Strip, Swap, Restructure

Mitu and I have been posting jointly of late about restructuring options for PDVSA and Venezuela. Alas, I’ll have to write this one myself, because it’s time to talk about an idea that Mitu and Lee Buchheit have proffered for restructuring much of PDVSA’s debt. Their proposal has important similarities to one by Adam Lerrick (also described briefly here and in more detail in the Financial Times), so I’ll cover both.

Both proposals are laudably clear-eyed about some fundamental aspects of the Venezuelan debt crisis. First, if it ever made sense to view PDVSA and the Republic as separate credits, that time is long past. Second, for a restructuring plan to be feasible, it must simplify an enormously complicated debt stock and encompass more than bond creditors. Thus, while neither creates a mechanism for encompassing all of PDVSA’s liabilities, both the Lerrick and Buchheit/Gulati proposals envision a restructuring of both bond debt and the pesky promissory notes that PDVSA has issued to trade creditors. The latter instruments are especially problematic from a restructuring perspective, because they lack contract-based mechanisms for modifying their terms. Finally, both proposals recognize that something must be done to protect oil-related assets, including future receivables, from holdouts.

These shared assumptions result in similar proposals. The difference is in the details, which turn out to be important. Let’s call the Lerrick proposal Strip, Swap, Restructure.

Strip, Swap, Restructure

In a nutshell, Lerrick proposes (i) that all of PDVSA’s Venezuelan assets be transferred to the Republic; (ii) that the Republic withdraw PDVSA’S concession to exploit hydrocarbon reserves; (iii) that PDVSA bond- and note-holders be offered the opportunity to exchange their instruments for new bonds, with identical terms, issued by the Republic; and (iv) that the Republic then launch a restructuring of all of its debt. To protect oil-related assets, Lerrick suggests requiring payment and transferring title in Venezuela. Buyers will want a price discount, of course. But hey, judgment-proofing ain’t free.

Lerrick notes that holdouts will retain their claims against PDVSA. But of course, PDVSA will not exactly be an inviting litigation target. He also notes that holdouts may ask courts to treat the government as the successor to PDVSA’s debts. Lerrick dismisses this risk, opining that any holdout who won on this argument would be “in the exact same position as if it had accepted” the Republic’s exchange offer.

There is a lot to like in this proposal. Lerrick is an extremely well-respected economist, and his views will carry great weight at Treasury. I also suspect he is less interested in legal details than in the basic structure of the proposal. Still, I’m a bit hung up on the part about the holdouts.

A PDVSA bondholder who participates in the exchange offer will have a claim against the Republic under the new bonds. The Republic has no money and intends to restructure these bonds. It will presumably do that by proposing another exchange, only this time participating bondholders will also vote to modify the bonds they are exchanging in unpleasant ways. This is the classic exit consent (and Mitu, if he were here, would want you to know how much he loves exit consents!). If the new bonds issued by the Republic are otherwise identical to the exchanged PDVSA bonds, they will not have CACs and will bar any "impairment" of a non-consenting bondholder’s right to payment or to institute suit. But even if these limitations remain in place, it’s relatively easy to envision a subsequent exchange offer successfully restructuring the Republic’s bond debt.  

I’m not sure I share Lerrick's confidence that holdouts will be no better off than participants in the initial exchange of PDVSA for Republic bonds. To begin with, it seems to me that this proposal essentially guarantees that courts will pierce the corporate veil and hold the Republic liable for PDVSA’s debts. Whatever one thinks about the withdrawal of the concession, the proposal envisions a straight-up transfer of PDVSA assets to the government. That’s an easy case for veil piercing.

Once PDVSA's bond liabilities are imputed to the Republic, it's hard for me to see holdouts as on equal footing with holders of Republic bonds. The modification provisions in the new Republic bonds will be useless against holdouts, who won’t own them. Nor could the Republic invoke the modification provisions in the holdouts’ own (PDVSA) bonds. Even if the Republic could claim the benefit of these provisions (possible, but not certain), who would vote in favor of a modification? Bondholders who exchange PDVSA bonds for Republic bonds that will surely be restructured signal their willingness to, well, restructure. It’s easy to imagine a majority–even a large majority–subsequently accepting a reasonable restructuring proposal by the Republic. But PDVSA bondholders who hold out are in it for the long haul. They’ll have non-restructurable claims for full principal and accrued interest against the shambling husk of PDVSA, against the government itself, and potentially against any entity that receives the oil and gas concession currently enjoyed by PDVSA. Yes, the government can take steps to shield oil-related assets from creditors, but that’s neither here nor there. PDVSA can take those steps now. And even if the government effectively shields oil-related assets, it will have to worry about holdouts lurking in the shadows every time it tries to access foreign commercial and capital markets.

