Debt restructuring and refinancing in Luxembourg

Consensual debt restructuring methods

Refinancing

Refinancing is not strictly speaking a restructuring method. It aims to replace an existing loan with a new one. The borrower may obtain more favourable conditions: greater facility amount, longer tenor, less stringent financial covenants. On the other hand, the lender may demand a higher interest rate to compensate for the increased risk incurred by providing new financing to a distressed company. Fresh security interests will be required.

There is no special priority in law – by way of preferential ranking for debtor-in-possession financing – given to the repayment of this funding if an insolvency proceeding is subsequently brought against the debtor. If the financing is granted after the commencement of insolvency proceedings, the lender will then be considered a creditor of the bankruptcy estate (créancier de la masse) and will be granted a priority claim against the estate.

Modification of debt terms

The debt may continue, but with modified terms taking into account the current financial situation of the borrower.

Usual concessions often include partial settlement of principal, interest rate adjustments, payment extension and alteration of (overly restrictive) covenants. These amendments do not constitute a novation of the existing debt. Fresh security interests are not required, provided that the original security agreements are drafted so as to cover any future amendment to the secured finance documents.

There is some discussion regarding a possible "tipping point", when amendments to existing finance documents are considered so substantial that new security should be taken. The following elements should be taken into account when determining whether or not this is the case:

(a) whether the nature and quantum of the amendments to the loan agreement are so substantial that they cannot be said to fall within the "general purview" of what the parties may have contemplated at the time of the original transaction;

(b) the terms of any security confirmation contained in the amendment agreement; and

(c) the contractual provisions contained in the amendment agreement and the security agreement regarding the continuance of security notwithstanding amendments to the secured obligations.

Debt forgiveness

A debt forgiveness relieves the debtor from a financial obligation. Such waiver leads to a taxable profit for the borrower. However, Luxembourg income tax law provides under limited circumstances for a tax exemption when the waiver is granted by most of the creditors and there is a risk that recovering the debt could result in the insolvency or bankruptcy of the debtor. Depending on the relationship between the creditors and the borrower, a hidden capital contribution treatment could potentially apply under specific conditions.

Asset swap / debt-for-equity swap

In an asset swap, the creditor agrees to accept an asset of the debtor (such as inventory, receivables or intangible assets) as final settlement of the debt. In an debt-for-equity swap, the debt is converted into equity (or similar) instruments, such as (preferred) shares or bonds plus warrants.

Under Luxembourg law, the conversion of all or part of a debt into equity requires the prior authorisation of the debtor's shareholders in order to: (i) increase the share capital by an amount equal to the value of the debt being converted (so that new shares can be issued); and (ii) enable the creditor to subscribe for the newly issued shares by means of contribution in kind of the debt held by it.

The valuation of the debt to be contributed may be challenging given its distressed nature. Such valuation must be confirmed in an auditors' report, and a board of directors' report when the debtor is a public limited company (S.A. - société anonyme) or a partnership limited by shares (S.C.A. - société en commandite par actions). When the debtor is a private limited company (S.à r.l. - société à responsabilité limitée), the valuation can be made by the managers of the company.

If the borrower is a listed company, and the creditor is acquiring more than 33⅓ per cent of the share capital of the company, the conversion of debt into equity could result in the obligation for the lender to make a mandatory takeover bid. It could also give rise to market abuse issues if the creditor has had access to price-sensitive information about the company.

Legal risks in out-of-court restructuring

All out-of-court contractual restructurings in Luxembourg must mitigate the following legal risks:

(a) Dealing with dissenting creditors

Syndicated credit facilities may often result in groups of lenders with diverse interests. In a restructuring process, borrowers or a specific group of lenders (eg. mezzanine lenders) may face opposition from one or more "hold-out" lenders who are motivated to seek an individual outcome. Unlike in the UK, however, no cram-down procedure is available in Luxembourg. It is not possible to compel dissenting creditors to agree with the terms of an out-of-court debt restructuring plan.

