The development of the Austrian capital markets over the last few years has shown that, besides established stock exchange-listed companies, more and more “small” issuers (start-ups, SMEs) have discovered the investing public as a source of financing. Preferred means of financing for and through “public participation” and “crowdfunding” are structures avoiding excessive advisory costs (for example, for the preparation of a prospectus).

In practice, some very common variants of structures evolved, including the so-called “qualified subordinated loan”. Compared to customary junior loans (where subordination is mostly restricted to cases of insolvency as provided for in section 67 (3) of the Austrian Insolvency Act (Insolvenzordnung, IO)), a qualified subordinated loan comes with an additional proviso: payments of capital or interest will not be made to investors also in those cases where such payments would give rise to a reason for instituting insolvency proceedings.

For several years, the vehicle referred to as (qualified) subordinated loan has been an established element of the Austrian Financial Market Authority’s supervisory practice (taken over from the German regulator BaFin) – in the form of an exemption from the requirement of a banking license for deposit business – and, recently, it was even expressly recognised by the legislator as an “alternative financial instrument” under the Austrian Alternative Financing Act (Alternativfinanzierungsgesetz, AltFG).

But now it seems that a current decision handed down by the Graz Regional Court for Civil Law Matters (Landesgericht (LG) für ZRS Graz of 10 June 2016, 35 Cg 153/15t) will put a stop to using that vehicle for raising funds from the general public. In that ruling (issued in first instance and still open to appeal), the court held that a subordination clause (of customary wording and, what is more, in conformity with the specifications established over years in circulars and “information” letters by the FMA) was “grossly prejudicial” and therefore ineffective when used in General Terms and Conditions (GTC). Since qualified subordinated loans used in practice for financing in line with capital market law are typically “granted” (subscribed to) by a multitude of investors, structuring under civil law in the form of GTC is practically unavoidable. Should the opinion of the Graz Regional Court for Civil Law Matters (which includes some highly contestable points) be confirmed by the Supreme Court, this would kill the qualified subordinated loan as a means of public participation and crowdfunding, which have both become increasingly popular in the last few years.

At the moment, one should therefore, for reasons of precaution, consider using an alternative structure (such as equity investments or issuance of securities) for new “small” capital market based financing schemes.

Borrowers under (Issuers of) existing subordinated loans are in a more precarious situation. They find themselves facing the following – widening – gap:

(i) If the civil courts stick with declaring qualified subordination clauses to be ineffective, this will – at least according to the current view of the FMA – result in the precondition for an exemption from the obligation to have a banking license for deposit business ceasing to be met. Thus, there will be imminent danger of a violation of banking supervision law – with draconian penalties under administrative criminal law.

(ii) Customary subject-to-change clauses (which allow the borrower / issuer to change contractual provisions in justified cases) that are included in GTCs (in the form of loan agreements or issue terms and conditions) will, as a rule, not permit such far-reaching changes to the terms of the loan as would be needed to comply with the requirements of supervisory law.

This goes to show that even carefully ensuring to act in line with the practice of the supervisory authorities will not protect capital market participants from the rigours of civil law. Great care in structuring any capital measures in the field of public participation and crowd funding is therefore of vital importance.