This article looks at certain key legal points that must be
addressed in order to achieve a successful issue of
exchangeable or convertible bonds by a German corporate issuer.
Some points that arise in the German context are common to
Germany and other jurisdictions. Other points, particularly in
the areas of taxation and corporate authorization, are specific
Convertible bonds are one of three types of security in
Germany which confer a conversion right into new shares of the
issuer. The others are bonds with warrants and naked warrants.
In contrast, exchangeable bonds confer an exchange right into
the shares of a third-party issuer.
One of the first points which will need to be addressed is
whether the bonds should be issued by the German company
("direct issuance") or by a foreign (ie non-German) issuing
vehicle (FIV), probably a wholly-owned subsidiary of the German
parent company, with the structure including a guarantee (and,
in the case of a convertible bond, an undertaking by the parent
company to the bondholders to grant conversion rights into new
but unissued shares) supporting the FIV bonds from the German
parent ("indirect issuance"). The answer to this depends on the
specific situation of the relevant corporate. It may be that an
indirect issuance is a viable alternative to direct issuance by
the German parent company because of German tax
If bonds with a maturity greater than one year are directly
issued, coupon payments are fully deductible for corporation
tax purposes but only half deductible for trade tax purposes.
The same is true: (i) if and to the extent that the amount of
the coupon falls short of the market interest rate for straight
bonds; and (ii) in the case of a bond with a redemption premium
(ie the redemption amount exceeds the issue price).
Issuing costs are tax deductible by the German issuer, save
that input VAT is not recoverable.
In the case of a convertible bond, the conversion by the
investor should not be a taxable event. In the case of an
exchangeable bond, the exchange will be a taxable event for
There are three major German tax points to be considered
when the issuer is an FIV. The first is that, if the bonds are
indirectly issued and the issue proceeds are onlent by the FIV
to the parent through an intercompany loan, interest payments
under this loan are only half deductible for trade tax
purposes. As in the case of a convertible bond, German
corporate law requires that the issue proceeds are fully paid
in at the level of the parent company. The German trade tax
situation can only be improved by use of an FIV if the proceeds
derived by the FIV from the issuance, and loaned to the parent,
are in turn onlent by the parent to another foreign subsidiary
(durchlaufender Kredit or channelled loan).
Second, issuing expenses incurred by an FIV are not
deductible at the parent level. This can be dealt with by
passing on such expenses, by fixing an appropriate interest
rate for the intercompany loan.
Third, the FIV issuer will be taxed on the fee paid or
deemed to be paid by the FIV for the German parent company
guarantee. The German federal fiscal court recently ruled that
the tax on the guarantee fee breaches EU law. However, this
fiscal court decision may not in practice be applied until the
European Court has ruled on the matter.
It is unclear whether an indirect issuance of a convertible
bond qualifies as an exchangeable bond (with the shares of the
parent company comprising the exchange property) so that the
conversion (exchange) will be a taxable event for investors.
Typically, however, German convertible bonds are structured in
such a way that the claims of the bondholders for the delivery
of the new shares upon conversion constitute direct claims
against the parent guarantor, not against the FIV. Therefore,
the conversion by the investor should, as in the case of a
direct issuance, not constitute a taxable event. However, it
cannot be entirely ruled out that the German tax authorities
qualify an indirectly issued convertible bond as an
exchangeable bond, arguing that the instrument is not exchanged
into new shares of the issuer of the bond.
Other tax points
Convertible and exchangeable bonds are subject to different
withholding tax treatment. The annual German withholding tax
rate on interest payments in respect of convertible bonds is
26.375% (including the solidarity surcharge). Withholding tax
will be withheld by the issuer, although no such tax is
withheld if the investor sells the convertible bond prior to
its maturity. The annual German withholding tax rate on
interest payments in respect of exchangeable bonds held in
Germany amounts to 31.65% (again, including the solidarity
surcharge). It will also be levied in the case of a disposal of
the exchangeable bond prior to its maturity and the withholding
tax will be withheld by the German custodian, if there is one.
