Investing in Bonds: How to Avoid Losing Money to a Legal Mistake

What to watch out for before you entrust your money to an issuer

Bonds are often presented as a relatively safe investment with a predictable yield. In recent years, however, the Czech market has filled up with issues that carry high risks — not only economic, but also legal. Unfortunately, many investors only fully grasp the legal consequences of their investment at the moment the issuer stops meeting its obligations. So what are the main legal issues associated with investing in bonds under Czech law?

A fundamental misconception among investors is the idea that a bond is a “safer alternative” to a fixed-term deposit. In legal terms, however, a bond is a security — that is, the issuer's obligation to repay the investor the amount owed under the conditions set out in the terms of issue.
As an investor, you become the issuer's creditor and the issuer becomes your debtor. The debt, however, is not insured by law. If the issuer becomes insolvent, the investor bears the full risk of loss — and in insolvency proceedings their claim is often satisfied only in part.

From a legal standpoint, the key documents are the bond's terms of issue and the prospectus. These determine, in particular:

• the bond's maturity,
• the amount and method of paying the yield,
• the option of early redemption,
• the investor's right to demand redemption of the bond before the maturity date,
• the terms of any security (if it exists),
• investors' rights in the event of a breach of the issuer's obligations,
• the unfavourable ranking of the claim should the issuer become insolvent,
• the conditions for trading the bonds.
In practice, you may come across terms of issue that are worded vaguely, drafted one-sidedly in the issuer's favour, or that contain provisions which significantly weaken the investor's position. A typical problem, for example, is the option to unilaterally change the terms or to defer maturity without any real protection for the investor.

With publicly offered bonds, you may come across the information that the prospectus has been approved by the Czech National Bank. However, the CNB's approval of a prospectus does not mean that the CNB assesses the economic merits of the investment, its safety or its potential enforceability — it merely reviews the formal requirements and the completeness of the information.
If an offer strikes you as extremely attractive at first glance, be on your guard! This is especially true if the bond is offered with a very high yield.
Go through all the information about the company in the Commercial Register. Does the issuer have a track record, or has it only just been founded? Are historical financial statements available so you can assess its past results? What is the holding structure of the business? If it is a new company, that will generally increase the level of risk. A so-called rating, if one has been assigned by a rating agency, can also help you assess the issuer's creditworthiness.

In recent years, on social media you will come across advice from financial influencers — so-called “finfluencers” — or advisers, but do not rely on their information. They may be (and usually will be) motivated to sell bonds by a commission or by personal ties.
Many bonds on the Czech market are unsecured. Even so, they are often marketed in a way that gives investors the impression of a certain guarantee or stability. From a legal perspective, the holder of an unsecured bond has the status of an ordinary unsecured creditor. If the issuer has no real assets, the investor is often left with nothing but a worthless claim.

Once an issuer becomes insolvent, the investor's options narrow considerably. The creditor must:
• file their claim in time,
• expect lengthy proceedings,
• accept a low rate of recovery.
A common problem is also the late reaction of investors who underestimate the situation and miss the statutory deadlines for asserting their rights.

Investing in corporate bonds is not inherently a bad thing — it is a legitimate financing instrument and a form of investment — but from a legal standpoint it is certainly not risk-free. The key is to understand what rights you actually have as an investor, which documents are decisive for the investment, and what consequences an issuer's default may have.
Legal prevention — that is, a thorough analysis of the terms of issue and an assessment of the issuer's risk profile before you invest — is often the only way to avoid losses that can no longer be effectively addressed by legal means afterwards.
Use common sense as well, and never put all of your money into bonds (especially from a single issuer).

Do you want to invest while keeping your money under control? We can't guarantee that the issuer will keep its business afloat, but we will gladly review the issue documentation for you and explain the legal risks in plain language.