European Union: Re-Transfer Of Liabilities From Good Bank Novo Banco To Bad Bank BES – Another Test Case For The Banking Recovery And Resolution Directive ('BRRD'*)?

A case of table tennis between the 'good bank' and 'bad bank'

Readers interested in the BRRD2 will no doubt have been following the ongoing travails of the Portuguese good bank (Novo Banco, S.A. ("Novo Banco")) / bad bank (Banco Espirito Santo, S.A. ("BES"))3.

The latest news hitting the headlines was on 29 December 2015, when Banco de Portugal ("BDP"), acting as Portuguese resolution authority, announced (the "2015 Resolution") that it had re-transferred five Portuguese law-governed senior unsecured bonds (the "Affected Liabilities") from Novo Banco back to BES (the "Re-Transfer"). The Re-Transfer occurs some 16 months after BDP had resolved to transfer the very same Affected Liabilities from BES to Novo Banco.

By way of reminder, Novo Banco was created as a "bridge bank" in connection with resolution powers exercised by BDP over the troubled BES in August 2014 (the "2014 Resolution"). As part of the 2014 Resolution, the Affected Liabilities (along with BES's other senior ranking liabilities), were transferred from BES to Novo Banco. Novo Banco was established specifically to take over those parts of BES that BDP considered viable, so as to enable a continuation on a "business as usual basis". This would facilitate BES (now only containing the non-viable parts of the business) being wound down in an orderly manner. The holders of the Affected Liabilities (the "Holders") would no doubt have been relieved that their assets were transferred to Novo Banco.

The Re-Transfer set out in the 2015 Resolution seems to have been influenced by the litigation before the English Court involving an English law-governed loan also transferred from BES to Novo Banco under the 2014 Resolution4. The English Court held that the 2014 Resolution was a valid exercise by the BDP of a resolution action pursuant to the Portuguese legislation implementing the BRRD in Portugal, and as such must be recognized (pursuant to article 66 BRRD) in the UK, but the court also held that a "ruling" subsequently made by the BDP with respect to the same loan did not constitute an exercise of a "resolution action" within the meaning of the BRRD. The "ruling" was that a previous transfer of the governed loan from BES to Novo Banco was never in fact made. The court held that since the "ruling" did not constitute the exercise of a resolution action, it did not qualify for recognition status within the scope of Article 66(6) BRRD. Unlike the transfer of the loan the subject of that English litigation, the Affected Liabilities in the 2015 Resolution are explicitly subject to a re-transfer formally authorised by a BDP board resolution. It is further interesting to note that only Portuguese law-governed bonds are the subject of the Re-Transfer while the instrument in the English litigation was English law-governed.

On 14 November 2015, BDP announced in a press release that, according to ECB Banking Supervision stress tests, Novo Banco had a shortfall (the "Shortfall") of EUR 1,398 million in the adverse stress test scenario (CET1 ratio of 2.43%, compared with a 5.5% threshold), estimated for end-20175. In the press release of 29 December 2015 (the "December Press Release"), BDP announced that effecting the Re-Transfer of the Affected Liabilities solved the Shortfall for Novo Banco.

Not surprisingly, the Holders are unhappy about the Re-Transfer, since they will be faced with a liquidation value return. The resulting destruction of value is reflected in the bonds now trading in the single digits (down from (near) par value before the Re-Transfer).


Holders looking at grounds to challenge the Re-Transfer have difficult questions with which to grapple. As we have previously reported, the BRRD grants extraordinary rights to resolution authorities and, such exercise of powers as there have been, have only been judicially tested a handful of times. Each case needs to be assessed in its own factual matrix. In each case, including this one, common threshold questions on the operation of the BRRD should firstly be explored, including the following:

1. Did the Re-Transfer itself constitute the exercise of a "resolution action" within the meaning of the BRRD6?

Could the Re-Transfer itself be said to constitute a "resolution action"7? Since, in accordance with Article 40(9) BRRD, Novo Banco (as bridge institution), is to be deemed a "continuation" of BES (as the institution under resolution), the Re-Transfer could arguably be said to have been an exercise of a resolution power to "transfer liabilities" within the meaning of Article 63(1)(d) BRRD.

