KEY POINTS TO TEST THE DIRECTIVE RECOVERY RESOLUTION BANK AND THE PUTTING –BayernLB and are locked in a battle over the winding-down of Hypo-Alpe-Adria Feature Bank, with BayernLB one of the largest creditors “bailed in” under a new special law which cancels sub-sovereign guarantees. –A complaint by BayernLB to the Austrian Constitutional Court may lead to a reference to the CJEU over interpretation of the Bank Recovery and Resolution Directive. –There are strong arguments that the new law fails to adhere to key restrictions on use of the bail-in tool. Interpretation of Arts 43 and 44 of the Bank Recovery and Resolution Directive is likely to be crucial to determining the legality of cancelling sub-sovereign guarantees as part of a bail-in.

Authors Hodge Malek QC and James Potts Putting the Bank Recovery and Resolution Directive to the test

This article examines a dispute over one of the most controversial European bank turing obligations until 2019; court bail-ins to date, of Hypo-Alpe-Adria Bank, and considers how the CJEU is likely to proceedings will determine whether they interpret the bail-in powers in the Bank Recovery and Resolution Directive. qualify as restructuring obligations, in which case they will cease to exist; –any liquidation profits to be distributed The likelihood of the Court of Justice provide welcome insight on the limits of proportionately to creditors of restruc- ■of the European Union (CJEU) the bail-in powers. turing obligations and then to share- being required to rule on EU bail-in holders, but without any regard to the legislation has significantly increased, as FEDERAL LAW ON REMEDIAL guarantees. German BayernLB pursues a MEASURES FOR HAA complaint to the Austrian Constitutional HAA has had a troubled history since a Likely to give rise to further Court over alleged “expropriation” of decade of breakneck expansion in Austria controversy is the fact that the guaranteed €800m in guaranteed as part of the and the Balkans came to a sharp halt in the subordinated debt includes €150m of debt bail-in of failed Austrian lender Hypo- financial crisis. It was sold by the province held by a subsidiary of the World Bank, Alpe-Adria Bank International AG of Carinthia to BayernLB in 2007, bailed the International Bank for Reconstruction (HAA). out by the Austrian government in 2008, and Development. The World Bank has Austria’s “Federal Law on Remedial and then nationalised in 2009. sought an exemption from the bail-in. Measures for HAA”, which came into force The Federal Law is part of a package Ordinarily, international convention is on 1 August 2014, seeks to wind down the of measures seeking to avoid HAA that it is given preferred creditor status. troubled bank whilst avoiding much of the simply going into insolvency by instead However, to date Austria has refused, and burden falling on Austrian taxpayers. It transforming it into an asset management the World Bank is said to be considering breaks new ground by wiping out €800m company (Heta Asset Resolution AG) legal action (Art VII(4) of the IBRD’s of loans by BayernLB (which is 94% owned without a banking licence and partially Articles of Association provides that its by the state of ) and €890m of other exempt from normal insolvency laws, in assets are “immune from… expropriation subordinated debt, despite guarantees by order then to wind down its portfolio and or any other form of seizure by executive or HAA’s home province of Carinthia. (It realise its assets. This will be carried out legislative action”). If the World Bank were is likely that the ultimate bill under the via a federal divestment holding company. exempted, the burden would fall yet more guarantees would have been picked up by The Federal Law provides for: heavily on other bondholders, which might the central Austrian government.) –bail-in of €890m of subordinated debt well give rise to further arguments that The Federal Law raises significant with redemption dates pre-dating 30 the bail-in offends the principle of equal questions about the scope and June 2019, for which Carinthia had treatment between creditors. interpretation of the Credit Institutions provided deficiency guarantees, together This is only one strand of a long-running Reorganisation and Winding Up with cancellation of those guarantees dispute between BayernLB and Bavaria, Directive (2001/24/EC) (“CRWD”) (however, guarantees by the State of on one side, and HAA and the Austrian and the Bank Recovery and Resolution Austria in respect of debt with redemp- authorities, on the other. The Directive (2014/59/EC) (“BRRD”). Many tion dates post-dating 30 June 2019 will Regional Court has begun hearing the trial of these issues are unlikely to be found not be cancelled); of BayernLB’s action against HAA for “acte clair” and therefore, unless Austria –bail-in of €800m of loans from BayernLB refusing to repay €2.4bn of loans following reaches a settlement with BayernLB and made after the 2008 bail-out, which were HAA’s nationalisation in 2009. HAA other affected creditors, may necessitate also guaranteed by Carinthia; claims it was under-capitalised from 2007- a reference to the CJEU, which would –compulsory deferral of disputed restruc- 2009 and that BayernLB’s managers hid

