LBO/MBO Structures Tested by Austrian Courts
→ Christian Herbst
Financial assistance rules play a role in particular in the context of acquisition financing transactions, leveraged transactions, group financings and cash pooling arrangements within groups of companies. A 2013 ruling by the Austrian Supreme Court on unlawful leveraged buy-out (LBO) structures will impact transaction structuring as to down-stream or upstream mergers following M&A transactions.
Ground rules on financial assistance
The ground rules follow.
What should be understood as unlawful financial assistance under Austrian law?
Austrian law does not allow repayment of capital to shareholders of GmbHs, GmbH&CoKGs, GmbH & CoAGs or AGs. Shareholders are only entitled to (i) dividends (ie, distribution of the net balance sheet profits of the company or corporation), (ii) funds and assets received in a formal capital reduction, (iii) liquidation surpluses (subject to creditor protection provisions) and (iv) consideration received in arms-length transactions with the company.
What is qualified lawful financial assistance?
Based on the rules set out in the general overview above, shareholders can – and will in particular in the context of acquisition financing – pledge their shares in the target company and pledge or assign their claims to dividends. Upstream or crossstream guarantees are possible when limited to the amount of dividends. Moreover, the pledge over assets of a GmbH or AG (or partnerships where a GmbH or AG is an unlimited partner) to the benefit of banks and other lenders financing the direct or indirect acquisition of the pledging company or corporation is subject to the limitations set by the capital maintenance rules.
Are there exceptions to the capital maintenance rules for granting a security interest in the context of acquisition financing?
Austrian courts have developed certain requirements under which pledging of the assets of the target and the granting of upstream and cross-stream guarantees may be deemed not to violate the capital maintenance requirements. Pledges, guarantees, sureties, mortgages or other securities granted by the target to the financing banks or other lenders can be compliant if (i) the target receives adequate (ie, arms-length) consideration (case law and legal literature have developed criteria to determine adequacy depending on the financial situation of the lender and the expected profitability of the Austrian target) and (ii) the management of the target have duly assessed the borrower’s capability to repay funds (ie, a proper risk assessment) and (iii) the creation of the security interest is in the interest of the Austrian company (corporate benefit).
Financial assistance not within the limits of the rules on capital maintenance, as interpreted by the courts, is considered a violation of law. The transaction will be rendered (partially) null and void by operation of law.
What are the legal consequences for violating capital maintenance rules?
Transactions that violate capital maintenance rules are considered (partially) null and void. The company can thus reclaim any payments made to shareholders that are qualified as unlawful repayment of share capital and claim related damages inter alia as a result of negative tax consequences.
Moreover, the shareholders of a stock corporation will become directly liable to the creditors for the amount received and, in certain circumstances, the shareholders of a limited liability company can be held liable for the amounts received by other shareholders.
Finally, the transaction will be held void also towards third parties, in particular towards financing banks, if these third parties had or should have had knowledge of the violation of the capital maintenance rules.
What is the directors’ liability?
The managing directors or board members could be held liable for having acted negligently for having permitted payments later deemed in violation of capital maintenance rules to shareholders or for having allowed the taking of security or for having made incorrect statements towards the companies or having prepared incorrect financial statements.
Merger of leveraged acquisition vehicle with target company in light of 2013 Supreme Court rulings on LBO structures
Only under certain circumstances, and if various criteria have been met, will Austrian courts allow and register in the companies register downstream mergers of two or more companies – if the company merged downstream has taken on debt. Although Austrian Supreme Court cases have set these criteria for downstream mergers only, these criteria are believed to apply to upstream mergers as well if companies involved carry (considerable) debt.
The Austrian registration court will decide on the registration of the merger based inter alia on the following criteria: (i) both the transferring and of the absorbing company must have a positive market value (ii) upon completion of the merger, the absorbing company must not be insolvent (ie, must not be over-indebted and must be capable of paying its debt when they fall due) and (iii) the merger of the transferring and the absorbing company must not result in a reduction or limitation of the creditors of the absorbing company.
Thus the registered share capital of the absorbing company post merger must be at least equal to or higher than the share capital of the transferring company, or protective measures for the creditors must be implemented. Such protective measures can be the establishment of a restricted capital reserve or (usually not feasible in the timeline) a capital increase at the absorbing company.
Under a 2013 Austrian Supreme Court ruling, the parties must avoid a structure the courts would consider in violation of capital maintenance rule. The following structure would be considered unlawful: Target (and not acquisition vehicle) takes up the loan. Loan is taken over by acquisition vehicle, not by merger but by contractual arrangement, and target is released from liabilities. Target is then merged into acquisition vehicle upstream. Such transaction plan was known by the financing banks at the time when the loan was granted.
Under the court ruling, such financing structure was illegal and the financing bank had to repay loan payments received to the bankruptcy estate in the later bankruptcy of the acquisition vehicle.