Trends and Developments

Introduction

Since the end of World War II, the Grand Duchy of Luxembourg (Luxembourg) has experienced significant and enduring economic growth, mainly due to its stable political environment, peaceful society, and central location in Europe.

As a founding member state of the European Union (EU), Luxembourg actively participated in shaping the organisation. As a result, the country has been at the forefront of numerous European initiatives, especially those related to financial and economic reforms. This, combined with a business-friendly attitude, positioned Luxembourg as a global financial centre. It ranks as the second-largest financial centre for investment funds worldwide, following the United States, and is the country of choice for private equity firms looking to establish their investment platforms for acquisitions.

Luxembourg's prominence as a financial centre and hub for private equity firms means it is uniquely positioned to monitor the latest trends and advancements in M&A activity.

Market Activity Overview

The strong M&A activity in 2021 continued into the first half of 2022. The domestic market experienced some notable acquisitions, especially in the finance sector. The following acquisitions are worth highlighting:

  • the acquisition by Swissquote Group Holding Ltd of the online Keytrade Bank Luxembourg;
  • the acquisition by Deustche Boerse AG of the fund services provider KNEIP Communication SA;
  • the acquisition by SV SparkassenVersicherung Holding AG of the reinsurer Resa S.A.; and
  • the acquisition by FE Fundinfo Limited of the fund services provider Fundsquare.

However, the second half of 2022 witnessed a significant slowdown in activity due to geopolitical tensions arising from Russia's invasion of Ukraine, high inflation, central banks increasing interest rates, and public market volatility. The decline of prices in the equity public markets has led clients to delay their exits through IPOs or de-SPAC transactions, and created uncertainty in private transaction valuations, making them more difficult to complete.

As a result, there has been an increase in the use of completion accounts instead of the traditional locked box mechanism for determining purchase prices in share purchase agreements. Earn-out clauses have also become more prevalent in the shift from a seller's to a buyer's market.

Legal Developments and Their Impact on the Corporate and M&A Environment

The end of COVID-19 measures

In response to the COVID-19 crisis, the Luxembourg parliament adopted a law on 23 September 2020 to introduce measures addressing the holding of meetings in companies and other legal entities. This legislation aimed to ensure the continuity of good corporate governance during the challenging period marked by lockdown restrictions imposed by governments to prevent the spread of COVID-19 (the "COVID Law").

The COVID Law enabled both listed and private Luxembourg firms to hold shareholder or partner meetings (including annual general meetings) remotely, even if their articles of association did not provide for such a possibility. The same rules applied to board of directors, board of managers, and supervisory board meetings. Initially set to be effective until 31 December 2023, the COVID Law was revised multiple times, and was extended until 31 December 2022.

Companies, particularly publicly traded ones, widely adopted this option, leading to a significant increase in virtual shareholders' meetings in recent years. Physical shareholders' meetings are set to resume in 2023, and it is likely that the experiences gained during this period will influence the further digitalization of shareholder meetings in Luxembourg in the coming years.

Companies, particularly publicly traded ones, widely adopted this option, leading to a significant increase in virtual shareholders' meetings in recent years. Physical shareholders' meetings are set to resume in 2023, and it is likely that the experiences gained during this period will influence the further digitalisation of shareholder meetings in Luxembourg in the coming years.

Emergence of a comprehensive competition law in Luxembourg

On 24 November 2022, the Luxembourg parliament adopted a new competition law, which came into effect on 1 January 2023 (the "Competition Law").

The Competition Law transposed Directive 2019/1 of the European Parliament and the Council into Luxembourg law, aiming to strengthenthe independence of the Luxembourg national competition authority and enhance its investigative and fining powers.

The current Competition Council (Conseil de la concurrence) changed its name to the National Competition Authority (Autorité de la concurrence du Grand-Duché de Luxembourg) and became an "établissement public" (ie, a legal person governed by public law with financial and/or administrative autonomy).

Although the Competition Law did not introduce a national merger control regime in Luxembourg, a positive response to a public consultation initiated by the Ministry of Luxembourg on 20 January 2022 resulted in a bill being prepared in this regard.

Given these developments, the Competition Law could be seen as the first step in future developments in competition law. The new organisation and expanded powers of the National Competition Authority will play crucial roles in its enforcement regime.

Due to the size of the jurisdiction, the volume of deals involving Luxembourg-based operating companies is relatively small compared to larger jurisdictions like Germany or France. However, with the bolstered powers of the National Competition Authority and the likely introduction of a merger control regime in the coming months, a comprehensive Luxembourg competition law is emerging. This development may significantly impact future domestic M&A transactions.

Clarifications to the 1915 Law

The law of 10 August 1915 on commercial companies (the "1915 Law") balances two fundamental principles: shareholder freedom and third-party protection. To modernise the law, a significant reform came into force in 2016 (the "2016 Reform").

Despite the considerable efforts of the drafters of the bill of the 2016 Reform, several errors and inconsistencies came to light as it began being implemented in practice. For example, a significant clerical error concerning the application of financial assistance rules to private limited liability companies (SARLs) was addressed by a law enacted on 6 August 2021 (the "2021 Law").

