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Why Not Accelerate and Sue Venezuela Now?

posted by Mark Weidemaier

Mark Weidemaier and Mitu Gulati

People have been asking for months when investors will accelerate PDVSA and Venezuela bonds that have fallen into default. Rumor has it that some investors have already done so. But there seems to be a consensus that investors aren't in a hurry. U.S. sanctions prohibit a debt restructuring, and few investors are eager for the legal battle that would follow acceleration. But we’re wondering if this view misses something important and unique to the Venezuelan crisis. It seems to us that investors who file suit may be able to negate most of the Republic's and PDVSA's restructuring tools, significantly enhancing leverage when a restructuring finally does occur and making it easier to hold out. So we’re a bit puzzled why some of the more aggressive investors aren’t already rushing to get judgments.

To explain: Almost every restructuring option available to the government and its state oil company involves exploiting modification provisions in the bond contracts. Most Republic bonds have CACs, which let a supermajority of bondholders in a given series modify payment terms for the entire group, leaving no holdouts. For bonds without CACs--i.e., all PDVSA and a small subset of Republic bonds--the exit consent technique has a smaller bondholder majority accept new bonds and vote to modify the old ones in ways that discourage (but do not eliminate) holdouts.

The problem, as we see it, is that contractual modification provisions do not work against investors who hold money judgments. It isn’t that a money judgment extinguishes all contract-based rights. Readers of this blog may remember the “me too” plaintiffs from the Argentine debt drama. These were holdouts, many holding money judgments, who wanted injunctions similar to the one entered in favor of NML. Judge Griesa gave them what they wanted, rejecting Argentina’s argument that their contract rights under the pari passu clause had “merged” into the judgment they had gotten through litigation. (Here’s his opinion, from June 2015.) We disagreed with him on the wisdom of granting the injunction in the first place, but he was probably correct on this question. Some contract rights are plainly intended to persist, even after one party has successfully sued for breach. And a lawsuit based on those rights often involves an entirely different claim than the one that produced the judgment. 

But the question here is different: It is whether a party who has lost a breach of contract lawsuit can later reduce the amount of the judgment by modifying the contract. The answer, we think, must be no. To use the Republic’s CACs as an example: those permit a vote to “modify, amend, or supplement the terms of the Notes,” including a vote to “reduce the principal amount,” so long as the relevant voting threshold is reached. But investors holding money judgments are no longer seeking to recover principal under the bonds; they have an independent right to the amount of money specified in the judgment. Even if the CAC (like the pari passu clause) survives a judgment, it doesn't seem to permit a modification of that right. And even if it did, courts have limited power to set aside judgments; a retroactive modification of rights, even if permitted by contract, doesn’t seem to be one of them.  

If the sanctions weren't in place, we wouldn't be talking about such questions. Litigation takes time, and a vote modifying the bonds would likely occur before entry of a judgment. Knowing this, prospective holdouts would favor bonds that are hard to modify. But here, the sanctions give holdouts plenty of time, although (presumably) not forever. So we’re wondering why holdouts aren’t being a bit more aggressive at pressing their claims. We’re also wondering whether they really have reason to prefer Republic bonds without CACs, as press reports indicate, and as would be true in a normal debt crisis. Anna has already expressed skepticism that differences among the Republic bonds will matter in a restructuring. This is another reason for skepticism. What good is a CAC if holdouts already have money judgments?

Not much, that we can see.

Comments

In thinking about an answer to the question posed in the title of the post, I can think of a few possibilities. Perhaps the unavailability of assets to satisfy a judgment currently, ,Citgo being mostly pledged and the State lacking any funds, is discouraging acceleration and suit. The sanctions themselves, while allowing more time for eventual holdouts to sue and get judgments, may be discouraging any action presently as people are wary of running afoul of any sanction. The uncertainty about what Venezuela itself is doing (issuing the Petro, doubling down on payments this fall perhaps), may also be inducing paralysis and indecision amongst bondholders.

