The Portuguese economy has traditionally leaned heavily on bank lending as its primary source of capital for both individuals and companies. Whether for personal consumption or business expansion, obtaining credit from banks has been the go-to option when access to financial resources is needed.
Such reliance on bank lending has shaped our economic landscape. For individuals, bank lending plays a pivotal role in facilitating access to home mortgages, personal loans and credit cards. The availability of such lending has allowed borrowers to purchase homes, finance education, or address unexpected expenses. Moreover, it has shaped consumer behaviour by fostering expenditure and investment across different sectors of the economy. Similarly, for companies, whether they are small family-owned businesses or larger corporations, bank lending has traditionally served as the primary method for raising capital and is seen a fundamental strategy for growth and sustainability of such companies.
Despite efforts in recent years to diversify sources of capital, such as promoting a more robust capital market, the trend of bank lending as the primary financial source remains remarkably entrenched. While there have been numerous initiatives to simplify regulations and reduce costs associated with alternative sources of financing, the cultural and historical inclination towards banking institutions has been a tough pattern to break. Bank loans persist as the top choice for capitalization and funding in Portugal.
Small and midsize enterprises (SME’s) constitute the backbone of the Portuguese corporate landscape, representing an overwhelming majority, with more than 99 % of all businesses falling into this category. The issue of credit defaults and distressed debt is a notable concern for Portuguese SME’s, as the intricate nature of their business environment (cash flow inadequacies, fierce competition, rising operational costs, economic downturns, poor managerial financial literacy) and vulnerability to economic fluctuations drive them to struggle to meet their financial commitments. About 14.6 % of companies faced distressed debt concerning their banking loans in 2022.
Among individuals, in Portugal, the predominance of distressed debt concerning their banking loans reached a historic low of 7 % in 2022 (since 2009). However, credit default within consumers remains a matter of concern, signalling the ongoing need for vigilant financial management and regulatory measures to address potential risks. As a significant portion of individuals’ loans is tied to mortgages, this issue gains added importance, particularly when interest rates continue to climb, with no stabilisation foreseen on the horizon. Fluctuations in interest rates can lead to financial hardship and potential defaults. Ensuring that borrowers are adequately educated about potential rate changes and providing options for rate-lock agreements can mitigate these concerns.
Moreover, Portugal is one of the European countries in which non-performing loans (NPL) have a significant weight in relation to the total number of loans granted by national credit institutions, representing around 33 billion Euros as of December 2019. Given the substantial NPL ratio, the sale of NPL portfolios plays a significant role in Portugal, aligning with the European trend to reduce the level of indebtedness of European banks. This has led to an expansion on the size and complexity (both in terms of financial and legal architecture) of such transactions.
Understanding and addressing the main legal dimensions of debt lifecycle is vital for both creditors, debtors and third parties involved.
Within the dogmatics of Private Law, this research project embarks on a comprehensive exploration of credit debt throughout its entire lifecycle, encompassing critical stages such as Credit Default, Distressed Debt, Debt Restructuring, and Non-Performing Loans. The project aims to conduct a global analysis akin to a laboratory setting (hence Debt Lab), shedding light on the multifaceted legal dynamics surrounding banking credit debt.
Primarily rooted in banking law, this project adopts a structural approach to address the research questions. So it also explores the bedrock of civil law, the law of obligations, company law, and insolvency law, interconnecting and interrelating a diverse array of issues encompassed within these legal domains.
A unique outset marks the inception of this research project. Almost a decade back, following the aftermath of the 2008-2009 global financial crisis, the CIDP took a first step towards addressing the subject of banking debt and its lifecycle. The first strides were made through collaborative sessions involving academics and legal experts as part of the Post Graduate Course on Banking Law. This course has been held successfully every year. It is currently in its 9th edition.
Over the span of nine editions, the investigation into credit debt has deepened and broadened, mirroring the dynamic shifts in the social and legal context surrounding this subject. This evolution has been evident in the face of events such as the pandemic, as well as the onset of periods marked by a war and soaring inflation, followed by the rampant rise in interest rates.
It is now time to leverage such CIDP’s past accomplishments and advance on a comprehensive research endeavour focused on this subject. This research project seeks to produce new knowledge of credit debt by studying it as a complete lifecycle through an in-depth analysis.
To do so, the DEBT LAB will follow certain sequential steps:
(i) Mapping the credit debt lifecycle;
(ii) Examining the legal frameworks and contractual arrangements that govern credit debt at each stage – with primary emphasis on the Portuguese and European legal arenas, while actively engaging in legal discourse with other systems;
(iii) Comparing international practices and case studies to identify best practices, gaps, and opportunities for enhancing the Portuguese legal framework;
(iv) Evaluate the socio-economic and financial implications of credit debt and its various stages on borrowers, lenders, and the broader financial ecosystem – particularly with regard to individual borrowers;
(v) Identify and propose legal and regulatory strategies for mitigating risks associated with credit distressed debt, with a focus on preventing litigation and promoting out-of-court debt workouts.
