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Enforcement of financial collateral arrangements in Luxembourg

27 May 2011

Recent judgment from Luxembourg Court of Appeal confirms and strengthens favourable environment for banks

A recent judgment from the Luxembourg Court of Appeal (Commercial section), 3 November 2010, n°35824 has confirmed and strengthened the favourable environment for banks established by the Luxembourg Act on financial collateral arrangements dated 5 August 2005 (the Collateral Act) for the enforcement of a pledge agreement.

In 2007, Landsbanki Luxembourg S.A. (Landsbanki) (currently in liquidation) granted a loan for a total amount of EUR35 million to a private individual (the Loan). EUR9 million was provided directly to the borrower for the financing of a real estate investment in France, whereas the remainder was invested into a complex financial structure. The borrower was compelled to invest the remaining EUR26 million in several investments backed by three life insurance contracts issued by a Luxembourg company but managed by Landsbanki.

The Loan was secured by various pledges, including pledges on the insurance contracts and a pledge on the assets held by the borrower with Landsbanki (the Pledges), granted by the borrower in favour of Landsbanki. The Pledges were governed by the Collateral Act.

In July 2009, the liquidator of Landsbanki asked for the reimbursement of the Loan. The borrower refused to pay the outstanding amount claimed by Landsbanki. Consequently, Landsbanki decided to enforce the Pledges.

The borrower filed an action before the Luxembourg District Court sitting in summary proceedings in order to obtain the suspension of the enforcement (or of the effect of the enforcement) of the Pledges. This action was principally based on Article 932, paragraph 1 of the New Code of Civil Procedure, according to which the President of the District Court may order, in urgent cases, by way of summary proceedings, any measure that is not seriously disputed or that is justified by the existence of a dispute.

On 4 December 2009, the President of the District Court held that even though Article 20, paragraph 4 of the Collateral Act provides that “financial collateral arrangements … are valid and enforceable notwithstanding reorganisation measures, winding-up proceedings or any other similar national or foreign proceedings”, this does not mean that general contract law and the consumer protection rules are inapplicable to those collateral arrangements. The President of the District Court justified its position by quoting Recital 17 of Directive 2002/47/EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements (the Directive) which provides that: “This Directive provides for rapid and non-formalistic enforcement procedures in order to safeguard financial stability and limit contagion effects in case of a default of a party to a financial collateral arrangement. However, this Directive balances the latter objectives with the protection of the collateral provider and third parties by explicitly confirming the possibility for Member States to keep or introduce in their national legislation a posteriori control which the Courts can exercise in relation to the realisation or valuation of financial collateral and the calculation of the relevant financial obligations. Such control should allow for the judicial authorities to verify that the realisation or valuation has been conducted in a commercially reasonable manner”.

The President found there was a clear emergency and a serious dispute between the borrower and Landsbanki on various issues, including the validity of the entire structure set up by the bank, and ordered, on the basis of Article 932, paragraph 1 of the New Code of Civil Procedure, the suspension of the enforcement of the Pledges until a final decision on the merits or until an agreement between the parties was reached.

On 3 November 2010, the Court of Appeal overturned this decision, albeit still basing its decision on the same paragraph 4 of the Collateral Act and on Recital 17 of the Directive.

The Court of Appeal held that the ex post control as expressly provided for by Recital 17 of the Directive remained possible in the framework of an action for liability in tort, even without the intervention at that stage of the procedure of the court sitting in summary proceedings.

The Court of Appeal justified this analysis by quoting Article 20, paragraph 4 of the Collateral Act, which it considered to be a mandatory rule (loi de police), the rationale of which is to protect financial collateral arrangements from a potential challenge and to offer to the lending institutions a framework within which they can operate safely.

Comment

The decision of the President of the District Court ordering the suspension of the enforcement of the financial collateral was contrary to the letter and the spirit of the Collateral Act. Once the legal and contractual conditions for the enforcement of the pledge exist, no prior judicial approval is required to enable the lender to enforce the financial collateral arrangement.

Fortunately, the Court of Appeal clearly rejected the position of the lower court and confirmed – and thus strengthened the favourable financial environment established by the Collateral Act. In its judgment, the Court of Appeal made it clear that the courts are not permitted to impose provisional measures that interfere with the enforcement of financial collateral arrangements.

The judgment of the Court of Appeal, which clearly supports the efficiency of Luxembourg financial collateral arrangements, acknowledges the legal protection granted by the Collateral Act to foreign and Luxembourg financial and banking sectors.

Further Information

The European Finance Litigation Review is a quarterly publication on recent developments in the finance litigation and regulatory sector in key European jurisdictions.  For more information please contact Amy Edwards amy.edwards@alleovery.com.