Later this year, a U.S. appellate court will decide whether sovereign immunity shields a nationalized Irish bank from claims by two investment funds holding notes issued by the bank. The decision will likely have broad implications for holders of European bank debt as the ongoing European debt crisis has already caused several banks to be nationalized (including Spanish bank BFA-Bankia in May) and more nationalizations may be on the way.
The Second Circuit Court of Appeals will be reviewing the November 2011 district court decision in Fir Tree Capital Opportunity Master Fund v. Anglo Irish Bank Corporation Limited. In 2005, two private investment funds organized in the Cayman Islands purchased $200 million in notes issued by the Anglo Irish Bank which was later nationalized in 2009. The lower court dismissed the funds' request to stop the bank from merging and liquidating its assets, and to set aside enough money in the U.S. to pay the funds back. The court's basic reasoning was that, after being nationalized, the Anglo Irish Bank was endowed with sovereign immunity under the Foreign Sovereign Immunities Act and hence beyond the court's jurisdiction.*
Creditors in European banks and other firms that have been or may be nationalized can take several actions to reduce this type of credit risk that arises from a non-U.S. debtor becoming immune to claims due to nationalization. These actions include charging higher interest to compensate for nationalization risk, an up-front waiver of sovereign immunity, organizing investment entities in the U.S. to benefit from U.S. treaties with other nations, or segregating a foreign bank's assets in a special purpose entity in the U.S.
Another method bank creditors can use is contractual. The notes (or a related agreement) should include a provision that expressly recognizes nationalization (or actions taken prior to nationalization) as an event of default that empowers creditors to accelerate their right of repayment. The court in Fir Tree highlighted the fact that the funds' notes did "not directly address the ramifications of a nationalization."
A May 2012 synthetic collateralized debt obligation exemplifies this contractual approach to protecting creditors from nationalization risk. As noted by Christopher Elias,
Following recent clashes in New York courtrooms between investors and nation states over sovereign immunity on nationalized assets, the debt programme includes a “nationalisation” trigger in its extraordinary events. The extraordinary events provide that upon a merger event, a de-merger, de-listing, insolvency or nationalisation, then the calculation agent may decide in good faith to apply a method of substitution with respect to the affected shares or ADRs. The method of substitution provides that affected shares or ADRs may be converted into cash and the proceeds reinvested in new shares or new ADRs.
This provision protects synthetic noteholders by permitting payments to be adjusted to events post-nationalization.
______________
*The court also rejected several arguments raised by the funds. The court found that sovereign immunity was not waived by the Irish government, that as Cayman Island-organized funds the plaintiffs were not entitled to protection under any U.S.-Irish treaty, and that the bank's conduct post-nationalization did not constitute the type of "commercial activity" required to pierce soverign immunity.
Comments