I. Introduction
Without a doubt, sovereign debt is one of the most controversial but yet relevant issues in the international legal arena, not solely for the States as debtors, but also for many private creditors and several other stakeholders. Sovereign debt has gained further attention and importance in light of the recent Argentina’s sovereign debt default, restructure and litigation in NY Courts. In light of these events, this brief note aims to assess the major advantages of the adoption of a multilateral convention regarding sovereign debt restructuring. Therefore, the following note is divided in three main sections; the first one describes the basic sovereign deb restructuring process currently existent. The second section, explains the Argentinian sovereign debt procedure, restructure and litigation. Finally, the third section advances the most positive and relevant elements that a sovereign debt multilateral convention can provide for the international community, by making reference to the other free market alternatives for sovereign debt restructuring currently available.
II. The Sovereign Debt Restructuring Process
When it comes to private debts – those owed by individuals or corporations – most, if not all, countries have developed mechanisms to resolve in an orderly manner the issues that arise in the event of insolvency.[1] Yet in the sovereign debt context there is no equivalent mandatory bankruptcy procedure upon default.[2] This is a concern that has been exacerbated and brought starkly into focus by the recent Argentine sovereign debt crisis[3] – the juncture at which international finance collides with international law.
At the outset, it should be noted that sovereign debt restructurings are widespread and common practice throughout the world.[4] Moreover, restructurings are a wholly legitimate and sometimes essential exit mechanism out of debt crises,[5] allowing distressed countries to restore the provision of essential public services and recover their domestic economies.[6]
So what then does the term debt restructuring entail? It refers to the making of voluntary changes to the originally envisaged payment terms, undertaken in order to create a more manageable liability profile or to reduce the debt’s net present value.[7] In reality what this tends to mean is that creditors agree to: either, take a “haircut” on the value of the debt they own, lower the interest rates they receive, or delay the bond’s repayment maturity date; as well as any combination thereof.
In this milieu, one of the greatest difficulties in restructuring claims against sovereign debtors is balancing the interests of the majority of the creditors with those of minority creditors.[8] This difficulty arises given the voluntary nature of the restructuring process: creditors are entitled to refuse to participate in a restructuring and instead “hold out” in the hope of receiving better repayment terms, or even the full value of their claims, through litigation or negotiated settlements based on that threat.
a). The Purpose of Holdout Litigation
Bond agreements actually contain clauses that explicitly contemplate enforcement litigation, such as, typically, the waiver of sovereign immunity, and choice-of-law provisions, through which the sovereign debtor submits to the laws and jurisdiction of a country with a mature and robust legal and financial system – typically the UK or USA.
Litigation, then, may function as a deterrent to the possibility of opportunistic default by a sovereign debtor, which in turn facilitates the functioning of the international capital markets.[9] Litigation may also operate as a check on the terms of a proposed restructuring, giving a creditor recourse against a restructuring with inappropriate or unfair terms.
Holdout litigation, therefore, serves a legitimate purpose and is not entirely the pariah that it has recently been made out to be. On the one hand, holdout creditors serve to limit collusive majority behaviour and act as a check on opportunistic defaults and unreasonable restructuring terms, yet on the other hand, their presence interferes with the restructuring process.[10]
Notwithstanding the foregoing, concerns about holdout litigation have acquired fresh urgency as a result of its use as a strategy by “vulture funds” during, inter alia – but most prominently, Argentina’s current financial crisis. This has led many commentators to question the ethicality of their predatory and speculative behaviour,[11] particularly as vulture funds are not comprised of individuals or funds that actually lent money to Argentina or bought Argentine bonds on good faith.
