Restructuring of bonds under the German Debenture Act – prospects and pitfalls
April 2015 | EXPERT BRIEFING | BANKRUPTCY & RESTRUCTURING
The new German Debenture Act (Schuldverschreibungsgesetz) was introduced in 2009 and replaced the old Debenture Act from 1899. The new law significantly broadened the ability of the bondholders’ meeting to change the terms and conditions of the bonds. Thereby, the new German Debenture Act constitutes an effective tool in restructuring scenarios. However, the past six years have shown a number of problems in the application of the law. This article flags some of those problems and highlights approaches to solve them.
The new German Debenture Act
With the Debenture Act 2009, the legislator aimed to adjust German law to international standards regarding bonds, as the former Act had not met those demands.
In light of the ongoing credit crisis, the Debenture Act 2009 was introduced as a restructuring tool. It allows the subsequent modification of the terms and conditions of a bond through a qualified majority decision of the bondholders’ meeting. Such modification can take place inside or outside of insolvency proceedings. To achieve such modification, the bondholders’ meeting is summoned by the emitter. A modification can become necessary during the emitter’s crisis or afterwards in its insolvency.
The Debenture Act 2009 also allows the appointment of a joint representative who then acts as a substitute for all bondholders. The joint representative has certain rights granted to him under the law and additionally the rights given to him by a bondholders’ majority decision. Most importantly, the joint representative exercises the bondholders’ rights, e.g., the voting rights in the creditors’ meeting during insolvency proceedings.
The joint representative can either be appointed from the beginning in the bonds’ terms and conditions or the bondholders can appoint one through a majority decision of the bondholders’ meeting at a later point in time.
Prospects and pitfalls
Six years after the introduction of the law, a number of issues regarding its applicability and its scope inside and outside of insolvency proceedings have arisen. Below is a short overview of the main issues.
Applicability to partly non-German law bonds. The Debenture Act 2009 generally only applies to bonds issued under German law. Thus, the question has arisen whether the Debenture Act 2009 is applicable if almost all terms and conditions of the bonds are subject to German law, but one marginal clause is subject to foreign law. The competent court took a very strict approach and denied the applicability of the Debenture Act 2009 in this case arguing with the intention and purpose of the Debenture Act. The Court referred to sec. 1 par. 1 of the Act which states the applicability only for debenture bonds emitted under German law. The court interpreted this rule strictly and did not make any exceptions. At present, it is not clear whether the German Federal Court will follow the court’s strict interpretation. However, until the German Federal Court has a chance to rule on this issue, bondholders should be aware of this case law when drawing up their agreements.
Applicability to bonds issued prior to 2009. Another issue is whether the Debenture Act 2009 is applicable to bonds emitted prior to 2009. This issue has been decided by the German Federal Court. Against two preceding regional court decisions, the Federal Court allowed the application on bonds which had been emitted prior to the introduction of the Debenture Act 2009. In the matter at hand, the bonds had not been covered by the former Debenture Act 1899 as the emitter had not been based in Germany. This condition was not met, but the condition of the new German Debenture Act 2009 – bonds emitted under German law – was satisfied. The court argued that the only preconditions for the applicability of the Debenture Act 2009 are those described in sec. 1 Debenture Act 2009 (applicability only on bonds emitted under German law) and in sec. 24 par. 2 Debenture Act 2009. The latter gives the bondholders’ meeting the opportunity to declare the new Debenture Act 2009 applicable also for bonds that were emitted before its introduction if the conditions of sec. 1 Debenture Act 2009 are met, i.e., the bonds were emitted under German law. It no longer matters whether the emitter was based in Germany at the time the bonds were emitted.
Void modifications due to a disadvantage of bondholders. In the same decision, the Federal Court commented on sec. 5 par. 2 s. 2 Debenture Act 2009. This section determines that a bondholders’ majority decision is null and void if it does not provide the same conditions for all bondholders in an equal way. In the case at hand, the bondholders’ decision to change the bonds’ terms and conditions conferred different rights depending on the bondholders’ voting behaviours. The Federal Court found that the decision was completely void and therefore there was no need to contest this bondholders’ decision. Thus, one has to pay close attention to providing equal consideration to all creditors to avoid an invalid decision.
