Recent decisions of the Frankfurt am Main Higher Regional Court on the scope and applicability of the new Bondholder Act 2009 have cast considerable doubt on the viability of certain debt restructurings under German law. These decisions, which affect the majority of outstanding German law-governed corporate bonds, have been met with surprise – if not incredulity – by practitioners, as it is a stated aim of the act to ease bond restructurings, rather than to artificially raise the bar for their succesful implementation.
Pursuant to the act, corporate and non-German sovereign bonds issued under German law may provide for a collective action mechanism under their respective terms and conditions. If this mechanism is adopted (or at least allowed), the issuer and bondholders may subsequently – and subject to some additional procedural requirements – agree on certain far-reaching changes and/or amendments to the terms and conditions with a qualified majority bondholder vote. The voting and its binding effect on all bondholders further requires that – in terms of value – at least 50% of all bonds outstanding at that time be present for the purpose of the collective decision making.
However, if the issuer does not explicitly adopt the newly introduced mechanism at the time of issuance, any subsequent amendments or changes to the terms and conditions will require the unanimous consent of all bondholders in order to have binding effect on them. In other words, it is up to the issuer at the time of issuance to decide whether to allow for the opportunity subsequently to modify the terms of this debt financing ('opt-in approach'). It goes without saying that the availiability of a mechanism may be of great value to financially distressed companies which have issued German law-governed bonds and need them to be involved in an overall restructuring of liabilities.
To faciliate this beneficial effect, the new act has dropped the collective action requirements of its 1899 predecessor – namely that:
- the bond in question had to be issued in Germany; and
- there had to be an objective and acute need to modify the terms and conditions in order to prevent a stoppage of payments or a declaration of insolvency of the issuer.
Thus, the scope of this mechanism has broadened significantly under the new act. To expand the applicability of the act even further, the German legislature has decided that the opt-in approach extends not only to bonds issued after the act's enactment ('new bonds'), but also to bonds issued previously ('old bonds'). To achieve this, the act allows issuers and bondholders of old bonds subsequently to amend their terms and conditions to include the new collective action mechanism, upon the initiative of the issuer and via a qualified majority vote of its bondholders.
But what debt issue qualifies as an old bond for this purpose? Unfortunately, the law is silent on the matter. While it describes how to effect the process, it does not explicitly address to whom it is available. This has become a highly contentious issue, on which the court has now ruled.
There are basically two schools of thought on the matter. Some argue that any old bonds which are governed by German law – regardless of the jurisdiction of the issuer – would fall within the scope of the new act. In this way, an unequal treatment of old bonds and new bonds would be avoided, as both would allow for the adoption of the collective action mechanism. Otherwise, there would be two regimes for bonds of a similar type.
However, the Frankfurt am Main Higher Regional Court has argued that the process should be available only for bonds which would otherwise be subject to the old act (ie, bonds which were issued in Germany). The court has highlighted that the retroactive applicability of the new act, with its opportunities to strip minority bondholders of their initially agreed contractual rights through majority voting, must be checked against the constitutional protection of acquired rights. In particular, the court has held that holders of old bonds were usually not warned about a later change in the voting regime and thus could not take such change into account when deciding on their investment or its pricing.
The practical impact of the court's view should not be underestimated. As it happens, quite a few of the old bonds were issued at the level of non-German holding companies or financing vehicles, and benefit from guarantees (or other means of financial support) of their respective Germany-domiciled operating companies which are in dire need of financial restructuring. Thus, it becomes pivotal to bail in these bond financings for a sustainable restructuring of the group of companies affected.
Ultimately, the court's decisions have triggered the failure of a broader set of restructuring agreements for the issuer involved, which might otherwise have saved the issuer and its operating subsidiaries in question. In addition, further attempts to embark on comparable restructurings have now been abandoned in light of the court's ruling and are alleged to have triggered further filings for insolvency.
Restructurings have now become far more complex, as the court has precluded the availability of the collective action mechanism for old bonds. While reports of the 'death' of the Bondholder Act are exaggerated, it is nevertheless true that the court's view will make restructurings much more costly and complex. Issuers may have to resort to other means of bond restructurings, such as exchange offers. Alternatively, majority bondholders may need to buy out opposing bondholders so as to secure a unanimous vote on amendments later. Obviously, all of these scenarios invite more, not less, opportunistic behaviour by minority bondholders, which is what the act was initially designed to avoid.
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