Definition and conceptual distinction of Mezzanine
The term Mezzanine (also Mezzanine capital or Mezzanine financing) refers to a form of financing that constitutes a hybrid between equity and debt capital. Mezzanine plays a significant role, especially in corporate finance and the real estate sector. A defining characteristic of Mezzanine is its intermediate rank and risk allocation between classical equity and senior debt capital.
Mezzanine financings are regularly structured as subordinated loans, silent partnerships, profit participation rights, or convertible bonds. They serve to strengthen equity, finance growth, facilitate restructurings, or supplement classical bank loans, among other things.
Legal characteristics of Mezzanine
Hybrid nature between equity and debt capital
Mezzanine capital is legally not clearly classifiable as either equity or debt capital. The specific structuring of the respective Mezzanine instruments determines whether they are treated as equity or debt capital in accounting and under company law. Decisive factors here include subordination, subordination agreements, participation in profit or loss, participation rights, as well as contractually agreed securities.
Subordination and subordination agreements
A central legal feature of Mezzanine is subordination in relation to senior debt capital. Subordination is usually contractually stipulated. In insolvency, claims arising from Mezzanine capital are only satisfied after the senior creditors have been paid. An agreement of subordination is usually expressly agreed (§ 39 (2) German Insolvency Code (InsO)). Creditors of Mezzanine capital thereby accept a higher risk, which is compensated by higher interest rates or profit participation.
Contract structuring and legal framework
Mezzanine instruments may fall under corporate law, contract law, or securities law:
- Subordinated loans (§ 488 BGB): Loan contractually agreed with subordination.
- Silent partnership (§§ 230 seq. HGB): Participation in a company’s commercial business, but without disclosure obligations.
- Profit participation rights: Confer entitlement to profit sharing, usually without voting rights or influence on management.
- Convertible and warrant bonds: Securitized debt instruments with the option of conversion into equity.
The precise legal classification depends on the contract structure. Due to this flexibility, a variety of structuring options exist, whereby, for example, contractual agreements with elements of company law may be combined.
Mezzanine in accounting and tax law
Accounting treatment
The accounting classification of Mezzanine largely depends on the contractual structure. Depending on whether the instrument exhibits characteristics of equity or debt, Mezzanine instruments are recorded either as equity (e.g., as “subscribed capital”) or as debt (e.g., as liabilities from trade payables) (§§ 266, 268 HGB).
Decisive for the classification are:
- Participation in losses
- Subordination in the event of insolvency
- Absence of termination rights by the capital provider
- Lack of collateral
The classification under commercial law affects the company’s equity ratio and insolvency resilience. According to IAS/IFRS, the economic substance (“substance over form”) plays a decisive role in the classification of Mezzanine capital.
Tax treatment
In tax law, the distinction between equity and debt is made according to the principles of the German Corporate Tax Act and Income Tax Act. In particular, the questions of whether interest is deductible as a business expense (§ 8 (1) KStG, § 4h EStG, § 8a KStG) and whether Mezzanine inflows are treated as hidden profit distribution can be relevant. Key criteria include:
- Whether there is profit or interest participation
- Whether the Mezzanine provider holds a corporate participation
- Whether the capital is subject to floating or fixed interest
The tax classification should be carefully examined, as different instruments (e.g., profit participation rights, silent partnerships) must be treated differently.
Aspects of company law
Participation rights and fiscal unity
Mezzanine instruments can be equipped with or without participation and co-determination rights. In silent partnerships, participation or control rights are generally not provided. Profit participation rights also usually confer no co-determination, but can provide for participation in the company’s growth.
Convertible bonds allow, upon conversion, the transition into a corporate participation. In these cases, the corporate rights and obligations of a shareholder apply.
Implications in insolvency
In insolvency proceedings, the treatment of Mezzanine capital is determined primarily by subordination agreements. Claims from subordinated capital are only satisfied after other creditors have been paid. Subordination agreements must be structured to be insolvency-proof and must comply with the requirements of the Insolvency Code. If insolvency, creditor protection, or abuse provisions are breached, the assertion of claims in insolvency may be jeopardized.
Regulatory and securities law framework
Banking law and the German Banking Act (KWG)
When issuing and granting Mezzanine instruments, the regulatory provisions of the German Banking Act (KWG) must be observed. In particular, a licensing requirement (§ 32 KWG) may apply if banking business is conducted on a regular basis. Disclosure and publication obligations may also arise for issuers and investors.
Prospectus obligations and securities supervision
If Mezzanine products are publicly offered, they may fall under the Securities Prospectus Act (WpPG), the Investment Act (VermAnlG), or other securities law requirements. Mezzanine structures in the form of profit participation rights, convertible bonds, or silent partnerships may therefore trigger prospectus requirements (sales prospectuses, minimum information).
In particular, the issuance of bonds and profit participation rights requires prior coordination with the competent supervisory authorities (e.g., Federal Financial Supervisory Authority, BaFin) to avoid breaches of information and disclosure obligations.
Typical contract types and structures in the Mezzanine sector
Subordinated loans
These are contractual debt agreements in which the lender expressly declares subordination to all other creditors of the borrower. Interest payments and repayment are subject to subordination in accordance with § 39 InsO.
Silent partnership
The silent partnership is structured as an internal relationship; the silent partner is entitled to share profits and, where applicable, losses. Publicity, accounting, or participation rights depend on the specific arrangement (§§ 230 seq. HGB).
Profit participation rights
Profit participation rights are structured as contractual claims. They typically include a profit share; a claim for repayment is not necessarily linked to participation or influence on management.
Convertible and warrant bonds
Convertible bonds grant the creditor the right to exchange the bond for company shares (§§ 221 seq. AktG). Warrant bonds combine a bond with a separate option right to acquire company shares.