2. Were the conditions set out in the BRRD for exercise of the "resolution action" satisfied8?

If the Re-Transfer by BDP in the 2015 Resolution qualifies as the exercise of a resolution action, the question then arises as to whether the conditions for the exercise of the "resolution action" were satisfied at the time of exercise (i.e. 29 December 2015). The BRRD sets a high bar for a resolution authority to exercise the extraordinary resolution powers in the BRRD. In short, these conditions require BDP to form the view that Novo Banco is9:

a. "failing or likely to fail",

b. that there is no reasonable prospect that an alternative private sector measure would prevent the failure, and

c. that the Re-Transfer is necessary in the public interest10.

The BRRD sets out guidance on the meaning of each of these conditions11. According to any natural reading of the guidance and without further explanation by BDP, the reasons given for the Re-Transfer in the December Press Release (namely the "negative effect" on Novo Banco's "financial situation" a blanket statement (without reasons) that the Re-Transfer was in the "public interest and aimed at safeguarding financial stability") are insufficient to conclude that these conditions are met.

3. Did BDP duly exercise the "resolution action" under the BRRD12?

A due exercise of a resolution action requires the resolution authority to have regard to the resolution objectives, to choose the resolution tools that best achieve the objectives applicable in the circumstances, to seek to minimize the cost of the resolution tools, and to avoid destruction of value unless necessary to achieve the resolution objective. Again, essential information to appropriately evaluate this is missing.

4. The scope of the "re-transfer" right

In its December Press Release, BDP seems to have assumed that it was entitled to cut across these threshold requirements and effect the Re-Transfer solely in reliance on the re-transfer power given to it in the 2014 Resolution which expressly authorised BDP to re-transfer assets and liabilities "at any time... between BES and Novo Banco" in accordance with Article 145-H(5) of the Legal Framework13. The BRRD itself contemplates re- transfers of liabilities from the bridge institution to the institution under resolution provided they are done in compliance with the conditions set out in the original resolution and "for the relevant purpose"14

Given the context within which the re-transfer right sits in the BRRD15, it is at least arguable that it cannot properly be construed as an unconditional power. For instance, Holders should be asking whether the Re-Transfer right may legitimately be used as a back-door means to breach the BRRD's fundamental requirement that resolution authorities treat creditors in the same class in an equitable manner16. Had BDP purported to pick and choose such liabilities on the initial transfer to Novo Banco in the 2014 Resolution, it would have been a clear breach of one of the general principles governing resolution.

Without further explanation, it is not clear why other liabilities of Novo Banco that rank pari passu with the Affected Liabilities remain with Novo Banco, while at the same time it was "necessary in the public interest" to re-transfer the Affected Liabilities from Novo Banco to BES. The convenience for BDP in choosing Portuguese law-governed bonds only is obvious: no questions of recognition by foreign courts will arise, and it seems that foreign courts will not have jurisdiction to hear disputes brought by disgruntled Holders. Holders will be likely to be required to bring their complaint, at least in the first instance, in the Portuguese courts.


While the BRRD does contain certain explicit safeguards, the remedies for affected stakeholders (such as the Holders) are limited17. A right of appeal against the 2015 Resolution should be available to Holders18, but the launching of an appeal will not alter the immediate effectiveness and enforceability of the 2015 Resolution19. The courts are required to use the economic assessments of the facts carried out by the resolution authority as a basis for their own assessment, and the burden of proof will lie with the party launching the appeal.

If Holders are successful in mounting a challenge, there may be two likely outcomes. One possibility is that the 2015 Resolution may be annulled and the Affected Liabilities put back to Novo Banco. But even if the Affected Liabilities are put back, the Holders will not necessarily be home and dry, since the BDP will still need to address the Shortfall. What action that is likely to be is difficult to speculate about at this stage and will require more information about Novo Banco. Alternatively, compensation may be awarded to Holders against BDP, the monetary value of which will likely involve a comparison between the value of the Affected Liabilities as a result of BDP's unlawful action, on the one hand, and the value of the Affected Liabilities had the BDP lawfully exercised its power to address the Shortfall.

If, on the other hand, Holders are not successful in challenging the 2015 Resolution, Holders could still be entitled to compensation if the so-called "Treatment Valuation" within the meaning of article 74 BRRD shows that the Holders have incurred greater losses than they would have incurred in a winding up of Novo Banco under normal insolvency proceedings20.