The post asks many questions, all in varying degrees of grayscale. Some of these questions are rather interesting—for example, the title of the post—why haven’t bondholders attempted to accelerate and sue? On this point, there is little but speculation. It would seem that acceleration enroute to obtaining a money judgment for principal and interest would be an obvious move. The writers mention a post on this site from Anna Galpern, which points out some interesting facts about the bonds which may offer some insight into the absence of acceleration. First, many of the issues require 25% of outstanding principal to accelerate—this would seemingly require some sort of cooperation among holders, as a single holdout is unlikely to be holding such a massive position. Furthermore, there is a 50% de-acceleration—considering those held directly or indirectly or voted by proxy or influence of Venezuela, a de-acceleration doesn’t seem all that unreasonable. So that would appear to leave the potential litigious holders with a due date of principal and interest in 2027 on the maturity date. Though this doesn’t negate all the benefits of having a money judgement in hand…

Speaking of the money judgement…the writers question whether or not a bond modification performed through the CAC (for those that contain them), or an exit consent for those that don’t, would actually have retroactive effect on one of those money judgments. I think they have rightly pointed out the seemingly logical problem with the idea of modification of the judgment by ex post facto contract modification. As discussed in the Griesa opinion for the “me-too” (not to be confused with Mitu) plaintiffs, the contract provisions would live on, and could be amended/litigated—however, that would be completely separate from the issue of the money judgement which would have been settled. While the courts have limited ability to set aside judgments, this would almost certainly fall outside of those criteria. So basically while the Republic could potentially win on the pari passu claim after the money judgement, in my opinion they would be barred from modification of the monetary judgment.

Maybe they haven’t sued because they are worried about current/additional sanctions, and the potential actions of an unpredictable administration.

Or maybe they haven’t sued because they don’t want “Hunger Bond”-Goldman Sachs-type attention or demonstrations outside of their offices because they chose to kick a government and population while they were down…

Perhaps the more aggressive bondholders are not concerned about the Republic's CAC bonds. They may have already coordinated blocking positions. They may then be confident that a restructuring could not legally result in a reduction of their principal and interest. In any case, the principal and interest won't likely be paid until after a restructuring.

Also, if the more aggressive bondholders bring suit, this may spark a feeding frenzy with no subsequent advantage between bondholders. Aggressive bondholders may prefer to litigate post-restructuring where other bondholders have taken haircuts and the Republic has an increased ability to pay.

A feeding frenzy may hasten the end of the Maduro regime. If they don't hold on to power, a new regime may begin a restructuring in the absence of sanctions before judgments are won.

Some bondholders may be superficially separating the idea of CAC vs. non-CAC bonds. However, the CAC bonds are vulnerable to coordinated blocking positions. If the CAC can be blocked, the CAC bonds would immediately become stronger than the non-CAC bonds, as the CAC bonds would then provide more protection against exit amendments pursuant to lower voting requirements.

Venezuela’s crisis is full of questions and uncertainty. After acceleration, investors might gain leverage if they go after a judgment, but taking such a step implies costs and risk. Investors might want to have a clearer picture before doing so. As we have seen, Venezuela’s crisis is unprecedented. Even if these investors could affect the tools that Venezuela’s government can use to restructure, this is worthless if Venezuela cannot fulfill what they demand. Their leverage is useful if they can receive the payment of their judgment. Unfortunately, Venezuela is not in the condition to make any payments. This could be more complicated if the line of creditors seeking judgments increase. Investors might want to compare what they could win as a holdout vs. a restructure. WIth US sanctions, that is har at this moment.

Id. on Stephen/Andres.

The question that remains for me from your post is: Is the phenomenon you're describing above unique to VZ's debt crisis? Because it seems to me as though this wouldn't be.

I'm not going to tell Mark/Mitu anything they don't already know, but here is how I would reason through their reflection. Although sovereigns are uniquely susceptible to court judgments (e.g. because there is no int'l bankruptcy regime), they are also uniquely protected against providing remedies to them (e.g. because a sovereign doesn't usually have that many assets outside of its borders in its own name). Such is the case with VZ. Although we have explored the possibility of veil-piercing strategies to seek remedies from PDVSA/subsidiaries assets in the past, obtaining financial satisfaction from a sovereign through a judgment is an arduous task for a creditor, taking a substantial amount of time and money.

