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You've sunk my battleship! And seized my carrier...

posted by Mark Weidemaier

There is a widely-held view that sovereign bonds don't contain the optimal terms but are slow to incorporate better ones. Right or wrong, that view has prompted many government-sponsored initiatives to reform bond contracts, such as the current plan to mandate the use of standardized collective action clauses in all euro area government bonds. These reform initiatives often fail, and the view persists that sovereign bond contracts could use some improvement.

Why do I mention this? My last post discussed how the sovereign immunity waiver in its bonds got Argentina into trouble, allowing jilted bondholders to convince a court in Ghana to help them seize an Argentine navy ship. Perhaps this was consistent with what Argentina agreed to in the bond, but the country predictably objected when the seizure occurred. The ensuing diplomatic kerfuffle highlights why enforcing jurisdictions (like Ghana, in this case) might be better off forbidding their courts to help private creditors seize a foreign country's military assets.

Below the jump, you'll find two figures showing how sovereign bonds have addressed the subject of sovereign immunity over the past two decades. As you'll see, Argentina is no outlier; plenty of bonds include waivers that are just as broadly-written.

To make sense of the figures, keep a few things in mind. First, they cover the period 1990-2010 and focus only on bonds that were (a) issued in foreign markets and (b) governed by New York or English law. (More details on the dataset here.) Also:

  • Countries are immune from suit in foreign courts and their assets are immune from execution (i.e., being seized and sold).
  • Creditors can sometimes overcome these immunities, but it's easier to do so if the sovereign has waived them in advance.
  • Immunity from suit and immunity from execution must be separately waived. A creditor who has obtained only the first kind of waiver will have to find some other way to overcome the sovereign's immunity from execution if it wants to enforce a judgment.
  • A broadly-worded waiver of immunity from execution, like Argentina's, might be read to allow seizure of all kinds of sensitive property - e.g., military, diplomatic, etc. But...
  • The law might forbid the seizure of such assets notwithstanding the waiver. Thus, even if Argentina's bonds say that creditors can seize its military assets, other countries don't have to help creditors do this.
  • Still, to be safe, a country that doesn't want to put sensitive assets at risk should exempt them from its waiver of immunity. Argentina didn't, and that got it into trouble.

The first figure shows that, over the past twenty years, virtually all issuers have waived their immunity from suit, and a sizeable majority have also waived their immunity from execution. Figure 1 post 4These latter waivers are generally pretty broad, like Argentina's, and could in theory be interpreted to allow creditors to seize military, diplomatic, and other sensitive assets. (Note: the law may distinguish between these asset types. For example, there are multilateral treaties that protect diplomatic and consular property.)

The next figure focuses on exemptions for military and diplomatic assets. (Some bonds include other exemptions - such as for central bank assets - but the figure omits those.) As the figure shows, bonds have increasingly exempted military and diplomatic assets from the issuing country's waiver of immunity from execution, but these exemptions remain relatively rare. Many bonds, that is, contain immunity waivers roughly similar to Argentina's.

Figure 2 post 4I have written about these varied contracting practices elsewhere, but until recently I have been skeptical that the differences in sovereign immunity waivers amounted to much. Really, how likely is it that a country would find itself in a fight over whether its military assets could be seized? Er... not that unlikely, it seems. Which makes me wonder whether we'll start to see changes in drafting practices with respect to sovereign immunity waivers. If not, perhaps other bond issuers can look forward to one day playing BattleshipTM with Death.



I'm curious whether you consider my paraphrase of one of your articles, in that blog past, as fair.

The first half of the post goes to Buchheit and Pam but read on -- I get to you soon enough.


Hi Christopher - thanks for the post. I left a more detailed comment on AllAboutAlpha (http://allaboutalpha.com/blog/2012/11/14/the-%E2%80%9880s-language-that-disappeared-part-of-a-sovereign-debt-mystery/), which really only adds a bit of extra color from our article.


Argentina's President Is Making Great Political Theater Out Of Paul Singer Seizing The Country's Naval Ship

Great thought-provoking post Marc.

I have a feeling that the thought of a military ship conjures up images of grey armoured, powerfully gunned, and technologically advanced vessels. Yet I would emphasize that Argentina's Fragata Libertad is actually a beautiful triple-masted sailing ship used to instruct sailors in the art of navigating the world's windswept oceans in the old-fashioned way.

I wonder whether the judge in Ghana that ordered the capture of the navy ship might have done so in the manner he did if the ship conformed to the more standard image of a true war machine. Maybe, just maybe, in such a case he would have considered it prudent to call Ghana's Ministry of Foreign Relations or its Ministry of Defense to inquire whether they welcomed or objected to the idea before issuing an order that is simultaneously both straightforward (based on elaborate contractual fine print) and controversial (based on common-sense sovereign diplomacy).

Only too late did the judge realize that the beautiful sailing ship was not manned by Argentine bon-vivants drinking champagne and heading for the Mediterranean, but rather, by an armed navy crew that will fire back at any port authority that attempts to board their vessel or proceed to sink the ship to avoid it falling into enemy hands... or both.

As with pair passu I believe the Ghana affaire has ceased to be a dispute about the meaning or intent of a clause in a contract to become - as Marc's research pushes me into considering - a debate about the capacity to execute proposed remedies without causing more harm than good. I am as bewildered as Marc seems to be that sovereigns have accepted these clauses and that investors have assumed they can execute them. And I would add, how about the role of investment banks in bringing the two parties together? I am left with the sense that by not thinking ahead enough, the so-called Masters of the Universe have created another house of cards for an ideal world but a true time bomb for the real world.

Could it be that waivers of inmunity were drafted as a mechanism to raise the ex-ante perceived costs to a sovereign (and hence possibly dissuade it) from adopting an Equadorean-style default decision. A useful clause or waiver would ideally be drafted with some thought regarding to how it will be implemented ex-post a default and what the implications of doing so successfully would be.

With default already a fact, and much like the pair passu clause, the process of implementing the waiver of immunity seems to multiply conflicts rather than put a lid on them. Parties to the contract have handed the Court a time bomb and expect the Court to deactivate it for them. To me this does not seem to be a reasonable request.

Should a Court simply allow parties to write absurd (difficult to implement) contractual clauses or waivers for ex-ante purposes rather than ex-post purposes, or should they make it clear that they aspire to be as independent from private parties unreal expectations as they aspire to be from the influence of the Ministry of Foreign Relations.


Vladimir: You may be right that the clauses are drafted to increase the perceived ex ante costs of default. That would be a sensible explanation for them, anyway. But as you say, the process of enforcement often seems to multiply the costs of default, and some of these costs are borne by third parties (e.g., the foreign policy consequences for the enforcing jurisdiction). So the final question you raise seems to be the critical one: To what degree should courts participate in enforcing sovereign loan obligations, especially when enforcement imposes costs on third parties? It's a hard question, and exactly the one Judge Griesa has to confront now.

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