The Re-Transfer contained in the 2015 Resolution raises a number of questions highlighted here. More information is clearly required to properly assess (both legally and otherwise) this latest twist in the continuing Novo Banco/BES saga. As one of the primary sources of the missing information, we would expect Holders to not only attempt to engage with BDP, but at the same time also consider more formal and rigorous steps. Another test case for the BRRD in the making, so it would seem.


 * Directive 2014/59/EU of the European Parliament and of the Council of May 15, 2014, establishing a framework for the recovery and resolution of credit institutions and investment firms.

2 See "The Banking Recovery and Resolution Directive – Should Creditors Be Concerned?" in Pratt's Journal of Bankruptcy Law, November/December 2014, pp. 607-619 (the "Pratt's Publication") and "Takeaways From Europe's Application Of Bank Recovery Law" in Law360, 8 September, 2015 ( ) the "Law360 Publication").

3 Goldman Sachs International v Novo Banco SA [2015] EWHC 2371 (Comm). See our previous report on this decision in the Law360 Publication.

4 Goldman Sachs International v Novo Banco SA [2015] EWHC 2371 (Comm). See also footnote 3 above.

5 Note that the press release also stated that Novo Banco successfully completed the ECB Banking Supervision stress test in the most likely baseline scenario (CET1 ratio of 8.24%, above the 8.0% threshold).

6 Article 32(1). Note also that the BRRD must be complied with regardless of the fact that a resolution authority's actions only affect instruments governed by the laws of its home Member State. Prior to the BRRD, BDP could have effected the Re-Transfer by its own sovereign powers since it was not purporting to affect non Portuguese law instruments and therefore had no need to invoke recognition by other Member States under CIWUD. (Directive of the European Parliament and of the Council of April 4, 2001 on the Reorganisation and Winding up of Credit Institutions (2001/24/EC). (Subject to compliance with the European Convention on Human Rights).

7 "resolution action" is defined in Article 2(1)(40) BRRD (in relevant part) as "the decision to place an institution or entity (...) under resolution pursuant to Article 32 or 33, the application of a resolution tool, or the exercise of one or more resolution powers".

8 Article 32(1)(a) – (c).

9 Article 32(1) BRRD.

10 According to article 32(5) BRRD this is the case if (i) it is necessary for the achievement of one or more of the resolution objectives, (ii) it is proportionate to one or more of the resolution objectives, and (iii) the winding up of Novo Banco under normal insolvency proceedings would not meet those resolution objectives to the same extent.

11 See Article 32(4) BRRD for scope of "likely to fail".

12 Articles 31 (resolution objectives) and 34 (general principles governing resolution) BRRD.

13 The "Legal Framework" is the Regime Geral das Instituicoes de Credito e Sociedades Financieras. (Article 145-H(5) seems to be an incorrect cross reference; the more likely provision being Article 145-H(4), which, in its terms, appears to provide an unconditional right to transfer liabilities from the bridge bank back to the original institution).

14 Article 40(7) BRRD.

15 An underlying rationale of the BRRD seems to be that "exceptional circumstances require exceptional powers". When an exceptional power is used, exceptional circumstances must therefore exist to merit its use. It would therefore be surprising if the fact that the 2014 Resolution met the BRRD requirements on 3 August 2014 is sufficient for the 2015 Resolution and there would be no need on 29 December 2015 to verify again if the BRRD requirements are met in respect of the Re-Transfer.

16 Article 34(1)(f)) BRRD. See also recital 47 ("(...) In particular, where creditors within the same class are treated differently in the context of resolution action, such distinctions should be justified in the public interest and should be neither directly nor indirectly discriminatory on the grounds of nationality (...)".)

17 This is underscored by the far-reaching effects of the exercise of resolution powers that follow from, inter alia, the following BRRD articles: article 37(8) BRRD [claw back rights are disapplied], article 68 BRRD [exclude effectiveness of certain contractual provisions], article 70 BRRD [suspend certain contractual terms], article 71 BRRD [restrict enforcement of security rights], article 72(4) BRRD [shadow/de facto director laws are disapplied], and article 86(1) BRRD [restrict opening of normal insolvency proceedings].

18 Article 85(3) BRRD.

19 Article 85(4) BRRD.

20 Article 75 BRRD.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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