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Repurchase of CPECS from shareholders is not illegal, rules Luxembourg court

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23 March 2016

Decision of the 15th Chamber of the District Court of Luxembourg, n°1648/2015, 23 December 2015 (appeal ongoing)

The Luxembourg District Court ruled that, from a company law perspective, Convertible Preferred Equity Certificates (CPECs) issued by a Luxembourg company are to be treated as debt instruments so that the repurchase of CPECs by an issuer from its shareholders is not the distribution of fictitious profits. CPECS are commonly used in U.S. investment structures due to favourable tax treatment.

CPECS – favourable tax treatment for U.S. investors

CPECs are unregulated and innominate financing instruments, used commonly in U.S. investment fund structures. Although similar to notes or bonds, they contain a number of features more commonly found in equity instruments. CPECs are treated either as debt or as equity for Luxembourg direct tax purposes, depending on their overall combination of features in any given case. Typically, the overall features of CPECs are such that they qualify as debt for Luxembourg direct tax purposes, but as equity for U.S. tax purposes. As such CPECs give rise to interest charges in Luxembourg on an accrual basis while U.S. taxation is deferred until interest is effectively paid. In other words, the main purpose, from a tax perspective, for using CPECs, as opposed to regular loans, notes or bonds, is to avoid dry tax charges for U.S. investors.
Notwithstanding the tax treatment of CPECs, the issue of their qualification from a legal point of view (equity or debt) has recently emerged. In this recent case the question arose as to whether a company, not being in position to distribute dividends, could repurchase from its shareholders the CPECs it issued without being in breach of article 72-1 of the Luxembourg law of 10 August 1915 on commercial companies as amended (the LSC), which prohibits the distribution of fictitious dividends.
CPEC cascade financing – then a restructuring
A consortium of investors (the Investors) invested in 2005 in the Greek group TIM HELLAS, which was active in the telecommunications market. The investment was made via a Luxembourg company (HELLAS II).

HELLAS II was fully owned by another Luxembourg Company (HELLAS I), which was in turn fully owned by another Luxembourg company (HELLAS). HELLAS was owned by the Investors.

The financing was partly made via issuances in cascade in 2005 and 2006 of CPECs with a par value of EUR 100. HELLAS II issued CPECs subscribed by HELLAS I, which issued a similar number of CPECs subscribed by HELLAS, which issued a similar number of CPECs subscribed by the Investors.

After a failed attempt by the Investors to sell the HELLAS group, HELLAS debt was restructured in December 2006 via:

− two public issuance programmes of notes by HELLAS II for EUR 960 million and USD 275 million respectively; and
− a “cascade” (partial) repurchase of the CPECs by the original issuers.

The CPEC repurchase

HELLAS II repurchased the CPECs it issued to its shareholder HELLAS I (the Repurchase). The Repurchase amount (over EUR 978 million) was used by HELLAS I to (partially) repurchase the CPECs it issued to its shareholder HELLAS for the (approximately) same amount. HELLAS then (partly) repurchased the CPECs it issued to the Investors.

The Repurchase price was calculated, in accordance with the Terms & Conditions of the CPECs, as the greater of: (i) the par value of the CPECs; or (ii) the market value, on a fully diluted basis, of the shares into which the CPECs could be converted reduced by 5%.

In 2007, the HELLAS group was acquired by an Italian company. In 2009, HELLAS II moved its centre of main interests to the UK and then entered administration. It was wound up in 2011.

Liquidators argue that the CPEC repurchase was an illegal distribution of profits

The liquidators argued (among others) that the Repurchase was an illegal distribution of HELLAS II’s profits under article 72-1 LSC.

HELLAS II’s liquidators, before the Luxembourg District Court:

− challenged the decision by HELLAS (as the director of HELLAS II) to repurchase the CPECs; and
− sought to recover the Repurchase price paid by HELLAS II to HELLAS I.

Article 72-1 LSC prohibits distributions to shareholders save where certain conditions are met concerning capital, non-distributable reserves and profits1. HELLAS II’s liquidators claimed that HELLAS II’s financial position did not meet the distribution conditions of Article 72-1 LSC, such that the payment to its shareholder of the Repurchase price was an illegal distribution of profits. They argued that the prohibition in article 72-1 LSC applies to any distributions made to shareholders, including a repurchase of CPECs from a shareholder.

Court holds that Repurchase is not illegal

The Court held that article 72-1 LSC only applies to distributions made to shareholders in their capacity as holders of shares representing the share capital. CPECs are contractual debt instruments which do not represent their issuer’s share capital or grant their holders any voting rights or a share of the profits distributed by the company to its shareholders. The repurchase of CPECs by an issuer from its shareholder is not subject to article 72-1 LSC.


CPECs have proven to be tax efficient and flexible financing instruments allowing, as in the present case, for the transfer of cash to shareholders in the absence of any distributable profits or alternatively, by their conversion into shares, the transfer of cash from shareholders to the company.

Article 72-1 LSC targets “distributions to shareholders”, leaving room for some debate about its scope. The District Court’s decision to exclude from the scope of this article a repurchase by an issuer of CPECs from its shareholders preserves the flexibility of CPECs.

Nevertheless, even though the repurchase by a company of CPECs or similar instruments from its shareholders is not subject to the prohibition on the distribution of fictitious profits, the operation is not risk-free. Among others, where the repurchase is found to be contrary to the company’s interests (which could be the case if the repurchase price does not reflect the real value of the CPECs2), liability may attach to the company’s directors. The validity of the repurchase could also be challenged by a minority shareholder, should the repurchase of CPECs only concern a majority shareholder (abuse of majority powers (abus de majorité)). Such risks would be all the more real if the timing of the repurchase of CPECs is connected to the issuer’s insolvency.

1 It should be stressed that article 72-1 LSC is further criminally sanctioned by article 167 LSC: “Any manager or director who, (…) contravenes article 72-1, shall be subject to [a jail term of one month to two years and a fine of EUR 5,000 to 125,000]” – Free translation.

2 Which are because of their convertible nature, directly linked to the value of the shares in which they can be converted.​