Form Requirements for Convertible Loans in Germany
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With a convertible loan, parties agree on the option or the obligation for the lender to convert the repayment claim into a participation in the borrower. Convertible loans are often used in venture capital investments to provide financing to start-ups in the early-stage or to provide capital needed between financing rounds.
One question that repeatedly arises with convertible loans under German law (“Wandeldarlehen”) is the form in which they must be concluded, in particular whether to involve a notary for notarisation or signature certification.
The difference between the two notarial forms is that a signature certification authenticates the signatory only while notarisation additionally involves a review regarding the legality and also explanation of the implications for the signatory by the notary.
The answer to this question largely depends on how the convertible loan is set up and what obligations the convertible loan agreement establishes.
Typically, a convertible loan agreement provides that the lender, instead of repayment of the loan amount (incl. interest), receives shares in the borrower in a previously determined conversion ratio. This is usually done by contributing the loan repayment claim to the borrower's free capital reserve with an additional cash payment to the borrower as capital contribution for the issuance of new shares in the borrower to the lender. To do this, however, the borrower must issue new shares, which presupposes a share capital increase.
- Authorisation to Conclude Convertible Loans
If the convertible loan agreement is only concluded between the borrower and the lender, the obligation to increase the share capital is incumbent on the borrower. However, in case of borrowers in the form of German corporations, i.e. GmbH or AG, the responsibility to increase the share capital lies exclusively with the shareholders, which is why the borrower and more specifically its managing director must be authorised to conclude such a convertible loan.
The opinion was occasionally expressed voicing that this authorisation must be notarised, because the (future) capital increase requires an amendment to the articles of association, for which section 53 para. 2 sentence 1 German Limited Liability Company Act ("GmbHG") stipulates a notarisation requirement. However, the prevailing view is that this is not required because an authorisation, comparable to the granting of a power of attorney, is in principle not subject to the same formal requirements as the main transaction.
- Shareholders' Obligation to Increase Share Capital
Quite often, the lender is interested in the shareholders of the borrower also signing the convertible loan agreement, so that they are directly obliged towards the lender to pass a resolution to increase the share capital. It is therefore common practice that the shareholders of the borrower co-sign the convertible loan agreement.
The overwhelming opinion in that case is that notarisation is not required even then. The requirement to notarise the capital increase resolution prescribed in section 53 para. 2 sentence 1 GmbHG serves first and foremost to properly document the capital increase process and not to warn and inform the shareholders about the consequences of their decisions by the notary. Therefore, there would be no reason to apply section 53 para. 2 sentence 1 GmbHG to the obligation to increase the share capital at a later point in time.
- Accession to Shareholder Agreements
However, the convertible loan agreement must be notarised pursuant to section 15 para. 4 GmbHG if the convertible loan establishes obligations for the acquisition or the sale of shares. This usually occurs under the following two conditions, which are not uncommon in practice:
- The lender is obliged to convert under specific conditions, the materialisation of which it cannot unilaterally control (mandatory conversion), and
- in the event of conversion, the lender must accede to a shareholders’ agreement, which contains obligations to acquire and sell shares, e.g. drag and tag-along, call and put options or pre-emptive rights.
- Share Subscription Obligation
A recent decision by the Higher Regional Court ("Oberlandesgericht - OLG") of Zweibrücken (Urt. v. 17.05.2022, Az. 8 U 30/19) provoked quite controversial discussions. It considered a notarial signature certification to be necessary if the loan agreement (i) provided for a mandatory conversion and (ii) upon conversion imposed the obligation on the lender to subscribe to the newly created shares .
Thus, OLG Zweibrücken not only dissented from OLG Munich (Urt. v. 04.05.2005, Az. 23 U 512/04), but also rejected the prevailing view in legal scholarship.
OLG Zweibrücken based its opinion on section 55 para. 1 GmbHG. According to this provision, the signature of a share subscription notice in the context of a share capital increase must be notarially certified. The Federal Court of Justice ("Bundesgerichtshof – BGH") as well as most authors recognise the reason for this formal requirement in the fact that the capital base of the company must be correctly reflected , and the certification therefore serves to secure the correct implementation of a capital increase and thus the protection of shareholders and creditors. Precisely for this reason, notarisation is not required, which, in contrast to mere signature certification, has clarification and warning functions vis-à-vis the declarant.
Sporadically, some authors called the above understanding of section 55 para. 1 GmbHG and of notarial certification into question. They asserted that notarial certification also contained explanatory and protective functions. These functions would already come into play in the case of an obligation to subscribe to shares, which is why notarial certification was necessary. OLG Zweibrücken adopted this argumentation as "telic" and annulled the convertible loan in their case for lack of form.
The court endorsed another minority opinion obiter dictum. It stipulated that, if the shareholders are obliged by the convertible loan agreement to implement a share capital increase, better arguments would speak in favour of notarisation in accordance with section 53 para. 2 sentence 1 GmbHG, provided that the lender is not already a shareholder.
- Conclusive Remarks
It is unfortunate that OLG Zweibrücken has rather created legal uncertainty with its ruling than clarifying the form question for the future. On the other hand, with the pending appeal (Az. II ZR 69/22) the BGH now has the opportunity to establish clarity for a popular and useful mezzanine financing instrument. Until then, notarisation of convertible loan agreements is recommended, at least in cases of mandatory conversions, which is most common in practice.
