Article Law360

New Opportunities For Distressed Investment In Germany

German bond market investors were burned badly by the twin bankruptcies of Pfleiderer AG (wood materials producer with over EUR 1 billion in funded debt) and Q-Cells SE (photovoltaic cell manufacturer with nearly EUR 1 billion in funded debt) in Spring 2012. Bondholders in those cases saw the Frankfurt Appellate Court (Oberlandesgericht Frankfurt, hereinafter “OLG Frankfurt”) save defeat from the jaws of victory in a much-criticized decision that sided with dissident bondholders and effectively ended both companies’ out-of-court restructuring efforts. In a recent decision, however, the German Supreme Court (Bundesgerichtshof, hereinafter “BGH”) openly departed from the OLG Frankfurt’s ruling and, in going so, reopened a restructuring path under the 2009 German Bond Act (the “New Bond Act”) that should put would be hold-out bondholders of German companies on notice.

The New Bond Act and the “Opt-In” Provisions

The New Bond Act replaced the century-old German Bond Act of 1899 (Schuldverschreibungsgesetz von 1899) (the “Old Act”) with a restructuring-friendly statute that, among other things:

  • permits implementation of a variety of measures — including debt-equity swaps, maturity extensions, principal and interest reductions and deferrals and release of securities — with 75 percent (principal amount) majority vote;
  • allows for appointment of a bondholder representative who can be vested with authority to undertake these measures on behalf of bondholders; and
  • enables bondholders, with 75 percent majority vote or decision by the bondholder representative, to restrict individual bondholders’ exercise of termination rights.

Voting occurs at a bondholders meeting for which 50 percent (principal amount) quorum is necessary. Should bondholders fall short of the quorum, a second meeting can be called, at which only 25 percent (principal amount) is necessary. In other words, far-reaching bondholder resolutions facilitating comprehensive restructurings can be passed with the consent of essentially 75 percent of 25 percent of the outstanding principal bond amounts (i.e., 18.75 percent).

The key New Bond Act provision at issue in the OLG Frankfurt and BGH decisions involved the ability of bondholders holding German-law bonds issued prior to enactment of the New Act nevertheless to opt in to that act in order to take advantage of its restructuring-friendly provisions.

The OLG Frankfurt Nixes the Pfleiderer and Q-Cells Restructurings

In Pfleiderer, the company and bondholders sought to take advantage of the opt-in provisions with respect to bonds issued by Pfleiderer BV, a Dutch special vehicle, pursuant to the Old Act. While the bonds generally were governed by German law, their subordination clause was subject to Dutch law. Bondholders challenged the opt-in, asking the Frankfurt District Court (Landgericht Frankfurt)[1] and then the OLG Frankfurt to nullify the bondholder resolution. Pfleiderer in turn sought clearance[2] of the resolution from the OLG Frankfurt notwithstanding the pending bondholder challenges.

The OLG Frankfurt sided with the dissident bondholders, holding that only bonds already subject to the Old Act and which contemplated majority decision-making could be made subject to the New Act through majority vote.[3] Because the Old Act only applied to German entities and because Pfleiderer BV, a Dutch entity, had issued bonds without majority voting provisions, the New Act could not be made to apply retroactively to them. The decision effectively ended Pfleiderer’s out-of-court restructuring process, sending it into German debtor-in-possession bankruptcy proceeding from which it emerged several months later.[4]

The ruling in Pfleiderer likewise marked the end of Q-Cells SE’s out-of-court restructuring efforts. Q-Cells, who, like Pfleiderer, had issued a German-law governed bond from a Dutch special purpose vehicle, had been unsuccessful in its attempts to convince the Frankfurt District Court to clear the way for its bond restructuring.[5] It discontinued its then-pending appeal to the OLG Frankfurt and filed for insolvency in the Local Court of Dessau-Roßlau.[6]

The BGH’s Decision “Overruling”[7] the OLG Frankfurt

The OLG Frankfurt denied leave to appeal the Pfleiderer ruling.[8] As a result, despite substantial criticism[9] of its decision that it misinterpreted both applicable law and the legislator’s intent, it was thought that it would remain in force. Over two years later, however, the BGH got its first opportunity to opine on the New Bond Act.

In the BGH case, the issuer, a German stock corporation, had issued profit-dependent convertible notes prior to enactment of the New Bond Act. The notes did not contain majority voting provisions. Upon maturity, the plaintiff, a noteholder, sought repayment of the notes and commenced a lawsuit to collect on the outstanding amounts, winning in the district court. During the pendency of the appeal before the OLG Frankfurt, the issuer convened a noteholders meeting at which the noteholders resolved to apply the New Bond Act to their notes and, pursuant to the act’s provisions, extend the maturity date of the notes. The OLG Frankfurt applied its existing jurisprudence and ruled that the noteholder resolution was null and void.[10]

The BGH reversed, holding that even those bonds not originally subject to the Old Bond Act and which do not contemplate majority voting on restructuring matters can be made subject to the New Bond Act pursuant to that act’s opt-in provisions.[11] The BGH explicitly rejected the OLG Frankfurt’s reasoning in Pfleiderer, finding that the legislator’s intent in enacting the New Bond Act was to facilitate out-of-court bond restructurings — which the OLG Frankfurt’s Pfleiderer ruling had directly undermined — and that enactment of the New Bond Act did not constitute a retroactive and constitutionally suspect deprivation of existing rights.[12]

Effect of BGH Ruling on Issuers, Distressed Investors and Hold Out Bondholders

The BGH’s decision reopens a door to German bond restructurings right at a time when billions of euros in high yield bonds are approaching maturity.[13] For those bonds issued prior to August 2009, the BGH’s rejection of the OLG Frankfurt ruling means that financially troubled issuers of those bonds will not be barred from taking recourse to the New Bond Act to effectuate a restructuring.[14] It puts another restructuring tool into bond issuers’ toolbox, providing additional opportunities for value-seeking distressed investors and negating the threat posed by hold-out creditors.

