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Africa is not just navigating its relationship with China
Earlier this month, President Ramaphosa attended a state visit to China with President Xi Jinping before the 9th Forum on China-Africa Cooperation (FOCAC) in Beijing.
Global | Publication | December 2022
Market Climate
How would you describe the current market climate for M&A activity in the financial services sector in your jurisdiction?
According to the international media agency Thomson Reuters, financial services are among the three sectors, along with TMT and automotive, where public M&A activity has picked up at the fastest pace in Luxembourg since the 2020 covid-19 pandemic.
Overall, the average size of Luxembourg deals has remained stable rather than grown considerably, which has had a certain impact on their features and structuring. Common characteristics of the transactions we come across are the involvement of foreign entities, a clearly above-average deal size and a constant subscription to warranty and indemnity insurance. The Luxembourg M&A market has further seen in the past year a significant increase in transactions in the financial services sector, leading to some concentration in the trust companies’ industry.
Luxembourg’s highly developed investment fund industry has also had an important impact on M&A transactions. For example, very recently, a European leader in fund data management and reporting solutions for the asset management industry based in Luxembourg was sold to a leading institution.
We also note that several M&A transactions have occurred in the banking sector during the past few years.
Generally, it can be stated that Luxembourg-based structures, including in particular investment fund structures, are often the preferred choice when it comes to M&A transactions relating to European targets. The number of M&A deals channelled through Luxembourg vehicles into non-Luxembourg markets remains high even though it can be observed that Luxembourg’s deal volume remains small. The are several factors that account for this situation including the particularities of the covid-19 pandemic (for example, post-takeover reorganisations as well as renegotiations of pre-pandemic financial conditions), the impact of material adverse change clauses and the significant loss of market value of a number of listed issuers. When it comes to distressed deals, which have become increasingly important in the market, adjusted earn-out provisions are one of the techniques being used to facilitate deals in this new environment.
In general, Luxembourg does benefit from above-average systemic stability. This pertains, first, to its political structure and the daily work of its legislative and judicial arms and other legal institutions. As a result, laws and regulations are predictable and applied coherently and with due regard to the rule of law. This stability helps market players with ties to Luxembourg to rely on the frameworks in place and thus act upon sell or buy opportunities decisively and ambitiously.
Furthermore, Luxembourg’s central geographical and political position in Europe links its market outlook to developments in the large economic spheres of the EU and beyond. Europe’s M&A activity is dominated by banking, asset and wealth management, fintech and e-payments, e-commerce, consumer finance and others. A rush for consolidation in these sectors has brought to life domestic and international stars and starlets. The China-EU agreement from December 2020, in principle, lays out a framework for much better access of European investors to the Chinese market as well as rules for their fair treatment. Luxembourg’s active and consistent approach to developing ties to the Chinese market and Chinese investors lends this agreement a particular weight from the Grand Duchy’s perspective.
How would you describe the general government policy towards regulating M&A activity in the financial services sector? How has this policy been implemented in practice?
The Luxembourg M&A regulations have been developed with a pragmatic, hands-on approach and compared with other EU jurisdictions are comparatively business-friendly. To give an example, the vendor’s mandatory disclosures under the 2006 Takeover Law are minimal, with significant discretion given for the structuring of the commonplace data room. Apart from the 2006 Takeover Law, other key pieces of M&A legislation are the Company Law and the RBO Law.
A major overhaul of Luxembourg’s competition law is currently in the pipeline. The country’s Ministry of Economy (Ministry) has recently commenced consultations on a potential bill of law, which would introduce a merger control regime. So far, Luxembourg has been the only EU member state without a merger control regime. The reforms, if implemented, will have a significant impact on M&A activity within the financial services sectors, particularly, in banking, owing to Luxembourg banking entities’ turnover and the usual transaction values. The initial consultations were scheduled to be completed by 31 March 2022.
The envisioned merger control framework is to set up a dedicated national authority and equip it with authority to examine whether transactions surpassing certain fixed thresholds may distort competition in the respective Luxembourg markets. Market players are still providing feedback as to what thresholds should be put in place for turnover, market share and other factors.
