Shareholders are among the many who have lost money in the multi-billion euro insolvency of the former DAX30 payment provider Wirecard and its allegedly fraudulent business practices. Wirecard had to file for insolvency after assets worth €1.9bn could not be found. Collectively, the shareholders claimed around €7bn in damages for intentional capital markets law violations by former Wirecard executives. Unsurprisingly, the shareholders are now trying to minimise their losses and secure at least partial payment on their claims from the insolvency estate. However, the insolvency administrator and the joint representative of the creditors of a Wirecard bond objected when the shareholders tried to register their damages claims as generally unsecured claims against Wirecard. An institutional investor then took the insolvency administrator and the joint representative to court, requesting a declaration that these claims are generally unsecured claims on par with creditor claims.
In its judgment of 23 November 2022 (case number 29 O 7754/21) the Regional Court of Munich I as court of first instance dismissed the claim. It held that former shareholders are not to be treated on par with creditors. This covers any claims related to the acquisition of shares, no matter the legal basis for such claims. Consequently, shareholders rank behind all creditors and will be satisfied only once all insolvency claims have been fulfilled, which is unlikely. The judgment can be appealed.
A sure thing?
The subordination of shareholders to creditors may not sound like spectacular news. However, due to previous rulings by the Federal Court of Justice (BGH) the case was not as straightforward as it appears. In 2005, the BGH held in its famous EM.TV judgment that investor protection rules trump the creditor protection regime based in corporate law (‘capital maintenance’) in cases of fraud and intentional capital markets law violations. The claimant sought to rely on this decision in the Wirecard case, arguing it would not have bought the shares had it not been for the intentional misinformation of the markets.
The court was not convinced. It distinguished the EM.TV case and Wirecard because EM.TV was not insolvent, therefore the priority of investor protection rules only affected other shareholders (‘holders compensate buyers’). Not so when the debtor is insolvent, as any amount paid to (former) shareholders on their claims would have reduced the insolvency quota of the creditors. With EM.TV not being applicable, the court had to rely on its interpretation of insolvency law to decide the case. The court followed two lines of reasoning:
- The shareholder claims aim – from an economic perspective – for reimbursement of equity. This is prohibited under the German Stock Corporations Act, and the court found the EM.TV exemption not to be applicable.
- Further, the court held that the ranking of creditors according to German insolvency law was principally based on the distinction of debt and equity, the latter being subordinated. Despite the alleged fraud, the Wirecard shareholders effectively became shareholders with all rights and privileges attached. As such, the shareholder claims are necessarily based on the acquisition of an equity position, and they are therefore to be treated according to equity rules under insolvency law. On the alleged fraud at the time of purchase, that court ruled any deception concerned only the value of the investment but not the fact that the claimant acquired an equity position. This position comes with a right to profit participation at the price of subordination in case of insolvency. As such, the alleged deception was legally irrelevant.
Take away: capital structure is key
The court recognised that any payout to shareholders on their claims would necessarily come at the expense of creditors. Such a result would significantly damage the capital structure of a company as creditors accept limited upside potential with their investments but are in turn prioritised in the case of insolvency.
Based on the judgment, shareholders’ chances of securing any payment on their claims are generally slim to non-existent. The decision reinforces shareholders’ incentives as owners of the company to protect their investment by exercising their shareholder rights and ensuring effective oversight before the company becomes insolvent. This is a sensible position both from a legal and from a policy perspective.
With the amount at stake the claimant will very likely appeal the judgment. The fundamental legal question on how deceived shareholders are to be treated when the company becomes insolvent has not yet been explicitly addressed by the BGH. Legal certainty can therefore only be achieved when the BGH has the final say on how its jurisprudence on investor protection is to be understood in a case of insolvency.
In our view, the well-reasoned judgment of the Regional Court of Munich I is firmly based on fundamental principles of insolvency law and has good prospects of standing after subsequent review by the Court of Appeal and the BGH.
Freshfields represents the joint representative of the bondholders in these proceedings with a team selected from its dedicated Insolvency Disputes Skills Group.