More specifically, the DEBT LAB aims to address and explore, as solutions:
(i) Private autonomy and credit default: a critical dimension of this research entails the thorough examination of the parameters governing private autonomy in determining the outcomes of credit default situations. This comprehensive analysis encompasses contracts executed en masse under general contractual terms, as well as those meticulously negotiated on an individual basis;
(ii) Contractual clauses (comparison): contractual clauses relevant to credit debt, predominantly sourced from credit agreements governed by common law systems, will be examined. The aim is to appraise their appropriateness or inadequacy within the Portuguese legal framework;
(iii) Launching a “Debt Clause Library”: the aim is to launch a drafting tool and a library/ bible intended to introduce greater standardization in how Portuguese banks negotiate and agree clauses (in particular, on credit default) and assure that those clauses are valid and fair, thus avoiding subsequent problems in the credit relationship; the tool will set out standard drafting options for frequently negotiated credit default provisions, as well as the most common variants of these provisions;
(iv) Debt restructuring & struggling borrowers: the aim is to map the main legal problems which can hinder the success of debt restructuring or workout proceedings, aiming at analysing the extension of those obstacles and identifying solutions out-of-court that succeed on giving the debtor financial breathing room, which ensuring the collective interests of the creditors and guarantors. Close attention is paid to the extent to which Portuguese and European banks engage in debt restructuring to support struggling individual borrowers, and how did regulatory bodies oversee and guide these efforts; and
(v) NPL portfolios: the aim is to identify trends in Portuguese and Europe markets regarding the sales of NPL portfolios and then to clarify the legal and contractual architecture underlying such sales, by gauging the legal nature and the contractual design of the transactions (sale, mass credit assignment, securitisation or synthetic transactions), and thus seeking to reduce the level of legal uncertainty as regards the validity and legal compliance of said transactions. It also addresses the growing concern in Europe about abusive and aggressive informal debt collection tactics and practices towards vulnerable borrowers, in particular when third-party debt collection agencies are hired to recover NPLs.
The DEBT LAB project has concerns of a dual nature: (i) achieving a socially significant impact in a crucial area for the operation of the Portuguese economy, and (ii) engaging in and adding to the forefront of international legal discussions concerning matters related to credit debt.
Both rest on a shared core of research that involves:
(i) Mapping and monitoring of novel legal issues arising from an ever-changing economic reality, as well as the legislative and regulatory responses to govern them; and
(ii) Analysing the main and most pressing legal issues relating banking debt cycle, scrutinizing them within the framework of Private Law while maintaining a continuous dialogue with cutting-edge research and literature.
Both types of concerns, besides encompassing adjoining issues and resting on a shared core, have a synergistic relation between them.
Therefore, in addition to the core research activities, each of these concerns corresponds to a project phase.
The first phase is focused on identifying the most pressing legal issues in the current state of the Portuguese economy concerning the banking debt lifecycle. It begins with empirical analysis work, conducted in collaboration with project partners, followed by an analytical phase. To maximize its dissemination and potential impact, this phase will be presented in two fora:
§ A conference on banking credit debt, aimed at the national legal community, particularly other legal experts, lawyers, regulators, and judges, allowing them to participate and provide their insights;
§ Publication of the research presented at this conference in open access format for wider accessibility and dissemination.
The empirical analysis conducted in the first phase, in collaboration with national partners (with a particular focus on the APB associated entities), will also enable the work on the “Debt Clause Library” output. To achieve this, contacts will also be made with international entities to identify best practices in the drafting credit agreements, as well as other related contracts (such as restructuring agreements and the transfer of ownership of non-performing loans, etc.).
At the conclusion of the first phase, an assessment will be conducted to identify the research outcomes of the first phase which have the greatest relevance to the international scientific debate concerning the legal issues covered by the project, particularly due to their cross-jurisdictional nature.
The second phase of the project will focus on the deepening and dissemination of the research. The outputs of the second phase of the project will result in the organization of an international conference in Lisbon addressing legal issues related to bank credit debt. The speakers will include members of the research project, invited keynote speakers, and international researchers selected through a call for papers specifically launched for this purpose. Conference proceedings will be published in an open access format after undergoing a peer-review process.
In addition, DEBT LAB will produce two academic papers published in an international and peer-reviewed law journal.