No withholding tax will be withheld if the exchangeable is held
in custody outside Germany, for instance, in Luxembourg. That
might change if the EU withholding tax directive comes into
German corporate investors are subject to trade and
corporation tax. Corporation tax (including the solidarity
surcharge) and trade tax in Germany amount to approximately
40%, if the issuer capitalizes and depreciates an asset. The
coupon, if any, will be taxable.
Corporate investors who hold convertible bonds and who are
subject to unlimited German tax liability or who conduct
business in Germany through a permanent establishment are
entitled to a credit or refund in their tax assessment.
Non-resident investors may be entitled to a partial refund of
withholding tax in whole or in part under double taxation
agreements. For example, there is a full refund under each of
the Germany-France and Germany-UK double taxation agreements.
Holders of exchangeable bonds who are subject to unlimited
German tax liability or who conduct business in Germany through
a permanent establishment are entitled to the same credit or
refund as above. For non-resident investors, the situation is
also as stated above.
No stamp or transfer taxes are in levied in Germany.
In the case of exchangeable bonds, no specific authority is
required for the management board of the issuer to issue the
In the case of convertible bonds, section 221 of the German
Stock Corporation Act (AktG) states that convertible bonds may
only be issued by a German company if a shareholders'
resolution is passed at a shareholders' meeting of the company
authorizing the company's management board to issue the bonds
within five years.
Further, an issuer of convertible bonds is normally required
to have sufficient of a particular form of authorized but
non-issued share capital, the so-called "conditional" capital
(bedingtes Kapital) to satisfy allotments of new shares
pursuant to conversion (section 192 AktG). This conditional
capital has to be in place at the date of issue of the
convertible bonds and is normally created by a shareholders'
resolution passed at the shareholders' meeting granting the
section 221 AktG authorization. Three factors should be kept in
mind in the context of a conditional capital increase:
- the conditional capital increase must be tied to the
section 221 AktG authorization outlined above;
- the increase must be registered with the commercial
- the aggregate nominal amount of shares which are the
subject of the increase cannot be more than half of the
existing nominal share capital at the time of the
shareholders' resolution on the conditional capital
In principle, the issuer must make a pre-emption offer to
shareholders. However, the pre-emption rights of the
shareholders can be excluded by a shareholders' resolution. To
avoid the need for prior shareholder approval at the time the
convertible bonds are issued, the shareholders' meeting which
authorizes the management board to issue the bonds may also
authorize it to exclude pre-emption rights. To obtain such
authorization, the management board is normally required to
submit a detailed written report to the shareholders' meeting,
justifying the exclusion of the pre-emption rights. Section 186
AktG requires that:
- the exclusion serves the issuer's interest;
- it is appropriate and necessary to achieve the proposed
- it is proportionate, ie the interest of the issuer can be
valued higher than the interest of the shareholders in
keeping their pre-emption rights.
However, pursuant to section 186(3)(4) AktG, an exclusion of
pre-emption rights is deemed justified if the authorization
sought is limited as follows:
- the new shares must be issued for cash (the issue of new
shares upon conversion of a convertible bond is generally
considered an issue for cash);
- the total nominal amount of the conditional capital does
not exceed 10% of the existing share capital of the issuer at
the time of the shareholders' resolution on the exclusion of
the pre-emption rights; and
- the issue price of the shares will be at, or not
materially lower than, the present market price of the
existing shares at the date of the management board
resolution to issue the shares. As no market price for the
convertible bonds to be issued exists, in practice an opinion
of an independent expert is obtained. The expert determines
the theoretical market value of the bonds at the time when
the board resolution to issue the bonds is passed.