Butterworths Journal of International Banking and Financial Law January 2015 7 Feature

this from regulators and investors; it has on the following bases: mechanism in either the CJEU or the counterclaimed for repayment of €3.4bn –Extra-contractual liability of the EU Spanish administrative courts. of loans that have already been redeemed. for losses resulting from adoption of Separately, in December 2014 Austria the bail-in scheme (pursuant to Arts CREDIT INSTITUTIONS filed a claim against BayernLB for €3.5bn 268, 340(2) and 340(3) TFEU). REORGANISATION AND WINDING alleging it was misled about HAA’s financial –Violation of the right to property in Art UP DIRECTIVE condition when Austria agreed to bail it out 17(1) of the Charter of Fundamental CRWD does not seek to harmonise in 2008. In the same month BayernLB sued Rights of the EU (“the Charter”) and reorganisation and winding up measures Austria for €2.4bn claiming the government Art 1, Protocol 1 of the European Con- across Member States, but principally aims had guaranteed HAA’s post-nationalisation vention on Human Rights (ECHR). to ensure that such measures are mutually loans. On 12 December 2014 the Vienna –Breach of the principles of proportion- recognised (see recital (6)). “Reorganisation Commercial Court handed down judgment ality, protection of legitimate expecta- measures” are defined in Art 2 as: dismissing a test case brought by BayernLB tions, and non-discrimination. against one of the former shareholders “measures which are intended to from which it bought HAA, finding that Netherlands preserve or restore the financial BayernLB had been misled but would have In 2013, the Netherlands nationalised situation of a credit institution and bought the bank without a discount anyway; SNS Bank and SNS Reaal, expropriating which could affect third parties’ pre- BayernLB has said it will appeal. the holdings of shareholders and junior existing rights, including measures Meanwhile, Austria has agreed to bondholders without compensation. The involving the possibility of a suspension sell off HAA’s prime asset, its Balkans Amsterdam Court of Appeal’s Enterprise of payments, suspension of enforcement PUTTING THE AND BANK RESOLUTION RECOVERY DIRECTIVE THE TEST TO network, to US private equity firm Advent Chamber ruled that compensation should measures or reduction of claims”. International and the European Bank for be paid, but this did not derail the bail-in Reconstruction and Development. A sale as a whole. The European Commission Article 3 provides that member states was one of the European Commission’s adopted Decision C (2013) 1053 (22 “shall alone be empowered to decide conditions for permitting Austria to grant February 2013), finding that state aid on the implementation of one or more state aid to HAA. BayernLB has indicated provided by the Netherlands as part of the reorganisation measures in a credit it will refuse to consent to the sale, which bail-in was compatible with the internal institution”, in accordance with domestic if it led to the deal falling through could market. A challenge to this decision, law. The Directive envisages that credit put HAA in breach of the EC’s state aid Adorisio v Commission (Case T-321/13) institutions in difficulty must be wound up conditions. was ruled inadmissible by the CJEU, in the absence of reorganisation measures including on the basis that annulment of or in the event of such measures failing NEW TERRITORY FOR EUROPEAN the Commission’s Decision would not have (recital (13)). BAIL-INS any legal effect on the expropriation of the However, the Directive does not Bailing in instead of bailing out is the new applicants and it had not been shown that, specify the content of powers to implement normal in the Eurozone. No wholesale even if annulment led to the insolvency reorganisation measures. Nor does it legal challenge to a bail-in has yet been of SNS Bank and SNS Reaal, this would mandate any derogation from fundamental successful, but none has gone as far as procure any advantage for them. Treaty principles, such as the principle the HAA bail-in in cancelling deficiency of equal treatment between creditors (to guarantees by a sub-sovereign body. Spain which express reference is made in recitals The Spanish bail-in legislation introduced (12) and (16)). Accordingly, it would be Cyprus under Royal Decree-Law 24/2012 (in force questionable if it were suggested that In the case of Cyprus in 2013, depositors from 31 August 2012) mirrors Spanish CRWD provides a mandate for the Federal with uninsured deposits over €100,000 insolvency law, with shareholders the Law, which both disadvantages creditors as were bailed-in as shareholders to first to bear losses, followed by preference compared with an insolvency situation, and recapitalise the Bank of Cyprus and the shareholders and then bondholders in order treats creditors unequally since guarantees Laiki Bank, whereas insured deposits of priority. There is specific provision that by Austria will be honoured whilst were exempt. A number of actions for investors whose assets are expropriated guarantees by Carinthia are cancelled. damages have been brought by investors are entitled to payment of no less than Austria does not itself appear to rely in the CJEU, but none have yet been that which they would have received in an on CRWD for that purpose. According to determined by the court. For example, in insolvency situation. This may be at least an Opinion of the European Central Bank K Chrysostomides & Co v Council (Case in part why there has been no reported dated 29 July 2014 on a draft version of the T-680/13) the applicant is bringing claims wholesale challenge to the Spanish bail-in Federal Law:

