Brexit has redirected and sharpened the focus of many on matters
which, Brexit aside, might not have merited as much attention. One
of those matters is the contractual recognition of bail-in in loan
documents (and other documentation). We give a quick overview of
what it is, why and when it is needed and what documents it
1. What is "bail-in"?
Broadly speaking, "bail-in" empowers a national
authority (a 'resolution authority') to cancel, reduce or
modify a failing financial institution's liabilities either by
writing down those liabilities or, in the case of debt or other
capital instruments, converting them into equity. It is therefore a
significant tool that permits interference with property rights to
effect the resolution of a failing financial institution by
recapitalisation. In practical terms, bail-in shifts losses on to
shareholders and creditors, such as bondholders, thereby avoiding
either liquidation or "bail-out" by governments (and the
attendant costs in each case).
2. What is contractual recognition of bail in?
The Bank Recovery and Resolution Directive (2014/59/EU)
("BRRD") requires EEA
banks and investment firms to insert language into contracts
governed by non-EEA law recognising that the
liabilities of the institution may be susceptible to bail-in.
3. Why is contractual recognition needed?
Bail-in of a liability under a contract governed by EEA law will
be effective in the EEA (i.e., European Union states and Iceland,
Liechtenstein and Norway) regardless of the terms of that contract
(under BRRD). The reason that the BRRD requires recognition of
bail-in in non-EEA governed contracts is that it is thought that if
a counterparty expressly consents to bail-in, the exercise of
bail-in powers is likely to be less susceptible to challenge in a
non-EEA court. Otherwise the resolution of an EEA financial
institution potentially could be threatened if it has significant
non-EEA liabilities and creditors in those non-EEA countries
brought proceedings where as a matter of that non-EEA law the
bail-in was not effective and so did not as a matter of that
non-EEA governing law bind them – in effect, holding the
financial institution to its original deal with its creditors
despite the purported bail-in.
4. What documents should contain a bail-in recognition
The documents which should include contractual recognition of
bail-in are those which are:
entered into (or materially amended) after 1 January 2016;
governed by the law of a non-EEA jurisdiction;
do not relate to a covered bond or protected deposit; and
not capable of otherwise being excluded from the requirement
(which, generally speaking, loan market documents are not).
Plainly this potentially covers a very broad range of documents,
including, for example, commitment letters, facility agreements,
intercreditor agreements, letters of credit, security agreements,
secondary loan trading documents and underwriting agreements.
5. Effect of Brexit
Of particular interest in light of Brexit, is whether a bail-in
clause should be included in contracts governed by English law,
which, if governed by non-EEA law, would require one. On this
market practice is divided. Some parties are including the bail-in
clause as standard in these English law documents, whilst others
simply do not include them as a matter of course. It is by no means
clear that the former course of including in every case is
necessary, but against that, it is not unjustifiable given the lack
of certainty over what Brexit will in the end entail. It seems that
the most prudent cause is to deal with each particular document in
its context and on a case-by-case basis.
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.
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