This article examines the prerequisites for the emergence of a special entity in the securities market – a single representative of bondholders – and analyzes the specifics of the relationship between bondholders and the issuer. The specific nature of these relationships suggests the existence of certain collective rights of bondholders of a single issue, which should exist alongside the individual rights certified by debt securities.
The modern securities market is filled with various intermediary relationships, which are legal connections between a company offering its securities and a wide range of potential counterparties (acquires of shares, bonds, participants in syndicated loans, etc.). For example, within the organization of a bond issue, investment banks act as intermediaries between the issuer (debtor) and investors (creditors), facilitating the process of offering and placing bonds. The depositary, which holds the global certificate, also enters into certain intermediary relationships with the issuer, bondholders, or their nominal holders. The subject of this article is the analysis of institutions, not named in Russian legislation, that worldwide facilitate interaction between the issuer (debtor) and its creditors – the bondholders – on key issues affecting the interests of all or most participants in these legal relations. These legal institutions are typically remembered during cycles of economic downturns and crises. They are the meeting of bondholders and their representative.
Their presence in legislation and their legal status demonstrate the ability of the law to provide market participants with necessary solutions both during difficult economic times (for restructuring and modifying bond-related legal relations) and during periods of economic boom (for structuring new financial instruments based on bonds) and, consequently, reflect the level of development of the system of legal regulation of investment relations in a country.
The institutions of the meeting of bondholders and their representative should be considered together and in interconnection, since the meeting is an element of the legal system that ensures the formation of a unified will of the creditors, while the representative is the conduit of this will in relations with third parties (including the issuer), also tasked with performing the necessary legally significant actions for its implementation. If these institutions existed separately, their social value would obviously be reduced to zero. Together, the relations regulated by these institutions are referred to in a number of foreign sources as relations for the exercise of collective rights by bondholders.
Before proceeding to examine these questions, let us once again note the complete absence of these studied institutions in the Russian legal system. Most likely, this is a consequence of insufficient attention from the legislator and representatives of civil law science to this type of relationship. Typically, Russian law only enshrines forms of implementing collective decisions that are associated with relations among all creditors in the case of debtor insolvency (meeting of creditors in bankruptcy) or with corporate relations (among shareholders or participants of business entities).
There are formal legal arguments for recognizing the collective rights of bondholders, since they (1) act as co-creditors whose individual contractual rights are based on a single act (resolution on issuance and/or a single global certificate), and (2) from a property law perspective, they can seemingly be considered co-owners of the certificate held by the depositary – the material embodiment of the debt security. Therefore, what follows in this work is solely the author's perspective on these institutions, formed based on the analysis of law enforcement practice, foreign literature and legislation, and based on the premise of the necessity of creating these institutions in our country for the further development of investment relations.
From our point of view, the collective rights of bondholders and the collective nature of the relations between them should emerge when the exercise of the holders' rights, from a legal standpoint, requires a joint decision, and from an economic standpoint, leads to a reduction in costs for the participants in the legal relationship.
Considering established international transaction practice, it appears that such cases may include: making a decision to amend the terms of the bond contract;
1) Joint protection of interests in court;
2) Exercise of any special right requiring a unified expression of will in accordance with the terms of the issue;
3) Enforcement against the collateral (enforcement rights).
Thus, in bond relations, one can distinguish collective rights exercised in connection with the issuer's default (collective rights arising from default) and in connection with the exercise of special rights established by the issuance documents (ordinary collective rights).
The aforementioned cases of the emergence of collective rights can be considered as the scope of competence of the general meeting of bondholders of a specific issue.
The competence of the bondholders' meeting in foreign transactions can be either a subject of legislative enactment or a condition of the issue described in the accompanying documentation.
For example, the right to receive information from the issuer or the right to delegate a representative to the issuer's control bodies can be features of a particular issue and therefore cannot be predetermined by law. The final set of such rights should depend on the provisions of the documentation. At the same time, in those countries where these legal relations are subject to legislative regulation (e.g., in German law), competence is typically defined directly in the law.
Foreign literature has developed a certain understanding of the functions of the bondholders' representative, implemented within standard transactions. Thus, Philip Wood highlights the following main functions.
Comprehensive monitoring: the representative ensures control over the issuer and analysis of the information it provides. Since information is not always subject to public disclosure or access to it is limited (commercial secret), it may in some cases be mandatorily transmitted only to the representative.
