For quite a few years now, terms like “crowdfunding” and “public participation” have been popular catchwords in company financing, especially where funding for SMEs is concerned.

Although it took the Austrian Alternative Financing Act (Alternativfinanzierungsgesetz, AltFG) of 2015 to introduce regulations making certain types of transactions noticeably easier (the most prominent example being a higher “minimum limit” with respect to the obligation to publish a prospectus as stipulated in the Austrian Capital Market Act (Kapitalmarktgesetz, KMG)), certain “guide rails” for companies (especially SMEs) entering the capital market had been established already before that time by the Austrian Financial Market Authority (FMA) in its day-to-day practice. For instance, the FMA had, for several years, been publishing circulars and information letters stating its interpretation of the law on financing structures that were not regarded as banking business (viz. deposit business), for which a licence is required.

Qualified subordinated loan

Especially the qualified subordinated loan has proven a popular form of financing. This does have its drawbacks for investors as they will not only, as a rule, end up empty-handed in the event of insolvency or liquidation; in addition, the flow of interest and principal back to them will stop as soon as the upcoming payment would actually cause insolvency to arise. But nevertheless this structure was relatively safe from the supervisory law perspective because the established practice of the authorities permitted planning ahead to avoid uncertainties.

It is less clear how to assess the qualified subordinated loan under civil law. Similar to classical capital market instruments, such as bonds or participation rights, it is often used to collect relatively small amounts of money from a multitude of persons – and therefore the loan agreement on which it is based usually needs to be classified as General Terms and Conditions. As a result, however, the agreement becomes subject to two very strict tests applicable to GTCs:
On the one hand, one may ask oneself whether a given qualified subordination clause is so unusual, prejudicial and surprising that it fails to become an integral part of the agreement at all (test as to validity). Well, this obstacle should be conquerable by designing the documentation accordingly, as one may probably proceed on the assumption that the subordinated loan is a commonly used instrument, given its recognition in a law (the AltFG).

On the other hand, the clause might be grossly prejudicial and thus void (test as to contents). Since this provision applies only to clauses that do not “specify any of the principal obligations of either side”, there is ample argument against subjecting qualified subordination to such a test at all.

But this is exactly what a court of first instance did recently, when it held a qualified subordination clause of customary design to be void. It stated the significant departure of the regulation from non-mandatory law as the key reason for its decision, which is indeed somewhat surprising, given the existence of applicable standards of insolvency law and the AltFG.

Issue in question

It remains to be seen whether this opinion is going to be revised upon appeal. Otherwise, lenders and investors could get caught between the devil and the deep blue sea: If the civil courts stick with declaring qualified subordination clauses to be ineffective, the result – at least according to the current view of the FMA – will be that the precondition for being exempted from banking license requirements ceases to apply. Thus, there will be an imminent danger of being in violation of banking supervision law, with corresponding penalties under administrative criminal law. Typically, GTCs do not include subject-to-change clauses that are wide enough to allow “remedying” the loan terms so as to comply with the requirements of supervisory law; (special) termination rights for comparable situations are also likely to be lacking.

Conclusion

This goes to show that “alternative” financing models continue to come with risks for both issuers and investors. In many cases, the best way to achieve the required transactional and legal certainty will thus be to use classic forms of financing (with support from banks).