For those that have not been following these developments, vulture funds are hedge funds that seek to enforce contractual claims against distressed sovereign debtors through litigation.[12] Most often they buy the relevant sovereign bonds on the secondary markets at rock-bottom prices and then sue for repayment at nominal value.[13] Put simply, they seek to exploit the current global legal vacuum in order to make exorbitant profits.[14]
III. Argentine Pari Passu Litigation
In December 2001, Argentina defaulted on its external debt – which amounted to well over eighty (80) billion dollars.[15] In the bond contracts governing that debt, Argentina selected New York law and consented to jurisdiction in the Southern District of New York.[16]
Subsequently, Argentina engaged in 2 restructurings – in 2005 and 2010.[17] This resulted in the restructuring of around ninety-two (91.3%) percent of the foreign debt which had been defaulted on in 2001.[18] The majority of the remaining bonds are in the hands of vulture funds.[19]
After the default, NML Capital brought a claim against Argentina in New York, as the bond contracts contemplated.[20] The vulture fund sued Argentina for specific performance of the pari passu (equal treatment)[21] clause contained in the bonds, arguing that the clause precluded Argentina from making payments on some of its debt contracts (the restructured bonds – which Argentina had been servicing) and not others.[22]
The now infamous Judge Griesa of the District Court found in favour of NML Capital,[23] granting an injunction against Argentina.[24] His judgment has been affirmed by the Court of Appeals[25] and the Supreme Court of the United States.[26]
Essentially the judgment made it illegal for Argentina to pay its restructured creditors (91.3% of its original creditors) without also making concurrent ratable payments to the holdout creditors (the vulture funds); an outcome ensured by the fact that Judge Griesa’s injunction also enjoined financial intermediaries from processing any payments not in compliance with his order. As an initial consequence of the judgment, Argentina entered into technical default on the 30th of July 2014.[27]
However, the judgment has wider reaching implications, including that bondholders might now be less inclined to accept bond swaps, safe in the knowledge that they can hold out for face value; which in turn will make it more difficult and more expensive for countries – often those in development – to restructure their debts. This has knock-on effects for their sustainable long-term development.
IV. The Need for an International Convention for Sovereign Debt Restructuring
As a result of the proliferation and success of holdout litigation by vulture funds, Argentina, with the support of the G77 group of developing nations, plus China, presented a draft resolution to the United Nations General Assembly to vote on whether to move forward with a new multilateral international Convention to regulate the restructuring of sovereign debt and curtail the power of holdout creditors.[28]
The draft resolution was approved on Tuesday the 9th of September 2014, and the General Assembly has now committed to adopting a new multilateral legal framework for sovereign debt restructuring processes during its sixty-ninth session.[29]
This is undoubtedly a great achievement.[30] But before evaluating the potential benefits of such an international Convention, the free-market alternatives available for limiting the power of holdout creditors must be analyzed. This is important as, currently, all sovereign debt restructuring efforts take place entirely under a free-market approach,[31] making a superficial understanding of these options necessary in order to determine their limitations.
a). Free-market based alternatives
- The inclusion of collective action clauses (CACs) in new bond issues.
This contractual mechanism permits a supermajority of bondholders to vote to change the payment terms of an issue of bonds.[32] Accordingly, once an agreement is reached with the sovereign debtor, the bonds can be restructured despite the objections of minority bondholders.[33] Crucially, the new terms bind all bondholders, thus negating the holdout problem.[34]
The use of CACs does, however, have certain disadvantages in terms of being a viable option for reforming the restructuring process. (i) CACs only function across specific issues, or series, of bonds. To put this into perspective, Argentina is attempting to restructure 152 different bond issues involving seven different currencies and the governing laws of eight different countries.[35] CACs offer little help in these situations. Moreover, (ii) the insertion of CACs into new issues of bonds does not address concerns regarding existing bonds, including the Argentine bonds, which contain clauses requiring unanimous voting to effect alterations to essential payment terms.[36] As such, and due to the long-term nature of sovereign bonds, the benefit of CACs will not be fully felt by the financial markets until decades further down the line. Countries like Argentina don’t have that long.
- The restructuring of sovereign debt through an exchange offer coupled with exit consents.
As suggested by its nomenclature, an exchange offer is an offer by the sovereign debtor to exchange new debt for old. Exit consents, in turn, are designed to mitigate the holdout problem by inducing (some would say coercing) all creditors to agree to the exchange.[37] This is achieved by requiring consenting creditors to waive any covenant protections in their bonds that can be waived without unanimous creditor consent.[38] These amendments are intended to reduce the value of the original bonds, thereby making their retention less attractive to would-be-holdouts.[39]
For all intents and purposes this mechanism has the effect of replacing the existing debt claims with securities governed by CACs and, therefore, is susceptible to the same drawbacks as the latter.