8 January 2015 Butterworths Journal of International Banking and Financial Law PUTTING THE BANK RECOVERY AND RESOLUTION DIRECTIVE TO TEST THE DIRECTIVE RECOVERY RESOLUTION BANK AND THE PUTTING Feature

“Article 6 of the draft law states that of significant adverse effects on the Restrictions on use of bail-in tool the Federal Law on the reorganisation financial system, and protection of There are significant restrictions on use of the of [HAA] serves the purpose of public funds “by minimising reliance bail-in tool, which are likely to be relied on by transposing Directive 2001/24/EC. The on extraordinary public financial BayernLB and other investors to question the ECB understands that the sole purpose support”; legality of the HAA Federal Law. of this provision is to establish that (2) in accordance with the general Firstly, Art 44 BRRD provides that measures provided for in the draft law principles governing resolution in Art the bail-in power is not to be applied are reorganisation measures within the 34, which include that creditors shall to certain types of liability, including meaning of Article 2 of that Directive.” bear losses in accordance with the covered deposits and secured liabilities order of priority of their claims under such as covered bonds and secured However, even that limited reliance normal insolvency law, creditors of hedging products. “Covered deposits” may be misplaced. The measures under the the same class are to be treated equal- refers to deposits protected under a Federal Law arguably do not fall within the ly, and no creditor shall incur greater deposit guarantee scheme (see Art 2(1) definition of “reorganisation measures” at losses than would have been suffered (5) of Directive 2014/49/EU on deposit all, since there is no intention for HAA to in an insolvency situation; and guarantee schemes). However, recital (70) continue in existence as a credit institution; (3) for at least one of the following appears to go further and states that: it is therefore doubtful whether these purposes: “[i]t is not appropriate to apply the bail-in are measures “intended to preserve or (a) to recapitalise an institution so that it tool to claims in so far as they are secured, restore the financial situation of a credit can continue its authorised activities, collateralised or otherwise guaranteed.” institution”. In particular, HAA will no such as banking activities (but only The words “or otherwise guaranteed” longer have a banking licence; rather, the if there is a “reasonable prospect” of are not found within the articles of the intention is to restructure HAA prior to measures restoring the institution to Directive itself, but appear to suggest that winding down in order to avoid the burden “financial soundness and long-term EU lawmakers did not envisage BRRD that would fall on Austrian taxpayers in a viability”); or being used as the basis for cancellation of straightforward insolvency situation. (b) to convert to equity or reduce the guarantees (not just in respect of covered principal amount of claims or debt deposits under a deposit guarantee BANK RECOVERY AND instruments that are transferred scheme). RESOLUTION DIRECTIVE pursuant to one or more of the other Secondly, any resolution action is The Austrian Government also relies resolution tools provided in BRRD, expressly subject to the provisions of the prospectively on BRRD, which entered namely: Charter. As stated in recital (13), “[i]n into force on 2 July 2014 and is to be (i)to a bridge institution (ie a com- particular, where creditors within the same implemented across Europe by 1 January pany controlled by the resolution class are treated differently in the context 2016. BRRD is a minimum harmonising authority which temporarily takes of resolution action, such distinctions measure intended to establish “a ownership of the institution: Art should be justified in the public interest framework for the recovery and resolution 40), or and proportionate to the risks being of credit institutions and investment (ii)under the “sale of business tool” (ie addressed and should be neither directly firms”; member states are allowed to adopt sale on commercial terms to a pur- nor indirectly discriminatory on the or maintain stricter or additional rules chaser who will continue the relevant grounds of nationality.” (Art 1(2)). authorised activity, such as banking: Thirdly, the resolution tools such as the Art 38) or the “asset separation tool” bail-in tool should only be applied where Bail-in tool (ie transferring assets to an asset they are necessary and the institution BRRD Arts 43 and 44 establish the management vehicle controlled by cannot be wound up under normal objective and scope of the bail-in tool. the resolution authority with the aim insolvency proceedings without destabilising Member states are required to ensure of selling or winding them down: the financial system; the principle of that national resolution authorities have Art 42). proportionality should be taken into account all of the resolution powers specified in (recital (49)). Interference with property Art 63, which include the power to cancel Given that the intention is not for rights should not be disproportionate, debt instruments. Use of the bail-in tool HAA to continue its authorised activities, and affected shareholders and creditors is subject to the conditions in Art 43(2), Austria could only rely on the purpose of should not be worse off than under normal namely that it must be exercised: converting to equity or reducing debt prior insolvency proceedings (recitals (50) and (1) having regard to the resolution objec- to use of the bridge institution and asset (73)). The bail-in tool should be applied so as tives in Art 31, including avoidance separation tools. to respect the pari passu treatment of creditors

