LUXEMBOURG is undeniably one of the leading jurisdictions for investment funds. Being the world's second-largest fund domicile after the United States, Luxembourg remains a major centre for traditional Luxembourg-domiciled undertakings for collective investment in transferable securities (UCITS) funds, but also for alternative investment funds, including private equity, private debt, real estate and infrastructure.
FUND REGIMES
When opting for Luxembourg as domicile for their investment funds, initiators can choose between the following categories of fund regimes, depending on the nature of the investments, the type of target investors and the region and manner in which the investment funds will be marketed:
- an undertaking for collective investment (Part II UCI), governed by Part II of the law of 17 December 2010, as amended, on undertakings for collective investment (UCI Law);
- a specialised investment fund (SIF), governed by the law of 13 February 2007, as amended, on specialised investment funds (SIF Law);
- an investment company in risk capital (SICAR), governed by the law of 15 June 2004, as amended, on the investment company in risk capital (SICAR Law);
- a reserved alternative investment fund (RAIF), governed by the law of 23 July 2016, as amended, on reserved alternative investment funds (RAIF Law); or
- a non-regulated ordinary commercial company (Soparfi), governed by the law of 10 August 1915 on commercial companies (1915 Law).
Part II UCIs, SIFs and SICARs are regulated investment funds subject to direct supervision of the Commission de Surveillance du Secteur Financier (CSSF) and require the prior approval of the CSSF before they can be set up.
RAIFs and Soparfis are unregulated investment funds that are not subject to direct supervision of the CSSF and do not require prior CSSF approval. They can be formed as soon as the constitutive documents have been finalised and arrangements with the required service providers put in place.
A considerable number of Luxembourg investment vehicles constitute AIFs subject to the Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on alternative investment fund managers (AIFMD), implemented in Luxembourg by the Law of 12 July 2013, as amended, on alternative investment fund managers (AIFM Law). An AIF is defined as a collective investment undertaking which, or the compartment(s) of which: (i) raise(s) capital from a number of investors; (ii) have/has a view to investing such capital in accordance with a defined investment policy for the benefit of those investors; and (iii) is not covered by the Directive 2009/65/EC on UCITS.
While a RAIF must qualify as an AIF within the meaning of the AIFM Law (and must accordingly appoint an authorised alternative investment fund manager (AIFM) and a depositary), exemptions under the AIFM Law may apply to the SICAR and the SIF, which are only required to appoint an AIFM and a depositary if they qualify as an AIF.
Legal forms
The formation process of a Luxembourg investment fund depends on its legal form. A SIF, a SICAR, a RAIF or a Soparfi may be structured as:
- a special limited partnership (SCSp);
- a common limited partnership (SCS);
- a corporate partnership limited by shares (SCA);
- a public limited liability company (SA);
- a private limited liability company (SARL);
- solely in case of the SIF and the RAIF, a common fund (fonds common de placement) (FCP); or
- a co-operative company in the form of a public limited liability company (Coop-SA).
A Part II UCI with variable capital may only take the form of:
- a public limited liability company (SA); or
- a common fund (FCP).
Apart from the FCP and the SCSp, all the other legal forms have a legal personality.
SCS and SCSp
A large number of Luxembourg investment funds are established as SCS and SCSp. The legal regime governing SCS and SCSp rests on the principle of contractual freedom. It allows a level of flexibility akin to that included in the popular "Anglo-Saxon" limited partnerships. It must be noted that the legal regimes governing the SCS and the SCSp are aligned with one another, as the Luxembourg legislator intended for those vehicles to be governed by similar rules.
One main feature distinguishes the SCS from the SCSp: while the former has legal personality, the latter does not. That being said, even if the SCSp does not have legal personality, this does not prevent it from operating as if it was an entity with legal personality. Accordingly, the SCSp has its own registered office, acts in its own name and, for its own account (through the intermediary of its manager (gérant)), may issue partnership interests and debt financial instruments and contract loans.
FCP
Another form of Luxembourg investment fund sometimes used is the FCP. The FCP is a common fund, which is similar to a unit trust in the United Kingdom or a mutual fund in the United States. It is organised as a co-ownership whose investors are only liable up to the amount they have committed or contributed.
Unlike companies, FCPs do not have legal personality, but consist of a pool of assets managed by a Luxembourg management company (société de gestion) (Management Company). In the absence of a corporate form, FCPs largely benefit from contractual freedom in terms of structuring and management. The Management Company draws up the management regulations (règlement de gestion) of the FCP and its compartments (if any).
The Management Company must perform its duties in an independent manner and in the sole interest of the FCP and the investors. It may not use the assets of the FCP for its own needs and it is liable towards the investors and third parties for the proper performance of its duties. The creditors of the Management Company have no rights of recourse against the assets of the FCP.
Umbrella investment funds/compartments
An element to be considered in the context of a fund financing transaction is whether the investment fund is a standalone entity or, as already briefly mentioned above, an umbrella investment fund with segregated compartments (sometimes also named sub-funds). Multicompartment investment funds are regularly engaged in fund financing transactions. Care should be taken by lenders when providing financing to these types of funds and in particular when putting the relevant finance documents (including the security package) in place.