As I mentioned, Lerrick may not be wedded to the details of his proposal. He is primarily interested in protecting oil-related assets and in simplifying the debt stock before a restructuring. The plan is elegant and may well provide the framework for a successful restructuring. But I’m not convinced that it effectively counters the risk of holdouts.  

Pledge, Swap, Restructure

To understand the Buchheit/Gulati proposal, just replace “Strip” with “Pledge.” To mitigate the risk of holdouts, Lee and Mitu take a deep dive into PDVSA’s bond contracts. My first-year law students sometimes enter my Contracts class believing that contracts exhaustively specify the parties’ rights and obligations, leaving few gaps to fill or ambiguities to interpret. I spend much of the semester teaching them otherwise, when I’d really just like to introduce them to Lee and Mitu. The drafters of PDVSA’s bonds probably didn’t envision quite this scenario, but Lee and Mitu proffer an entirely reasonable interpretation of a particular clause. Actually, sub-part 23 of that clause. The clause defines Permitted Liens (i.e., liens that PDVSA can create despite the negative pledge clause in the bond) to include:

(23)  Liens in favor of the Venezuelan government or any agency or instrumentality … to secure payments under any agreement entered into between such entity and the Issuer …”

Like Lerrick's proposal, the Buchheit/Gulati proposal envisions that PDVSA bondholders will swap their bonds for new ones issued by the Republic. To encourage participation, they too want to turn PDVSA into an uninviting litigation target. But rather than strip away its assets, they propose that PDVSA grant the Republic a security interest in everything it owns. With the Republic assuming much of its debt, PDVSA will promise to repay whatever the Republic spends. (Whether it actually repays is another question, but of course failure to do so will make the arrangement look a bit of a sham.) The pledge of security will back that promise, while also creating a senior lien to effectively prevent holdout creditors from seizing PDVSA assets.

Arguably, not much distinguishes the Lerrick and Buchheit/Gulati proposals. Isn’t this asset stripping by another name? Well, perhaps not. By finding express contractual authority for their transaction, Lee and Mitu may mitigate the risk that the Republic will be treated as PDVSA’s alter ego. Moreover, the transaction bears at least some resemblance to an ordinary commercial loan.

On the other hand, if a court views PDVSA’s reimbursement obligation as a pretense, existing only to justify the lien, will it really allow the subordination of PDVSA’s bond creditors? More generally, if a court concludes that PDVSA is Venezuela’s alter ego, won’t it simply disregard the lien? Lee and Mitu recognize this risk and, to mitigate it, suggest that Venezuela should “promptly restore a degree of independence to PDVSA.” That seems like good advice, for all kinds of reasons. Like, for instance, creating a functional oil company. But when it comes to defeating the claims of PDVSA's current creditors, I worry that the horse is out of the barn.

PDVSA’s creditors argue, with some force, that Venezuela has used its control as shareholder (and regulator) to enrich itself at their expense. Examples include requiring massive contributions to social programs, orchestrating large debt-fueled dividend payments, and other shenanigans. If these acts are problematic, it isn’t clear to me that Venezuela can protect itself by reforming its relationship to PDVSA now. To be sure, the decision to disregard a corporation’s separate legal status is an equitable one. If Venezuela starts acting more like an ordinary shareholder, perhaps the equities will weigh less heavily in favor of imputing PDVSA’s liabilities to the Republic. This may be what Lee and Mitu have in mind, and I acknowledge that the argument has some force.

But it’s quite easy to see matters differently. Courts tend to disregard the corporate veil when a shareholder uses its control over the corporation to elevate itself in priority over corporate creditors. If you ask a creditor like Crystallex, that’s just what Venezuela has done. Indeed, the argument retains force even if a large majority of PDVSA bondholders participate in the swap envisioned by Lee and Mitu. Perhaps Venezuela’s abuse of the corporate form has left them with few better options. If that’s so, I don’t see why it should matter if Venezuela suddenly decides to straighten up and fly right. 