These initial consultations should also help develop the framework for the merger notification procedure. The Ministry is currently considering three options: an optional notification, a mandatory one and a hybrid between the two.
Legislation
What primary laws govern financial services M&A transactions in your jurisdiction?
The primary laws that govern financial services M&A transactions in Luxembourg include:
What regulatory consents, notifications and filings are required for a financial services M&A transaction? Should the parties anticipate any typical financial, social or other concessions?
Both the seller and the buyer will typically need to approve the acquisition. Approval is given at board level and shareholder approval or supervisory board approval, or both, may also be needed where the constitutional documents (articles of association or shareholders’ agreements) require it. Where the shares of the target company are encumbered, the beneficiaries of such encumbrances may need to release these or consent to such transfer of shares.
Except for a large concentration that may trigger the application of national or European competition laws, unregulated entities do not require any specific authorisation to proceed with an M&A.
A regulated entity that is under the permanent supervision of the relevant Luxembourg regulator must evidence, prior to any change of significant shareholding, that the new shareholders are fit and proper for the regulated activity of the acquired company. Such ‘fit and proper’ test may vary significantly depending on the type of regulated activity that the company is involved in and is usually driven by the anti-money laundering risks associated with the activity. In certain cases and when this solution is possible, the seller may decide to surrender prior to implementing their M&A. This may reduce the attractiveness of such a structure for potential buyers and therefore prevent the transaction from happening.
Are there any restrictions on the types of entities and individuals that can wholly or partly own financial institutions in your jurisdiction?
‘Financial institution’ is a broad term that can include entities that are regulated by the Luxembourg supervisory authority, the Luxembourg Financial Sector Supervisory Commission (CSSF) including, but not limited to, banks, insurance companies, portfolio management companies and investment management companies. Maintaining a licence as a regulated entity in Luxembourg is generally subject to sound and prudent management as defined in Chapter 3 of the joint guidelines of the European Supervisory Authorities (the European Banking Association, European Insurance and Occupational Pensions Authority and European Securities and Markets Authority) as requiring the direct and indirect shareholdings of such regulated entities to be compliant with the following criteria:
These criteria should be fulfilled both before and during the life of the regulated financial institution and are assessed in concreto (ie, depending on the type and nature of the activity of the relevant institution). Therefore, any significant change in direct or indirect shareholding of such regulated financial institution shall be notified to and approved by the CSSF.
Financial institutions whose activities fall outside the scope of any licence are not subject to such restriction.
Are there any restrictions on who can be a director or officer of a financial institution in your jurisdiction?
In principle, the Company Law does not define nationality, residence or qualification standards as prerequisites to the appointment of managers or directors in a Luxembourg company in general and in financial institutions in particular. However, the shareholders may define such restrictions in the articles of association or in a shareholdersʹ agreement, if any.
Furthermore, managers or directors must:
For Luxembourg-regulated entities, the managers or directors must, fulfil certain criteria and be approved by the relevant authority, notably the Luxembourg Financial Sector Supervisory Commission or the Luxembourg Insurance Commissioner.
Although residence and citizenship are not legal prerequisites to being a company manager or director, it is important for the company, in line with the applicable real seat theory, to have its central administration in Luxembourg for it to qualify as a Luxembourg entity and for Luxembourg law to apply to it.
If the financial institution exercises an operational activity requiring a business licence, one or more of its directors or managers may need to apply for such a business licence before the Luxembourg Ministry of Economy. To obtain such business licence, the manager or director must comply with certain conditions, and in particular must:
What are the primary liabilities, legal duties and responsibilities of directors and officers in the context of financial services M&A transactions?
Under Luxembourg law, all managers or directors are independent (regardless of whether they are executive or non-executive or external managers) and have to abide, inter alia, by the fiduciary duties of care and loyalty.
