Key considerations for bankruptcies of Luxembourg subsidiaries of international groups

This article highlights certain features of Luxembourg insolvency laws relevant for international groups, which include Luxembourg companies. Following the end of Covid-related support measures and considering the current challenging global economic conditions, the number of bankruptcy filings in Luxembourg has increased recently. Since Luxembourg is an important financial hub, many of such bankrupt companies are part of international groups or parties to international transactions. While there is a global convergence towards alignment of legal provisions, stakeholders relying on the assumption that Luxembourg bankruptcy laws are substantially identical to those of their jurisdiction or other European jurisdictions would be ill advised.

Criteria for bankruptcy

According to article 437 of the Luxembourg Code of Commerce (LCC), a company is in state of bankruptcy (faillite) if it meets two cumulative conditions: cessation of payments and loss of creditworthiness. Cessation of payments is the inability to repay debts which are due and payable. The condition of loss of creditworthiness allows to distinguish between the companies which only have temporary liquidity problems and those which do not have any reasonable prospects of finding any form of financing or accommodation from either external sources or from shareholders (new loans, extension of maturity, standstill, etc). Therefore, Luxembourg bankruptcy is not a balance sheet insolvency. While the value of the assets may exceed its liabilities, a Luxembourg company which has ceased payments may be nevertheless declared bankrupt. There is no minimum amount or number of claims which the company should be unable to pay – often, in practice, relatively minor debts to tax authorities often lead to bankruptcy.

Obligation of managers to file for bankruptcy and other liability risks

According to article 440 LCC, the managers must file for bankruptcy (aveu de faillite) within one month upon becoming aware of the cessation of payments in order to avoid being declared personally liable to the company or any third party for the damage created by the late filing, or being declared criminally liable for simple bankruptcy (banqueroute simple) (article 573 LCC). No such filing obligation exists however for the shareholders or the creditors. The managers are also personally and jointly and severally liable for the administration of the company’s tax liabilities.

Other cases of simple bankruptcy include borrowing funds on behalf of the company after becoming aware of its bankruptcy and refusing to cooperate with the bankruptcy receiver or judge. The aggravated form of liability – fraudulent bankruptcy (banqueroute frauduleuse) – which may result in imprisonment, applies in case of asset dissimulation, voluntary alterations of company records and recognition of fictive debts towards certain creditors. However, even after the beginning of financial difficulties, the managers do not owe any particular duty of care towards the company’s creditors – save exceptional circumstances, they are only liable towards the company. Article 495 LCC provides for the joint liability of managers with the company which have contributed to bankruptcy while seeking illicit personal gains. Therefore, it is advisable that, from the moment when the financial difficulties arise, the managers hold board meetings to assess if, in their opinion, the conditions for bankruptcy are met and document the steps taken to prevent it.

Shareholders – liability risks

For Luxembourg private (sarls) and public limited liability companies (SAs, SCAs, etc), the liability of the shareholders (including in bankruptcy) is limited to their equity contribution. Furthermore, shareholders which provide debt funding to Luxembourg subsidiaries are not subordinated to, and have the same rights as, any other creditors, including in case of bankruptcy. They are therefore under no obligation to provide additional funding and they can file for its bankruptcy in their capacity as creditors. While there is no automatic impact on their liability, when a shareholder acts as a de facto manager (ie it has an active and predominant role in the management of a company which subsequently becomes bankrupt), then it becomes subject to the same liability as managers, including the extension of the bankruptcy to itself and joint liability for the company’s debts.

To limit such risks, the management decisions for Luxembourg companies are to be taken by its managers, acting in the interest of each specific Luxembourg company which they manage and be properly documented (for example board resolutions). Structures involving several Luxembourg companies are often set-up for the purpose of a specific, complex transaction. Where all the companies part of the group share a common economic goal and sometimes may have common managers, it is often challenging to keep a strict separation of roles. However, especially for key decisions and when a company starts having financial difficulties, it is particularly important that the managers assess (and document such assessment) the individual situation of each company and assess its interests separately from the overall business transaction/group.

Shareholder support to companies in financial distress

Shareholders of Luxembourg companies do not have legally any obligation to provide financial support to their subsidiary. If they do decide to do so, such support (which may also include providing extensions of intra-group debt, new equity support undertaking or granting of additional loans) may help to show that the condition of loss creditworthiness for the opening of bankruptcy is not met. Careful assessment of the adequacy and the timing of the support provided is necessary, as certain transactions may be challenged in case of a subsequent bankruptcy. Pursuant to article 442 LCC, the bankruptcy opening judgment sets the date of cessation of payments which cannot be earlier than six months and 10 days prior to the date of the judgment. The transactions carried out after the date of the cessation of payments may be either void (no or insufficient consideration, payments of debts not yet due or made via unusual payment method) or voidable (if the other party was aware of the cessation of payments).

Bankruptcy receiver (curateur)

The creditors cannot appoint a receiver to take control of the assets of a financially distressed company. While creditors can request in court the bankruptcy of a company, it will be the court which will appoint the bankruptcy receiver (curateur). Its main role is to liquidate the company’s assets in order to pay its creditors and it is directly liable to, and takes instructions from, only the court. Upon its appointment, the managers will be divested from all their representation and management powers, depriving thus the shareholders and the creditors of the flexibility of a contractual arrangement with the managers.

Exit and winding up of structures

There is no obligation for the shareholder of a bankrupt company to remain into existence until the end of the bankruptcy process (which can take several years) and there is no prohibition from transferring the shares. A more delicate situation is when companies with liabilities which are not yet due (eg subordinated intra-group or senior debt not yet accelerated), but which have no reasonable prospects of obtaining additional revenue – they cannot file for bankruptcy and given the existence of debts cannot use a voluntary (solvent) liquidation either. In such cases, the company needs the cooperation of creditors for formally requesting the payments of their debts or the consent of senior creditors for the intra-group lenders to accelerate to file for bankruptcy and thus limit the accumulation of ongoing operational costs.