Corporate / M&A

LBO/MBO Structures Tested by Austrian Courts

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.

Acquisition Financing/LBO structures, in particular downstream mergers following acquisitions, must be tailored to comply with court precedents on capital maintenance.