Both of these free-market alternatives to an international statutory framework seek, exclusively, to combat the holdout problem – which we could call, without resorting to hyperbole, the residual vulture fund menace – and both achieve this, albeit imperfectly.
b). Advantages of a UN Convention
As the contents of the proposed UN Convention are at present conjecture, we shall proceed by assuming its assimilation, in terms of sine qua non features, with an unsuccessful IMF proposal – known as the Sovereign Debt Restructuring Mechanism (SDRM).[40]
An international statutory bankruptcy procedure would allow sovereign debtors to voluntarily decide whether to apply the provisions to their debt problems by filing a petition. It would create a process by which a supermajority of creditors could negotiate a binding restructuring for all creditors.[41] The most salient advantages of this approach over the universal use of CACs include the capacity to deal with multiple issues and series of bonds (by grouping all creditors into a single class) as well as its applicability to existing debt.[42] These represent two monumental gains at the outset.
Critics and sceptics might, reasonably, point out the concern that holdout litigation offers an apparatus by which minority creditors can challenge restructurings designed principally for the benefit of the majority.[43] But such unfairness concerns are inherently addressed: since all creditors are similarly situated, the outcome of a vote that binds holdouts should benefit all creditors equally.[44] This presupposes that all such creditors were not speculative purchasers of the sovereign bonds, in this way indirectly clamping down on the practices of vulture funds.
The advantages of a multilateral Convention, however, go beyond the scope of the issues that have so far been dealt with. Intrinsic to any restructuring is the concept of default – an inability to meet payments as they become due. It follows, then, that after any restructuring has been carried out, a sovereign debtor will need to borrow money to fund critical expenses borne during the process. Herein lies the problem: who would lend to a nation that has just proven its unreliability as a borrower? Such a lender would insist on priority creditor status as a condition of any loan.
An international Convention can provide for the requisite legally enforceable first priority right of repayment to new loans.[45] Existing creditors could be protected through the right to object to a new loan if its amount is too high or its terms are inappropriate.[46] Moreover, a nation that abuses these borrowing privileges would encounter difficulty in receiving supermajority creditor approval for its debt restructuring plan anyway.[47] Ultimately, sovereign debtors that act in bad faith could be excluded from making recourse to the Convention.[48]
Lastly, a Convention would also eliminate the threat of moral hazard.[49] Such a state of affairs was not present in Argentina, but was apparent in, e.g. the EU bailout of Greece. It arises in cases where there is a high risk of financial contagion – where a sovereign debt default can trigger a systemic collapse.[50] As the trend of global financial integration continues, this scenario of “too big to fail” becomes ever more likely.[51] By imposing strict austerity conditions on bailouts, as has become the norm, a Convention could take precedence and ensure an orderly restructuring of debts in these crises, thereby preventing taxpayers from bearing the brunt of sovereign financial imprudence.
V. Conclusions
As has hopefully been made evident by now, the problem in the sovereign debt restructuring arena is not holdout litigation per se, but rather it is the immoral deployment of it by vulture funds and the potentially sovereignty-violating judicial decisions of foreign states – formalistically adopted to uphold the contractual language of sovereign bonds, which now constitute a substantial impediment to the voluntary method of debt restructuring that had been the long-standing custom.
This is why a binding international Convention could be of much greater value than the current free-market solutions: it resolves the (i) holdout, (ii) funding and (ii) moral hazards problems that arise in such situations, not only concurrently but convincingly. It will not, however, enable sovereigns to renege on their debt by restructuring whenever they please. Argentina take heed! It is a mechanism of last resort and the provisions of any Convention should make that clear.
Nonetheless, the restructuring of debt is a sovereign prerogative, which, as recognized by the UN Resolution in question, “should not be frustrated or impeded by any measure emanating from another State”. A binding UN Convention would restore that essential element of sovereignty back to nations and enable them to determine sustainable levels of debt based on their real payment capacity, thus empowering them to meet the fundamental needs of their societies whilst simultaneously providing much needed predictability to the financial markets.