Engagement of professional advisors: the representative may have the administrative resources to engage professional advisors and consultants, the need for which may arise from time to time.
Correction of documentation: the representative can make adjustments to the constitutive documents (e.g., for bonds convertible into shares, such adjustment may be necessary if the number of shares issued by the issuer increases).
Furthermore, the bondholders' representative can participate in negotiations in case of default or debt restructuring, as well as monitor compliance with the obligations undertaken by the issuer; provides the issuer with protection from a non-constructive bondholder (mad bondholder); ensures proportional distribution of incoming payments, etc.
Summarizing the above, we can distinguish the following groups of functions of the representative:
Aimed at ensuring the realization of collective rights;
Aimed at protecting the interests of the majority of bondholders;
Protecting the public interest.
Despite the obvious advantages of these institutions, they also have one significant drawback – the considerable costs for the representative's services and the performance of its functions. Typically, the representative is a well-known company with significant reputational capital in the securities market. Its costs are built into the transaction cost and are paid by the issuer, mostly prior to the placement of the bonds. This, in turn, affects the cost of the capital raised.
Below we will provide several brief examples of the regulation of these relations in Germany and England, and also analyze the only Russian draft law aimed at their regulation.
Germany
The regulation of collective actions by bondholders in Germany is now over a hundred years old.
The first law (Schuldverschreibungsgesetz - SchVG), regulating the procedure for amending the terms of bonds issued under German law through meetings of their holders, came into force in 1899. As noted today, this law was due for revision because it no longer corresponds to existing relations.
Previously, these issues were most often resolved unanimously by all holders. The old law established the possibility to change the terms of the issue by a majority vote of bondholders only in case of a threat of the issuer's bankruptcy.
The new legislation allows for the amendment of bond terms by majority vote if a collective action clause is included. According to the law adopted in 2009, German legislation may also apply to bond issues by legal entities not incorporated in Germany. Holding meetings without the physical presence of bondholders is permitted, which accounts for the possibility of making such decisions using modern technologies and without unnecessary costs for holding meetings. Amendment of the bond contract, as mentioned above, is possible without the unanimous decision of all holders.
Furthermore, issues such as extension of the bond term, changes to the interest rate or part of the nominal value, establishment of subordination of the issuer's bonds, and release of property serving as collateral are decided by majority vote.
England
By tradition, in England there is no single legislative act regulating relations related to the placement and circulation of bonds, and the realization of collective rights occurs through the figure of a trustee. Relations within a bond issue are generally recognized as falling within the realm of contract law.
The use of a trustee presupposes the existence of a person towards whom the issuer bears an obligation that mirrors the bond debt, which is considered primary when it is necessary to exercise any collective right of the bondholders. In the event of default, the obligation to the trustee becomes primary, and all payments must be made to its benefit. It, in turn, must distribute the received amounts based on the pari passu principle (equality of all security holders).
A trust deed is concluded at the placement of the securities; it explicitly specifies the conditions for the trustee's actions. Some regulations contain rules governing the procedure for amending the trust deed.
Bondholders become a party to the agreement upon acquisition of the security (contract of adhesion). It is the trustee who enters into relations with the defaulting debtor and executes the will of the established majority of bondholders. Since the unanimous consent of all creditors (bondholders) is most often not required, an analogue of corporate relations emerges within a single large loan, where the most significant creditors (by the number of securities they hold) can shape the will and, consequently, change the rights of all other bondholders without their direct consent.
English law does not require the mandatory appointment of a trustee, but such a rule may exist at the level of listing rules. Similar institutions exist today in the legal systems of the USA, Luxembourg, France, and other states.
Russia
During the 2008 financial crisis, an attempt was made in Russia to legislatively enshrine provisions on the meeting of bondholders and their representative, for which a separate draft law was submitted to the State Duma of the Russian Federation. According to it, the meeting of bondholders is convened on the initiative of the issuer, the representative of the holders, or a person holding a 10% block of bonds. Decisions are made on the principle of "one bond – one vote" by a majority vote. Decisions of the general meeting are binding on all bondholders. A lawsuit against the issuer can only be filed by the representative of the bondholders.
Let us analyze the legal nature of the relations between the representative and other parties to the legal relations (the issuer and investors) in domestic civil law from a scientific perspective.
