Definition of terms and legal classification of notes
Definition and basic principles
The term Notes refers in the legal and economic context to debt securities that typically represent securitized, tradable claims against the issuer. Notes are regularly securities that are usually issued as fixed-interest or variable-interest investments. They are among the key instruments of corporate and government financing and are legally to be assigned to bearer bonds (§§ 793 et seq. BGB) or order bonds (§§ 778 et seq. BGB). In international terminology, short-term debt securities in particular are referred to as notes, while longer-term ones are often termed bonds or debentures.
Legal nature of notes
Legal foundations of obligation
Notes establish a contractual relationship between the issuer (debtor) and the holder (creditor) of the security. The noteholder is entitled to repayment of the nominal amount and, where applicable, to payment of interest. Notes are often issued within the framework of public bond programs, private placements, or so-called promissory note loans.
Forms of structuring
Notes may be structured as bearer, order, or registered bonds. The legal structure varies; the respective issue prospectus and the law applicable to the contract are decisive. In Germany, the German Civil Code (BGB) is usually decisive, internationally other legal systems may apply, especially English or US law.
Types and variants of notes
Plain vanilla notes
This standard form corresponds to classical fixed-interest bonds with a predetermined interest rate and maturity date.
Floating Rate Notes (FRNs)
These are variable-interest securities, usually linked to reference interest rates (e.g., EURIBOR, LIBOR). The interest rate is adjusted regularly.
Structured notes
These are structured financings whose terms of repayment and interest mechanics may deviate from market standards. They frequently include derivative components or variables, such as share prices or commodity prices.
Commercial Paper (CP) Notes
These short-term debt instruments, usually redeemable within a few months, are used for short-term liquidity financing.
Issuance process and legal implications
Prospectus requirements and investor protection
The issuance of notes is subject to strict capital market regulations in the European Union and Germany. According to the EU Prospectus Regulation (Regulation (EU) 2017/1129), a securities prospectus must be provided for a public offering of notes, which must comply with certain transparency and disclosure requirements. Exceptions exist, particularly for private placements or issues to professional investors.
Securities trading and transferability
Notes, as securities, are generally fungible and can be sold on the secondary market. Transferability is determined by the particular structure of the debt instrument (bearer, order, or registered bond). The acquisition process is governed by §§ 793 et seq. BGB (bearer), §§ 778 et seq. BGB (order), or by general assignment law (§§ 398 et seq. BGB) for registered bonds.
Rights and obligations of the parties
Creditor rights
Noteholders have the right to repayment of capital and to payment of agreed interest. Additionally, ancillary rights, such as rights to information, cancellation, or exchange, may be securitized. The legal position of the holder is regularly governed by the general conditions of the bond (bond terms) and the applicable law.
Obligations of the issuer
The issuer is obliged to service the note in accordance with its terms. The principal obligations include timely payment of interest and repayment of the nominal value. Breaches of these obligations may give rise to claims for damages and rescission.
Special provisions and risks
Treatment in insolvency law
In the event of the issuer’s insolvency, notes are regarded as claims arising from securities and participate in the insolvency proceedings as claims pursuant to § 38 InsO. Security rights (e.g., secured notes) can ensure preferential satisfaction.
Provisions on accounting and tax law
The accounting treatment of notes is determined by the requirements of the German Commercial Code (HGB) or by international accounting standards (IFRS, US GAAP). For tax purposes, notes are explicitly considered capital claims and are therefore subject to withholding tax pursuant to § 20 EStG.
Third-party debtor and investor liability
In the context of false statements in the securities prospectus, civil liability of the issuer and any placing institutions may arise, particularly pursuant to §§ 13, 14 Wertpapierprospektgesetz (WpPG).
International standards and specific features
US and UK law
In international legal transactions, notes are often subject to US or English law. The legal framework is shaped by specific regulations such as the US Securities Act or the UK Companies Act, which, in particular, regulate disclosure requirements, admission prerequisites, and liability issues.
Listing and clearing
Notes are regularly listed on national and international securities exchanges and managed by central securities depositories (e.g., Clearstream, Euroclear). This infrastructure ensures tradability and protection against tort.
Summary
Notes represent a central component of debt financing and securities markets and are legally treated as debt securities. Regulation ranges from civil law provisions of German and international debt securities law to supervisory requirements and capital market and tax law conditions. The decisive factors are always the specific design of the note as well as the applicable national and international legal bases.
Note: This article serves solely for general information and does not constitute legal advice. For specific issues, it is advisable to review the current legal situation and, if necessary, obtain qualified counsel.
Frequently asked questions
What legal risks arise when acquiring notes?
The acquisition of notes can involve various legal risks. As notes are debt securities, there is generally the risk of issuer default (so-called issuer risk). This means that in the event of insolvency of the issuer, repayment of the invested capital and, where applicable, the payment of interest may be suspended or become wholly impossible. Another legal risk is the possibility of disadvantageous contractual conditions (‘covenants’), through which creditors’ rights can be restricted, for example with regard to early termination or collateral security. Moreover, it must be noted that notes are often issued as so-called ‘unsecured’ obligations, so that in the event of insolvency, only a pro rata satisfaction junior to secured creditors takes place. Depending on the specific structure of the note (e.g., convertibility, subordination, special exclusion clauses), further risks may arise from unfavorable interpretation by courts or disputes regarding interpretation of the prospectus. In addition to these aspects, regulatory risks may arise, for example if the note has not been duly registered or published under the German Securities Trading Act or the Capital Investment Code, potentially leading to claims for rescission or damages.
