306 6 Mezzanine
nised as a liability. In contrast, normal preference shares do not have a fixed ma-
turity, and the issuer does not have a contractual obligation to make any payment.
Therefore, they are equity.^105
A contractual right or obligation to receive or deliver a number of its own
shares or other equity instruments that varies so that the fair value of the entity’s
own equity instruments to be received or delivered equals the fixed monetary
amount of the contractual right or obligation is a financial liability.^106
When a derivative financial instrument gives one party a choice over how it is
settled (for instance, the issuer or the holder can choose settlement net in cash or
by exchanging shares for cash), it is a financial asset or a financial liability unless
all of the settlement alternatives would result in it being an equity instrument.^107
Compound financial instruments. Some financial instruments - sometimes
called compound instruments - have both a liability and an equity component from
the issuer’s perspective. In that case, IAS 32 requires that the component parts be
accounted for and presented separately according to their substance based on the
definitions of liability and equity.^108
To illustrate, a convertible bond contains two components. One is a financial li-
ability, namely the issuer’s contractual obligation to pay cash, and the other is an
equity instrument, namely the holder’s option to convert into common shares. An-
other example is debt issued with detachable share purchase warrants.
6.5 Profit-sharing Arrangements................................................................
In some countries, profit-sharing arrangements can be based on mezzanine in-
struments that are neither typical loans nor shares. In Germany, such instruments
include silent participations (for partification certificates, see above).^109
Defined in the German Commercial Code (HGB), a silent participation (stille
Beteiligung) is a contract between the parties.^110 Silent participations are subject to
registration requirements in limited-liability companies.^111
A silent participation means that an investor makes a capital contribution to the
firm. The contribution can be money, property, rights, or services.^112
The investor and the company agree on informal articles of incorporation that
set out the purpose of the venture, the objectives of the company, and the sharing
of profits. A fixed interest rate is not sufficient; however, the parties may agree on
(^105) IAS 32.18.
(^106) IAS 32.20.
(^107) IAS 32.26.
(^108) IAS 32.28.
(^109) See Wiehe H, Jordans R, Roser E, Mezzanine Finance Structures under German Law,
JIBLR 22(4) (2007) pp 219–220.
(^110) §§ 230–237 HGB; §§ 705–740 BGB.
(^111) § 292(1)(2) AktG.
(^112) Article 27 of Directive 77/91/EEC (Second Company Law Directive) will not apply.