A limited exception to this principle is provided for by article 1244 of the Luxembourg Civil Code, which enables a court, at the debtor's request and taking into account the debtor's position and the creditors' needs, to postpone or reschedule the payment of sums due (délai de grâce).

Another exception exists in relation to bondholders as a specific category of creditors. Majority bondholders may bind dissenting minorities in relation to specific decisions, such as the postponement of one or more interest payment dates, the reduction of the interest rate or a change to the conditions of payment thereof, the substitution of bonds by shares of the issuer or the substitution of bonds by shares or bonds of other companies.

(b) Directors' duties

Under Luxembourg law, the directors of a company may be liable for (i) the non-execution of their mandate; (ii) any misconduct in the management of the company's affairs; and (iii) any damages caused by their own fault or negligence.

The performance by the directors of their duties is assessed in the light of the company's best interest. They must safeguard the interests of the distressed company and preserve its business value. While doing this, the directors must also verify that the conditions for the opening of insolvency proceedings, being the cessation of payments and the impaired ability of the company to raise credit, are not met. The Luxembourg Commercial Code requires that directors file for bankruptcy with the commercial court within one month of the company having ceased its payments. Not filing for bankruptcy within this time frame constitutes serious misconduct, which could lead the court to order the directors to bear all or part of the debts of the company.

(c) Lender's risks related to the provision of new money

A lender can be held liable both towards the company and towards third parties if it acts in an imprudent or ill-advised manner in connection with a company in financial difficulties. This can occur if such lender knew or should have known that the company was on the verge of bankruptcy and the lender's actions have abusively delayed the date of cessation of payments or created a false impression of solvency towards third parties. If liability is established, the creditor can be ordered by the court to reimburse the party suffering loss.

(d) Voidable transaction risks

The following transactions if performed during the six-month period preceding the opening of a bankruptcy proceeding are automatically null and void:

(i) contracts entered into by the insolvent company, if its obligations under such contracts are significantly more onerous than the obligations of the other party (similar to transaction at an undervalue risk in English law);

(ii) any payment made by the insolvent company in respect of debts that are not yet due;

(iii) any payment made in kind (e.g. asset transfer) by the insolvent company in respect of debts that are due (excluding cash and negotiable instruments); and

(iv) except with respect to pledges governed by the law of 5 August 2005 on financial collateral arrangements, any security granted by the insolvent company to secure obligations incurred before the security contract was entered into (i.e. for post-consideration).

Additionally, any contract or payment can be annulled by the court if the other party had personal knowledge that the company was insolvent at the relevant time.

Court-driven restructuring proceedings

Luxembourg restructuring procedures

Formal court-driven restructuring proceedings are available in Luxembourg, but, for practical reasons, these are rarely used.

Draft legislation on business preservation and modernisation of bankruptcy law is under discussion. Along with extra-judicial procedures aimed at avoiding formal insolvency proceedings (appointment of a mediator, procedural framework for mutual agreement with certain creditors), the draft legislation proposes to introduce the possibility of a moratorium in order to reach either:

(a) an out-of-court agreement with creditors (accord amiable extra-judiciaire);

(b) a reorganisation by collective agreement (réorganisation judiciaire par accord collectif) enforceable against all the creditors for the purpose of reducing debt or deferring payment; or

(c) a judicial reorganisation by transfer under legal control (réorganisation judiciaire par transfert sous autorité de justice) of all or parts of the debtor's business.

Foreign restructuring procedures

Moving the centre of main interest (COMI) of a company to the UK in order to benefit from certain English law restructuring procedures (including pre-pack sale and scheme of arrangement), which are considered more practicable than those available in Luxembourg, is another option for debt restructuring. While such relocation may be a relatively straightforward process when involving a holding company, relocating the COMI of an operating company to the UK, if indeed possible, may well involve physically moving the headquarters and employees, and effectively requires a degree of agreement from the main creditors.

An English scheme of arrangement may also be available to an overseas company irrespective of where its COMI is located. Sufficient connection to England will suffice. This may be the case in financing transactions that are sufficiently connected to English law.