If we consider such a representative as an ordinary attorney, and the arising relations between the parties as an agency agreement (contract of mandate), many questions may arise. It must be admitted that such an interpretation is somewhat inconsistent with the existing understanding of this institution in our country. In particular, the relations of an attorney typically allow the principal an independent status in any relations with third parties. It is difficult to imagine a situation where a fully capable principal would be deprived of the right to independently perform legally significant actions. At the same time, the model proposed in the draft law deprives bondholders of an independent status (for example, they lose the independent right to sue). Enshrining a prohibition on independent protection of their rights by bondholders without introducing the category of "collective rights of bondholders" seems quite controversial and could be considered a violation of Part 1 of Article 46 of the Constitution of the Russian Federation.
According to Article 975 of the Civil Code of the Russian Federation, the attorney's expenses must be reimbursed by the principal, while the expenses of the bondholders' representative and its remuneration are typically paid by the issuer. The remuneration factor is one of the most important, considering the need to involve highly professional securities market participants in these relations.
Furthermore, as shown above, the actions performed by the representative are not always legal in nature. For example, for the effective performance of its functions, the representative's powers must include control over the collateral, receipt and processing of information from the issuer, etc., i.e., be of a factual nature.
Overall, it must be admitted that certain contradictions found in the draft law are the result of the lack of necessary recognition of the collective rights discussed above in bond relations.
If their existence is recognized, the status of the bondholders' representative should be considered in comparison either with a trustee (which is closer to international practice using the English trust structure) or as an agent of the bondholders. It is also easy to see that its status is close to that of a bankruptcy administrator, with the only difference being that it must express the will not of all creditors, but only of those who provided the company with bond capital.
Let us consider the status of the representative as a trustee of the collective rights in more detail. Recognizing the representative as a trustee can be based on the provisions of the Civil Code of the Russian Federation. According to Article 1013, the objects of trust management include enterprises and other property complexes, individual objects related to real estate, securities, rights certified by non-documentary securities, exclusive rights, and other property. According to Part 3 of Article 5 of the Federal Law No. 39-FZ "On the Securities Market" dated April 22, 1996, a license for securities management activities is not required if the trust management is related only to the manager exercising the rights attached to the securities.
Such trust management can arise provided a special provision (collective rights clause) is included in the constitutive documents for the bonds. The relations between the representative and the bondholders can be characterized by the category of multiplicity of persons on their side. This can justify the fact that the representative must express the will not of all, but of a fixed majority. In this case, an analogy is appropriate, for example, with the general meeting of shareholders, where the company's management bodies must await not a unanimous consensus, but only the decision of the majority, and be guided by it.
According to Part 2 of Article 1012 of the Civil Code of the Russian Federation, while managing the property in trust, the trustee has the right to perform, in relation to this property and in accordance with the trust management agreement, any legal and factual actions in the interests of the beneficiary. This provision implies the possibility of endowing the manager with certain control functions over the rights transferred to it. Its competence may include, for example, monitoring the condition of the collateral object or the financial position of the issuer in general, etc.
From an economic point of view, collective rights allow for the reduction of financial and social costs for participants in social relations by uniting the will of the creditors into a single decision (decisions). This allows the issuer (debtor) to formally enter into relations with a multiplicity of persons on the creditor side through a single counterparty – their representative, expressing the will of all or a majority fixed by law or constitutive documents.
At the same time, as indicated above, the value of this institution most often manifests itself when it is necessary to restructure the debt or enforce it. Recognizing collective rights arising from the issuer's default allows the law to develop effective mechanisms for solving these problems. In 2008-2009, hundreds of issuers defaulted, and the main reason for the defaults (which creditors understood) was the devaluation of the goods they produced and the property they owned. Its realization within bankruptcy proceedings obviously could not benefit either the bondholders or the issuer. However, Russian law does not provide participants in these relations with legalized instruments for discussing debt restructuring terms and formalizing them. The models used in practice were, as a rule, artificially created and therefore quite costly for the parties in terms of both time and expenses for consultants engaged. This is partly why only a few dozen companies were able to use them.
From the point of view of public interest, a unified enforcement mechanism would significantly reduce the burden on the judicial system, which during economic crises is overwhelmed by homogeneous litigation. Since the last financial crisis and up to the present, domestic courts have been loaded with hundreds of identical cases in which bondholders of the same series attempt to enforce claims based on the same constitutive document – the resolution on the issuance of bonds – and essentially on the same evidence. Even more questions arise when they receive court decisions with differing content.
Summarizing all of the above, we must conclude that the analyzed institutions are necessary for domestic law for the further development of the financial market and the planned creation of an international financial center in Russia.