- Germany has introduced key changes to bond legislation replacing a more than one hundred year old legal regime that was regarded as highly unattractive by both bond issuers and bondholders.
- In the past, bond restructuring in Germany was hindered by various obstacles of the formerly applicable law such as the prohibition on debt equity swaps.
- As a result, either the bond restructuring measures were not capable of preventing the issuer’s insolvency or bond issuers attempted to circumvent the application of the German bond restructuring scheme by relocating their registered office to another jurisdiction.
- The new German Bonds Act will facilitate restructuring of bonds under German law and make the choice of German law more attractive for issuers.
Bond restructuring in Germany has for many years been regarded as highly unattractive from an investor’s and also from an issuer’s perspective. The reform of the legal framework will remedy this lack of acceptance by opening the way for, inter alia, debt equity swaps by bond issuers in financial difficulties. Rüdiger Litten and Matthias Bell describe the weak points of the former law and the key features of the reformed bond restructuring scheme.
Bond legislation in Germany
On 5 August 2009, the reformed German Bonds Act (the Reformed GBA – Gesetz über Schuldverschreibungen aus Gesamtemissionen) came into force after a protracted legislative procedure. The Reformed GBA traces back to a draft Bill which was introduced in 2003 but later abandoned. The recently enacted Reformed GBA is based on draft Bills of the Federal Ministry of Justice and the Government introduced in May 2008 and February 2009, respectively.
Primarily, the Reformed GBA governs the procedure of restructuring bonds both prior to and after the opening of insolvency proceedings in respect of the issuer. The Reformed GBA replaces the German Bonds Act of 1899 (the GBA 1899 - Gesetz betreffend die gemeinsamen Rechte der Besitzer von Schuldverschreibungen) which had only been marginally revised over a period of more than 100 years and was no longer capable of fulfilling the requirements of modern capital markets. Consequently, the GBA 1899 has been rarely applied in recent years. Both issuers of bonds and investors attempted to circumvent the application of the GBA 1899 such that the GBA 1899 was described as dead law by various commentators.
Bond issuers in financial difficulties
From an investor’s perspective, in the case of financial difficulties of a bond issuer, there are two basic alternative approaches, the first one being terminating the bond and the second one restructuring the bond.
Before the bondholder can exercise his right of termination he would normally need to wait for an event of default to occur such as the issuer’s failure to make a payment of interest. The termination of the bonds obviously exacerbates the financial problems for the issuer since the redemption amount is much higher than the interest that has to be paid. Accordingly, if the Issuer cannot pay the interest it is highly unlikely that it will be able to pay the redemption amount.
In order to achieve a bond restructuring, the terms and conditions of the bonds must be altered. For example, the parties may agree upon a moratorium of payment, an alteration of the interest rate or a change of the redemption amount. However, altering the terms and conditions of the bonds requires the consent of all bondholders. In practice, such unanimous consent is almost impossible to achieve.
The GBA 1899 – Legal concept and restrictions regarding restructuring of bonds
The GBA 1899 allowed the bond issuer to call a meeting of the bondholders (the Bondholders’ Meeting) at which the terms and conditions of the bonds could be amended by a majority of bondholders rather than with the unanimous consent of all bondholders. Decisions of the Bondholders’ Meeting were binding on all bondholders, irrespective of their attendance at the meeting and how they voted.
To understand why both issuers and bondholders tried to circumvent the application of the GBA 1899, it is necessary to look at the various restrictions which the Act imposed. The Bondholders’ Meeting was not entitled to reduce the principal claim. Thus, a debt equity swap prior to the insolvency of the issuer (which is generally the most promising instrument to reorganise finances) was excluded by operation of law. Furthermore, the GBA 1899 provided that the Bondholders’ Meeting could only decide restructuring measures where the opening of insolvency proceedings in respect of the bond issuer was imminent. This restriction had the effect that both bondholders and the issuer were compelled to wait until it was almost too late, namely for the upcoming insolvency of the issuer before being able to put in place restructuring measures. Last but not least, decisions of the Bondholders’ Meeting altering the terms and conditions were only effective for a maximum period of three years.
In summary, bond restructuring under the GBA 1899 was hindered by various obstacles.
Examples of bond restructuring measures in the past
This legal framework is the main reason why bond restructuring in Germany has been anything but a success story in recent years. The GBA 1899 did not provide for adequate instruments to restructure the businesses of bond issuers in financial difficulties such as EM.TV & Merchandising AG, Deutsche Nickel AG and Schefenacker AG, to name but a few.