More importantly, it is after the dust of a restructuring settles that a holdout might be best situated to bring a claim and find viable recovery. The creditor logic might be something like: If we all seek judgment/remedy on this default at present-i.e. before a restructuring-the pot of money will be spread too thinly, and as a group we will recover very little (if anything). However, if we allow for a restructuring/relief to transpire and then seek a remedy, that will uniquely situate us to obtain a remedy on a judgment. And since there are few VZ assets available to creditors, then seeking some type of negotiated settlement or judgment after a restructuring might be the best strategy a holdout would have. VZ might also be less worried about reputational harm given their already marred reputation and the fact that their copious oil reserves might not preclude them from returning to capital markets. Thus, an aggressive creditor might have less leverage on that front as well (which would presumably induce a settlement due to the RoV's desire to maintain good standing). In a word, a holdout might fear that, if they seek judgment now, that would open the floodgates and discourage an orderly restructuring from occurring, thus impeding anyone from getting paid (much less themselves).

Additionally, VZ can continue to default and pass the buck right now as well, thus leaving creditors to look to the US for the delayed restructuring. All of the rhetoric from the Maduro regime seems to be that they desire greatly to restructure, but that US sanctions prohibit them from doing so. Most creditors, depending on the mechanism and terms of the deal, would probably prefer an orderly restructuring which would allow for everyone to recover something (at least eventually, even if with a haircut and over a longer period of time). Additionally, as Shane aptly noted, there is a strong chance that they cannot get the 25% across a series (or that subsequently it would be de-accelerated). If I were a vulture fund or aggressive creditor, therefore, I would probably do the same. Such creditor reticence might also have to do with how the debt ranks as well, but I'm not entirely sure how it does and I have spilled enough ink as of now.

I think your last line points to an answer. A CAC, and indeed a restructuring altogether, does not make much sense if other creditors are stampeding VZ's money trough through litigation. Plain and simple, there isn't strength in numbers for the opportunistic-type holdouts here.

Venezuela's situation presents a difficult scenario for any bondholder. These bondholders want to get paid, and given the present situation, it is uncertain when or how much they will. Patience here might be the best course of action. As noted above, I agree that it is the safest bet to wait for a restructuring to take place before seeking a monetary judgment. Pursuing a judgment now has low benefit and high risk. Venezuela would have a low capability of having assets to pay for a judgment, but after a restructuring, there is at least somewhat of a chance to receive payment. As everyone else has pointed out, the sanctions further complicate the scenario. It would be better to wait and see what happens in a restructuring where there (presumably) would be no sanctions and a guarantee of payment.

I agree with Will; I think that because of a number of factors investors are unsure what they will really get out of obtaining a judgement award. Getting a judgement award takes time, money and a lot of effort but if Venezuela is entirely out of money and the risk of triggering US sanctions is broadening, why go through the trouble? Even if investors got a judgment on the acceleration of the debt, there is just no money to pay that judgment. Some sort of restructuring of the debt is everyone's best chance to get any real return on investment. Are bondholders just waiting to see what happens in the next few months with defaults and the presidential elections? Are they unwilling to take the risk? Is there an event that would suddenly make it worthwhile for investors to go through the trouble of obtaining a judgment?

Lack lack of eagerness to accelerate seems puzzling to me as well. Though money judgments, presumably, cannot be affected by using CACs, I would have expected acceleration to be used to lead to a quicker restructuring, avoiding additional judgments that would further restrict bondholders' recovery. However, as noted, the sanctions pose an additional problem that may not be worth attempting to get around quite yet.

Investors may not have the requisite 25% vote to accelerate for the bonds' payments because it could actually hinder their ability to get the payment overall – sovereigns have limited resources, so once he money is out, the creditors are out of luck. So if they forced the sovereign to pay, it could actually hinder the ability for Venezuela to use the limited funds that they do have to save their financial situation to actually eventually obtain money to pay back their creditors.

