As part of European banking reforms adopted in response to the global financial crisis, Article 55 of the EU Bank Recovery and Resolution Directive (BRRD) authorizes European regulators to “bail-in” any failing European Economic Area (EEA) financial and credit institution by writing down, converting into equity, or otherwise modifying certain liabilities. In a bail-in, a financial institution is rescued by forcing its creditors to write off debts owed to them, as opposed to a bail-out, where third parties rescue failing financial institutions (e.g., sovereign states use taxpayer money). In practical terms, from January 1, 2016, Article 55 of BRRD requires certain EEA institutions, including European banks, to include a contractual bail-in provision in many non-EEA law governed contracts, including those governed by U.S. law.
In terms of timing, Article 55 applies only to (i) new contracts entered into after January 1, 2016; (ii) new liabilities arising under a contract entered into before January 1, 2016; and (iii) material amendments of a contract entered into before January 1, 2016.
As to what contracts and parties the new rules apply, Article 55 of BRRD applies when the following three conditions are satisfied: (i) the contract is governed by the laws of a non-EEA country (e.g., a credit facility, a guarantee governed by the laws of New York); (ii) an EEA financial institution is a party to the contract in any capacity whether as a lender, an administrative or facility agent, a security agent, a trustee, a purchaser of receivables, or an issuing bank, and (iii) the EEA 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. BRRD covers all liabilities of an EEA financial institution, except for 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/social security authorities.
Bail-in powers have already been used by certain EU regulators. For example, in April 2016, the Austrian Financial Market Authority (FMA) shored up a $US9.1 billion hole in the balance sheet of Heta Asset Resolution AG by insisting on a 53.98 percent bail-in for all eligible preferential liabilities, cutting Heta’s senior liabilities by 54 percent and extending the maturities of all eligible debt to the end of 2023. Annabelle Ruthven and Michael Speranza, Bail-In and Contractual Recognition: The Impact on U.S. and Other Non-EU Counterparties and the Potential Impact of Brexit (Aug. 29, 2016).
To date, many EEA international banks and other financial institutions have added bail-in language to their U.S. law governed legal documentation forms, which has generally been accepted by borrowers without significant objection. However, the new bail-in powers pose certain practical concerns to financial market players. For example, Brexit may give rise to the question of whether, in agreements that are subject to English (or Scottish or Northern Irish) law that are likely to continue for longer than two years, we should include a bail-in clause. Moreover, it is still unclear what is meant under “material amendment” or covered liabilities for purposes of the new rules since specific definitions are not provided in the legislation. Finally, whether contractual recognition clauses will be enforceable under U.S. state laws is an open question since there is no assurance that bail-in clauses satisfying Article 55 will be enforceable in non-EEA jurisdictions. The “wait and see” attitude is currently dominating the financial market, and any additional guidelines and clarifications by European authorities would be helpful to shed more light on potential issues relating to the implementation of new bail-in rules.