The Co-Operative Bank calls in the lawyers

The "˜ethical' bank's current problems have a legal dimension, says Hannah Langworth Hannah Langworth

The Co-operative Group has agreed to a radical restructuring of its banking division, the Co-operative Bank, which has thrown up a number of complex legal issues.

Swap shop

The Co-operative Bank found itself in severe financial trouble several months ago for a number of reasons, including significant investment in the mortgage-backed products that helped cause the financial crisis, fines from mis-selling payment protection insurance, IT problems and over-aggressive expansion of the business.

The bank faced a £1.5 billion shortage in capital, which has now resulted in a deal under which 70 per cent of the bank will be handed over to some of the bank's creditors through the issue of new shares to them in exchange for debt cancellation and further cash injections.

This type of legal arrangement, an alternative to a formal insolvency procedure, is known as a debt-for-equity swap, balance sheet restructuring, or a bail-in.

Lawyers play an important role in structuring and negotiating the terms of this kind of deal. Important issues they'll consider includes the type and terms of the new shares issued; how best to legally effect and document the new relationships between shareholders and creditors; ensuring legally valid shareholder approvals are obtained; whether any regulatory approvals are required; the tax implications of the deal; and the effect of the deal on the legal rights of members of any company pension scheme.

Business as usual?

Many commentators have questioned whether the bank will be able to maintain its ethical business policy following the changes in its ownership, but the bank has taken legal steps to address the issue.

Every company incorporated in the UK must have a constitution, which in the case of a bank is known as its charter. This consists of its articles of association and memorandum, and sets out the terms on which the business is run.

The constitution often also contains provisions relating to the company's aims and ethics, and it's these that have been changed in the Co-operative Bank's charter to attempt to embed its current ethical business principles into the way it'll conduct itself in the future. In addition, provision has also been made for the Co-operative Bank's values and ethics to be policed by a new board committee. As corporate constitutions are complex legal documents, lawyers will almost certainly have undertaken the process of implementing these changes on behalf of the bank.

Some have argued, however, that these measures do not go far enough. Campaigning group the Fair Shares Association claims that the recapitalisation deal means that the bank no longer complies with definitions of a co-operative set out in English, EU and international law.

Prior to its change in ownership, despite the fact that the bank itself was a public company and not a co-operative, the fact that the majority of it was owned by the Co-operative Group which was a co-operative meant that the bank was legally justified in using the term "co-operative" in its name.

But its name is now misleading, Fair Shares argues, which means both UK regulator the Financial Conduct Authority and the government have a legal obligation to intervene and force the bank to change the way it operates, or its name.

Firm commitments

Several prominent City law firms are acting on the recapitalisation deal. These include Clifford Chance for the Co-operative Group, while Shearman & Sterling is advising some of the creditors.

Stephenson Harwood is also advising some of the creditor group on some aspects of the deal, while Addleshaw Goddard is assisting the Co-operative Group and the Co-operative Bank with intergroup issues.