Stay of modifications due to legal action of minority bondholders. Due to sec. 5 Debenture Act 2009, a qualified majority decision of the bondholders is necessary to change the terms and conditions of the bond. The details of this collective action clause are described in sec. 5 par. 3 of the Act. However, sec. 20 Debenture Act 2009 provides the opportunity for the overruled bondholders to avoid the decision by bringing an action against the emitter. The challenged decision cannot be performed – with small exceptions stated in sec. 20 par. 3 – until a final court decision declares the bondholders’ decision to be lawful. Thus, majority decisions can be put on hold for a significant amount of time through minority bondholders. This creates incentives for minority bondholders to vote against modifications and to drop the court action against the emitter only in return for a considerable financial compensation. Sec. 20 par. 3 Debenture Act 2009 refers to some prescriptions regarding the German stock corporation law, especially to sec. 246a German Stock Corporation Act in which the conditions for the release procedure are described. If these conditions are met the competent court declares the bondholders’ decision to be able to be performed even though the action against this decision is pending before the court. It remains to be seen whether this legal tool will prevent the risks described above.
Joint representative in insolvency proceedings. During the emitter’s insolvency the bondholders are allowed to appoint a joint representative by majority decision if they have not done so before. If the bondholders do not have a joint representative when the insolvency proceedings are opened, the insolvency court is obliged to call a bondholders’ meeting. In this meeting the bondholders have to decide whether they want to name a joint representative. They are not obligated to appoint one, but if they do so the bondholders are not allowed to exercise their rights by themselves anymore. The joint representative is now the sole contact for the insolvency administrator in all issues regarding the bonds.
The appointed joint representative has to participate in the creditors’ meetings during the insolvency proceedings and to exercise the voting rights which the bondholders normally, without the appointment of the joint representative, would have as insolvency creditors. There is some disagreement in German legal science as to whether the joint representative has to exercise his voting right unanimously. Unless there is case law, the joint representative should exercise this right unanimously according to the prevailing opinion.
The joint representative’s compensation is paid by the emitter (sec. 7 par. 6 Debenture Act 2009). With the opening of the insolvency proceedings the claim for remuneration becomes an estate debt (Masseverbindlichkeit).
Another unresolved question concerns the relation between joint representative, bondholders and the emitter. Either there exists a management agreement between the joint representative and the bondholders or a contract with the emitter. In accordance with the prevailing view in legal literature, the agreement exists between joint representative and bondholders with the effect that the bondholders can give instructions to their joint representative which he has to follow. He is obligated to exercise their rights in accordance with their ideas and concepts, even though he is paid by the emitter.
On the other hand, a decision made by another German Court regarding the bondholders’ rights during the insolvency proceedings weakens these rights. It states that the insolvency court is not obliged to summon the bondholders’ meeting if the bondholders’ claims against the emitter are declared to be subordinated as shareholder loans (sec. 39 par. 2 German Insolvency Act) behind the regular creditors and thus cannot expect to receive any repayment on their bonds. The court argued that in this case the summoning of the creditors produces unnecessary cost to the detriment of all other creditors. However, the ruling has not been approved by a higher court, so it remains to be seen if other courts will decide in the same way.
The Debenture Act 2009 is establishing itself as a helpful tool in bond restructuring inside and outside of insolvency proceedings. However, this short overview shows that there are still some unresolved issues regarding the Debenture Act 2009, especially regarding its accurate application during an emitter’s insolvency proceedings. With a number of bond restructurings coming up in 2015, time will show whether the courts will be able to provide a usable interpretation of the law or whether the legislator will need to apply some fine tuning.
Dr Heiko Tschauner is a partner and Christine Ede is an associate at Hogan Lovells International LLP. Dr Tschauner can be contacted on +49 89 290 120 or by email: email@example.com. Ms Ede can be contacted on +49 89 290 120 or by email: firstname.lastname@example.org.
© Financier Worldwide
Dr Heiko Tschauner and Christine Ede
Hogan Lovells International LLP