Of course, as with any international Convention, its real success will be a function of the level of participation it achieves. The onus is on the world’s nations now – they can either expel the vultures forever or allow them to keep circling overhead.
Manuel Jordán Bassó
LL.B. from the University of Glasgow, Scotland. LL.M. in Oil and Gas Law candidate at the University of Aberdeen, Scotland. 2015 International Bar Association (IBA) Section on Energy, Environment, Natural Resources and Infrastructure Law (SEERIL) Energy Law Studies Scholar.
Juan Pablo Hugues Arthur
Law Degree (Highest Honors) from the CIDE, Mexico. International Law Attorney-Counsel for the Attorney-General on Fiscal and Financial Issues, Mexico.
_________________________________________
[1] S L Schwarcz, Sovereign Debt Restructuring: A Bankruptcy Reorganization Approach (2004) 85 Cornell Law Review 4 [Hereinafter, S L Schwarcz, Sovereign Debt Restructuring], p. 958.
[2] See: Mechanism Must Be Found to Avoid Moral Hazard in Crises, IMFDepuy Says, 69 Banking Rep. (BNA) 623 (Oct. 20, 1997).
[3] J E Fisch, C M Gentile, Vultures or Vanguards: The Role of Litigation in Sovereign Debt Restructuring Conference on Sovereign Debt Restructuring: The View from the Legal Academy (2004) 53 Emory L.J. 1043 [Hereinafter: J E Fisch, C M Gentile, Vultures or Vanguards: The Role of Litigation in Sovereign Debt Restructuring], p. 1046; S L Schwarcz, Towards a “Rule of Law” Approach to Restructuring Sovereign Debt (2014) Harvard Law School Forum on Corporate Governance and Financial Regulation (Available at http://corpgov.law.harvard.edu/2014/10/14/towards-a-rule-of-law-approach-to-restructuring-sovereign-debt/. Last visited 14 May 2015) [S L Schwarcz, Towards a “Rule of Law” Approach to Restructuring Sovereign Debt].
[4] For general references on the history of sovereign debt default, see: M Waibel, Sovereign Defaults before International Courts and Tribunals (CUP, 2011) [Hereinafter, M Waiblel, Sovereign Defaults], pp. 3-19. See also in this same sense C G Paulus, The Interrelationship of Sovereign Debt and Distressed Banks: A
European Perspective, 49 Tex Int’l LJ 201 (2014); A Sde Vicuña y Barroso, ‘Identical
Collective Action Clauses for Different Legal Systems: A European Model’, in K Bauer et al., Collective Action Clauses and the Restructuring of Sovereign Debt (2013); U S Das et al., Sovereign Debt Restructurings 1950–2010: Literature Survey, Data, and Stylized Facts, 30–36 (Int’l Monetary Fund, Working Paper WP/12/203, 2012) (Available at http://www.imf.org/external/pubs/ft/wp/2012/wp12203.pdf. Last visited 22 May 2015).
[5] T Jones, When vulture funds circle, who will make debt repayments fairer? (8 September 2014) (The guardian) (Available at http://www.theguardian.com/global-development/poverty-matters/2014/sep/08/vulture-funds-restructure-debt-repayments. Last visited 22 May 2015).
[6] Ibid.
[7] M Waibel, Opening Pandora’s Box: Sovereign Debt in International Arbitration (2007) 101 AJIL 711, p. 712.
[8] J E Fisch, C M Gentile, Vultures or Vanguards: The Role of Litigation in Sovereign Debt Restructuring.
[9] J E Fisch, C M Gentile, Vultures or Vanguards: The Role of Litigation in Sovereign Debt Restructuring, p. 1047.
[10] Jeffrey D. Sachs, Do We Need an International Lender of Last Resort, Frank D. Graham Lecture at Princeton University 8 (Apr. 20, 1995), p. 6 (Available at http://www.cid.harvard.edu/archive/hiid/papers/intllr.pdf. Last visited 14 May 2015); C Lipson, ‘Bankers’ Dilemmas: Private Cooperation in Rescheduling Sovereign Debts’ in Cooperation Under Anarchy 200 (Kenneth A. Oye ed., 1986).