I agree with Gavin and Austin that a rush to get judgments would prove ineffective given the general lack of available funds that would not be worth it to divide between the judgment-holders. Perhaps they are predicting that a restructuring and recovery of Venezuela's economy would ultimately result in a larger sum. Assuming the majority of these creditors are sophisticated institutions, they may have an interest in preserving their international reputation. Additionally, they may be hesitant to rush for judgments in this instance because it might result in their competitors rushing for judgments in future sovereign default cases.

Maybe the answer is in information asymmetry.

Considering the costs of litigation, I assume that suing PDVSA/Venezuela would only be interesting if the plaintiff could demand 100% of the face value plus accrued interests. To do that, the bondholders must accelerate the bonds.

Most, if not all, the bonds contain acceleration clauses requiring vote of at least 25% of the bondholders. Those bonds also contain a provision allowing for a de-acceleration upon vote of 50% of the bondholders. I am unaware of a bondholder that have accumulated a 25% position. Even if they were willing to do so, they would probably fear to expend the resources necessary to do so if they are not comfortable that 50% of the bondholders will not reverse the acceleration. Not knowing who the bondholders are, and even suspecting that some (or many) of those bondholders may be connected to Venezuela's government, may be an important factor to the question presented in the post. After all, the question of why Venezuela keep making efforts to pay their bonds despite the extreme situation of their citizens is as interesting as why bondholders are not litigating.

I think it's in the interest of the investors to not accelerate. As many have mentioned, there isn't much to go after or share upon default/acceleration, and considering Venezuela's abundant oil reserves, it would be beneficial for most investors to wait for Venezuela to recover. Investors are still buying Venezuela debt, anticipating that the heavily discounted bonds will return a significant return. I believe this partly considers Venezuela's natural resources and its ability to recover economically. In addition, I think acceleration makes restructuring much more difficult because to rescind/nullify acceleration requires curing the default AND obtaining 50% to agreeing to rescind the acceleration. When most investors want to wait for Venezuela to recover economically to pursue recovering their investments, it would make less sense to accelerate when doing so makes it much difficult to reverse acceleration and distributes much less to creditors now.

I agree with many of the previous comments that the reason investors haven't accelerated and sued Venezuela is likely due to uncertainty and a lack of resources. Suing Venezuela is not a zero cost option, and would result in investors spending significant time and resources when it's not clear that Venezuela has anything to give them even if they win. This may make it more beneficial to wait and see if a restructuring or any of the government's plans to turn the economy around are successful. However, these arguments seem to make more sense if a pool of creditors attempted to accelerate and sue Venezuela. If only a single creditor, or even a small number, took this approach while the rest waited on a restructuring, Venezuela would likely have sufficient assets to fulfill a judgment against them. Thus it's not clear to me why none of the creditors have tried this approach.

The problem this poses on using exit consents or CACs to restructure the debt shows further reason to examine any possible option in bankruptcy under Chapter 15. While a money judgment might not be able to be altered ex post by a change in the underlying contract, it could certainly be altered by a bankruptcy proceeding. In bankruptcy, a money judgment based on a bond contract would be a claim just as any other, and holders of those claims could have their claims modified under the plan like any other creditor could. Though bankruptcy is a longer shot in terms of chance of success, the ease at which it could deal with creditors who have obtained money judgments is another benefit that makes it worth exploring the possibility.

What holders of the Venezuelan PDVSA bonds, should be doing, and I am willing too, is start going after every shipment of oil leaving any Venezuelan port, Venezuela's situation is much different than most of the nations that have defaulted, since every drop of oil is own and sold by the government, they own 100% of the company. the percentage of all foreign currencies that the administration, if that can be call, administration, receives is nearly 99%...who is the issuer of the debt..?, the republic, and PDVSA, who owns the oil, they do, therefore....am going to go against the assets of my debtor...this, I believe is the way to get our investment back.. The regime, still buys millions of dollars in armament, spends millions, in corruption.....buying members of the opposition...why should we let them do this while people do not have food or medicine...?

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