Credit Suisse (CS) might be no more after it was forced into the arms of rival UBS, but the legal backlash arising from the government-orchestrated deal is just gathering storm. With investors worldwide (including in Asia) decrying the Swiss authorities for evaporating billions of dollars in additional tier one (AT1) bonds, law firms are gearing up for protracted legal battles.  

But first, a bit of background. CS met its sudden demise in March, as mounting fears for the troubled Swiss lender’s liquidity essentially penned a swift end to its 167-year history. This episode not only put regulators on heightened alert, but also introduced a fresh slew of legal questions facing the Swiss authorities.   

In a bid to preserve the golden brand of Swiss banking, the Swiss government swooped in to orchestrate a shotgun marriage between CS and its local rival, UBS, hoping to smother a wider financial crisis of global implications reminiscent of 2008.

Some level of confidence seemed to have been restored, and the global banking system is still standing. But the government’s bold emergency rescue has unleashed a foreseeably protracted legal fight with multiple fronts. Lawsuits have been filed from countries including the United States, the UK, and Singapore, against the Swiss financial regulator, Finma.

Sanctioned by two emergency ordinances, Finma greenlit the wipe-out of $17 billion of AT1 bonds issued by CS to make the deal easier to swallow for UBS. As a result, holders of these high-risk convertible bonds took the bullet, while shareholders were handed $3.25 billion in UBS shares, in a move that appeared to bust the debt recovery rulebook wide open and caused uproar amongst empty-handed investors feeling blindsided by the move.

Litigation powerhouse Quinn Emanuel Urquhart & Sullivan led the charge against Finma by joining forces with several law firms representing AT1 bondholders across different jurisdictions. Their case is centred on the “proportionality” and “good faith” of Finma’s decision following the Swiss Constitution.

Across the Asia-Pacific region, Singapore Big Four firm Drew & Napier is working with Swiss firm Nater Dallafior to help two groups of around 90 bondholders bring administrative law challenges based on Swiss legal principles.

“Our clients are seeking to, among other things, set aside the Finma Order with CS reversing the write-down and cancellation of all AT1 bonds and acknowledging its obligations to bondholders with retroactive effect to the time immediately before the write-down,” explains Benedict Teo, head of banking and financial disputes at Drew & Napier.

“The challenge rests on the basis that Finma’s exercise of its discretion to order CS to write down the AT1 bonds was improper and/or invalid and that the order to CS to write down the bonds violated the principle of proportionality and was issued in bad faith,” notes Teo. Mahesh Rai, a dispute resolution director, is working on the matter with Teo.

Some law firms representing investors based in Asia are pursuing alternative legal strategies to seek redress. One of these arguments accused Finma of breaching investment protection clauses enshrined in the multilateral treaties signed between Switzerland and these Asian countries, including Singapore, China, Japan, and South Korea.

Shaun Leong, a dispute resolution partner at Withers KhattarWong, says his firm is taking a rights-centric approach based on international investment law when representing “a massive group of investors, funds to family offices” mainly from Singapore.

There are questions “as to what extent can non-Swiss based investors avail themselves of any arguments arising from the Constitution. It is also not immediately clear how the administrative action would result in compensation to investors,” says Leong.

However, “Investors have rights, and we hope to be able to challenge against any arbitrary exercise of powers,” he adds.

Insurance specialist RPC advises institutional intermediaries, who are under pressure from their bondholder clients and bondholders in Asia, according to disputes and investigations partner Jonathan Crompton.

In addition, “we are in the process of advising bondholders in Asia on practical options that will maximise their chances of recovering losses from the bonds in a cost-effective manner,” says Peter Kwon, a financial disputes and advisory partner at RPC.

VIOLATING EXPECTATIONS

Traditionally known as the “absolute priority rule” in corporate reorganisation and bank restructurings, creditors cannot be forced to accept cuts if shareholders are not completely wiped out.

As such, lawyers representing bondholders accuse Finma of violating the investors’ legitimate market expectations in a rebuke to the argument that it was never codified that the AT1 instruments are senior to equity.

“One of the key questions we need to ask is, ‘What legitimate expectations did the AT1 bondholders have in the face of such an extraordinary intervention by the state?’ When it comes to debt securities, this is a legal question and not merely a practical one, which is evident from extensive risk factors set out in the relevant documentation,” says RPC’s Kwon.

Leong of Withers points out that bondholders’ expectations that their investment ranked above equity go beyond common-sense legal hierarchy. “Bondholders are not granted the powers and privileges that come with being a shareholder,” says Leong.

Drew’s Teo concurs, drawing on an industry-wide rebuttal to the Swiss decision. “European regulators, including the Bank of England and the European Central Bank, as well as the Monetary Authority of Singapore, issued statements reassuring investors that AT1 bondholders rank above shareholders under the resolution frameworks in their jurisdiction. These moves underscore the long-established practice of giving bondholders priority over shareholders in debt recovery,” says Teo.

CONTRACTUAL RIGHTS

On May 18, a Swiss court handed the first legal victory to aggrieved bondholders by ordering Finma to release the fateful decree asking CS to wipe out their investments, giving claimants a boost of visibility into the core legal issue.

Finma has insisted that the order was justified based on the AT1 prospectuses, which stipulated that write-downs could be triggered if a “Contingency Event” or a “Viability Event” occurs.

It was undisputed that a “Contingency Event” – which required the common equity tier 1 capital ratio of CS to fall below seven percent – did not materialise.

But debates have been raging over whether there arose a “Viability Event,” where in one scenario, Finma must determine that a write-down is essential to prevent CS from becoming insolvent or from ceasing to carry on its business while “customary measures” to improve the bank’s capital adequacy are at the time “inadequate” or “unfeasible.”

Alternatively, there must be an “irrevocable commitment of extraordinary support from the Public Sector” that improves CS’ capital adequacy.

Alluding to the second scenario, Finma stated in its decree - cited by the Financial Times - that it has satisfied the so-called “Viability Event” clause to give CS the power to write off the AT1 instruments by itself because government-backed facilities had “a direct positive effect on the liquidity and capital situation” of the Swiss lender.

“There are very specific criteria that need to be met for CS to write down its AT1 bonds under a Viability Event, and there appears to be a real question about whether all of these criteria were met properly,” says RPC’s Crompton.

Teo of Drew believes the emergency ordinances – issued by the Swiss government to give Finma a “clearer legal basis” to wipe out the bonds - speak volumes to the viability, or lack thereof, of the contractual conditions justifying the action. 

“If (CS’) contractual entitlement to do so were clear, it would not have been necessary for the Swiss Federal Council to pass the emergency ordinance to empower Finma to order the write-down and for Finma to do so accordingly,” points out Teo.

He also notes that even CS reportedly disputed privately that a “Viability Event” had been triggered to warrant a write-down. “This lends support to the view that the contractual conditions for the write-down had not been met,” notes Teo.

Adds Withers’ Leong: “While there may be a contractual provision in the bond documentation that allows for the AT1 bonds to be written down, the law could in some instances imply or read provisions into the contract. It would also likely be important to understand whether the power to write down was exercised reasonably and within the applicable legal limits.”

Going forward, Teo’s team will likely be filing supplemental submissions and expect Finma and CS to respond to the appeals. “Should the appeals be successful, and depending on the grounds of the Court, this case may provide useful guidance on how AT1 bonds are dealt with in similar situations in the future,” says Teo.

And as a key takeaway, Leong suggests that investors should consider “the relevant provisions in their documentation, and ideally have a sense of the applicable dispute resolution options arising from any potential disputes on their investments” to shun a repeat of similar predicaments.