Beyond expected returns, investors must understand the legal rights, protections and enforcement mechanisms underpinning their investments.

As financial markets face renewed uncertainty, amid high debt, more expensive refinancing and increasingly sophisticated structures, do we really know what we are investing in?

What Returns Do Not Tell Us About an Investment

A productive, value-creating investment is one that can generate a return. But expected performance does not tell the whole story. Every major economic or financial crisis brings the same realisation: investors discover, often too late, that they did not fully understand either the rights they had acquired or the risks attached to them.

The 2008 financial crisis illustrated this clearly. The wave of defaults on US mortgage loans and the complexity of the securitisation transactions involved showed how difficult it could be to understand the underlying asset, the chain of rights and the consequences of a default.

Investing Also Means Acquiring Rights

From a legal perspective, investing is not simply about acquiring an asset or seeking a return. It means acquiring rights whose nature, scope and, above all, enforceability depend on several factors.

The first is the applicable legal framework. In international transactions, the law governing the contract may differ from the law governing the company, the security interests or the applicable insolvency rules. The identity of the counterparty also matters: its legal form, place of establishment, nationality, or public or regulated status may affect the applicable rules and the conditions under which an investor can enforce its rights. Robust contractual protection may therefore produce very different effects depending on the applicable law and jurisdiction or on the identity of the counterparty concerned.

Equity and Debt: Different Rights

The precise legal nature of the investment must then be identified.

Is it an equity investment? A shareholder is not, in principle, a creditor of the company and has no right to repayment of its contribution. Its protection lies in a bundle of rights: voting, information and representation rights, reserved matters, veto rights, anti-dilution protection, pre-emption rights, exit mechanisms, drag-along or tag-along rights. In Luxembourg, these rights must be considered in light of company law, the articles of association and, where applicable, the shareholders’ agreement. For a minority shareholder, the value of its investment also depends on the robustness of this framework when interests diverge.

Debt investments follow a different logic. A creditor has a right to repayment, but the actual value of that right depends on its ranking, any subordination, the finance documentation and, above all, the security supporting it. Pledges, security interests and first-demand guarantees do not all provide the same level of protection. Their effectiveness must be assessed at the structuring stage, but also in terms of how they can be enforced in the event of default or insolvency. In this respect, Luxembourg law provides creditors with protective mechanisms, particularly in relation to financial collateral arrangements.

Finally, the distinction between equity and debt is becoming increasingly blurred. Convertible bonds, mezzanine financing, participating instruments, preferred equity and structures combining fixed returns with upside participation share characteristics of both categories. The more complex the instrument, the less its label alone tells us: only an analysis of the rights attached to it reveals its true nature.

Beyond Returns

In conclusion, perhaps the first question an investor should ask is not only “what return can I expect?”, but also: “what rights am I actually acquiring, under which law, against which counterparty, and how effectively can I enforce them?” When circumstances deteriorate, it is no longer marketing materials or projected returns that protect an investment, but the quality and enforceability of the rights acquired.

To explore the legal issues surrounding the structuring and protection of investments, speak with Nicolas Thieltgen, Managing Partner at Brucher Thieltgen & Partners.

This sponsored article was published in the 11th edition of Forbes Luxembourg.