While there is some controversy in German legal literature
as to whether section 186(3)(4) AktG can be applied to
convertible bonds, there are German regional and appellate
court rulings affirming its application. Because there is no
defining German federal court ruling on this question, there is
a risk that a dissenting shareholder may file an action to
annul the shareholders' resolution which excludes pre-emption
rights within a period of one month from the shareholders'
meeting. However, if not so challenged the resolution is final,
and the management board can then rely on the authority when
resolving upon the issue of the convertible bonds and the
exclusion of the pre-emption rights. In practice, many issuers
take this route.
Each of the section 221 AktG authority and the section 186
AktG authority, as well as the creation of conditional capital,
require that a shareholders' resolution is passed by the
holders of over 75% of the share capital present at a general
meeting of the company, and by a simple majority of all voting
shares in the company, unless the company's articles of
association provide for a higher capital majority.
Where to list
Frankfurt and Luxembourg have been the stock exchanges of
choice for previous public issues of German exchangeable bonds.
German convertible bonds are normally traded with an official
quotation on the Frankfurt stock exchange, and potentially on
further German stock exchanges. The listing regimes for
Frankfurt and Luxembourg stock exchanges are very similar,
since both are subject to the EC Listing Particulars Directive
80/390/EEC. Both exchanges will require disclosure of two full
years' financial statements plus published interim financial
statements, of the German company or companies. In the case of
a non-German issuer, for example an FIV, both exchanges will
permit the offering circular/listing prospectus to be in
English. In the case of direct issuance by a German company,
however, a German language offering document/listing prospectus
is required. In the case of convertible bonds, the offering
circular will also double as the listing prospectus for the
conditional capital and if a Luxembourg listing of a
convertible bond is contemplated, prior clearance should be
obtained from the listing department of the Frankfurt stock
exchange that it does not require a German language listing
prospectus. If a listing on the Frankfurt stock exchange is
sought, the Frankfurt stock exchange will review and comment
upon the offering circular/listing prospectus in the statutory
period of 15 Frankfurt business days, pursuant to section 36 of
the German Stock Exchange Act.
In practice, the crucial determinants of which stock
exchange is used will also be marketing considerations,
investor preference and that of the German company, which may
prefer a German listing and indeed may already be listed on a
Placement of the bonds
Any offer and sale of bonds in the Federal Republic of
Germany may only be made in accordance with the provisions of
the Securities Sales Prospectus Act of December 13 1990, as
amended (Wertpapier-Verkaufsprospektgesetz) implementing EC
Public Offers of Securities Directive 89/298/EEC. In the case
of a public offer of the bonds in Germany, generally a formal
securities sales prospectus is required to be prepared, filed
and published in Germany prior to the commencement of the offer
in accordance with applicable rules and regulations (section 1
of the German Securities Sales Prospectus Act).
Such securities sales prospectuses must generally be
published in the German language, or, in the case of a foreign
issue, for example an FIV, in the English language.
However, in practice a formal securities sales prospectus is
in many cases not required in connection with bond issues, as
such issues often benefit from one or several exemptions from
the prospectus requirement, the most commonly used being the
"Euro-securities exemption" and the "professionals
The Euro-securities exemption applies if the following
requirements are met:
- first, the bonds must be acquired and distributed by a
bank syndicate whose members are based in different
- second, a substantial proportion of the bonds must not be
offered in the country where the issuer has its seat. To
satisfy the second exemption, at least 50% of the securities
must be allocated and underwritten by syndicate members whose
registered seat is outside the country in which the issuer
has its registered seat. At least two members of the
syndicate must have their registered seat in different
countries from each other, each bearing its own placement
- third, the Euro-securities exemption requires the bonds
may only be subscribed or initially acquired through a credit
institution or another financial institution.
The exemption for professionals means that a sales
prospectus need not be published if securities are only offered
to persons who purchase and sell securities as part of their
profession or business, either for their own account or for the
account of third persons.
No sales prospectus need be published if the bonds are in
minimum denominations of at least DM 80,000 ($37,400) or
minimum trading lots of at least DM 80,000 per investor.
Linklaters Oppenhoff & Rädler
Mainzer Landstrasse 16
Tel: +49 69 710 030
Fax: +49 69 710 03333