Of course, I’m telling the story in the light most favorable to creditors; I don’t mean to prejudge the merits of the veil piercing arguments. The point is only that Lee and Mitu don’t fully engage with the risk that a court might view this transaction as a sham or might disregard the corporate partition separating PDVSA from Venezuela. I worry that the risk is a substantial one. The fact that they bury this discussion in a footnote (on p. 5) makes me wonder whether they feel the same way.

************

Enough about veil piercing and holdouts. But while I’m on a roll… One of the best features of the Lerrick and Buchheit/Gulati proposals is that they are simple, easy-to-explain solutions to an extraordinarily complex problem. That’s no faint praise. Any restructuring will require significant creditor buy-in, and creditors aren’t likely to buy in if they can barely understand the mechanics of what the government proposes. Complexity also works to the advantage of holdouts, who can exploit ambiguities in a lengthy, convoluted restructuring process.

Yet Venezuela has created such a mess that many questions remain unanswered. Here’s one of them: Rumor has it that many PDVSA bonds and promissory notes were issued with principal amounts that were … a bit on the high side? The so-called Hunger Bonds are an example, but there are reportedly others. In any event, the principal purportedly due at maturity bears little relation to the amount actually paid at issue. It’s reasonable to suppose a number of these wound up in the hands of likely holdouts. What will happen to these bonds? If ever there were an argument for treating sovereign debt as illegitimate, or for disallowing claims for the difference between the face value and the issue price, it applies here. But it’s an open question whether courts applying New York law will recognize the difference between these bonds and others issued under normal market conditions. Does it matter whether a new Venezuelan government is in place? Will creditors holding these bonds be treated differently in a restructuring? My sense is that many market participants are ignoring questions like these for now, but that they may become more important when restructuring negotiations begin in earnest.

Comments

[Andrea Kropp]

While I agree with Lee and Mitu that risk-mitigation would be greatly helped by restoring “a degree of independence to PDVSA,” I fear that PDVSA/ Venezuela may have backed itself into a corner with the language contained in some of the prom notes regarding such independence — specifically, in the definition of a “Change of Control” as being:

(a) the failure at any time of Venezuela to

(i) legally and beneficially own and control, directly or indirectly, at least 100% of the issued and outstanding Equity Interests of the Issuer, or

(ii) have the ability to elect (and to have actually elected) and control all of the board of directors (or equivalent) of the Issuer . . .

The way I see it from this language, if Venezuela cedes some level of control to PDVSA, it would trigger a Change of Control Default; If it doesn’t, then this language adds further fuel to alter ego claims.

(a) also causes some concern when it is read in conjunction with (b) of the Change of Control covenant, as (b)’s language mimics that of (a) save for substituting Venezuela with Issuer and Issuer with Guarantor (which is PDVSA Petroleo, a subsidiary of PDVSA):

(b) the failure at any time of the Issuer to

(i) legally and beneficially own and control, directly or indirectly, at least 100% of the issued and outstanding Equity Interests of the Guarantor, or

(ii) have the ability to elect (and to have actually elected) and control all of the board of directors (or equivalent) of the Guarantor.

This language adds weight to the proposition that just as PDVSA Petroleo is a subsidiary of PDVSA, so too is PDVSA a subsidiary of Venezuela.

I also have concerns about PDVSA’s ability to pledge all/ substantially all of its assets to Venezuela, as it seems to me that there is competing language in PDVSA’s issuances - although the Permitted Liens scenario does seem possible, 4.01(c) of the Indenture governing PDVSA’ s notes (Limitation on Consolidation, Merger, Sale or Conveyance) says that:

The Issuer will not, in one or a series of transactions, consolidate or amalgamate with or merge into any corporation or convey, lease or transfer substantially all of its properties, assets or revenues to any Person or entity (other than a direct or indirect subsidiary of the Issuer) or permit any person (other than a direct or indirect subsidiary of the Issuer) to merge with or into it unless [the successor company assumes the Issuer’s obligations].

When this is read in conjunction with the proposition presented above that PDVSA is a subsidiary of Venezuela, how could a parent also be a successor? And even if this were structurally possible, couldn’t this just allow PDVSA and Venezuela to keep flipping the debt back and forth between themselves (which would be a blatant abuse of corporate form)? On a more basic level, if there is potentially competing language I would think that a court would side with the scenario that was more likely contemplated by the parties . . .