[11] See: F Salmon, Vulture Funds in Distress, REUTERS (24 February 2011), (Available at http://blogs.reuters.com/felixsalmon/2011/02/23/vulture-funds-in-distress/. Last visited 22 May 2015).
[12] C C Wheeler & A Attaran, Declawing the Vulture Funds: Rehabilitation of a Comity Defense in Sovereign Debt Litigation (2003) 39 Stan J Int’l L 253, p. 254.
[13] K H Fukuda, What is a vulture fund? (2008) University of Iowa College of Law Center for International Finance & Development 2.
[14] Vulture Funds in the Sovereign Debt Context, African Development Bank Group (Available at http://www.afdb.org/en/topics-and-sectors/initiatives-partnerships/african-legal-support-facility/vulture-funds-in-the-sovereign-debt-context/. Last visited 14 May 2015).
[15] J F Hornbeck, Argentina’s Defaulted Sovereign Debt: Dealing with the “Holdouts” (2013) Congressional Research Service [Hereinafter: J F Hornbeck, Argentina’s Defaulted Sovereign Debt], p. 1.
[16] Republic of Argentina v. NML Capital LTD, et. al. On Petition for Writ of Certiorari to the United States Court of Appeals for the Second Circuit PETITION FOR WRIT OF CERTIORARI (February 18, 2014), p. 8.
[17] J F Hornbeck, Argentina’s Defaulted Sovereign Debt, pp. 4-6.
[18] Ibid., p. 7.
[19] J Muse-Fisher, Starving the Vultures: NML Capital v. Republic of Argentina and Solutions to the Problem of Distressed-Debt Funds (2014) 14 CalLRev 1671, p. 1688.
[20] NML Capital, Ltd. v. Republic of Argentina, No. 08 Civ. 6978(TPG), 2011 WL 9522565 [Hereinafter: NML Capital v. Argentina]; Stephen Davidoff Solomon, In Court Battle, a Game of Brinkmanship With Argentina, N.Y. TIMES (Nov. 27, 2012), (Available at http://dealbook.nytimes.com/2012/11/27/in-court-battle-a-game-of-brinkmanship -with-argentina/. Last visited 22 May 2015).
[21] L C Buchheit & J S Pam, The Pari Passu Clause in International Debt Instruments (2004) 53 Emory L J, p. 851.
[22] NML Capital, Ltd. v. The Republic of Argentina.
[23] “It is DECLARED, ADJUDGED, and DECREED that the Republic is required under Paragraph 1(c) of the FAA at all times to rank its payment obligations pursuant to NML’s Bonds at least equally with all the Republic’s other present and future unsecured and unsubordinated External Indebtedness.”). The specific pari passu clause provides that “[t]he Securities will constitute […] direct, unconditional, unsecured and unsubordinated obligations of the Republic and shall at all times rank pari passu and without any preference among themselves. The payment obligations of the Republic under the Securities shall at all times rank at least equally with all its other present and future unsecured and unsubordinated External Indebtedness. It is DECLARED, ADJUDGED, and DECREED that the Republic lowered the rank of NML’s bonds in violation of Paragraph 1(c) of the FAA when it made payments currently due under the Exchange Bonds, while persisting in its refusal to satisfy its payment obligations currently due under NML’s Bonds. 6. […] It is DECLARED, ADJUDGED, and DECREED that the Republic lowered the rank of NML’s bonds in violation of Paragraph 1(c) of the FAA when it enacted [the relevant Laws] […]” NML Capital v. Argentina, pp. 1-2.
[24] Ibid. p. 254.
[25] NML Capital, Ltd. v. Republic of Argentina, No. 12-105 (2d Cir. 2013).
[26] Republic of Argentina v. NML Capital, Ltd, 134 S. Ct. 2250 (2014).
[27] J Hartley, Argentina’s Default: Lessons learned, what happens next? Forbes, 2014 (Available at http://www.forbes.com/sites/jonhartley/2014/08/04/argentinas-default-lessons-learned-and-what-happens-next/. Last visited 22 May 2015).
