In this briefing we look at the typical collateral packages provided in favour of a secured party in a subscription finance deal. This briefing focuses on both the similarities and differences between the Cayman Islands and Luxembourg in the context of a subscription finance collateral package and issues to be considered by a secured party when structuring a transaction.
Security over uncalled capital commitments and rights to call capital are generally expressed as an assignment by way of security and it is typical for a Cayman fund structured as an exempted limited partnership (which acts through its general partner) and its general partner to both be party to such security document. A key feature of a subscription finance collateral package involving a Cayman fund is that there is no reason why such security document needs to be Cayman law governed and in the majority of cases the security document will not be governed by Cayman law (even though the collateral will include rights arising under a Cayman law governed limited partnership agreement and related subscription documents).
Furthermore, it is not necessary to have a Cayman law governed security agreement to document security over the collateral account into which investors' capital contributions are deposited – the collateral account would not usually be located in the Cayman Islands so the collateral account security would be governed by the laws governing the account (typically US or English law).
Priority of the security over the uncalled capital commitments is achieved by giving notice of the creation of the security interest to the investors. Aside from establishing priority, giving notice to the investors has additional benefits for a secured party. After investors have been notified of the security interest the investors will not be able to set-off against their uncalled capital commitments any amounts which become due and payable to the investors (from the Cayman fund) after they have received the notice. In addition until investors receive notice of the security interest they are entitled to treat the fund/its general partner as the person to whom they are liable and to obtain a good discharge by payment to, or settlement with, the fund/its general partner.
There is no central security registration regime in the Cayman Islands for security over uncalled capital commitments and rights to call capital. Cayman companies (including limited liability companies) are required under the Companies Law to maintain a register of mortgages and charges into which details of all security interests granted by a Cayman company need to be entered. The register of mortgages and charges is an internal register only and failure to make an entry does not affect priority or validity of the security. Where a Cayman company is the general partner or ultimate general partner of a fund that has granted security, it is common for the general partner or ultimate general partner to make an entry in its register of mortgages and charges in respect of security interests granted by it in its capacity as general partner or ultimate general partner (as the case may be), but there is no strict requirement to do this.
Security over uncalled capital commitments and rights to call capital can be created in Luxembourg either by a pledge or an assignment by way of security, but the general preference is to use a pledge rather than an assignment by way of security. Both the Luxembourg fund and its general partner will typically be party to the security agreement, but it is usually only the Luxembourg fund that enters into the agreement as a pledgor. The general partner will enter into the security agreement in its capacity as general partner of the Luxembourg fund only, the reason behind this being that the rights to uncalled capital commitments, to make capital calls, to receive capital contributions and all other rights relating to the uncalled capital commitments under the Luxembourg fund's partnership agreement are viewed as rights belonging to the fund itself and not the general partner.
A Luxembourg law governed collateral package is necessary, with either separate Luxembourg law governed security agreements or split jurisdiction and governing law provisions in the US law (or other non-Luxembourg law) security agreements. While the latter is an option, it is market practice (and highly recommended) to put in place separate Luxembourg law governed security agreements over the uncalled capital commitments and rights to call capital. Such security created under the Luxembourg law of 5 August 2005 on financial collateral arrangements (the Financial Collateral Law) ensures that the benefits and protection of the Financial Collateral Law apply to secured parties in relation to the perfection and enforcement of the security, in particular in the event of insolvency and bankruptcy proceedings (for further information on the benefits of the Financial Collateral Law, please see our earlier briefing here).
In US transactions, collateral accounts are usually maintained in the US, and therefore no Luxembourg law security is required in respect of such accounts. However, where a collateral account is located in Luxembourg, Luxembourg law security would be required on the basis that such accounts and the assets contained therein would be viewed as Luxembourg situs assets. Moreover, the account banks in Luxembourg may not be willing to acknowledge any US law governed security created over those Luxembourg situate accounts, thereby causing issues in the longer term in the event of an enforcement by a secured party.
Under the Financial Collateral Law, the security agreement over uncalled capital commitments and rights to call capital is perfected by the simple execution of the security agreement identifying such contractual rights as between the parties. While not strictly necessary for perfection, notice of the creation of the security interest should nevertheless be given as under the Luxembourg civil code (and reiterated in the Financial Collateral Law), if an investor (debtor) is unaware of the security interest created over its obligation to pay (the pledged claim), the investor may validly discharge that obligation directly to the Luxembourg fund. Although this is likely to be contractually agreed in relation to times when no default has occurred, this could become problematic (if not notified) following the occurrence of a continuing event of default.
In respect of security created over collateral accounts, perfection (and priority) of that security can only be achieved through the giving of notice to the account bank of the creation of the security interest over the collateral account and, crucially, the receipt of an acknowledgement from the account bank in which it agrees to relinquish any rights of set off, combination of accounts or first ranking pledge in respect of the collateral account which would otherwise apply in standard account bank terms and conditions.
There is also no central security registration regime in Luxembourg for the registration of security interests. There is therefore no way of determining if there is prior security granted over the uncalled capital commitments, rights to call capital and collateral accounts of a Luxembourg fund other than through due diligence and reliance on the representations given by the Luxembourg fund and the general partner in the finance documents.