Managers or directors need to comply with the reference standard of a diligently acting ordinary and reasonable manager or director put in the same circumstances (objective bona pater familias standard) and act at all times in the corporate interest of the company. The concept of corporate interest, although not defined under statute, is, in light of recent case law as regards financial holding companies, generally seen as being tantamount to the financial interest of all shareholders, while there is currently a tendency to factor in the interests of all (but not one particular) stakeholders (concept of ‘enlightened stakeholderism’).
The duties of managers of a Luxembourg private limited liability company or directors of a Luxembourg public limited liability company, during their appointment, can be summarised as follows:
The liability of the managers of a Luxembourg private limited liability company or directors of a Luxembourg public limited liability company can be triggered on the following grounds.
Civil liability grounds
Liability of managers for a breach of duty towards the company (article 441-9, 1st paragraph juncto article 710-16 of the Company Law)
This individual contractual liability may be engaged by the general meeting of shareholders or the bankruptcy receiver in the case of a bankruptcy. The three following criteria must be established: fault, loss and causal link.
This joint and several liability towards company and third parties for violation of the Company Law or the articles of association can be initiated by the general meeting of shareholders or a bankruptcy receiver in the case of bankruptcy or a third party.
General civil liability (‘tort liability’) under article 1382 of the Luxembourg Civil Code
This personal and individual liability may be initiated by any individual, but to succeed a personal fault of the manager outside of their ordinary duties as an agent of the company (fault severable from the mandate) has to be established. It covers all kinds of erroneous behaviour or wrongdoing and fault that is a breach of a provision of any law applicable to managers or general duty of care, prudence, diligence and competence or provision imposing a specific obligation of a non-contractual nature.
Criminal liability grounds
Criminal liability regime for legal entities
In this case, the company is liable for acts of its corporate body, statutory or de facto managers, committing felonies and offences in the name and for the interest of the legal entity.
White-collar crimes set out in articles 1500-1 to 1500-15 of the Company Law comprise, for example:
Crimes and offences as provided by the Luxembourg Criminal Code are:
Liability in the context of bankruptcy proceedings
Managers or directors have a legal obligation to declare, within a month, with the clerk of the district court sitting in commercial matters, a bankruptcy if payments ceased and if the company lost its creditworthiness.
Managers or directors need to be aware of a ‘hardening’ or ‘twilight’ period set out in article 445 of the Luxembourg Commercial Code; a period of up to six months (plus 10 days) prior to judicial bankruptcy adjudication; specific transactions will be voided upon demand of the bankruptcy receiver (such as for nil transfers, for instance).
Extension of bankruptcy proceedings to the real decision maker, including statutory or de facto manager, of the company (article 495 of the Luxembourg Commercial Code)
Managers or directors may be declared personally bankrupt if payments ceased and gross misconduct of the manager is established; there is commingling of estates (eg, use of corporate assets for personal purposes, commingling of assets, abusive pursuit of loss-making business); or the plaintiff is a bankruptcy receiver on behalf of company or creditors.
Liability to cover unpaid debts (article 495-1 of the Luxembourg Commercial Code)
Such liability ground requires a fault of particular gravity, such as the pursuit of a loss-making business clearly leading to bankruptcy; the entering into transactions completely out of proportion to the company’s financial capabilities.
Liability under the Luxembourg Criminal Code article 489 provides for criminal sanctions against managers of bankrupt companies who:
What foreign investment restrictions and other domestic regulatory issues arise for acquirers based outside your jurisdiction?
In accordance with article 3 of the current Competition Act dated 23 October 2011, as amended, there shall be prohibited any agreements between undertakings, decisions by associations of undertakings and concerted practices that have as their object or effect the prevention, restriction or distortion of competition within the market, and in particular those that:
However, for now, the laws of the Grand Duchy of Luxembourg do not foresee the implementation of an autonomous merger control regime. According to a recent decision of the Luxembourg Administrative Tribunal dated 25 January 2021 (Role No. 43114), the Luxembourg Competition Council is not competent to carry out a purely preventive merger control, but only control based on concrete abuses, within the framework of its competences being the monitoring of compliance by market participants with the provisions on abuse of dominant positions.