[1] See LG Frankfurt Judgment (27 Oct. 2011) – 5 O 60/11.
[2] The New Bond Act permits the issuer to seek judicial clearance of a resolution notwithstanding bondholder challenges if, inter alia, the court finds that the interest in completing the measures contemplated in a bondholder resolution outweigh challengers’ interest in blocking it, giving consideration to potential material harm that bondholders are likely to suffer. See § 20, para. 3, sent. 4, cl. 2 SchVG. The provision derives from and makes reference to the § 246a of the German Stock Corporation Act (Aktiengesetz).
[3] OLG Frankfurt Judgment (27 Mar. 2012) – 5 AktG 3/11.
[4] AG Düsseldorf (17 April 2012) – 501 IN 84/12 (commencement order – Pfleiderer AG).
[5] LG Frankfurt Judgment (23 Jan. 2012) – 3-05 O 142/11.  Interestingly, the lower court judgments in Pfleiderer  and Q-Cells included in their reasoning the fact that the respective bonds, while subject to German law, contained subordination clauses subject to Dutch law that, per the lower court, ruled out application of the New Bond Act. The OLG Frankfurt did not take up this reasoning and most commentators believe that it is not good law.  See Langenbucher/Bliesener/Schneider, Bankrechtskommentar § 1 SchVG ¶ 3 n.1 (collecting sources).
[6] AG Dessau-Roßlau (3 April 2012) – 2 IN 121/12 (commencement order – Q-Cells SE).
[7] German law, in contrast to U.S. and English law, does not follow stare decisis (i.e., the principle that lower courts must follow the decisions of higher courts on similar sets of facts) other than with respect to decisions of the Constitutional Court. See, e.g. Lundmark, JuS 2000, 546, 548-50 (discussing stare decisis concept with jurisdictional comparisons); § 31, para. 1 Fed. Const Ct. Act (Bundesverfassungsgerichtsgesetz) (providing for binding effect on lower courts of Constitutional Court decisions); § 325 German Code of Civil Procedure (Zivilprozessordnung) (restricting effect of court judgments to the parties to the dispute).

However, while not legally binding, German Supreme Court judgments generally are followed by lower courts in the interest of promoting legal and economic certainty. Heldrich, ZRP 2000, 497, 499 (observing development in German jurisprudence of a tendency toward Anglo-American style “case law”); see also Staudinger/Sach/Fischinger, § 138 BGB ¶ 63 (noting that lower courts should depart from higher court rulings only where grave concerns regarding their correctness exist) (citing sources).
[8] OLG Frankfurt Judgment (27 Mar. 2012) – 5 AktG 3/11 ¶ 46.
[9] See, e.g. Heidel, Aktienrecht und Kapitalmarktrecht, § 24 SchVG 4. ed. (2014) ¶ 2 n.8 (citing Friedl, BB 2012, 1305, 1309-10; Than, WuB I G 7. 1.13; Weckler, NZI 2012, 477, 480; Lürken, GWR 2012, 227; Keller, BKR 2012, 15; Paulus, EWiR 2012, 259; FK/Hartwig-Jacob-Friedl, SchVG § 24 ¶¶ 12 et seq.; Baums/Scmidtbleicher, ZIP 2012, 204, 209).
[10] OLG Frankfurt Judgment (15 Mar. 2013) – 24 U 97/12.
[11] BGH Judgment (1 July 2014) – II ZR 381/13 ¶¶ 12-13.
[12] BGH Judgment (1 July 2014) – II ZR 381/13 ¶¶ 13-15 (citing BT-Drs. 16/12814 at 27; BVergG Judgment (13 June 2006) – 1 BvL 9/00).
[13] AFME European High Yield & Leveraged Loan Report (2014 Q1) at 7 (3.4 European Corporate Bonds Maturity Wall) (showing over EUR 3 trillion in high yield bond maturities in Europe from 2014-2016); Habersack/Mülbert/Schlitt, Unternehmensfinanzierung am Kapitalmarkt § 18 3. ed. (2013) ¶ 12 n.2 (noting typical high yield bond maturities of up to 9 years).
[14] Importantly, the definition of “bond“ (Schuldverschreibung) in the New Bond Act encompasses a wide array of financing instruments, including standard high yield bonds, fixed and floating rate notes, zero coupon notes, convertible notes, option notes, profit-dependent notes (Genussrechte), hybrid bonds, certificates, asset-backed securities, credit-linked notes, CDOs, catastrophe bonds and contingent convertible bonds. See Langenbucher/Bliesener/Schneider, Bankrechtskommentar § 1 SchVG ¶¶ 53-66.  It does not include, however, so-called Schuldscheine (German tradeable debentures). See Heidel, Aktienrecht und Kapitalmarktrecht, § 1 SchVG 4. ed. (2014) ¶ 1.