[Shane O'Neill]

While I can appreciate the desire for simplicity, I don’t know that the solution to one of the largest and most complex international debt crises should be adapted from the directions on the back of a shampoo bottle…”lather, rinse, repeat” won’t work here—someone will have to get their hands dirty. Lerrick ignores the legal and structural difference of the bond contracts—he’s an economist, so we cut him a break—after all they love to make assumptions. In this case the assumptions amount to rainbows and unicorns, we love to assume that Maduro, his government and all the policies in place will change to make this restructuring easier on all of us—let’s face the facts…potential holdouts are one of—if not THE—biggest issue with a potential Republic or PDVSA restructuring, and the Lerrick proposal seems to say that everyone would feel warm and fuzzy because they were getting bonds that had assets underlying them. But if the government withdraws the hydrocarbon rights for these purposes, it will not be viewed as a friendly move, and the courts will almost certainly pierce the veil as it resembles the Houdini-like move by the government of Turkmenistan when they decided to just create a new company. As implied above, this sort of action may actually leave holdouts in a better position for full recovery.

If Lerrick’s proposal is shampoo, the Gulati & Buchheit proposal is more like a combined shampoo & conditioner. As lawyers, they clearly found it more difficult to ignore some of the legal issues that Lerrick glazed over. As stated in the original proposal, they have dug into the contracts to locate a provision that works to support the exchange of PDVSA bonds for Republic bonds. However, I am not sure that they hit the target squarely either. That action could easy be considered a de facto transfer of assets again resulting in those holdouts recovering in full before the Republic is able to pay any other creditors that agreed to the exchange. Beyond that, this proposal takes several steps in explaining what it offers provided that its substantial assumptions are in place as well.

All the talk of a functional oil company, and the government maintaining a more proper status with regard to PDVSA operations would give some potential of separation, but that potential is tenuous at best considering the aforementioned history of behavior and “shenanigans” to the contrary. An equitable court decision to disregard the lien as a sham seems more likely to me.

When this is over, Venezuela will need to be able to reenter the markets, as they have a serious economic rebuild in front of them. The nation is rich in natural resources, which is one of the reasons why all of the international players have been willing to lend them the money thus far, and those resources are certainly the vehicle on which any successful rebuild will occur. Because of that, protecting the sales of those resources from creditor enforcement actions will be paramount.

On a final note, the post seems to question the legitimacy of the Hunger Bonds, and others issued for amounts under face value. Considering the issue of “discount bonds” is a completely legal practice in general finance terms, I am hard pressed to see the reason to allow non-payment on a contract based on the price that was paid considering this was intended to account for the risk being taken by the investor. Both parties here are certainly “sophisticated” in the legal sense of the word for securities purposes. I am also not seeing the fraud perpetrated here by those purchasing the bonds. This discount was bargained for in the sense that it was commensurate with risk, and the only way that ANY money was flowing in to Venezuela, to penalize those bondholders would be to penalize those nations and organizations that go to the markets for money when they need it the most.

[Aditya Mitra]

While both proposals are correct in stating that treating both the Republic and PDVSAs debt as one may be more efficient for restructuring, but it also reduces confusion for potential-holdout creditors as well. The fact that the debt is currently split amongst two separate entities makes it quite uncertain even for hold-out creditors as well as judgment creditors due to unusual relationship between Venezuela and Republic. In fact, both being separate and one at the same time probably leads to holdout creditors as well as judgement creditors spending a great deal of time (and money) on legal strategy which in some ways dilutes the threat of holdouts as long as the relation between the Republic and PDVSA seems to be in somewhat of a flux. Post Integration of debt it becomes clear for all hold-out debtors to pursue NML style litigation against Venezuela to maximize their payoff. So, while it may seem based on the incentives highlighted by each proposal that creditors may be dissuaded from hold-outs there is potential for hold-outs (litigation) to get more concentrated in tandem with the concentration of the debt.

[Matthew Taylor]

The simplicity of both Lerrick and Buchheit/Gulati are one of both plans best features. However, I worry, along with Professor Weidemaier, that both proposals underestimate the reluctance of holdouts to change their PDVSA bonds to Republic bonds that are certain to be restructured. The terms of the PDVSA bonds are much better than republic bonds, because of the lack of collective action clauses allowing amendments to payment terms in the contracts. Therefore, if holdouts feel like they have any chance of recovery against PDVSA they are unlikely to make a swap for new Republic debt. This likely rises and falls with the likelihood of veil piercing. If there is a chance that these assets can be executed on by holdouts then some holdout will likely try to pursue it, and even if this is unsuccessful it would expose PDVSA and the Republic to another legal battle that would prove costly.