A new draft law (No. 7479) was filed, which intends to reorganise the competition law-related matters, whereby (1) the Luxembourg Competition Council will be replaced by the National Competition Authority being a public institution with further powers in other domains including unfair practices (pratiques déloyales), the agri-food sector, services in the internal market or relations between online platforms and their professional users and (2) the Competition Act dated 23 October 2011 will be repealed. Such draft law was subsequently split into two separate draft laws (No. 7479A and No. 7479B), such that the provisions regarding the determination of prices by way of Grand-ducal regulations now form part of the draft law 7479B. The reason for this was to (1) provide more time to adapt the price determination procedure as requested by the Luxembourg Conseil d’Etat, and (2) to react to ongoing infringement proceedings against the Grand Duchy of Luxembourg for failure to transpose Directive (EU) 2019/1 on time.
The draft law (No. 7479A) was voted on 24 November 2022 and the exemption of the second constitutional vote was granted by the Luxembourg Conseil d’Etat on 29 November 2022. The law (No. 7479A) will enter into force on 1 January 2023, but still does not foresee a preventive merger control while its vote opens the door, however, to the introduction of a contemplated merger control of companies on a national level, which was subject to a public consultation. Such draft law is expected in spring 2023.
What competition law and merger control issues arise in financial services M&A transactions in your jurisdiction?
Luxembourg does not currently have its own national merger control regime. However:
Although Luxembourg does not currently have its own merger control regime, M&A transactions involving Luxembourg entities may require merger control filings or approvals in other jurisdictions:
M&A parties should also be mindful of not infringing the general EU and Luxembourg competition law rules regarding arrangements they enter into in the context of M&A transactions. In particular, ‘clean team’ or confidentiality arrangements offer protection against the risk that information exchanged during due diligence or transaction planning might constitute an unlawful exchange of competitively sensitive information between competitors (and, if merger control approvals are required, also protect against the risk that unrestricted exchanges of such information before completion can amount to ‘gun-jumping’ – implementing the transaction before required approvals).
The scope and duration of non-compete provisions to protect the value of the acquired business should be carefully drafted. Overly broad restrictions may amount to unlawful market sharing. Guidance is provided in the European Commission’s Ancillary Restraints Notice.
Common structures
What structures are commonly used for financial services M&A transactions in your jurisdiction? (What are the advantages and disadvantages of each?)
The main vehicles used for acquisition structures in the Grand Duchy of Luxembourg are Luxembourg private limited liability companies, Luxembourg public limited liability companies, Luxembourg common limited partnerships and Luxembourg special limited partnerships.
These corporations or partnerships are often used to structure the sale or purchase of shares or units respectively (share deal) or may be the vehicle that sells or purchases an asset such as non-performing loans, real estate, domestic or foreign companies directly (asset deal). The choice for a share rather than an asset deal or vice versa may depend on various factors (such as the tax treatment of the buyer or seller, the willingness to buy all the assets and liabilities (share deal) instead of only certain ones, resulting in a different level of due diligence and risk, etc).
Three of the most popular acquisition structures are the following:
What is the typical time frame for financial services M&A transactions? What factors tend to affect the timing?
The overall timing of an M&A transaction, the negotiation of the term sheet and dealing with investment banks pitching the transaction and proper tax structuring left aside, is largely driven and influenced by the following key considerations.
Regarding the set-up of an acquisition structure, there is a need to organise the opening and running of bank accounts allowing for wire transfers.
General considerations include:
Regarding a share sale or asset sale:
Regarding a merger, demerger or contribution of branches of activity (with opt-in to demerger rules) entail:
What tax issues arise in financial services M&A transactions in your jurisdiction? To what extent do these typically drive structuring considerations?
In financial services M&A transactions, a buyer will usually seek both tax warranties and a tax covenant on a share acquisition. The tax covenant gives protection for historic tax liabilities of the target up to an agreed date (usually the date by reference to which the purchase price has been determined or from which it has been agreed commercially that risk and reward will move to the buyer).
The tax warranties provide the basis for the disclosure exercise under which the seller provides information about the target. They also provide a basis for a claim for breach of contract if subsequently found to be incorrect. Where a pre-sale reorganisation has been undertaken, the tax covenant is likely to include specific protection for any possible adverse tax consequences.