During ongoing discussions on the 2016 Reform, the decision was finally made to limit the prohibition of financial assistance rules to public limited liability companies (SAs) due to the private nature of SARLs.

Regrettably, the reference to SARL shares in the relevant criminal provisions was mistakenly retained, sparking debate among practitioners about the applicability of financial assistance rules to SARLs. This debate held significant importance, as SARLs are the primary vehicles used for structuring M&A transactions in Luxembourg. The 2021 Law expressly excluded the application of financial assistance rules to SARLs, thereby bringing the debate to a close.

Further errors, omissions and inconsistencies were discovered, necessitating further clarifications. Bill No 8007 was introduced in the parliament on 6 May 2022 to address these issues, correct clerical errors or omissions, and update definitions and references to laws that have changed or been repealed since the 2016 Reform. Bill No 8007 has not yet been enacted, and is currently under discussion and may undergo further changes.

In the context of M&A, a primary focus is the clarification Bill No 8007 will bring to the pre-approval procedure for SARLs in the event of a transfer of shares to a third party. Article 710(12) of the 1915 Law stipulates that any transfer of SARL shares to a third party is subject to prior approval from shareholders representing at least three-quarters of the shares, or half of the shares if permitted under the company's articles of association.

Upon approval, a share transfer is completed. If the transfer is refused, within three months of the refusal the other shareholders can acquire the transferor's shares, or the company can reduce its share capital by repurchasing and cancelling the transferor's shares. If no action is taken by the company or shareholders within the three-month period, the transferor can transfer their shares to the original third party.

As Article 710(12) is considered a matter of public order, it is not possible to bypass such pre-approval. Practitioners must carefully verify compliance with this requirement before acquiring shares in a Luxembourg SARL, or the acquisition's validity may be called into question.

The current Article 710(12) refers to the company's refusal to consent to such transfer, which may create confusion, as it could imply that the management body's approval is also required in addition to shareholder approval. Bill No 8007 removes the reference to the company and refers only to the refusal of consent.

Another clarification in Bill No 8007 concerns share repurchase in case of refusal. The requirement for the transferor's consent for repurchase has been removed, as the transferor, by prohibiting the company from repurchasing its shares within the 3-month period fixed by law, could be in a position to transfer them to the original third party despite the refusal of the shareholders.

Additionally, it is clarified that repurchase of the shares can be followed by their cancellation or not.

While it is difficult to provide an exhaustive list of all clarifications in Bill No 8007, other notable amendments to the 1915 Law from a corporate and M&A perspective include:

  • Bill No 8007 resolves ambiguity resulting from the exclusion of SARLs as a sole shareholder under certain provisions governing SARLs in Article 710(28) of the 1915 Law. Bill No 8007 clarifies that pre-approval is not required if a SARL's shares are held by a single shareholder. It also explicitly states that a sole-shareholder SARL can have authorised share capital and that its management can transfer the registered office within the same city or to another city.
  • In the event of SARL's liquidation, Bill No 8007 eliminates the existing double majority in terms of headcount and share capital. As a result, Liquidation approval will require the consent of shareholders representing three-quarters of the capital, eliminating the need for consent from half of the shareholders.
  • Lastly, in terms of voting rights, Bill No 8007 seeks to align the regime between SAs and SARLs. It stipulates that shares with suspended or waived voting rights in a SARL or SA are not taken into account when determining the quorum and majority voting rights. Likewise, following the example of SAs, it has been clarified that repurchased shares of a SARL are not taken into account in determining the quorum and majority voting rights.

The Upcoming Transposition of the Mobility Directive

In its willingness to modernise and simplify company law rules across the European Union, the European Parliament and the Council adopted Directive (EU) 2017/1132 related to certain aspects of company law (the "Company Directive").

The Company Directive established provisions for both cross-border and domestic mergers. However, it did not address cross-border divisions and conversions. As a result, Luxembourg practitioners have to date relied on distributive application of the laws of the Member States involved in these transactions.

To fill the legal gap left by the Company Directive, the European Parliament and Council adopted Directive (EU) 2019/2121 (the "Mobility Directive") on 27 November 2019. The Mobility Directive amended the Company Directive, improving the current regime for cross-border mergers and introducing provisions to harmonise cross-border divisions and conversions. Its goal is to facilitate cross-border company mobility while enhancing stakeholder protection.

However, by introducing new protective mechanisms such as anti-abuse control, exit rights for shareholders, and mandatory management reports for employees, the Mobility Directive may inadvertently have the opposite effect. The implementation of these mechanisms will increase companies' administrative costs and workload, making the process particularly burdensome for intra-group reorganisations.

The deadline for implementing the Mobility Directive was 31 January 2023. Luxembourg introduced Bill No 8053 on 27 July 2022 to implement the Mobility Directive. Although the transposition deadline has passed, Bill No 8053 remains in the parliamentary process and may undergo further modifications. No date has been announced for the bill's enactment.

