Slovenia: Subordinated Bondholders vs. State Aid: 0:1
In December 2013, the Bank of Slovenia adopted exceptional measures resulting in the annulment of financial instruments held by shareholders and subordinated bondholders for the purpose of burden-sharing in rescuing five Slovenian banks.1 In its decision of 19 July 2016, the European Court of Justice confirmed that such burden-sharing is not contrary to EU law; however, the Slovenian public remains divided.
Contested measures trigger outrage
From 2010 onwards, the five (largest) Slovenian banks succumbed to the global financial crisis, which led them to suffer capital shortfalls, ie they did not have sufficient assets to satisfy their creditors and to cover the value of deposits. Consequently, the Bank of Slovenia decided to adopt emergency measures, which became a point of contention. The contested measures adopted on the basis of the Slovenian Banking Act (Zakon o bančništvu) included writing off equity capital as well as hybrid capital and subordinated debt, in exchange for a significant capital injection by the Republic of Slovenia, which be-came the only shareholder.
The measures triggered loud disapproval from the subordinated bondholders, who claimed a violation of their (constitutional) rights, especially their right to property. They turned to the Slovenian Constitutional Court (Ustavno sodišče) and called for a constitutional review of the contentious provisions of the Slovenian Banking Act. The Constitutional Court considered that it cannot examine the respective provisions before the nature and validity of the European Commission’s (“EC“) Banking Communication,2 on the basis of which the contentious provisions were adopted, is clarified. Therefore, it turned to the European Court of Justice (“ECJ“) for help, requesting a preliminary ruling on, inter alia, whether the provisions of the Banking Communication should be considered (de iure or de facto) binding and whether points 40 to 46 of the Banking Communication – which make the possibility of granting state aid conditional on the requirement to write off capital, hybrid capital and subordinated debt instruments – are compatible with the right to property and the principle of protection of legitimate expectations.
The European Commission’s Banking Communication
The EC introduced the updated EU state aid rules for banks during the crisis in 2013 with a view to defining common EU conditions under which Member States can support banks with recapitalisations, guarantees or bad asset transfers. The Commission vice-president in charge of competition policy, Joaquín Almunia, stressed that “bank owners and junior creditors will need to contribute before any more taxpayers’ money is spent on bank bail-outs” and that “banks will need to present a sound restructuring plan, which will lead to swifter and more efficient restructuring.“. The Banking Communication therefore provides that in case a bank no longer meets the minimum regulatory capital requirements, state aid cannot be granted before equity, hybrid capital and subordinated debt have fully contributed to offset any losses.
Should the Banking Communication be considered binding on Member States?
Sometimes the EC adopts guidelines or communications in order to establish the criteria on the basis of which it assesses the compatibility of the notified aid measures. By doing so, however, it imposes a limit on the exercise of that discretion, which it cannot exceed. In the judgment at hand, the ECJ also recalled that the EC holds exclusive competence over the assessment of the compatibility of aid measures with the internal market and enjoys broad discretion when deciding which measures are compatible with the internal market.
It follows from the foregoing that if a Member State notifies the EC of a state aid meas-ure compliant with the Banking Communication, the EC is obliged to authorise such aid. As the ECJ also emphasised, however, the Banking Communication does not relieve the EC of its obligation to examine specific exceptional circumstances. In short, (i) the Banking Communication is not binding on Member States, and (ii) the Member States retain the right to notify the EC of a proposed aid measure that does not meet the criteria laid down by the Banking Communication. In exceptional circumstances, the EC may authorise such proposed aid.
Does the principle of burden-sharing go against the principle of protection of legitimate expectations and the right to property?
The principle of protection of legitimate expectations and right to property are both generally recognised as superior principles and fundamental rights of EU law. The ECJ, how-ever, did not concur with the applicants that either of the two were breached as a consequence of the burden-sharing obligation.
In accordance with general rules applicable to shareholders of public limited liability companies, shareholders are liable for the debts of the bank up to the amount of its share capital, whereby the bank’s creditors, in accordance with the Banking Communication, should only contribute (i) after losses are first absorbed by equity, and (ii) if there are no other possibilities’ available to overcome the capital shortfall.
Banks’ shareholders and subordinated bondholders must be aware of and fully bear the risk of their investments. The ECJ recalled that the scale of losses suffered would, in any event, be the same, regardless of whether they are caused by potential insolvency proceedings, as no state aid has been granted, or by a procedure for the granting of state aid which is subject to the prerequisite of burden-sharing. In economic terms, neither shareholders nor subordinated bondholders would be worse off and hence it cannot be reasonably maintained that the burden-sharing measures, such as those laid down by the Banking Communication, constitute interference in the right to property or the principle of protection of legitimate expectations of shareholders and subordinated creditors.
In whose favour is the adopted decision?
Interestingly, the reaction to the ECJ’s judgment was positive. It seems that all parties involved in Slovenia believe that the ECJ’s decision works to their benefit. On the one hand, the Slovenian Investors’ & Shareholders’ Association is certain that this decision means that the contested burden-sharing measures should not have been adopted. On the other hand, the Slovenian Ministry of Finance also welcomed the ECJ’s decision, which confirmed that the measures in question fully comply with EU law.
The Slovenian Constitutional Court will have the final word whether the measures implemented with the Slovenian Banking Act, which required burden-sharing of the respective shareholders and subordinated bondholders, are acceptable despite the fact that the EC’s Banking Communication as such is not binding upon Member States.
Nevertheless, the ECJ’s reasoning should not come as a surprise, and while the Member States are in principle free to propose state aid measures that are not in compliance with the principles established by the EC’s decisional practice and guidelines, in practice this means that the outcome of such proceedings is much more uncertain and also time-consuming, which especially in times of crisis Member States most likely (will) try to avoid.
In economic terms, neither shareholders nor subordinated bondholders would be worse off and hence it cannot be reasonably maintained that the burden-sharing measures, such as those laid down by the Banking Communication, constitute interference in the right to property or the principle of protection of legitimate expectations of shareholders and subordinated creditors.
- Nova Ljubljanska banka, d.d., Nova Kreditna banka Maribor, d.d., Abanka Vipa, d.d., Probanka, d.d., and Factor banka, d.d.
- Communication from the Commission on the application, dated 1 August 2013, of state aid rules to support measures in favour of banks in the context of the financial crisis (the “Banking Communication”) (OJ 2013, C 216, p.1).