Investors file legal challenge over Portugal's BES rescue

A group of investors that lost money on Banco Espirito Santo subordinated debt, including Dan Loeb's hedge fund Third Point and Brazilian investment bank BTG Pactual, has filed a legal challenge against the Portuguese central bank over its restructuring of the distressed lender.

The lawsuit, filed on Friday in Portugal, will provide a vital test of a European regulator's ability to impose losses on shareholders and subordinated debt holders by bailing them in to rescue a failing bank instead of the lender being bailed out with taxpayer money.

The €4.9bn rescue of the distressed Portuguese lender protected taxpayers and senior creditors by leaving them in a "good bank", now called Novo Banco, but left shareholders and subordinated creditors in a "bad bank" holding only toxic assets.

The lawsuit aims to reverse the restructuring of the bank and to halt any further asset sales by Novo Banco. But ultimately the funds, including distressed debt investors GoldenTree Asset Management, Beach Point Capital and EJF Debt Opportunities, hope to recover some or all of the €375m they invested in a €750m subordinated debt issue from BES a year ago.

The investors, which hold about half the tier two unsecured debt issued by BES, are claiming that the bank's rescue was unlawful because it was decided under an unconstitutional legal framework. They argue that it breached their constitutional property rights and the right to equal treatment under the Portuguese constitution.

They also claim that the solution chosen to resolve the crisis at BES was disproportionate, inappropriate, unnecessary and unfair, because alternatives were available to inject private capital into the bank.

The investors attempted for several months to negotiate a settlement with the central bank of Portugal, but eventually gave up and instructed their lawyers at Shearman & Sterling to take legal action.

"Our view is very much there was an inconsistency in the way various creditor classes were dealt with and we have a fiduciary duty to challenge that," said one of the investors.

Finally, they allege the restructuring breached the principle of "bona fides" or "good faith" because they claim the Bank of Portugal knew, or should have known, how bad the situation at BES was and did not fully disclose it or do enough to fix it until it was too late.

The investors were angered by the announcement of a recent deal by Novo Banco to write off 80 per cent of a €3.6bn loan to the Angolan subsidiary of BES and to convert the remainder into shares and loans to the African unit.

Mr Loeb, founder of the hedge fund Third Point, is famed on Wall Street for his sometimes vitriolic style of activism, in which he publicly berates the objects of his anger. He made large returns for his fund by investing in Greek sovereign debt at a time when many believed the country would be forced out of the eurozone.

Third Point, however, has generated more attention for its activist campaigns against companies Mr Loeb believes are underperforming, with recent battles involving the internet group Yahoo, and auction house Sotheby's.

Lisbon lawyers said numerous legal actions relating to the collapse of the Espirito Santo group were in preparation, some against former BES executives and others against the Portuguese state and regulators.

The cases are seen as a severe test of the Portuguese legal system, which besides lacking resources and accumulated experience for dealing with complex financial cases has a reputation for moving slowly.

Court cases involving two much smaller failed banks have not yet been fully resolved more than five years after they came to light.

A parliamentary hearing into the affair, scheduled to begin on November 16, is expected to call more than 100 witnesses, including 12 current or former government ministers and high-ranking officials from the European Central Bank as well as Ricardo Espirito Santo Salgado, former chief executive of BES. The hearings are expected to last at least six months.

Additional reporting by Miles Johnson in London and Peter Wise in Lisbon

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