Austria: Bad Bank and Own Funds Instruments

Introduction

In order to raise funding, credit institutions issue various forms of capital market instruments. Those instruments include senior unsecured bonds, covered bonds (if the institution is authorised to issue such instruments), subordinated bonds and various forms of own funds instruments. As is the case in other countries, some Austrian banks failed or almost failed, and were or are in the process of restructuring. Certain of those credit institutions were transformed into wind-down companies or wind-down units which do not hold a banking licence; in other instances, the credit institution was split into a good bank and into a bad bank (with the bad bank still holding a banking licence). As a consequence, investors hold instruments in a non-bank or in a bad bank which is not a going concern and the task of which is to wind down its business. May investors who have invested into a regulated institution terminate the instrument held by them as a consequence of such development?

The Austrian Supreme Court has answered some of these questions recently.

Right of termination in case that banking licence is returned?

In its decision of 26 September 2014 the Austrian Supreme Court (OGH; 5 Ob 4/14w) held that returning a banking licence does not per se entitle any holder of an instrument of supplementary capital of a (former) bank to terminate the contract and request re-payment. The investor needs to stay invested. It may also not rely on changed circumstances (no clausula rebus sic stantibus). In its decision the Austrian Supreme Court highlighted that the restructuring of the relevant credit institution by transferring its viable business to a NewCo and by winding down the non-viable business in a deregulated entity, was an appropriate solution in order to avoid failure and insolvency of the bank. A holder of supplementary capital needs to accept such restructuring as typical market risk. By this decision, the Austrian Supreme Court has favoured the orderly wind-down of a credit institution split into a good bank and a deregulated bad bank.

The decision by the Austrian Supreme Court of 26 September 2014 deals with supplementary capital which is a Tier 2 instrument and forms part of the own funds (equity) of a credit institution. No Supreme Court decision has been handed down so far as to whether this principle would also apply to a senior unsecured bond. We believe that the reasoning applied by the Supreme Court in the above cited decision on supplementary capital may also be applied to unsecured bonds (not forming part of the institution’s equity). Also holders of non-subordinated bank issues need to bear the market risk connected with their investment.

In another recent case the Austrian Supreme Court (29 June 2015, 6 Ob 68/15s) held that provisions of the Austrian Banking Act (Bankwesengesetz) excluding the right of ordinary and extraordinary termination for regulatory reasons prevail over the general principle of Austrian contract law that any contract may be terminated with immediate effect for good cause. The exclusion of any right of termination by the investor for certain own funds instruments, such as supplementary capital and as set out in the Austrian Banking Act, is enforceable, both when the issuer is still a bank and also when it is deregulated and becomes a wind-down company. The Supreme Court’s rationale is that permitting a right of termination under general principles of law for own funds issues would run afoul of the principles of banking regulation, ie, to allow for a capital buffer in the event of a crisis, and that it would be illogical to require an exclusion of termination rights in the Banking Act, if such prerequisite were not enforceable under private law.

Further, in this decision of 29 June 2015, the Austrian Supreme Court held that the termination of a supplementary capital instrument cannot be based on either good cause or on changed circumstances (no clausula rebus sic stantibus). The Court preserves the assets and the liquidity of the (former) credit institution, also in the event of a crisis, because own funds of a credit institution shall provide a buffer for the entire term of the instrument, irrespective of whether the issuer still is or has discontinued to be a credit institution.

Reduction of share capital and participation capital

Austrian company law provides for a simplified reduction of share capital in order to set off losses incurred against the registered share capital. Thereby a company can reduce or eliminate its losses by booking them against the registered share capital and may in the future again be in the position to pay dividends, if profitable again (and with certain restrictions for the first two years after the reduction of share capital). Prior to the implementation of Basel III, the Austrian Banking Act provided for an instrument referred to as participation capital (Partizipationskapital) which was eligible as a Tier 1 instrument (now § 26a of the revised Austrian Banking Act provides for a CET1 instrument without voting rights which has some similarity to participation capital).

Since participation capital has always been considered to have some similarities with preferred stock but without any element of a cumulative dividend and without providing shareholder rights (except for the right to attend shareholders’ meetings of the credit institution) it has been accepted by the Austrian Supreme Court that in the event of a simplified reduction of the share capital of a credit institution, the participation capital will be reduced in the same proportion as share capital (Austrian Supreme Court (OGH) 29 April 2014, 2 Ob 84/13m; 27 April 2015, 6 Ob 90/14z). Contrary to the first decision of 29 April 2014, the Supreme Court held in its decision of 27 April 2015 that the statutory liability reserve (Haftrücklage) need not be dissolved in case of such simplified reduction of share capital. In the meantime, this solution has been explicitly set out in art 57 para 5 of the Austrian Banking Act.

The Austrian Supreme Court held that in the event of a credit institution returning its banking licence, the investors may not terminate the instruments forming part of the own funds of the credit institution, neither for good cause nor due to changed circumstances. The exclusion of the right of ordinary and extraordinary termination set out in the Austrian Banking Act is valid and enforceable. The Austrian Supreme Court has thus favoured the orderly wind-down of a (former) credit institution.

author: Peter Feyl