The European Union is never happier than when it is changing a sovereign country’s laws for it. Normally it limits its role to changing the laws of the various EU member states. However, when the EU elected to make mandatory provisions for non-EU foreign law governed documents in the Bank Resolution and Recovery Directive (or EU Directive 2014/59, to give it its official title) that certainly looked like breaking new ground.
The premise behind the Directive is not terribly exciting. For anyone who hasn’t been paying attention for the last five or so years, various European banks have managed to get themselves into financial trouble. A number of them have been the subject of state intervention. More recently (as taxpayers became more and more stretched) this aid has taken the form of “bail-ins”, which is a nice way of saying forcibly writing off or converting external debt into equity in the bank.
However, the concern of the Commission was that where a European financial institution was subject to a bail-in or other form of Governmental intervention, the effect of that intervention might not be recognised in a foreign (non-EU) country. At its crudest level, the worry was that if the creditors of an EU bank were forced to take a haircut, the Commission was concerned that foreign creditors might seek to enforce any security or guarantees for the full face value of the debt, and disregard the haircut.[i]
Mandatory contractual provision
The Commission could not literally re-write foreign laws, so they tried to do the next best thing. The Directive introduces a mandatory requirement: any person who enters into a foreign law governed contract with a person who is regulated in an EU country as a bank[ii] is required to include a clause in their contract providing that any haircut or debt-to-equity swap mandated by a competent authority in that EU country will be given effect to.
Although circumventing the operation of foreign national laws by trying to force provisions into contractual documents is clunky, it is certainly not unprecedented. Most offshore jurisdictions put similar provisions into their laws in relation to segregated portfolio companies to prevent the operation of foreign bankruptcy laws in a way which conflicts with the intended operation of the regime. And derivative contracts have used the “one contract” clause familiar in ISDA Master Agreements for decades to circumvent and prevent cherry picking under foreign bankruptcy laws.
However, the Directive works slightly differently. It requires counterparties to include such covenants in their debt documents when dealing with EU banks. But it doesn’t specify what consequences will apply if you don’t. This is probably because the debt document is, by definition, governed by a foreign law, and so it is that foreign law which will have to determine the consequences.
Effect of breach
What exactly will the consequences be if a party does not include such a clause in their contract? Well, in the common law jurisdictions such as BVI, Bermuda and Cayman, the answer is not immediately clear. EU law is not directly applicable in those jurisdictions. Failing to take account of a provision of foreign law where the only connection with the contract is that one of the parties is domiciled there does not normally have any impact under conflict of laws rules unless that is the place of the performance of the obligation in question.[iii] The most likely possible source of consequences might be an exposure to an action by a national regulatory authority when the Directive is implemented under the laws of member states. However, the obligation to include the clause is expressed to be an obligation of the EU bank only, who is the party that the clause is also intended to benefit. If a bank has been the subject of Governmental intervention, it seems an unlikely candidate to then be fined.
Accordingly, whilst it seems likely that most counterparties dealing with European Union banks are likely to comply with requests to include such provisions in their contracts (not least because it seems likely that banks will insist upon them), it is certainly going to be interesting to see what happens if a Governmental authority does try to impose a haircut in a foreign contract where such a provision has not been included.
[i] This is oversimplifying it slightly. Article 63(1) of the Directive contains a long list of types of intervention which must be given effect to – it is not limited to simple haircuts or debt-to-equity swaps, although those are clearly what the Commission was most concerned with.
[ii] This is also oversimplifying it slightly. The Directive contains a more detailed definition of entities which are caught, and these are set out in Article 1(1) (although cross-refer to other European Directives).
[iii] Ralli Bros v Compania Naviera Sota y Aznar  1 KB 614;  2 KB 287.