The buyer should not be subject to Luxembourg tax on receipt where the tax warranty or covenant payments are made by the seller to the buyer as an adjustment to the purchase price. It is increasingly common for a buyer to take out W&I insurance on a share acquisition and for recourse to the seller to be limited as a result.
Also, a Luxembourg corporate seller anticipating a gain on a disposal of shares will hope to benefit from the domestic participation exemption regime that, where conditions are met, provides an exemption from corporation tax for taxable gains on share disposals. However, the seller should double-check the full tax neutrality of such exemption due to the recapture mechanism. Under this mechanism, expenses in relation to the participation, which have reduced the company’s fully taxable commercial profits, would be recaptured and taxed at the time of the sale.
Last but not least, where a change of control may intervene, particular attention should be paid to the availability of tax losses. The availability of such losses is not automatic, notably, if the activities performed by the target company are changing post acquisition.
Where leaving a corporate tax group or consolidation, the sale documents may also include provisions addressing VAT groups or corporation tax group payment arrangements under which one group entity accounts for tax on behalf of a group to ensure that payments (or refunds) are allocated and made appropriately between the target and retained group.
How do the parties address the wider public relations issues in financial services M&A transactions (eg, commitments to social issues)? Is environmental, social and governance (ESG) a significant factor?
Increasing shareholder activism, regulatory requirements and societal expectations from companies around matters such as reducing carbon footprint, improving labour policies, diversity, equity and inclusion and community engagement have led companies to become more accountable towards their investors and customers on a voluntary basis in recent years. ESG is one of the most significant topics in Luxembourg since the European Commission introduced its Action Plan on sustainable finance back in March 2018. Since then, ESG issues have become a value driver in financial services M&A deals. The Action Plan has already crystallised its first regulation, Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services sector (the SFDR), which came into effect on 10 March 2021. In parallel, on 15 April 2020, the Council of the EU adopted the long-awaited Taxonomy Regulation that establishes an EU-wide taxonomy on environmental sustainability. The combination of the requirement of disclosure under the SFDR and the introduction of a standard classification under the Taxonomy Regulation provides transparency to both investors and stakeholders so that they may monitor compliance more efficiently.
In the light of the regulatory developments, buyers need to conduct due diligence that goes beyond the assessment of historical non-compliance and assess how the target will comply with those obligations that have not yet come into force under the SFDR, the Taxonomy Regulation and their technical regulatory standards. When making this assessment consideration is not only given to current disclosures but also to future disclosures that will likely become mandatory. The purpose of such due diligence can be clustered as for transaction risk mitigation, reputational and fiduciary issues, assessment of corporate values, access to acquisition financing as well as the ongoing financing post-closing, and reporting obligations. In the pre-closing phase once ESG due diligence has been completed the above-mentioned issues can be addressed by contractual protections. In addition to standard representations and warranties, more specific ESG-focused representations and warranties and special pre-closing covenants requiring detailed reporting and disclosure of any new ESG issues that may arise, and in the case of private company transactions, special indemnity clauses related thereto may be included.
In the post-closing phase, it is essential to keep ESG as a strong focus for integration as well as to address material ESG risks of the target company and monitor remedial efforts and compliance going forward.
How do the parties address political and policy risks in financial services M&A transactions?
Political and policy risks that may potentially lead to changes in laws or regulations represent a risk in financial services M&A transactions. Luxembourg is a very stable country and policymakers observe to keep this stability. However, to mitigate the risks, buyers are advised to conduct a heightened due diligence or risk assessment and be particularly prepared when it comes to negotiations regarding representations and warranties in relation to potential unexpected material events. For transactions that are in the process of being negotiated, buyers and sellers, with a view to addressing such risk, may want to include provisions in the share purchase agreement (SPA) specifically relating to:
The covid-19 pandemic is a good example for the parties to M&A deals to seek enhanced contractual protection against the occurrence of unexpected risks between the signing and closing dates.
