(Adds detail on basis of challenge, companies involved, background on BES split)
By Laura Noonan
LONDON Aug 20 Junior bondholders of Portugal's Banco Espirito Santo have selected law firm Shearman & Sterling to represent them in a challenge to the terms of the bank's rescue and will open discussions with the Bank of Portugal later this week, a source familiar with the situation said.
A dramatic restructuring plan agreed on Aug. 3 moved most of Banco Espirito Santo's business into the newly created Novo Banco, which was bolstered by 4.9 billion euros ($6.5 billion) of capital from the country's bank resolution fund.
Claims of junior bondholders and shareholders were left in the original bank, along with troubled lending to the bank's founding Espirito Santo family, which had helped push BES to a ruinous loss of 3.6 billion euros for the first half of the year.
Junior bondholders owed 750 million euros by the Portuguese lender are unhappy with the terms of the split and feel they would have fared better if the bank had been liquidated, several sources told Reuters.
Under Portuguese law, a bank's restructuring must not be worse for any creditor than closure. The Bank of Portugal told Reuters on Aug. 12 that the principle had been upheld in BES' restructuring.
A group of those bondholders agreed on Aug. 12 to appoint Shearman & Sterling to explore avenues to have the terms of the rescue changed, a source familiar with the discussions said. Shearman & Sterling could not immediately comment.
The source said the first step will be to send a letter to the Bank of Portugal and other relevant parties outlining the bondholders' concerns. These letters will be sent in the next day or two, he said.
The group, which includes holders of about half the outstanding bonds, is open to a consensual restructuring of the deal or a legal action.
A key concern is the way the assets staying with the bad bank were selected, in particular the decision to give the new bank 3 billion euros of interbank loans to Banco Espirito Santo's Angolan subsidiary at a valuation of zero.
The bondholders feel that loan should have been left with the original BES since the original bank had to take the full write-off for the amount.
The Bank of Portugal told Reuters on Aug. 12 that the decision to write off the full amount of the credit line did not "reflect, in any way, a lack of expectations of recovering the loans."
(Euro = $1.3258) (Reporting by Laura Noonan; Editing by Chris Reese and Jan Paschal)