The Impact of Banking Resolution Mechanisms on Shareholders’ rights
In the aftermath of the 2008 financial crisis, which exposed significant shortcomings in institutional crisis preparedness, the European Union introduced a robust banking resolution framework designed to handle the failure of financial institutions without jeopardizing financial stability or burdening taxpayers. Key among these are the Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism Regulation (SRMR).
Bank resolution differs fundamentally from traditional insolvency proceedings, and thus liquidation. Resolution mechanisms aim to broader objectives such as to preserve public interest by maintaining critical functions, ensuring financial systemic stability, and protecting taxpayers and depositors. In practice, the EU resolution framework is designed to ensure that a failing institution can resume operations as a non-failing entity on the after the "resolution weekend."
While saving the banks could be achieved through bail-outs, shifting the financial burden to taxpayers and offering leniency to shareholders, the EU’s resolution framework prioritizes bail-ins, ensuring losses are absorbed primarily by the bank’s shareholders and creditors.
Resolution stages
The resolution framework follows four stages: preparation and prevention (drafting of recovery and resolution plans), early intervention, write-down or conversion of capital instruments , and resolution. The first stage is preparatory, while the subsequent stages, which involve actual intervention, are triggered only if specific conditions for resolution are met.
Conditions for resolution
First, the resolution authority must determine if the bank is FOLTF (failing or likely to fail). Under Article 32 of the BRRD (article 18 par 4 of SRMR), an institution is deemed FOLTF if:
(a) it violates or is likely to soon violate authorization requirements, possibly due to significant losses depleting its funds; and/or
(b) its assets are or are likely to become less than its liabilities (over-indebtedness); and/or
(c) it is or is likely to become unable to pay debts as they fall due (liquidity problems); and/or
(d) it requires extraordinary public financial support, except in cases addressing serious economic disturbances and preserving financial stability.
Second, there are no reasonable prospects of private sector intervention or supervisory action restoring the institution's viability within a reasonable timeframe.
Third, the resolution is deemed necessary in the public interest.
The resolution mechanisms
If a financial institution is deemed to be under resolution by the resolution authority, the authority is vested with four resolution tools (articles 37 to 44 of BRRD). The bail-in tool, along with three transfer to a separate entity tools: the sale of business tool (transfer of viable parts of a failing institution to a purchaser under commercial terms, 20 excluding bridge institutions), the bridge institution tool (establishment of a temporary bridge bank), and the asset separation tool (isolation underperforming or toxic assets). The bail-in process involves two key ways: a) recapitalizing a financial entity under resolution to restore its regulatory compliance and long-term viability, while also converting claims or debt instruments into equity or b) reducing their principal to provide capital for a bridge institution or facilitate asset sales during the resolution process.
Resolution and moral hazard
The existence of a bail-in also helps mitigate moral hazard. BRRD positions shareholders claims in the bottom of the ladder according to the “shareholders bear losses first” principle. Wihtout the bail-in process, shareholders and managers might be incentivized to take excessive risks, assuming that any losses in the event of failure would be borne by external governmental intervention.
Shareholder Rights Under Pressure
The BRRD and SRMR grant resolution authorities extensive powers, including the ability to write down equity, transfer shares, or appoint special managers. Shareholders' property rights and governance rights often bear the brunt of these measures. For instance, the bail-in tool converts or eliminates shareholder equity to absorb losses or recapitalize the bank, potentially reducing investments to zero.
Right to property
The right to property is protected under Article 17 of the CFREU[1] and article 1 of First Protocol to the European Convention on Human Rights.[2] According to these provisions, the deprivation of property is prohibited unless it satisfies specific and essential conditions.
First, it must serve a legitimate and duly justified "public interest".
Second, any interference with shareholder rights must balance public needs and individual protections, ensuring fairness under the EU Charter of Fundamental Rights.
Third, central to justifying such a restriction on the right to property in the interest of the public is the requirement for "fair compensation". In this regards, the No Creditor Worse Off (NCWO) Principle outlines that shareholders cannot suffer greater losses in resolution than they would have in standard insolvency proceedings. If they do, they are entitled to compensation.
Governance rights
Under company law, shareholders, including minority shareholders, play an active role in controlling the company and participating in decision-making. However, resolution legal framework provides resolution authorities with powers that may infringe the the governance rights of shareholders, in the following ways:
a) In the early intervention stage, the resolution authority is entitled to take appropriate measures.
b) In the resolution process, the resolution authority is entitled to appoint a temporary administrator who must act, though, in compliance with the proporionality principle, a safeguard for shareholders.
c) Under article 35 of BRRD, the resolution authorities may appoint a special manager to replace the management body of the institution. Again, any act of the special manager must be in compliance with the proportionality principle.
d) Finally, the resolution authority is vested with the “general powers” of article 29 BRRD. Those with the greatest impact on shareholders right to governance include the authority to demand necessary information, conduct on-site inspections, assume full control of the institution (exercising all rights of shareholders, owners, and management), transfer shares, rights, or assets to another entity with its consent, and reduce eligible liabilities to zero, effectively eliminating shareholder value. Under Article 62 par. 2 BRRD, resolution authorities can execute these actions without seeking approval from shareholders.
Conclusion
In conclusion, the tools and principles established by the BRRD and SRMR have demonstrated their effectiveness in preserving financial stability and minimizing taxpayer burdens during bank resolutions. However, their implementation remains a complex and contentious area, raising critical questions about balancing public interest with the protection of shareholder rights. While the resolution framework incorporates safeguards—both through specific provisions in the legislation and the overarching principles of EU law—ongoing refinement and judicial interpretation are necessary to ensure fairness, legal certainty, and proportionality. For investors and regulators, understanding these dynamics is essential in navigating the evolving landscape of banking resolution.
[1] Article 17 of the CFREU: “everyone has the right to own, use, dispose of and bequeath his or her lawfully acquired positions. No one may be deprived of his or her possessions, except in the public interest and in the cases and under the conditions provided for by law, subject to fair compensation being paid in good time for their loss. The use of property may be regulated by law in so far as is necessary for the general interest.”
[2] Article 1 of the First Protocol: “Every natural or legal person is entitled to the peaceful enjoyment of his possessions. No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law. The preceding provisions shall not, however, in any way impair the right of a State to enforce such laws as it deems necessary to control the use of property in accordance with the general interest or to secure the payment of taxes or other contributions or penalties”.
Disclaimer: This article is for informational purposes only and should not be construed as legal or financial advice. The content reflects a general analysis based on publicly available information and academic discussions but may not address specific situations or jurisdictions. Readers seeking legal, financial, or other professional advice should consult a qualified expert. The author and owner of this website disclaim any liability for actions taken based on this article.
