Austrian Supreme Court confirms admissibility of crowdfunding based on qualified subordinated loans

In its recent decision on crowdfunding¹, the Austrian Supreme Court classified qualified subordinated loans as a specific type of contract. The test set out in section 879 (3) Austrian Civil Code to determine whether a subordination clause might be grossly prejudicial to investors was not applicable.

The action filed with the Graz Regional Court by the Austrian Consumer Information Association (Verein für Konsumenteninformation, VKI) on behalf of collective interests dealt with various crowdfunding-related contract clauses used in loan terms by a Graz-based photovoltaic and renewable energy company.

Among other things, VKI claimed that the subordination clause for investors as contained in the loan terms was grossly prejudicial within the meaning of section 879 (3) Austrian Civil Code. The key elements of this subordination clause are as follows:

• the lender waives claims for repayment and interest insofar as this would cause the borrower’s company to become over-indebeted or insolvent;
• the lender cannot assert claims under the subordinated loan ahead of, but only on a pari passu rank with, the company’s claims for repayment of contributions and only after a crisis, if any, has subsided; and
• the lender’s claims will irrevocably rank behind all claims asserted by present and future other non-subordinated creditors in the case of an insolvency.

Under section 879 (3) Austrian Civil Code, provisions contained in general terms of contract or contract forms that do not specify any of the principal obligations of either side are null and void if they are grossly prejudicial to one party, with all circumstances being duly taken into consideration. According to VKI, the qualified subordination clause would put investors, who are not shareholders and who, under the loan agreement, are not granted the rights of a co-entrepreneur, in the same position as co-entrepreneurs in the case of an insolvency or in a crisis. The risk of loss of capital to be borne by the investors thus far exceeds the general default risk in the case of insolvency, so VKI. Neither does VKI consider higher interest an adequate justification for such grossly prejudicial treatment.

The company being sued objected to the general applicability of section 879 (3) Austrian Civil Code arguing that the subordination clause being criticised regulated and specified in detail one of the principal obligations. However, the Graz Court of Appeal had initially dismissed this objection arguing that section 879 (3) Austrian Civil Code was applicable when a clause merely restricted, changed or undermined the contractual promise as such.

On the issue of applicability of section 879 (3) Austrian Civil Code, the Austrian Supreme Court did not follow the Graz Court of Appeal. According to the Austrian Supreme Court, the subordination clause is a constitutive element of this type of contract. The rank in which the relevant lender’s claim is to be satisfied must be seen as a factor that defines the type and quality of the contractual performance being owed, as it is contingent on this whether the loan is to be regarded as debt capital or mezzanine capital. What is more, the Austrian Alternative Financing Act (Alternativfinanzierungsgesetz, AltFG) explicitly refers to the subordinated loan as an (independent) form of funding and the adding of a qualified subordination clause is to be considered as a novation of contract.

According to the Austrian Supreme Court, the subordination clause in qualified subordinated loans is therefore, for the time being, not subject to the test set out in section 879 (3) Austrian Civil Code.

However, the Austrian Supreme Court’s decision is not equivalent to establishing definitive legal certainty on the issue of the admissibility of qualified subordinated loans in crowd investment, as the Austrian Supreme Court’s remit was only the issue of the applicability of the test set out in 879 (3) Austrian Civil Code. Whether subordination clauses are admissible with a view to other legal provisions, such as for instance in respect of the transparency rule set out in section 6 (3) Consumer Protection Act (Konsumentenschutzgesetz), was not an issue addressed in the proceedings.

In practice, this means that, in the wording of terms and conditions for crowd investment, special attention will have to be paid, also in the future, to carefully balancing interests and adhering to the transparency rule.

¹ OGH (Austrian Supreme Court) 24/08/2017, 4 Ob 30.3.2017 (Graz Court of Appeal 30/03/2017, 4 R 142/16h)