The compartmentalisation of certain Luxembourg investment funds is quite frequent in Luxembourg and governed by express legal provisions. The UCI Law, the SIF Law, the SICAR Law and the RAIF Law (together the Product Laws) provide for the possibility to set up umbrella funds with different compartments, where each compartment corresponds to a segregated part of the assets and liabilities of such fund.
The fund's constitutive documents must expressly allow for the creation of compartments. The documentation of the umbrella fund will comprise separate specifications/supplement per compartment, containing the name, duration and investment strategy of each specific compartment, as well as the borrowing and other indebtedness provisions and leverage limitations applicable to such compartment.
Compartments do not have separate legal personality, but the segregation between the assets and liabilities of each compartment is recognised by each of the Product Laws. For the purpose of the relations as between investors, each compartment is deemed to be a separate entity, unless a clause included in the constitutive documents provides otherwise.
The rights of investors and of creditors concerning a compartment or which have arisen in connection with the creation, operation or liquidation of a compartment are limited to the assets of that compartment, unless a provision included in the constitutive documents provides otherwise. The assets of a compartment are exclusively available to satisfy the rights of investors in relation to that compartment and the rights of those creditors whose claims have arisen in connection with the creation, the operation or the liquidation of that compartment, unless a clause included in the constitutive documents provides otherwise.
DUE DILIGENCE AND GENERAL LUXEMBOURG ISSUES
Capacity of the investment fund
The starting point of any lender due diligence with respect to a Luxembourg investment fund is the fund documentation (notably the limited partnership agreement, articles of association, management regulations or any other equivalent governing documents). When reviewing the fund documentation, lenders shall assess whether the fund is allowed to borrow (including, if applicable, on a joint and several or cross-collateralised basis), to grant guarantees and security interests (including, if applicable, for the obligations of other entities, and/or on a cross-collateralised basis).
Lender friendly provisions
Subscription line lenders must also carefully analyse:
- the capital call provisions (notably, the entities empowered to make capital calls (such as general partners, AIFM or any other managing entity), the purpose for which the investment fund can call capital from its investors, the impact of excuse provisions, the existence of overcall provisions to cover defaulting investors and the possibility to call capital if the investment/commitment period is suspended or terminated); and
- whether the fund documentation contains waivers of investors' defences and right of set-off and subordination provisions (for the benefit of the lenders). Particular attention should be paid to the "no third-party right" provisions in the fund documentation. Lenders should preferably be indicated as third-party beneficiaries to avoid any interpretation issues as to whether they may benefit from the waivers of the investors' defences and set-off rights.
Term of the fund and its investment/commitment period
As already described in the general section, lenders should pay particular attention to the investment fund's term to ensure that the termination date of the credit facility falls before the term of the investment fund. In addition, whether the investment fund will still be able to draw investors' commitments to repay its borrowings and indebtedness following the termination and/or suspension of the commitment/investment period should be checked.
Consents
The fund documentation (notably the AIFM agreements, the investment management and advisory agreements) must be reviewed in order to determine whether there is a need to involve the AIFM and/or the investment manager/advisor in the financing transaction. It has to be assessed whether the power to issue drawdown notices to the investors and/ or the power to enter into financing arrangements have been delegated to the AIFM and/ or the investment manager/advisor. In certain cases, the fund documentation may provide that the consent of the AIFM and/or the investment manager/advisor is necessary in case of entry into financing/borrowing arrangements and/or the granting of security interests over the assets of the fund.
It is mandatory for AIFs (managed by authorised AIFMs), RAIFs, SIFs and SICARs to appoint a Luxembourg depositary. The depositary is generally in charge of the safekeeping and supervision of the fund's assets and the control over the transactions. Depositary agreements must be diligenced in order to (i) determine whether there is a need to inform the depositary and/or obtain its consent in respect of the envisaged financing transaction, and (ii) check whether there is a pledge granted by the investment fund over its assets in favour of the depositary (which may need to be released).
In addition, it has to be assessed whether the fund documentation requires the prior consent of the LP advisory committee (or any other equivalent committee) before the investment fund can enter into the relevant financing arrangements.
Unitised investment funds
The SA, a SARL, SCA and Coop-SA issue shares. SCS and SCSp may issue securities/units, but can also implement partnership interests represented by partners' capital accounts (comptes d'associés). The capital accounts reflect the investor's contributions to the SCS or SCSp and are adjusted over time to reflect the participation in profits and losses. In this respect, while it is more common to structure liquid funds in the form of an SA or an SCA, managers of closed-end funds have a preference for the SCS or SCSp.
In case of unitised funds with investors' capital commitments structured as obligations of the investors to subscribe for units, securities or shares, it may be helpful to include in the fund documentation a specific undertaking of the investors to fund their commitments without any defence, particularly to any situation in which it is impossible for the investment fund to issue such units, securities or shares (notably in the case of insolvency). Such undertaking is also important in case of suspension of the net asset value (NAV) calculation of the fund, which may result in an inability to issue units, securities or shares in certain cases.