[28] Y Li, U.N. to negotiate a multilateral legal framework for sovereign debt restructuring (2014) (Opinio Juris Blog) (Available at http://opiniojuris.org/2014/09/16/guest-post-u-n-negotiate-multilateral-legal-framework-sovereign-debt-restructuring/. Last visited 14 May 2015).
[29] GA Resolution 68/304: “Towards the establishment of a multilateral legal framework for sovereign debt restructuring processes”. See Resolution on Sovereign Debt Restructuring Adopted by General Assembly Establishes Multilateral Framework for Countries to Emerge from Financial Commitments (9 September 2014) (Available at http://www.un.org/press/en/2014/ga1 1542.doc.htm. Last visited 15 May 2015).
[30] See: B Muchhala, Historic UN General Assembly vote on a multilateral sovereign debt mechanism (Available at http://www.twn.my/title2/unsd/2014/unsd140903.htm. Last visited 15 May 2015); A Caliari, Historic agreement paves the way for just response to sovereign debt crises (Available at https://www.coc.org/rbw/historic-agreement-paves-way-just-response-sovereign-debt-crises-september-2014. Last visited 15 May 2015).
[31] See footnote 2 supra.
[32] W Mark, C Weidemaier & M Gulati, A People’s History of Collective Action Clauses (2014) 54 VirJInt’lLaw, p. 53.
[33] See: W Mark, C Weidemaier & M Gulati, ‘How Markets Work: The Lawyer’s Version’ in From Economy to Society? Perspectives on Transnational Risk Regulation (Bettina Lange et al. eds, 2013).
[34] Ibid.
[35] G Nielsen, Secretary of Finance of Argentina, Remarks in Dubai 14 (Septembre 22, 2003), (Available at
http://www.argentinedebtinfo.gov.ar/documentos/discurso_gn_dubai_con_diap_english.pdf. Last visited 15 May 2015).
[36] S L Schwarckz, A Minimalist Approach to State “Bankruptcy” (2011) 59 UCLA L Rev 322, pp. 329-331.
[37] L C Buchheit & G M Gulati, Exit Consents in Sovereign Bond Exchanges (2000) 48 UCLA L Rev 59, pp. 65-66.
[38] Ibid.
[39] Ibid.
[40] Anne Krueger, New Approaches to Sovereign Debt Restructuring: An Update on Our Thinking, Address
to the Institute for International Economics Conference Sovereign Debt Workouts: Hopes and Hazards (1 April 2002) (Available at https://www.imf.org/external/np/speeches/2002/040102.htm. Last visited 22 May 2015).
[41] S L Schwarcz, Sovereign Debt Restructuring Options: An Analytical Comparison (2012) Harv Bus L Rev [Hereinafter, S L Schwarcz, Debt Restructuring Options] p. 107.
[42] Ibid.
[43] J E Fisch & C M Gentile, Vultures Or Vanguards? The Role Of Litigation In Sovereign Debt Restructuring (2004) 53 Emory L.J 1043, p. 1098.
[44] S L Schwarcz, Sovereign Debt Restructuring: A Bankruptcy Reorganization Approach (2000) 89 Cornell L Rev 956, p. 1005; B J Houser et al, ‘Plan Issues: Classification, Impairment, Subordination Agreements’
in Chapter 11 Business Reorganizations 317, 328 (ALI-ABA Course of Study Materials S024, 1998).
[45] S L Schwarcz, Debt Restructuring Options, p. 113.
[46] Ibid. Pp. 113-113.
[47] See: W W Bratton & G M Gulati, Sovereign Debt Reform and the Best Interest of Creditors (2004) 1 VLRev 54, p. 26.
[48] S L Schwarcz, Debt Restructuring Options, p. 110.
[49] Which denotes a situation whereby a party does not bear the full costs for the risks it takes. See: O Gürtler & M Kräkel, Double-Sided Moral Hazard, Efficiency Wages, and Litigation (2010) 1 J Law Ec Bus 54.
[50] S L Schwarcz, Towards a “Rule of Law” Approach to Restructuring Sovereign Debt.
[51] Ibid.