This article was written by Annie Williams, London.
If you occasionally or routinely deal with documents governed by non-European law (including Australian, Hong Kong, New York or PRC law) then you need to be aware of the new requirements about bail-in clauses.
Broadly speaking, the requirement concerns all EU banks and large financial institutions, as well as their EEA parent/holding companies, branches (wherever located) and certain EEA-incorporated subsidiaries, and applies on the basis of the law governing a document rather than “where” the deal or other arrangement is concluded. The new rules can affect any document creating a liability, not just banking documents.
Very briefly, the background is as follows:
What is a “bail-in clause”?
The EU Bank Recovery and Resolution Directive (2014/59) is part of the EU’s response to the financial crisis -- it sets out the rules for the resolution of banks and large investment firms (‘’banks’’) in all EU member states. European regulators have been granted powers to intervene in the operations of banks in order to prevent bank failures. If a bank does face failure, regulators now have a comprehensive range of tools to restructure the business, including by writing down the bank’s liabilities and/or converting those liabilities into equity. The aim is to allocate losses to shareholders and creditors whilst preserving the relevant bank’s functions and avoiding bail-outs funded by EU taxpayers’ money.
Article 55 of the Directive deals with documents governed by the law of a non-EEA country. It requires entities within scope to ensure that a special term is included in almost every document to which they’re party where that document is governed by non-EEA law and exposes them to potential contractual or non-contractual liability. It doesn’t matter in what capacity the entity is a party. The special term, or “bail-in clause’’, requires the counterparties to acknowledge that the other party’s obligations are subject to a European regulator’s exercise of write-down and/or conversion powers. The thinking behind this is that it may make a counterparty less likely to challenge a regulator’s interference if it has expressly acknowledged that these powers exist and may be invoked.
What liabilities are subject to bail-in?
A wide range of liabilities are potentially subject to bail-in powers. If a financial institution happens to be a borrower, then its liabilities to repay debt will be caught. A bank acting as lender, agent, issuer or trustee will also incur liabilities which may be caught by bail-in, including pursuant to loan commitments, indemnities, confidentiality undertakings, requirements to share recoveries, restrictive covenants contained in intercreditors and obligations to supply information. Liabilities for misrepresentation or failure to disclose may also be caught. It’s important to note that bail-in does not apply solely to loan and capital market documents – it can apply to any contract of any type. Some liabilities are specifically excluded, such as certain secured liabilities, liabilities relating to protected deposits and salaries due to employees, although the number and scope of these exclusions is limited.
Which banks will be caught (and what about branches and subsidiaries?)
The precise scope will depend on the implementation in the EU member state in question and so will be a matter of local law. However, in general the Directive covers EEA banks and certain large investment firms, plus certain of their EEA subsidiaries and their parent/holding companies incorporated within the EEA. A non-EEA branch of an EEA bank is caught but a non-EEA subsidiary should not be caught. The EEA branch of a non-EEA bank should not be caught but if the non-EEA bank has a subsidiary incorporated in the EEA, that subsidiary will be within scope.
The Directive doesn’t apply automatically – it has to be enacted in each member state of the EEA. The UK has already enacted the bail-in machinery via amendments to the Banking Act 2009 while the rules about contractual recognition of bail-in have been dealt with by regulations issued by the UK Financial Conduct Authority and Prudential Regulatory Authority. Some EEA states have not yet enacted the Directive.
As regards the documents which will be caught by the requirements of Article 55, these will include all relevant documents entered into or acceded to after 1st January 2016 and pre-existing documents which are materially amended or under which new liabilities arise post 1st January 2016.
What will the new bail-in clause look like?
Various market and trade associations in different jurisdictions have produced recommended forms of bail-in clause. The EU has not prescribed a form of clause that has to be used (although some guidance is under development) but it is important that any bail-in clause complies with the minimum requirements of Article 55. By way of example, the recommended form of bail-in clause suggested by the LMA (London Market Association) together with user’s guide is available here. If you would like more information about the Directive and contractual recognition, then the user’s guide is a good introduction.
The LMA bail-in clause is designed to “fit” with a range of different non-EEA governing laws so that it can be inserted in documents without (it is hoped) major amendment. The LMA consulted with lawyers qualified in Hong Kong, New South Wales, South Africa, Singapore and the US regarding the wording. However, the LMA note that local law advice will still be needed and that the clause may require amendment if it is used in documents which are not loan-related. The suggested wording must also be amended to reflect the powers of the particular European regulator in question as specific powers vary from state to state.
What happens if the bail-in clause is omitted?
Bail-in can still occur even if there is no formal recognition of bail-in in the relevant documentation. Penalties for breach of the requirements for contractual recognition vary between EEA states. In the UK, failure to include the clause would not lead to the entire contract becoming unenforceable but would be a breach of regulatory rules that could result in disciplinary action for the bank or firm in question.
How will this affect the documents we work on?
Documents governed by the law of an EEA state don’t need to incorporate the bail-in clause. However, lawyers will need to watch out for transaction documents which are governed by non-EEA law and which feature an EEA bank as party. The classic situation where Article 55 will be relevant is a non-EEA law governed security document. .
Lawyers who work with documents governed by non-EEA law but to which an EEA bank is party will need to consider including the bail-in clause. If dealing with a suite of documents, it may be sensible to include the wording once in the intercreditor or other “hub” document and draft it so that it binds all relevant transaction documents. It will be interesting to see how much resistance there is in the market to the inclusion of bail-in provisions – counterparties forced to accept the wording may well be pondering whether courts in non-EEA countries will be reluctant to recognise the new bail-in clause.