This decision confirmed the theoretical possibility of obtaining a declaration of nullity against the enforcement of a pledge subject to the law of 5 August 2005 on financial collateral arrangements, as amended (the 2005 Law), on account of fraud or abuse of right, although the application of this principle is rarely successful owing to the merits of the cases showing no wrongdoing on the part of the pledgee.

Protection afforded by Article 20(4) of the 2005 Law

The 2005 Law, which implemented Directive 2002/47/EC^[2] (the Financial Collateral Directive) into Luxembourg law, greatly reinforced the attractiveness of the country as a significant jurisdiction for the creation of robust, easily enforceable and insolvency-remote security interests over financial instruments and claims.

One of the cornerstones of the 2005 Law is Article 20(4), which disapplies certain domestic and foreign provisions and measures that could otherwise prevent the enforcement of financial collateral arrangements or jeopardise the existence of the security interests. More specifically, the ordinary rules governing civil pledges,^[3] as well as all Luxembourg or foreign provisions governing reorganisation measures, winding-up proceedings (with the exception of the Luxembourg law on over-indebtedness)^[4] or other similar proceedings and attachments, cannot adversely affect the enforcement process of a pledge. Similarly, attachments (whether civil, criminal or judicial), penal confiscation and disposals concerning the financial instruments or claims over which security is created will not impede the enforcement of the rights of the collateral taker.

Article 20(4) of the 2005 Law transposes Article 8(1) b) of the Financial Collateral Directive, pursuant to which Member States should ensure the protection of financial collateral provided during a time period preceding the commencement of reorganisation measures or winding-up proceedings against the collateral provider. Accordingly, Luxembourg financial collateral arrangements are not subject to any clawback actions or voidance actions affecting certain acts which took place before or after the opening of insolvency proceedings in Luxembourg.

Another reason for adopting Article 20(4) was to protect financial collateral arrangements against any risk of nullity or unenforceability amid the opening of insolvency proceedings in a Member State. By application of the rules on rights in rem under Council Regulation (EC) No 1346/2000 of 29 May 2000 on insolvency proceedings, as amended (Regulation (EC) 1346/2000), the law of another Member State which applies to the insolvency proceedings (the lex concursus) would not affect financial collateral arrangements subject to the 2005 Law, as they would remain exclusively governed by Luxembourg law.^[5] In addition, even if financial collateral arrangements amount to acts detrimental to the other creditors, they are not subject to the rules on voidness, voidability and unenforceability under a foreign lex concursus, provided, amongst other things, that Luxembourg law does not allow any means of challenging them in the relevant case.^[6] Regulation (EC) 1346/2000 has since been repealed and replaced with Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings (recast) (Regulation (EU) 2015/848), which has replicated the rules on rights in rem and detrimental acts from Regulation (EC) 1346/2000.^[7]

In consideration of these rules, the Luxembourg legislator took the stance of reinforcing the exceptional protection afforded to Luxembourg law-governed financial collateral arrangements – stating that Article 20(4) of the 2005 Law is an overriding mandatory rule (loi de police). Where the pledgor fraudulently acts in concert with the pledgee, awarding damages would be the most appropriate remedy.

Admission of fraud and abuse of right to nullify the enforcement of a pledge

In the Pillar case in 2013, the Luxembourg District Court^[8] ordered the nullity of an enforcement of a share pledge for the first time, which was carried out by way of appropriation. The court held that the bank, which was the pledgee under the pledge agreement, had artificially caused the occurrence of an enforcement event 48 minutes after granting refinance to the borrower. By doing so, it had committed a manifestly fraudulent act to abusively appropriate the pledged assets. The decision of the Luxembourg District Court was upheld by the Court of Appeal^[9] and the Supreme Court.^[10]

The principle recognised in the Pillar case was confirmed in 2017 by the Luxembourg District Court^[11] and in 2020 by the Court of Appeal^[12] in the Courtepaille case, although some clarifications were provided. In particular, the courts specified that fraud and abuse of right are standalone grounds which can lead to the nullity of the pledge.

However, when assessing the merits of the Courtepaille case, the lower and higher courts concluded that the constituent elements of fraud or abuse of right on the part of the pledgee were not established. The courts held that the pledgor will not be successful in trying to have the enforcement overturned, as long as the pledgee acts in good faith and adheres to the contractual provisions of the pledge agreement which regulate the enforcement of the pledge.

The courts also confirmed that, as permitted by the 2005 Law (and although no default has occurred yet under the obligations secured by the pledge), the pledgee can enforce a pledge by way of appropriation upon the occurrence of one of the other enforcement events agreed with the pledgor in the pledge agreement (eg breaches of financial ratios), if the enforcement proceeds are applied to the secured obligations. This court finding was also supported by the fact that, after a breach of a financial ratio, the pledgee and the finance parties did not act in bad faith since they had long negotiated with the investors to salvage the borrower’s group and had requested them to recapitalise it to no avail. Therefore, the behaviour of the pledgee when enforcing the pledge was not found to be fraudulent or abusive.

Furthermore, the lower and higher courts held that the pledgee was entitled to appropriate the pledged assets at nil value on the basis of the valuation provided by the independent statutory auditor appointed pursuant to the appropriation and valuation clauses of the pledge agreement, given that doing so was in line with the terms contractually agreed between the parties to that agreement.

Conclusion

As confirmed by the decision of the Court of Appeal of 22 January 2020, fraud and abuse of right can, under specific circumstances, lead to the nullity of the enforcement of a pledge governed by the 2005 Law. This conclusion is welcome as it allows the pledgor to have its rights protected against a fraudulent or abusive pledgee who would unduly try to hide behind the protection embedded in Article 20(4) of the 2005 Law.

Even if the recognition made by the courts in the Courtepaille case is revolutionary, it is of limited applicability – only concerning fraud and abuse of right affecting the very decision to enforce the pledge. Therefore, where a pledge could in any event be enforced, and the pledgee commits a fraud or an abuse of right which only affects the implementing conditions of the enforcement (such as the valuation of the pledge assets or the determination of the price obtained for the sale of the pledged assets), there is no reason for a Luxembourg court to overturn the enforcement of the pledge. In this situation, allocation of damages remains the most appropriate remedy.^[13]