For instance, in the pre-closing stage, parties should look at whether covid-19 constitutes a MAC under the SPA. To qualify as a MAC, an event must be unforeseeable at the time of engaging the contract and must have a long-term and material impact on the target. A MAC clause can be qualified as either a condition precedent or a condition subsequent. If the MAC is qualified as a condition subsequent, the agreement will automatically terminate if a MAC event occurs.
A MAC event can also be qualified as a unilateral termination clause. This gives the contractual right to one of the parties to walk away from the contract, provided certain circumstances occur to unilaterally terminate the agreement.
In Luxembourg, the validity of MAC clauses is based on the prevailing principle of freedom of contract so that the parties are free to allocate risk as they deem appropriate.
In the post-closing phase, the parties to an SPA should consider trying to negotiate the implementation of force majeure and hardship mechanisms.
How prevalent is shareholder activism in financial services M&A transactions in your jurisdiction?
As there are very few publicly available examples of shareholder activism in Luxembourg-listed companies, it is difficult to assess the practical importance of shareholder activism in Luxembourg, which appears to be more of an Anglo-Saxon concept to us. The takeover of Arcelor by Mittal is the best-known example and was only made possible following shareholder pressure.
In addition to the Company Law, there are other pieces of legislation that seek to improve the rights of activist shareholders. Many of these have been influenced by EU legislation and include:
Of these pieces of legislation, shareholders tend to rely on:
What third-party consents and notifications are required for a financial services M&A transaction in your jurisdiction?
Financial services M&A transactions are no different from regular M&A transactions insofar as customary consents may be required. These may relate to obtaining:
If an acquisition is structured as a merger particular attention needs to be paid to the form and constitutional documents of the target or acquiring company, the transaction and the merger plan to be compliant with Luxembourg administrative formalities (regarding depositing of documents at the registered offices of the merging entities, the auditor and management report requirements, filing of the merger plan with the Luxembourg Trade and Companies Register and creditor protection rules).
Setting aside the required regulatory consents (as set out in this chapter), be it with the Luxembourg Financial Sector Supervisory Commission or another Luxembourg regulatory authority, depending on the type and constellation of the transaction (eg, licence of the entity sold or the licence to be granted to an entity merged or moved cross-border including managers etc, as the case may be) and creditors, there is no third-party consent or notification for a financial services M&A transaction in Luxembourg prior to the transaction.
Legal due diligence
What legal due diligence is required for financial services M&A transactions? What specialists are typically involved?
The acquisition of a financial services institution is usually subject to a thorough due diligence process often involving a multi-disciplinary team of lawyers and professional advisers who specialise in corporate, anti-money-laundering, contract law, tax, employment, environmental and financial services regulatory. The following briefly touches on financial services regulatory due diligence.
The financial services regulatory due diligence process includes an evaluation of the compliance risk and the regulatory hurdles that need to be dealt with prior to signing.
Sometimes there is insufficient time in the context of the transaction to verify compliance of the entirety of the target firm’s business with the full spectrum of financial services regulation and therefore the assessment is carried out only in relation to specific areas of the target firm’s business. In such instances the issues that are often covered revolve around whether the target firm has the necessary regulatory permissions to carry on its activities, whether individuals performing certain activities have regulatory approval and whether the firm is complying with rules that are currently the focus of attention by the regulator.
In terms of reviewing the target firm’s documentation, regulatory due diligence normally covers, among others, reviews of internal or external compliance reports, the minutes of board and compliance committee meetings and any documents regarding investigations or enforcement taken by the regulator.
Consideration is also given as to whether any regulatory notification or approval is required (if so, how long this will take) and whether any conditions precedent will need to be inserted into the sale agreement.
If the acquirer is subject to the Alternative Investment Fund Managers Directive (Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No. 1060/2009 and (EU) No. 1095/2010), it may be required to make certain notifications under the ‘portfolio company disclosure rules’.
Representations and warranties are also considered and these may include, a fairly generic warranty that the target firm is in material compliance with all applicable laws and regulation, and then, supplemented by warranties covering specific areas that may have arisen during due diligence.
What other material due diligence is required or advised for financial services M&A transactions?