Investors' debt commitments
While most of the Luxembourg investment funds are funded with equity contributions, the investors' commitments of certain Luxembourg investment funds are sometimes structured as debt commitments (i.e. commitments to make loans to the fund or to subscribe for debts instruments/notes issued by the fund). Given the uncertainty as to the possibility for Luxembourg entities to incur indebtedness after the opening of insolvency proceedings, it may be helpful if possible to include in the fund documentation a conversion mechanism pursuant to which the investors' debt commitments may be converted into equity commitments in an insolvency scenario, so that the investors will be required to make equity contributions after the opening of insolvency proceedings.
Another potential mitigant for this issue is to request a specific waiver from the investors (to be included in the fund documentation or in a separate investor's letter) whereby they explicitly agree to advance their debt commitments without any defences relating to the inability of the investment fund to incur indebtedness, including as a result of the opening of any insolvency proceedings. If the investment fund is financed by its investors with loans and debt instruments, particular attention will need to be paid to ensure that there are subordination provisions pursuant to which the investors agree that their claims against the fund will rank junior to the claims of the lenders.
Powers of attorney
Concerning the ability for subscription line lenders to call capital from the investors on the basis of a power of attorney, it has to be noted that under Luxembourg law, each power of attorney, mandate or appointment of agent, whether or not stipulated irrevocable (i) may terminate by virtue of law without notice upon the occurrence of insolvency proceedings (relating to the investment fund and/or its general partner), and (ii) it may be revoked despite being expressed to be irrevocable. Given the risk of revocability of the power of attorney, it is customary for lenders to take pledges over the investors' commitments. If such pledges are taken, the right to make capital calls and enforce the obligations of the investors to contribute capital should be considered as an ancillary right to the pledged claim (droit lié à la créance gagée), and, as a result, the security taker may elect to exercise that right in accordance with the provisions of the pledge agreement (without the need to rely on any power of attorney).
LEGAL DOCUMENTATION: THE FACILITY AGREEMENTS
In most of the Luxembourg fund finance transactions originating in Europe, the facility agreements are governed by English law (noting that a number of US originated fund finance transactions will instead be governed by New York law). There are some Luxembourg specific provisions to be included in the facility agreements in respect of representations and warranties, undertakings, events of default and conditions precedents. The representations as to status and the applicable regime will need to be carefully prepared on a case-by-case basis for the particular investment fund and its applicable regime. It is common to include representations confirming, inter alia, that:
- the relevant investment fund, its general partner and its AIFM comply with the AIFM Law and the Product Laws (if applicable);
- the AIFM and the depositary of the relevant investment fund have been validly appointed; and
- the central administration (administration centrale) and the centre of main interests (COMI) (to the extent applicable) of the relevant investment fund and its GP are in Luxembourg.
The provisions in relation to the fund documentation and the constitutional documents need to be carefully considered to ensure that they correctly reference the relevant documents for the fund, which may vary on an entity-by-entity basis (such as articles of associations for SA, SCA and SARL, partnership agreements for the SCS and SCSp, management regulations for the FCP, offering documents for the RAIF and SIF, prospectus for the SICAR, etc.).
Umbrella investment funds/compartments
If the borrower/guarantor entity is an umbrella fund acting in relation to a compartment, care needs to be taken with respect to the name of the relevant compartment(s). The finance documents have to contain the exact description of the relevant borrower/guarantor entity (i.e. the investment fund acting in respect of the relevant compartment, as opposed to just the compartment), and the signature blocks have to be prepared accordingly.
Specific representations and undertakings are required by lenders to ensure segregation between the compartments and separate accounting and administrative treatment of the compartments and their respective assets and liabilities.
FCP
If the borrower/guarantor entity is an FCP, the finance documents must contain the exact description of the relevant borrower/guarantor entity (i.e. the Management Company acting in respect of the relevant FCP), and the signature blocks must be prepared accordingly
Specific representations and undertakings are required by lenders to ensure (i) proper performance of the Management Company in the interest of the FCP and its investors, and (ii) a segregation between the respective assets and liabilities of the Management Company and the FCP.
AIFMD leverage considerations
The AIFMD imposes certain rules as to the use of leverage by AIFs (defined as any method by which the AIFM increases the exposure of an AIF it manages, whether through borrowing of cash or securities, leverage embedded in derivative positions, or by any other means).
Each financing transaction has to be analysed on a case-by-case basis to determine whether it constitutes leverage for the purpose of the AIFMD. In case of a financing transaction constituting such leverage, the fund documentation has to be diligenced, with a particular focus on (i) the possibility for the fund to use leverage and grant security interests, and (ii) the applicable borrowing/leverage limitations
In case of subscription/capital call facilities, borrowings would not be considered as leverage for AIFMD purposes if they: (i) are temporary in nature (the industry consensus being for no more than 12 months); and (ii) relate to and are fully covered by investors' capital commitments.
Depending on how they are structured, NAV financings may constitute leverage within the meaning of the AIFMD.
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