As of January 1, 2016, financial institutions from the European Economic Area (EEA) — which includes member states of the European Union, Iceland, Liechtenstein and Norway — are subject to new requirements under Article 55 of the European Union (EU) Bank Recovery and Resolution Directive (2014/59/EU) (BRRD). Such financial institutions are now required to include — in contracts governed by the laws of a non-EEA country — contractual terms recognizing the "bail-in" powers granted to European regulatory authorities in the event of a failing EU financial institution (EU Bail-In Rules).
The scope of the EU Bail-In Rules is broad. As such, they may apply to a credit agreement or another finance document governed by the laws of a Canadian province and entered into by a Canadian borrower.
BACKGROUND
The BRRD is part of a series of banking reforms implemented in the aftermath of the European financial crisis. It seeks to avoid the "too big to fail" scenario by ensuring that an EU financial institution that has reached the point of non-viability can be resolved and recapitalized outside of a formal liquidation proceeding without recourse to taxpayer funds.
Article 55 of the BRRD applies to all EU-incorporated banks and credit institutions, certain investment firms as well as their respective branches and subsidiaries located outside of the EEA (EU Financial Institutions). Non-EU-incorporated institutions and their EU branches and subsidiaries are out of scope.
"Bail-in" powers are powers granted to European regulatory authorities to elect to write down and/or convert into equity certain liabilities of a distressed EU Financial Institution with a view to having existing creditors bear some of the financial burden (Bail-In Powers). In practice, this means that unsecured and similar liabilities of an EU Financial Institution towards its counterparties may be cancelled, written down, modified or converted into equity issued to the counterparties. The European regulatory authorities may therefore have an effect on an EU Financial Institution's obligations towards a Canadian borrower under a credit agreement or another finance document governed by the laws of a Canadian province. It should be noted, however, that one of the principles underlying the exercise of the Bail-In Powers is that creditors should not be left worse off than they would have been had the financial institution gone into liquidation.
WHEN EU BAIL-IN RULES APPLY
In practical terms, Article 55 applies when the following three conditions are satisfied:
- The contract is governed by the laws of a non-EEA country (e.g., a credit facility, a guarantee or a swap arrangement governed by the laws of New York or the laws of Ontario or Quebec)
- An EU Financial Institution is a party to the contract in any capacity whether as a lender, an administrative or facility agent, a security agent, a hedging bank, a trustee, a purchaser of receivables or an issuing bank
- The EU Financial Institution has a potential liability towards any of its counterparties under this contract including any obligations to lend, pay or indemnify in case of a contractual non-compliance or is subject to any potential claims in negligence or misrepresentation.
The BRRD provides that all liabilities of an EU Financial Institution are covered with the exception of a very limited set of liabilities, such exceptions including: liabilities secured by a collateral, a pledge or a lien, deposits for small and medium enterprises below a certain cap, liabilities arising out of a fiduciary relationship, liabilities with a maturity of less than seven days, liabilities to employees, and liabilities to tax and social security authorities.
In addition, Article 55 only applies to:
- A new contract entered into after January 1, 2016
- New liabilities arising under a contract entered into before January 1, 2016
- A material amendment of a contract entered into before January 1, 2016.
CONTRACTUAL TERMS OF THE RECOGNITION OF BAIL-IN POWERS
Provided that the conditions set out above are satisfied, an EU Financial Institution must include in a contract governed by the laws of a non-EEA country, a contractually binding clause pursuant to which its counterparties (such as a borrower or the beneficiary of a guarantee) acknowledge and consent that the financial institution's obligations under this contract are subject to the right of the European regulatory authorities to exercise their Bail-In Powers, including writing down, converting, amending and even cancelling the liabilities of the EU Financial Institution towards the counterparties and the conversion of certain liabilities into equity issued to the counterparties.
Model clauses in relation to liabilities of lenders party to a credit agreement have recently been developed by organizations such as the Loan Syndications and Trading Association.
PRACTICAL CONSIDERATIONS
Given the relatively wide-ranging scope of application of the EU Bail-In Rules, borrowers may expect not only to receive requests to include the contractual recognition of the Bail-In Powers when entering into new finance contracts with EU Financial Institutions, but also requests for material amendments with respect to contracts entered into prior to January 1, 2016.
In light of the fact that failure of an EU Financial Institution to include a contractual recognition clause in a contract may lead to considerable fines and regulatory sanctions, borrowers should anticipate very little flexibility in disregarding the contractual recognition clauses or in negotiating their terms.
We will continue to monitor the interpretation and application of the EU Bail-In Rules — particularly the finalization of the draft regulatory technical standards pursuant to Article 55 of the BRRD for guidance purposes — and will stay informed of the trends and news on this matter.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
