Contractual Recognition Of Bail-In

Contractual Recognition of Bail-in

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 affects.

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...