The EU Bank Recovery and Resolution Directive (2014/59/ EU) (the BRRD) establishes the framework for the resolution of failing EEA financial institutions. BRRD gives regulators a range of powers including bail-in powers to write-down and/ or convert liabilities of a failing institution into equity (the Powers).
01 January 2016 was the deadline for EEA member states to implement the bail-in provisions set out in articles 43 to 55 of BRRD. The regulator's exercise of the write-down and conversion powers will be effective in respect of any liabilities of an EEA financial institution under a document governed by the laws of an EEA country regardless of the terms of that document. It is less certain that the Powers will be recognised and enforced by a foreign court where the document is governed by the law of a non-EEA country (the Foreign Law).
To ensure the cross-border effectiveness of the regulator's Powers, article 55(1) BRRD requires in-scope financial institutions1 (an EEA Institution) to include a term in contracts governed by a Foreign Law to which they are a party (the Article 55 Requirement). Based on these contractual terms, the EEA Institution's counterparty (the Counterparty) acknowledges that the EEA Institution's obligations under that document are subject to an EEA regulator's exercise of those Powers. The contractual term is commonly referred to as the Bail-in Clause.
The Article 55 Requirement is only applicable to a document governed by a Foreign Law. To the extent that the transaction is a European-based lending transaction, the inclusion of a Bailin Clause would still be relevant where the security documents or other finance documents are governed by a Foreign Law.
Article 55 Requirement
The Article 55 Requirement is not retrospective and will apply if one of the trigger events listed below occurs on or after the date specified in the relevant national implementing legislation which, in most cases, is 01 January 20162. Occurrence of the following events in relation to a Foreign Law-governed agreement on or after 01 January 2016 will trigger the Article 55 Requirement:
(a) An EEA Institution becomes party to a document.
(b) Material amendments are made to an agreement to which an EEA Institution is a party.
(c) New liabilities arise under an existing document to which an EEA Institution is a party.
What should the Bail-in Clause look like?
The European Banking Authority has prepared draft regulatory technical standards3 requiring the Bail-in Clause to include certain mandatory features such as a description of the Powers set out in the EEA Institution's national implementing legislation. Moreover, the Bail-in Clause should also contain an acknowledgement and acceptance by the Counterparty that:
(a) The EEA Institution's liabilities may be subject to the exercise of the Powers by the EEA regulator.
(b) The Counterparty is bound by the effect of an EEA regulator's application of the Powers.
(c) The terms of the relevant documents may be varied as necessary to give effect to the exercise of such Powers.
(d) The Counterparty may be issued equity or other ownership instruments in the EEA Institution as a result of the exercise of the Powers.
Scope of liabilities captured
Beyond the limited exemptions provided in Article 55, the Article 55 Requirement applies broadly to any document governed by a Foreign Law under which the EEA Institution may have contractual or non-contractual liability. While it is clear that debt liabilities of an EEA Institution (such as bonds, capital instruments and other instruments created indebtedness) are captured, the Article 55 Requirement is far wider in scope. By way of example, contingent liabilities including letters of credit and guarantees, operational liabilities under service agreements, derivative instruments and liabilities to clearing and settlement systems outside the EU would also fall within the scope of the Article 55 Requirement.
Of particular relevance for banking transactions, the Article 55 Requirement would apply to obligations commonly undertaken by a financial institution as lender or as administrative party under finance documents, typically security agreements, governed by a Foreign Law. The following obligations commonly undertaken by lenders, security agents and/or facility agents would trigger an Article 55 Requirement:
(a) Lending commitments.
(b) Requirements to share or turnover recoveries made from the borrower.
(c) Indemnities typically given to the facility agent, security agent and issuing bank.
(d) Confidentiality duties.
(e) Requirement to obtain borrower consent/consultation prior to transfer of participation.
(f) Administrative obligations such as notifications of tax status or requirement to make other notifications.
(g) Potential non-contractual liability under loan market documentation such as claims in negligence or misrepresentation.
Consequences of non-compliance
Failure by an EEA Institution to include a Bail-in Clause in a Foreign Law-governed finance document will result in a breach of the law of the jurisdiction of that EEA Institution transposing BRRD. Article 55(2) BRRD provides that failure to include a Bail-in Clause does not preclude the EEA Institution's resolution authority from exercising its Powers. Consequences of non-compliance with the Article 55 Requirement may result in fines or regulatory actions being imposed on the EEA Institution but it is generally expected that the contract will remain valid and enforceable.
Because of the wide scope of both the trigger events and liabilities captured by the Article 55 Requirement, Mauritian counterparties and especially Mauritian financiers will need to take a judgement call on the inclusion of the Bail-in Clause when preparing Foreign Law-governed finance documents.
For instance, where no syndicate members are EEA Institutions, the arranger / facility agent may still wish to build in flexibility across the finance documents to facilitate transfers to EEA Institutions in the future.
Where a facility agreement is governed by an EEA law, parties should determine whether there are (or if it contemplated that there may in the future be any) other security documents governed by a Foreign Law. Even where none of the parties to a Foreign Law security document are EEA Institutions, parties should consider whether they want to include the Bail-in Clause to provide for (i) potential non-contractual liabilities, or (ii) future change of security agent to an EEA Institution.
The Loan Market Association has produced a recommended form of the Bail-in Clause and an accompanying user guide. Because Article 55 requires a description of the Powers under the national implementing legislation in the Bail-in Clause rather than a generic description of the directive, the Loan Market Association has also produced an EU bail-in legislation schedule setting out a description of all relevant legislations which can be incorporated by reference in the relevant contracts. The schedule has been prepared as part of the co-operation between the Loan Market Association, Loan Syndications and Trading Association, Asia Pacific Loan Market Association and International Capital Market Association.
1. Article 55 applies to EU incorporated banks and qualifying investment firms, their EU incorporated holding companies, their subsidiaries which are EU financial institutions and certain affiliates. Non-EU incorporated firms and their EU branches are out of scope. Careful consideration should be paid to the national implementing rules to determine whether entities are in scope.
2. BRRD requires EEA member states to specify this date as no later than 1 January 2016. This article refers to 1 January 2016 for simplicity and the date of application may vary in some EEA member states.
3. The regulatory technical standards prepared by the European Banking Authority have been submitted to the European Commission and are currently available in draft form only. These standards will be binding and directly applicable in all EU member states upon adoption by the European Commission.
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.