Butterworths Journal of International Banking and Financial Law January 2015 9 Biog box Feature Hodge Malek QC and James Potts are barristers at Thirty Nine Essex Street Chambers specialising in financial services and commercial law. Website: www.39essex.com. Email: [email protected]; [email protected]

and the statutory ranking of claims under the resolution of HAA. NEXT STEPS applicable insolvency law (recital (77)). Accordingly, it may well be possible for HAA will have until around January Although as stated in recital (55) the BayernLB and others to argue successfully 2015 to respond to BayernLB’s complaint resolution tools should be applied before that cancellation of the Carinthia guarantees to the Constitutional Court, and a ruling resort to extraordinary public financial is a disproportionate interference with is expected later in 2015. Meanwhile, support, the Directive expressly envisages property rights and a breach of the Charter a number of other investors are taking circumstances in which public financial and ECHR. The Federal Law does not action in the courts in Carinthia. support may be provided (subject to state aid provide for reasonable compensation, Austria’s Finance Minister has indicated rules) to protect deposits covered by deposit as is usually a requirement in cases of willingness to hold talks with HAA’s guarantee schemes or discretionarily excluded expropriation (and as the Dutch courts held creditors. It is as yet unclear whether creditors. in the case of SNS Bank and SNS Reaal). Austria will grant the World Bank preferred creditor status; if not, the World Bank could take action against “... it may well be possible for BayernLB... to argue Austria, but granting an exemption successfully that cancellation of the Carinthia guarantees will reinforce BayernLB’s complaints of unequal treatment. is a disproportionate interference with property rights...” It waits to be seen whether the Austrian courts consider they need to BRRD as basis for HAA Federal Law On the other hand, the CJEU tends to afford interpret and apply the Directives in There are strong arguments that the Federal member states considerable discretion over order to determine the complaint, and PUTTING THE AND BANK RESOLUTION RECOVERY DIRECTIVE THE TEST TO Law contravenes the restrictions on the use of how they organise their financial affairs, if so whether they consider the EU law the bail-in tool. making the court slow to intervene. It would in this area to be “acte clair” or whether Firstly, recital (70) suggests the bail-in therefore be interesting to see whether the a reference to the CJEU is required. tool should not be applied to guaranteed CJEU would draw the distinction between It will be particularly interesting to claims, which appears to be wider than just recourse to taxpayers based on pre-existing see what position adopts on “covered deposits” under a deposit guarantee liabilities and recourse as a direct result of a any reference, since on one hand it has scheme. However, given that the words “or bank resolution. spearheaded the EU’s policy of bailing- otherwise guaranteed” are not repeated in the Thirdly, there may well be an argument in over bailing-out but, on the other, its body of the Directive, it will be interesting to that cancellation of the Carinthia but own banking system has till now relied see whether the Constitutional Court (and, not the Austria guarantees is indirectly heavily on sub-sovereign guarantees to if necessary, the CJEU) interprets this as discriminatory on grounds of nationality Landesbanken. applying to the guarantees by Carinthia or if (as seems to be the case) the Carinthia Whilst this continues, and BayernLB construes it more narrowly as including only guarantees were given disproportionately struggles in the German courts to recoup covered deposits. in favour of non-Austrian bondholders its loans made to HAA following its Secondly, there is clear unequal treatment such as BayernLB in the wake of the 2008 nationalisation in 2009, BayernLB may of subordinated creditors within the same class bail-out of HAA. itself have to delay repaying loans received since guarantees by Carinthia, but not those by Fourthly, the cancellation of the from Bavaria during the financial crisis, Austria, have been cancelled. It is difficult to guarantees by Carinthia means creditors raising issues as to whether the European see a coherent justification for this distinction, are significantly worse off than they would Commission would consider this a breach of let alone how it is proportionate in light of have been in a straightforward insolvency state aid rules. „ the very substantial disadvantage suffered situation. Again, there is a lack of credible by holders of debt guaranteed by Carinthia. justification for departing from ordinary Although EU policy increasingly seeks to avoid insolvency principles (which are generally Further reading taxpayers shouldering the burden of struggling respected as part of bail-in mechanisms, –From bail-out to bail-in: Are banks financial institutions before bondholders such as that of Spain in Royal Decree-Law becoming safe to fail? [2014] 8 JIBFL (hence the policy shift from bail-outs to bail- 24/2012). The potential burden on taxpayers 494 ins), on the face of it any future demand on in a normal insolvency situation arises from –Valuation in resolution and the “no the guarantees provided by Carinthia would pre-existing liabilities under the guarantees, creditor worse off principle” [2014] 1 not have been “extraordinary public financial rather than being akin to taxpayers being JIBFL 16 support” of the type deprecated by BRRD: the forced to bail out a bad bank, so the –Lexis PSL: : guarantees were provided to BayernLB and justification for avoiding that burden seems Recovery and resolution: failing others on a commercial basis years before the weak. financial institutions

10 January 2015 Butterworths Journal of International Banking and Financial Law