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07 September 2010
Exclusion of termination rights in terms and conditions
No limitation of extraordinary termination rights for consumers
Equivalent termination rights for issuer and certificate holders
Only a few months after the Supreme Court issued a landmark ruling concerning the invalidity of prevalent and customary clauses included in terms and conditions of Austrian law-governed bond issues regarding consumer bondholders, a new Supreme Court ruling has extended some of the court's legal views to the terms and conditions of profit participation certificates. The decision ended a lawsuit between the Austrian Consumer Protection Association and the insolvency administrator of an Austrian issuer of profit participation certificates.
According to the ruling, the exclusion of ordinary and extraordinary termination rights regarding consumer profit participation certificate holders was found to be illicit, even though the certificates had been listed on a stock exchange. Furthermore, the Supreme Court dealt with the qualification of profit participation certificates and held that profit participation certificates constitute creditors' rights in personam (in the form of continuing obligations, as opposed to rights comparable to equity). As a result, due to their creditor status, the certificate holders have a more senior position (compared to equity holders) in the issuer's insolvency.
The terms and conditions of the relevant profit participation certificates issuance did not foresee ordinary or extraordinary termination rights for profit participation certificate holders. The issuer's insolvency administrator tried to justify the exclusion of termination rights for certificate holders by arguing that the certificates had been listed on a stock exchange and that such listing would allow an exit. Accordingly, the certificate holders would be entitled to sell their certificates, which in effect would be similar to a termination right. In addition, the insolvency administrator's defence related to the argument that profit participation certificates should be treated similarly to non-voting preferred stocks or participation capital according to the Banking Act. In his view, the certificates resembled equity and should therefore not carry termination rights as holders of non-voting preferred stocks would not be entitled to termination rights as well. Therefore, investors would be able to exit their equity-like profit participation certificate investment only by selling the certificates on a stock exchange.
In addition, the terms and conditions of the profit participation certificate included a clause entitling the issuer to terminate the profit participation on its sole discretion after three years of the issuance.
In connection with the exclusion of extraordinary termination rights, the Supreme Court held that profit participation certificates constitute creditors' rights in personam in the form of continuing obligations and not rights comparable to equity. The main reasoning for this view was that profit participation certificates do not entitle the holders to vote in a shareholders' meeting or to challenge any decision by the shareholders of the issuer. Furthermore, the court held that profit participation certificates cannot be compared to participation capital according to the Banking Act. Accordingly, the exclusion of extraordinary termination rights harms consumer investors because an extraordinary right of termination is imminent to continuing obligations and must not be excluded under Austrian law. The exclusion of such extraordinary termination right offends Austrian public policy and is not applicable to consumer certificate holders.
According to the terms and conditions of the profit participation certificates, the issuer was entitled to terminate the certificates and to repurchase them after approximately three years on its sole discretion. As the terms and conditions contained no corresponding termination right of the certificate holders, the Supreme Court followed the arguments of the Consumer Protection Association, stating that this clause grossly disadvantaged consumer certificate holders. The court dismissed the issuer's argument that the option to sell profit participation certificates on the stock exchange constituted an equivalent exit right for certificate holders compared to the early termination and repurchase right of the issuer. Even though a possibility to sell certificates on a stock exchange may generally constitute an equivalent right to end the certificate ownership (compared to an issuer's termination right), this is not the case in connection with profit participation certificates: in the given context, any increase in the issuer's earnings would normally increase the value of the profit participation certificates. If the issuer was entitled to terminate and repurchase the profit participation certificates at his discretion (which is likely to happen if the value of the certificates increases), this would actually rebut the possibility of the certificate holders to increase the value of their investment, even though the value of the certificates would normally increase without such termination right by the issuer. Conversely, if the issuer's earnings decreased, the certificate holders would be entitled to sell their certificates only via the stock exchange with a loss.
Therefore, the clause was found to be grossly disadvantageous to consumer profit participation certificate holders.
This decision can be taken as a true landmark ruling since it addresses certain issues in Austrian law-governed terms and conditions for profit participation certificates, in particular aspects of their qualification as debt or equity, which impact on the creditor rank in the issuer's insolvency. In addition, the ruling reiterates the Supreme Court's view regarding the invalidity of certain common clauses in terms and conditions (used not only for profit participation certificate issues, but also for corporate bond issues, for example). Therefore, the new guidelines set forth by the Supreme Court are likely to be relevant not only for upcoming profit participation certificate issues, but also for aspects of termination rights in connection with bond issues in Austria.
For further information on this topic please contact Ursula Rath or Christoph Moser at Schönherr Rechtsanwälte GmbH by telephone (+43 1 53 43 70), fax (+43 1 53 43 76100) or email (firstname.lastname@example.org or email@example.com).
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