Fields of application for Mezzanine
Corporate finance
In corporate finance, Mezzanine is primarily used to strengthen the equity base, for expansion projects, buy-outs, or to bridge liquidity shortages.
Real estate financing
In the real estate sector, Mezzanine is used as a substitute for equity financing, for project developments, and for structuring financing packages. Especially in large-scale construction projects, Mezzanine capital acts as a gap filler between bank loans and equity.
Conclusion and outlook
Mezzanine is a complex form of financing that requires a nuanced legal analysis. The structuring possibilities are diverse, offering opportunities for both capital seekers and capital providers. The specific legal classification always depends on the individual case and the structure of the financial instrument. Key aspects are subordination, accounting and tax treatment, legal and regulatory boundaries, as well as insolvency law implications. The growing importance of alternative forms of financing underscores the relevance of Mezzanine in modern economic and legal practice.
This article provides a comprehensive, objective, and legally sound overview of the topic of Mezzanine. For specific questions, a careful review of the contract structure and the applicable legal framework is recommended.
Frequently asked questions
What legal framework applies to Mezzanine financings in Germany?
Mezzanine financings in Germany are not subject to a specific statutory scheme, but are situated at the intersection of equity and debt capital law. The structuring of Mezzanine instruments is usually done contractually, with company law, contract law, and insolvency law playing a central role. Depending on the design, the German Banking Act (KWG), Securities Trading Act (WpHG), as well as provisions of the German Civil Code (BGB) may also be relevant. The legal structure is crucial for liability and tax implications. With regard to prospectus requirements, certain Mezzanine products, such as profit participation rights or subordinated loans, may qualify as securities or investments and then be subject to extensive information and publication requirements under the Securities Prospectus Act or Investment Act. Additionally, further consumer protection regulations must be taken into account for certain investor groups, such as consumers.
How is subordination legally structured and secured?
The subordination of Mezzanine capital is expressly regulated in the relevant contracts—typically in the loan agreement or in the terms and conditions of profit participation rights or silent partnerships. Legally, this usually takes the form of a qualified subordination clause, whereby the creditor’s claims are satisfied only after the senior debt creditors, but before the equity holders. In insolvency, the ranking is determined in accordance with § 39 of the Insolvency Code (InsO). To secure subordination in practice, a clear and insolvency-proof wording of the clauses is required. Depending on the design, subordination agreements may include waivers in the event of insolvency or over-indebtedness of the company.
What regulatory requirements must be observed when issuing Mezzanine products?
The regulatory requirements depend largely on the specific contractual structure of the Mezzanine instrument. If Mezzanine capital is granted as a loan with qualified subordination or as a profit-participating loan, these may fall under the Investment Act (VermAnlG), in which case a sales prospectus may be required. In the case of a public placement, attention must also be paid to prospectus requirements under the Securities Prospectus Act (WpPG). Where a prospectus is required, detailed information about the investment must be published and approved by the Federal Financial Supervisory Authority (BaFin). Furthermore, specific structuring (e.g., profit participation rights as tradable securities) may require the consideration of additional securities law provisions. Regulatory banking law requirements must be met if the issuer is a regulated institution or if Mezzanine products qualify as deposits.
What rights and obligations do Mezzanine creditors have under the law?
The rights and obligations of Mezzanine creditors arise primarily from the contractual agreements and are structured differently depending on the chosen Mezzanine instrument. Typically, Mezzanine creditors have no influence on the management of the company and possess no voting rights at shareholders’ meetings. Their claims for repayment and interest are subordinated and may be linked to the company’s profits. An important aspect involves the obligation to provide information: depending on the arrangement, creditors may be entitled to specific corporate information. The enforcement of rights in insolvency depends on agreed subordination clauses and the legal nature of the instrument, such as profit participation rights, silent partnerships, or subordinated loans.
What special rules apply to Mezzanine capital in case of insolvency?
In the event of insolvency, the deciding factor is whether and how subordination was agreed upon and structured. Mezzanine capital generally ranks only after the claims of ordinary debt creditors, i.e., only after all claims from traditional bank loans or supplier credits have been satisfied. In practice, Mezzanine creditors are usually only paid if there remains any insolvency estate after the senior creditors have been satisfied. The exact ranking depends on the respective contract and the provisions of the Insolvency Code (§§ 38 ff. InsO). Failure to draft subordination clauses in an insolvency-proof manner can lead to capital intended to be subordinated being treated as debt capital in insolvency—with corresponding risk to all involved.
What tax aspects are relevant in connection with Mezzanine instruments?
The tax classification of Mezzanine products depends on their legal qualification, i.e., whether they are classified as debt or equity. This affects both the tax deductibility of distributions as business expenses for the debtor and the taxation at the level of the capital provider (income tax, corporate tax, possibly withholding tax). In the case of hybrid instruments, such as the profit-participating subordinated loan, tax analysis is required to determine classification. In addition, value added tax and trade tax implications must be considered—especially within a group of companies (keyword: add-backs under the German Trade Tax Act). Internationally, treaty law issues may also be relevant, for example, in cross-border structuring of Mezzanine capital.
Are there special legal requirements for institutional investors as Mezzanine creditors?
Yes, institutional investors are often subject to specific regulatory requirements, such as the German Capital Investment Code (KAGB) or special laws for insurance companies or pension funds. When acquiring and holding Mezzanine instruments, it must be checked whether these investments can be included in their regulatory portfolio and how they must be treated for regulatory purposes (keyword: eligibility, risk weighting, reporting requirements). Moreover, internal investment guidelines may impose further restrictions. Contract structuring must take these aspects into account, especially with regard to documentation, reporting, and providing evidence to supervisory authorities.