The recommended material due diligence always depends on the assets held or the activities of the target company. In addition to corporate, tax, employment, environmental and financial services regulatory, the following aspects may, for example, be analysed:
Are there specific emerging technologies or practices that require additional diligence (eg, blockchain and cryptocurrency activities)?
Previously, Environmental, Social, and Governance (ESG) issues were not something that generally required additional due diligence. However, this is changing given the introduction at the EU level of legislation, notably, the SFDR, the Taxonomy Regulation and their Regulatory Technical Standards (RTS), which enter into force on 1 January 2023. These regulations are directly applicable at the national level and aim to prevent the actors of the financial place to value or market their companies based on criteria that are not considered as ‘green’ in the meaning of European laws. This has a huge impact on the marketing practice of the financial market as the companies will be under the loop of any green lies towards the markets and their potential investors and advisers and lawyers need to remain vigilant when advising their client on the topic as clients that may not understand the wrong in casually promoting shady or even false ESG criteria.
Distributed ledger technology (DLT) is a type of technology that has been used for many years and its rise coincided with the appearance of blockchain (which is nothing less than a type of DLT). According to the Luxembourg Regulator, DLT is seen, by some, as the next stage in digital transformation and may have a significant impact on the financial sector in the decade to come. In this regard, the Luxembourg Financial Sector Supervisory Commission published a white paper on 21 January 2022 aimed at guiding professionals on the due diligence process related to the DLT.
Pricing
How are targets priced in financial services M&A transactions? What factors typically affect valuation?
Three main factors regarding the valuation of the target are the following:
What purchase price adjustments are typical in financial services M&A transactions (eg, earn-outs and net value adjustments)?
Typical price adjustments are the following:
Completion accounts
This mechanism is used if the parties agree that the buyer once they took ownership of the target at closing shall be able to assess with the help of a third-party auditor the financial position of the target at completion based on final completion accounts drawn up at or shortly after completion. Such accounts will then fix the final purchase price.
Purchase price adjustments may generally be foreseen in agreements in accordance with the principle of contractual freedom. The purchase price may generally be adjusted upward or downward to reflect the final fair market value or book value of the target as of the transfer date. It may be foreseen that the final purchase price shall be determined by an auditor.
How are acquisitions typically financed? Are there any notable regulatory issues affecting the choice of financing arrangements?
In the context of holding activities, a mix of debt and equity instruments typically finances acquisitions, whereby a generally accepted debt-equity ratio of 85/15 shall be respected.
The approximate 15 per cent equity ratio will typically be financed via an equity increase of the relevant company, generally via an increase of the share capital (with or without share premium) or the 115 account (equity contribution without issuance of shares) by way of a contribution in cash or in kind or the incorporation of reserves.
The approximate 85 per cent debt ratio will typically be financed by way of debt instruments such as loans, preferred equity certificates (convertible or not) or warrants.
The choice of such instruments are mainly tax, efficiency or time and cost driven.
Representations and warranties
What representations and warranties are typically made by the target in financial services M&A transactions? Are any areas usually covered in greater detail than in general M&A transactions?
The target as such is typically not giving representations and warranties for itself, as it generally only acknowledges its own transfer.
The seller generally gives representation and warranties, whereby obviously referring to the target, which in general M&A transactions concern:
Depending on the target and its activities or held assets, further representations and warranties may be given, in particular in relation to:
The list is not exhaustive and may be contractually adapted depending on the activities of a target and the protections requested by a buyer.
What indemnities are typical for financial services M&A transactions? What are typical terms for indemnities?
Typical indemnities requested by the seller include those relating to:
Typical terms for indemnities are:
Statute of limitation
The statute of limitations is 30 years for civil law matters and 10 years for commercial law matters.
For tax warranties, the statute of limitations is in principle five years in Luxembourg starting on 1 January following the fiscal year under review. This period might be extended to 10 years if no tax return has been filed or if it reported incorrect information (new facts discovered by the tax administration and not reported) or if the tax returns were incomplete (irrespective of the existence of a fraudulent intention).