In January 2004, the bondholders of a €400 million convertible bond of EM.TV & Merchandising AG, a media company trading in film distribution rights, agreed to a restructuring plan setting out a reduction of the interest coupon to 0 per cent, a deferral of the principal claim and a waiver in respect of future rights to terminate. All measures were limited to a period of three years. These amendments of the terms and conditions carried out in compliance with the GBA 1899 were not capable of successfully restructuring the finances of the company. Subsequently, 94.22 per cent of the bondholders agreed upon a reduction of the principal claim. This time, the measures were not based on the GBA 1899 but on a contract between EM.TV Merchandising AG and the relevant bondholders. Therefore, the waiver was not binding on all bondholders but only the ones who were party to the contract. This last attempt to restructure the company also failed.
The bondholders of a €120 million bond of Deutsche Nickel AG, a wire manufacturer, agreed to a deferral of interest payments in September 2004 meaning that insolvency proceedings were avoided. In 2005, Deutsche Nickel AG was converted into a GmbH (private limited company) and sold to the British DNICK Holding plc. Subsequently, the bondholders agreed to the commencement of restructuring proceedings under English Law (in this case, a company voluntary arrangement) and to the completing of a debt equity swap.
In 2006, the former German automotive mirror specialist Schefenacker (based in the UK and operating under the name of Visiocorp since December 2007) encountered severe financial difficulties. The holders of a €200 million bond agreed to a restructuring plan setting out a waiver in respect of the redemption of the nominal amount of the bond. Instead, the bondholders received €7.5 million by means of cash compensation and 5 per cent of the shares plus an option to receive a further 10 per cent of the shares. Similar to Deutsche Nickel AG, the application of German restructuring law was avoided by converting the company into a public limited company.
Recently, English courts have become more and more reluctant to accept forum shopping of bond issuers (as Deutsche Nickel AG and Schefenacker AG did) and scrutinised thoroughly where the centre of main interest of the issuer was i.e. where the operational business was conducted when deciding whether or not English insolvency law was applicable. Therefore, simply relocating the registered office to the UK can no longer be regarded as a means of circumventing the application of German restructuring law.
The reformed GBA
In contrast to the GBA 1899, the Reformed GBA applies to all bonds which are governed by German law irrespective of the place of the registered office of the issuer. Only Pfandbriefe i.e. covered bonds issued in compliance with the German Covered Bonds Act (Pfandbriefgesetz) and government bonds are not subject to the new legal regime. Therefore, the Reformed GBA also applies to structured bonds such as certificates, warrants and asset backed securities. However, when drafting terms and conditions, issuers should bear in mind that the provisions of the Reformed GBA governing resolutions of the bondholders amending terms and conditions are only applicable if such rights are explicitly provided for in the bond. Bondholders of bonds issued prior to the 5 August 2009 who want to make use of the new bond restructuring scheme are entitled to amend the terms and conditions with a qualified majority (i.e. 75 per cent of the bondholders voting have to consent).
The Bondholders’ Meeting representing the common interests of the bondholders is called either by the issuer or the bondholder trustee. The Bondholders’ Meeting has to be called if bondholders who hold at least 5 per cent of the aggregate amount of the bond so request. Terms and conditions of the bond can be amended to effect a restructuring if a qualified majority of bondholders vote in favour of the amendments. Other than under the GBA 1899, waiving or limiting rights of bondholders no longer requires the imminent insolvency of the issuer. Moreover, the duration of restructuring measures decided by the Bondholders’ Meeting is not restricted. The Bondholders’ Meeting may, inter alia, agree to
- a deferral or waiver in respect of the interest receivable or a lowering of the interest rate;
- a deferral or reduction of the principal claim;
- a debt equity swap;
- a waiver or restrictions regarding the bondholders’ rights to terminate; and
- a release of collateral.
In contrast to the position under the old bond restructuring scheme, the bondholder trustee may not only be elected by the Bondholders’ Meeting with a simple majority but may also be appointed in the terms and conditions of the bonds. It is the duty of the bondholder trustee to represent the interests of the bondholders. In particular, the bondholder trustee may negotiate with the issuer on behalf of the bondholders and file the bondholders’ claims in the case of insolvency of the issuer.
From an investor’s perspective, restructuring of bonds under German law is now much more attractive than it was under the GBA 1899 since the various restrictions in respect of restructuring measures no longer apply. The reform of the German bond restructuring scheme also results in German law becoming more competitive from an issuer’s perspective. The Reformed GBA facilitates the restructuring of bonds which is likely to be of immense value in current times.