Due to the potential negative impact of the Mobility Directive's new rules on businesses, the Luxembourg legislature has opted for a minimalist approach in its implementation. Bill No 8053 aims to simplify and improve the current regime wherever possible, implementing mandatory provisions without exceeding what is necessary. Optional provisions will only be transposed if they promote corporate mobility.

Bill No 8053 establishes two regimes: a general regime for domestic transactions and cross-border transactions between a Luxembourg company and a non-EU company, and a special regime for cross-border transactions between a Luxembourg company and an EU company. The general regime remains largely unchanged from the current applicable regime, so no significant changes are expected in existing practice. In contrast, the special regime's introduction will significantly impact practice and require a period of adaptation by Luxembourg practitioners.

It is worth highlighting the following main innovations that will be brought about by Bill No 8053.

Special limited partnerships

Since its introduction in 2013, the special limited partnership (société en commandite simple spéciale or SCSp) has gained significant traction in Luxembourg, particularly within the funds industry. However, due to its lack of legal personality, the SCSp was unable to participate in mergers or divisions, either domestically or cross-border. To enhance the appeal of the SCSp, Bill No 8053 expands the scope of these transactions to include SCSp, allowing their implementation without the need for an unnecessary conversion into a limited partnership (société en commandite simple or SCS), thus reducing costs and delays.

A new mechanism for corporate reorganisations

Bill No 8053 introduces a new mechanism to facilitate corporate reorganisations. It will now be possible to execute side-stream mergers in the context of a merger by absorption without issuing shares. The Bill No 8053 permits mergers between companies directly or indirectly owned by the same person or by the same shareholders in the same proportion. This side-stream merger will apply to both domestic and cross-border transactions.

Enhanced shareholder rights

Bill No 8053 enhances shareholder rights in three categories of cross-border transactions by providing an exit right. Shareholders involved in transactions within the general regime's scope will not receive this exit right. The withdrawal opportunity will apply to shareholders who voted against the international transaction's approval. They will be allowed to sell all their voting shares in exchange for a cash payment made within two months of the transaction's effective date. No partial exit is possible. Non-voting shares and beneficiary shares (parts bénéficiaires) will not have access to the exit right. Additionally, the exit right will not apply to shares transferred between the date of publication of the cross-border transaction proposal and the date of the cross-border transaction's general meeting.

New legality control

Bill No 8053 introduces a new legality control. Completion of the cross-border transaction will necessitate a notary's prior issuance of a certificate (the "Certificate"). The notary will not issue the Certificate if they determine that the cross-border transaction does not meet all conditions, formalities, and procedures, or that the transaction is blatantly (manifestement) implemented for abusive, fraudulent, or criminal purposes. In practice, notaries' control over the transaction's abusive, fraudulent, or criminal nature may prove problematic, as it exceeds their current competencies.

Special report for shareholders

Another noteworthy innovation concerns the management body of the relevant company, which must prepare a special report for shareholders and employees. This report should explain and justify the cross-border transactions' legal and economic aspects and outline the implications for employees and the company's future operations. The report must be addressed to both shareholders and employees, either in a single report with two distinct sections or in two separate reports. Some exceptions exist: shareholders can choose to waive the report addressed to them, and the report addressed to employees may be omitted if the company or its subsidiaries have no employees other than management body members. The Luxembourg market is characterised by a prevalence of holding companies that are part of a group. Therefore, it seems unlikely that such a criterion will be met, as the Luxembourg company likely has an indirect subsidiary at some level with employees.

Looking Ahead

The current economic indicators are far from promising. From a macroeconomic perspective, several uncertainties persist, particularly in Europe, where inflation remains high. In the coming months, the European Central Bank is expected to continue its policy of raising interest rates, which will likely impact the financing of M&A transactions. Nevertheless, there is optimism that the situation will improve in the third and fourth quarters of 2023, provided that the war in Ukraine does not escalate and trigger a broader global conflict.

At present, we seem to be in a holding pattern. PE firms have become major players in the M&A landscape, significantly influencing the sector's activity. Despite recent fundraising challenges, dry powder levels remain high, and PE firms must invest these large funds to generate returns.

Valuation discrepancies between buyers and sellers remain a challenge. Sellers, encouraged by recent market highs, have not yet significantly adjusted their valuations to align with current market conditions. However, such a reduction in valuations should eventually occur, reigniting PE firms' interest.

PE firms are also adapting to the new economic environment. For instance, some deals are being structured to retain existing debt without requiring new financing. With exit numbers at a low, PE firms will likely focus on creating value within their existing portfolio companies, leading to an increase in add-on acquisitions. The low value of stocks in public equity markets makes public-to-private transactions particularly attractive for PE firms this year.

The funding challenges faced by PE firms may also be addressed as private debt funds enter the market to fill the gap left by traditional banks. Moreover, with lower valuations, strategic buyers less reliant on leveraging acquisitions for profit upon exit may become more active.

Considering these factors, we could see a potential resurgence of activity in the second half of the year. Against the odds, the end of 2023 might be busier than ever.

Originally published by Chambers and Partners.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.