How is the legal transfer of notes carried out?
The legal transfer of notes strongly depends on their structure. For physically certificated notes, transfer is effected by transferring possession of the security while complying with specific civil law formalities, in Germany particularly by agreement and delivery in accordance with § 929 BGB. In practice, however, notes are frequently deposited as a global certificate with a central securities depository, so that only ‘co-ownership shares’ or ‘credits’ in securities custody accounts exist. The transfer of such custody-held notes is generally performed via booking transactions in accordance with the Safe Custody Act (DepotG) and by assignment of the corresponding right. Depending on the legal system, there may be particularities regarding the effectiveness of the transfer, necessary notifications or registrations, for example in connection with disposal restrictions, consent requirements, or lock-up periods. For notes that qualify as securities under the German Securities Trading Act (WpHG), reporting requirements and, if necessary, procedures for verification of legitimacy must also be observed.
What prospectus requirements must be observed in the public offering of notes?
In the case of the public offering of notes, there is generally a prospectus requirement under Regulation (EU) 2017/1129 (Prospectus Regulation), unless exemption conditions apply, such as offers to fewer than 150 non-qualified investors or denominations of at least 100,000 euros. The prospectus must contain all information essential to an investor’s decision, including issuer information, risk warnings, detailed contractual terms of the notes, use of proceeds, and, if applicable, tax notes. The legal requirements concerning content, form, and language of the prospectus are strict and monitored by the national supervisory authority (in Germany: BaFin). The absence or inaccuracy of a prospectus can have significant civil and supervisory legal consequences. In case of violations of prospectus requirements, investors are entitled to rescission or damages under § 21 WpPG (‘prospectus liability’).
Are there any special notes regarding place of jurisdiction and choice of law for notes?
When issuing notes, the issuer and creditor can generally agree freely on the place of jurisdiction and the applicable legal system. In international issues, the law of an internationally recognized financial center, such as English or Luxembourg law, is often agreed upon, with corresponding courts such as London or Luxembourg being specified as the venue. In the absence of a chosen place of jurisdiction, the general rules of the Code of Civil Procedure (ZPO), the Brussels Ia Regulation (for EU matters), and the relevant national private international law provisions apply. It should be borne in mind that a choice of law clause is not necessarily enforceable for all, including any ancillary or control actions that may arise, especially where consumers are involved. A clearly formulated choice of law and a clear place of jurisdiction are central for compliance with deadlines, enforceability of claims, and cost calculation.
What investor protections apply in connection with notes?
Notes are generally subject to the investor protection regime composed of European and national regulations. Special disclosure obligations apply to structured or complex notes under MiFID II and WpHG, also with respect to product classification, target market determination, and suitability statement in the context of advisory services. All risk warnings and cost structures must be presented clearly and understandably. In addition to supervisory obligations, civil liability for prospectuses plays a key role. Under certain circumstances, and where notes are distributed by regulated banks or financial service providers, compensation mechanisms such as the Compensation Scheme of German Banks GmbH (EdB) may also apply, though this is only limited for claims from notes. Furthermore, the Securities Trading Act protects against unfair business practices and market manipulation, and the Capital Investor Model Proceedings Act (KapMuG) offers options for collective legal enforcement in cases of erroneous information.
What role do tax aspects play from a legal perspective for notes?
The legal treatment of tax aspects is essential for investors in notes, as payouts (interest and repayment) may be subject to tax. In Germany, interest income from notes is subject to withholding tax unless a tax exemption applies. Issuers are required to withhold and remit capital gains tax to the tax office upon payment of interest. For foreign investors or unusual structures (e.g., zero-coupon notes or notes issued below par), international tax treaties (DBA), withholding tax regulations, and certain reporting requirements may become relevant. The tax consequences of transfer or sale of notes must also be considered; depending on the structure, this may constitute realization of hidden reserves and lead to tax liability. Erroneous tax advice or unclear provisions in the terms of issue may result in liability claims.
To what extent can notes be structured as subordinated or senior, and what are the legal implications?
Notes can be structured with different seniority. In the case of senior notes, the creditor ranks equally with other unsecured creditors in the issuer’s insolvency. Subordinated notes, on the other hand, are ranked junior; creditors of these notes are satisfied from the insolvency estate only after senior creditors (e.g., other bonds, suppliers, or banks) have been paid—in many cases, little or nothing remains for them. The specific subordination is individually governed by the contractual terms and must be clearly and understandably set out in the prospectus and the securities terms in order to avoid misleading information and resulting liability risks. The ranking plays a central role in assessing the risk profile and in supervisory issues, especially in relation to recognition as part of banks’ equity capital (Basel III). Incorrect classification of the ranking may lead to investor lawsuits and regulatory consequences.