In practice, time limitations with respect to core warranties may usually be capped at around five years and time limitations with respect to non-core warranties may usually be capped at around two years.
What closing conditions are common in financial services M&A transactions?
The following closing conditions are common:
What sector-specific interim operating covenants and other covenants are usually included to cover the period between signing and closing of a financial services M&A transaction?
During signing and closing, a seller shall maintain the target entity in the same situation as known to the buyer as of signing. Hence, during this period, the seller may not cause any material changes affecting the target company or sell the target company to a third party without the approval of the buyer.
During signing and closing, once the terms and conditions are agreed upon between the parties and in particular, the will to respectively sell and buy a target company, usually the following covenants are foreseen:
Common claims and remedies
What issues commonly give rise to disputes in the course of financial services M&A transactions? What claims and remedies are available?
Before going into detail, a clear difference must be made between (1) a breach of representations and warranties leading to compensation or indemnification (such as the reduction of the value of shares), and (2) contractual violations (such as covenants or any other contractual obligations) leading to damages under the Luxembourg Civil Code.
Common issues that may give rise to claims in financial service M&A transactions are breaches of representations and warranties that are given in relation to tax, financial statements, corporate statements or compliance with the laws and regulations, for example.
Other issues stem from price adjustment notably when based on completion accounts and the parties are unable to agree upon such accounts determining the final purchase price. The same issue may also arise when the earn-out mechanism is being implemented, whereby the target’s financial performance may be analysed in different ways by the parties.
Further issues may arise from uncovering historic issues post-completion that may lead to interpretation issues of certain provisions of the SPA over which the parties may be in disagreement.
Most remedies to such issues can be found through negotiation and discussion between the parties if found at an early stage, such as during the due diligence process. If commercial resolution fails, litigation ensues.
In addition to the indemnifications in the case of breach of representations and warranties, which are mostly explicitly foreseen in the relevant agreements, the following remedies are possible in the case of a contractual breach under Luxembourg law:
How are disputes commonly resolved in financial services M&A transactions? Which courts are used to resolve these disputes and what procedural issues should be borne in mind? Is alternative dispute resolution (ADR) commonly used?
It is difficult to assess how disputes are commonly resolved given that ADR proceedings are confidential.
It is, however, no secret that in the case of litigation, the district court is most likely to be the most appropriate forum given the value of the claim. In this respect, the claimant will have to choose between filing the claim with a civil chamber or a commercial chamber. In the case of the latter, the claimant must also bear in mind the complexity of the case and decide in light thereof between the normal oral procedure or a written procedure. While the normal – oral – procedure in commercial chambers is usually fast, the complexity of the case may suggest using a written procedure to ascertain that the court can fully grasp the extent of the issues before rendering its ruling.
ADR in Luxembourg in financial services M&A transactions are mainly arbitration and mediation. Arbitration covenants are often implemented in M&A agreements and thus constitute a common form of dispute resolution.
Trends, recent developments and outlook
What are the most noteworthy current trends and recent developments in financial services M&A in your jurisdiction? What developments are expected in the coming year?
The covid-19 pandemic has made customers more reliant and comfortable with digital transactions and in response the financial services industry has focussed more and more on technology and digitalisation. In light of this, there may be a greater need for acquirers to start investigating their target’s IT systems as part of the due diligence process. In particular, how can the target’s systems integrate with the acquirer’s own systems?
It may be that it will become more common for financial institutions to hold crypto-assets and this will add a further layer of complexity to the due diligence process. In particular, the acquirer will want a clear understanding of the nature and extent of the target firm’s crypto dealings and ascertain whether any crypto-related prohibitions or sanctions apply in the target’s jurisdiction.
Regulatory reform, particularly in the environmental, social and governance space, continues in a number of jurisdictions, and acquirers will need to keep a close eye on what new rules come into force before their transaction closes.
Law stated date
Correct on 30 November 2022.
Publication
Earlier this month, President Ramaphosa attended a state visit to China with President Xi Jinping before the 9th Forum on China-Africa Cooperation (FOCAC) in Beijing.
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