Just when Europe seems to be exiting recession, and following Portugal’s formal exit from its Eurozone bailout earlier this year after 3 years of painful austerity, a bank collapse in Portugal has hit the business pages as further revelations come out on a daily basis.

Banco Espírito Santo SA (“BES”) is a publicly traded universal financial services company headquartered in Portugal, the largest Portuguese listed bank by market capitalization and the second largest private-sector bank by total assets. It was held partly by its Luxembourg parent, Espírito Santo Financial Group SA, and Crédit Agricole, the latter holding over 14.6% of its capital.

BES currently has a high level of exposure to Espírito Santo group entities, and in particular, significant exposure due to subsidiary BES Angola ("BESA"). There are allegations of a substantial fraud involving BESA. In late 2013, the Angolan government guaranteed €4.2 billion ($5.2 billion) of BES’s lending, but the guarantee has apparently been revoked. It has just been announced that BESA is now under intervention by the local bank regulator, the National Bank of Angola.

On July 30, 2014, BES disclosed its semi-annual accounts. In the first six months of 2014, the bank lost the equivalent of €3.5 billion ($4.8 billion) raising concerns about the health of the bank. BES shares fells by 89%.

On August 4, 2014, as a result of these estimated losses of €3.5 billion, the Bank of Portugal passed a resolution, approved by the European Commission, to split BES into a ‘good’ bank (Novo Banco) and a ‘bad’ bank as follows:

  • BES’ general activities and assets will be transferred to Novo Banco. The share capital of Novo Banco in the amount of €4.9 billion is fully subscribed by the Portuguese Bank Resolution Fund which obtained a loan in the amount of €4.4 billion from the Portuguese government with recourse to the remainder of the banking recapitalization fund set up during the financial assistance programme by the European Commission, the European Central Bank and the IMF. Novo Banco will be “duly capitalized and clean of problem assets” and deposits are “fully preserved, as well as all unsubordinated bonds”.
  • BES will be the ‘bad’ bank and will continue to hold its problem assets, including BESA, Aman Bank (Libya) and Espírito Santo Bank (US – Miami). As the Bank of Portugal announcement states: “the losses related to problem assets will be borne by shareholders and subordinated creditors of [BES]”.

The split has led to junior bonds sliding in value as they are clearly prejudiced by this measure. Clearly, many investors and shareholders of BES are going to be not only affected by this decision but strongly aggrieved by it and will be assessing their options.

Others have also been affected and are keeping their options open. As a result of Crédit Agricole’s holding in BES, the French bank’s profits nearly halved after it wrote off the value of its investment in BES to zero. Crédit Agricole has stated that it reserves the right to take legal action. As CA's chief executive Jean-Paul Chifflet said:

"We can only regret having been misled by the family with which Crédit Agricole was trying to create a true partnership to build the biggest private bank in Portugal."

Civil and criminal investigations have apparently been commenced in Portugal and Luxembourg, but what options might be available to affected parties? Given that the full facts and details of what has happened, both at BES and in relation to the bank split have yet to emerge, it is too early to assess precisely what will happen but potential options include the following:

  • Portuguese insolvency claim: a number of actions are likely to be commenced against the bad bank which will be entering into liquidation, as the Bank of Portugal has determined that all major liabilities of BES (including all liabilities for wilful default, fraud, and breach of regulatory rules) would remain in the bad bank, together with subordinated creditors claims. 
  • Contract claims: there are likely to be contract claims against the relevant BES entities, under any notes for example. If subject to English law, then these claims may well survive an event such as this, but it will depend on whether any trustee can be forced to take action, whether any worthwhile action can be taken, and whether there is an entity on the other side with any assets that will filter down to holders at the relevant level. At the moment, there is uncertainty about precisely what assets and entities have remained with the bad bank and which have been transferred to Novo Banco. 
  • Investment arbitration claims against Portugal: the measures taken by Portugal in relation to the bank split may well constitute expropriation and unfair or discriminatory treatment of foreign investors in violation of the obligations contained in Portugal’s bilateral investment treaties. This summer, Greek depositors and bondholders of Laiki Bank and the Bank of Cyprus, whose funds were confiscated as part of Cyprus’ 2013 bailout, filed notice of ICSID investment arbitration proceedings against Cyprus. The value of the claim is estimated to be over €50 million. Similar claims for expropriation might also be brought before the European Court of Human Rights in Strasbourg for unlawful interference with property rights. 
  • Claims against parties involved in any fraud: there remains a significant lack of clarity as to precisely what went on in relation to BES, but there have been allegations of fraud in relation to BESA and it may be that investors and parties contracting with BES or its entities have been misled by them. There are also reports that a Swiss entity is somehow connected with what has gone on. 
  • Administrative law claims in Portugal: it is likely that the decision of the Bank of Portugal will be challenged before the Portuguese administrative courts (not least by the shareholders) on the ground that it is in breach of various constitutional principles, including the principle enshrined in article 62 of the Portuguese constitution that any expropriation must be in the public interest and fair compensation must be provided. 
  • Claim against BESA: Novo Banco holds a loan of over €3 billion against BESA. It is uncertain as to whether Novo Banco will be able to recover this amount from BESA. The shareholders and creditors of BES may challenge the decision of the Bank of Portugal to transfer the loan to Novo Banco, whilst the shareholding in BESA remained with BES and request that such loan is transferred back to BES. 
  • Rights issuance in BES (May 2014): retail investors have formed an association to request the annulment of the rights issue of May 2014, on the basis of the provision of incomplete and misleading information. This action may be commenced against BES, but compensation may also be sought from the Portuguese Securities Commission, which approved the Prospectus relating to the offer, but also against the entities responsible for the information contained in the Prospectus, such as the lead managers (BES Investimento, UBS and Morgan Stanley) and the auditors (KPMG).

As further facts come to light things will hopefully become clearer, but the Bank of Portugal’s split of BES undoubtedly will not satisfy all of its victims and may just have exacerbated the situation for some.

Brown Rudnick LLP has extensive knowledge of the EU Bank Recovery and Resolution Directive and extensive experience in cases similar to BES, including in Ireland, the United Kingdom, Germany, Spain, and Cyprus.