Defaulting on bonds worries more and more clients

Quick overview

If the issuer defaults on the bonds, the investor has several defences:

• call on the issuer to pay the amount owed

• contact the bondholders’ representative

• file a lawsuit for payment of the debt

• file a claim in insolvency proceedings if the issuer is bankrupt

However, each case must be assessed according to the terms of the issue and the issuer’s specific situation.

Has the bond issuer stopped paying you or gone into insolvency? Such a situation can be legally complex. Our attorney can help you prepare a demand for payment and, if necessary, represent you in court or insolvency proceedings.

What is the purpose and importance of bonds?

A bond is a security to which the legal system attaches the right to repay a certain amount owed, possibly also the payment of specified returns and other obligations. It thus provides its issuer (the issuer) with a source of financing without the need to take out costly loans. The issuer may be not only the state or a region, but also commercial companies.

Currently, many people are reacting to the high inflation rate and trying to save their savings. They are looking for a suitable platform to keep the value of their finances from falling and are therefore contacting financial advisers for advice.

There are thousands of them in the market, from the top ones who are continuously educated and have extensive knowledge of financial instruments and investments, to those who will recommend almost anything that will bring them a high commission.

And it is the high commissions that some issuers promise to advisers, who in turn offer their financial products to a wide range of recipients regardless of whether it is right for them.

The bottom line is that not only from the point of view of investors, but also from the point of view of issuers, mass distribution of bonds may in some cases appear short-sighted. Doing business primarily with other people’s money carries a considerable risk of loss and can ultimately be a threat to all involved.

In practice, we often see investors buying the bonds of smaller companies without any in-depth due diligence on the issuer. The most common mistake is to rely solely on marketing materials or financial advisor recommendations without analysing the terms of the issue.

Is it better not to buy bonds?

The aim of our text is certainly not to discourage readers from buying any type of bonds or limiting their investments. However, it should be stressed that there are now a large number of offers on the market and not all of them are worthwhile for everyone.

The basic advice to clients is therefore to be cautious in choosing qualified advisers who will act primarily in their interests and not in their own. There are a number of reputable managers on the market who can advise and pitch an investment well. Which leads to another piece of advice, namely that it pays to “not bet everything on one horse”.

How to deal with unscrupulous financial advisers?

Taking a clear legal position on a situation where a client, on the advice of a financial adviser, buys sub-prime bonds that are not repaid is not easy and, in fact, impossible. It is always necessary to study exactly what the financial adviser promised the client, what information he provided to the client and on what basis the client made his investment decision.

If financial advisers have explicitly misrepresented themselves, lied to clients about certain investment instruments and may have misled them, and if such conduct is proven, these clients may be able to bring criminal charges. This could be, for example, a fraud offence or other criminal offence. If clients have been harmed by the loss of their investments, civil proceedings may also be taken to seek compensation.

In any event, we recommend that clients do not leave the situation alone, but gather as much documentation as possible and always consult their options with an attorney so that they can make an informed decision on how to proceed.

What can be done against issuers that do not report on their commitments?

Bond default cases cannot be generalized, but they do have one thing in common: our clients do not generally take action against non-serious financial advisors, but seek to recover their claims directly from the issuers. So either they do not blame the financial advisors at all or they do not feel they have enough evidence or documentation to support their position.

Moreover, it should be said that pointing out only that the financial advisor cooperated with the issuer on a commission basis is not relevant in the Czech context. The vast majority of advisers work in this way here and there is nothing illegal about it. However, in a number of European Union countries, this practice has already been banned or at least restricted and other models of financing these services have been found.

Therefore, if an investor wants to deal directly with the issuer, he should first of all study the terms and conditions of the issue, where the procedure is usually outlined. Another important guide is the Bond Act. Both regulations provide for a bondholders’ meeting, which can be called in certain exceptional cases. However, before that, it is appropriate to approach the issuer itself and resolve the situation with it.

If neither procedure is effective, a court case is initiated, usually preceded by a pre-action summons. But here the investor is engaged in an unbalanced struggle with a large corporation, and here, too, the representation of a lawyer is appropriate.

In this context, some financial analysts wonder whether we should expect a collapse in the bond market. We will leave it to them to answer that question. From a legal practice perspective, we can say that we are looking at a period of several years when we will see more of these cases than we have seen to date, and we find that very worrying.

Default procedure

If a bond issuer defaults, we recommend the following several steps:

1. Review the terms and conditions of the bonds.

2. Contact the issuer and invite them to remedy the situation.

3. Contact the bondholders’ representatives.

4. Consider the possibility of legal enforcement.

5. In case of bankruptcy, file a claim in insolvency proceedings.

Summary

A bond is a security that gives the investor the right to repay the amount borrowed and any proceeds according to the terms of the issue. If the issuer of a bond defaults, it is important to first check the terms of issue to see what rights the bondholders have. In some cases, joint action by investors or negotiations with the bondholders’ representative may help. If the issuer fails to pay the debt even after a call, the investor can pursue its claim in court or file for insolvency proceedings if the issuer becomes insolvent. However, each case is individual and further action depends mainly on the terms of the issue, the financial situation of the issuer and the specific circumstances of the investment.