An unpaid bond: why the Investment Guarantee Fund will not cover the loss and when to look at whoever sold you the bond

The issuer has not paid the coupon, the principal is at risk and the investor is looking for someone to cover the loss. Two ideas are heard most often: that the money will be returned by the Investment Guarantee Fund because the bond was bought through a bank or a securities dealer, and that the issue was safe because the National Bank of Slovakia approved the prospectus. Both are inaccurate. We examine the second in our answer on whether approval of a prospectus means the issue is safe. This article deals with the fund and with when it makes sense to examine whoever sold you the bond as well.

What the Investment Guarantee Fund covers

The Securities Act defines the purpose of the fund narrowly:

The Investment Guarantee Fund is hereby established […], which pools the monetary contributions […] of securities dealers […] for the provision of compensation for unavailable client assets accepted by a securities dealer or a foreign securities dealer, a management company or a foreign management company for the performance of an investment service […]

— Section 80(1) of Act No. 566/2001 Coll. (unofficial English translation)

Client assets are the funds and financial instruments a client has entrusted to a dealer in connection with an investment service (Section 81(1)). They become unavailable if the dealer has been declared unable to meet its obligations to clients or if a court has, in bankruptcy, suspended its power to deal with client assets (Section 82(1)). Securities that the dealer is able to return to the client without detriment to other clients are not unavailable (Section 82(2)).

The fund therefore protects the investor against the failure of the dealer with which its assets are held, not against the failure of the issuer. If the issuer does not pay, the bonds remain in your account and the dealer can deliver or transfer them; the problem is that the issuer is not performing. In such a case no compensation comes from the fund, and the claim must be pursued against the issuer, its guarantor or out of the security. The position would be different if the dealer itself with which your bonds or money are held were to fail; the question then is whether the assets are protected client assets under Section 81 et seq. and to what extent the fund compensates them.

What duties the seller of the bond had

If you bought the bond through a securities dealer or a bank, the rules on conduct towards clients applied to it. The basic rule reads:

In providing investment services or ancillary services and in performing investment activities, a securities dealer is obliged to act in accordance with the principles of fair commercial dealing, honestly, fairly and with professional care in the interests of its clients.

— Section 73b(1) of Act No. 566/2001 Coll. (unofficial English translation)

All information, including marketing material, had to be clear, transparent and not misleading (Section 73c). The dealer should have explained comprehensibly the risks of the instrument and whether it was intended for non-professional clients having regard to the target market (Section 73d(1)(b)). If it recommended the bond to you, that was investment advice: it had to ascertain your knowledge and experience, your financial situation including your ability to bear losses and your investment objectives, to recommend only suitable instruments (Section 73f(1)) and to give a non-professional client a written suitability statement before the transaction (Section 73f(3)). For other services it generally had to assess appropriateness and warn you if the instrument was not appropriate for you (Section 73g(1) and (2)); the exception for transactions in non-complex instruments, for example bonds admitted to a regulated market, executed at the client’s initiative is governed by Section 73h. How the National Bank of Slovakia supervises these rules in relation to corporate bonds is described in our article on the NBS and the sale of corporate bonds. In assessing a particular sale, the wording of the statute in force at the time of the sale applies.

If the bond was arranged for you by a financial agent, its duties are additionally governed by Act No. 186/2009 Coll. on financial intermediation and financial advice and must be assessed separately.

When a breach may give rise to a claim

A breach of these duties does not of itself mean that the seller will compensate your loss. Liability in damages rests on someone having breached a legal duty, loss having arisen and there being a causal link between them (for instance Section 420(1) of the Civil Code). As a rule it must be shown that, had the proper procedure been followed, you would not have invested in the bond or would have invested differently. The documents from the sale are decisive: the questionnaire on knowledge and experience, the suitability statement or the warning of inappropriateness, marketing materials, emails and recordings of conversations. Which statute applies to the claim and what limitation period runs for it depends on the nature of the contractual relationship with the seller.

The order of steps

• Preserve the claim against the issuer. Rights from bonds are time-barred on the expiry of 10 years from the date on which they fell due (Section 23 of Act No. 530/1990 Coll.), but speed matters, especially where the issuer is approaching insolvency. How to proceed once bankruptcy is declared is explained in our article on a bond issuer in bankruptcy.
• Document the sale. Ask the dealer for copies of the documents you signed or received on purchase, while they are still available.
• Establish whether the issue has a common representative. To the extent that the representative exercises the rights from the bonds, the holders may not exercise them individually (Section 5d(3) of Act No. 530/1990 Coll.). A claim against the seller, however, does not arise from the bond but from your relationship with the seller, so it must be pursued separately.
• Assess the seller only once you have the documents. A claim in damages has its own limitation period, which does not run from the maturity of the bond, so it should not be left until recovery against the issuer has ended.

We will assess the claim under the terms of issue, the issuer’s position and the way the sale was conducted together, under our recovery of claims from bonds service. Send us the terms of issue, the extract from the holder’s account and the documents from the sale; we will usually come back to you with an initial assessment within 24 hours.