[Charlie Saad]

I think the biggest obstacle for these proposals will be to keep Venezuela and PDVSA as separate entities. I am hesitant that a change in behavior may be enough to overcome what has already transpired. Having said that, one big factor to pierce the corporate veil is a showing of control over day-to-day activities. It will be interesting to see whether such control will be shown. Lastly, one positive about such a proposal, especially the Gulati/Buchheit proposal (because of the explicit provision), is that even threatening the proposal might be enough to bring the creditors to the table.

[Samantha Hovaniec]

Echoing the original post and many of the comments, I am also concerned that the Buchheit/Gulati proposal did not adequately address the potential for holdouts. Although they suggest that Venezuela provide PDVSA with independence, it seems unlikely that at least the current regime would be willing to release any control of PDVSA. Even if Venezuela did agree to give PDVSA some degree of independence, a court may see through the timing of this sudden independence and consider it a sham designed to create the appearance of separate entities. The Lerrick proposal provides a much greater veil piercing concern, as it explicitly demonstrates the veil piercing factor of commingling shareholder and company assets. However, the Buchheit/Gulati proposal, even though it appears to be permitted by the bond contracts, is not that functionally different from Lerrick's, and the courts may similarly allow veil piercing. If there is even a likelihood that the veil will be pierced, it's unclear to me whether bold holders would be willing to engage in this type of transaction and risk the threat of holdouts accessing Venezuela's assets.

[Gavin Kim]

Both Lerrick and Buchheit/Gulati proposals are beautifully simple. As others have mentioned, they do come with risks such as holdout creditors and veil piercing. But for the sake of restructuring their debt, I am not sure if there is anything more important than this initial step to consolidate debt into one pool. Although it can show PDVSA's dependence on Venezuela, this isn't something new and the strategy offered in both proposals isn't going to add to the already existing legal risks. Rather, I think the initial steps taken by Venezuela can simplify their restructuring plan, and also positively signal to creditors their willingness to restructure. Neither Venezuela nor PDVSA has done anything to indicate plans for their debt obligations going forward. In my humble opinion, a creditor of PDVSA would like some certainty or faith that they'll be able to salvage some of their investments for it's quixotic to think any creditor would recover all their investments. I think both proposals direct our attention in the right direction.

[Evaristo Pereira]

My feeling is that every proposal that encompass turning PDVSA an empty shell (by removing the license, pledging assets or otherwise without any kind of consideration to PDVSA) increases the risk of a veil piercing. And although Mark made a great argument on the effects of such piercing on the hold outs, I think we should also think about the effects of this restructuring on PDVSA's other creditors. If any doubt remains on whether PDVSA's veil should be pierced, this kind of restructuring would wash it away. Not only the hold-outs, but judgment creditors, trade creditors and other relevant players would be in a stronger position to claim Republic's assets.

Another point in my mind is whether a proposal suggesting transferring of PDVSA assets without adequate consideration a this point would be considered fraudulent transfer under US law. It is not my specialty. Any thoughts?

[Kelsey]

I do agree with the praise of both proposal's simplicity; though a complicated problem with severe consequences and externalities, the possible transaction costs involved and time it may take for a complicated solution would exacerbate the financial, political and social problems of the country. The suggestions of simplicity are out of necessity. Nevertheless, I do worry about how the unknown components of the outstanding debt will ruin the neat structure of either of these plans-most worrisome is the unknown variable of the promissory notes.

It is unknown exactly how much promissory note debt there is; how inflated the note amounts are; to whom it is all owed; and how variable the contracts are. We do know that promissory debt is owed to a number of American and foreign companies, and it is possible that such debt has been incurred as recently as in the last two weeks (there is some question as to how the crude oil delivered to the Lesser Antilles refineries were paid for last week). Being unable to account for all the outstanding notes would make it hard to include them in any proposed exchange to help unburden PDVSA of its debts. While some of these prom notes include the "lien in favor of Venezuela" language discussed in the Gulati/Buchheit proposal, they have a few clauses that could be problematic for inclusion in a PDVSA-Sovereign exchange. The two that should be noted are: (1) an anti-merger clause similar to those in the bonds, which aims to prevent the merger or consolidation of the company's properties to any entity that is not a subsidiary; and (2) a clause mandating the "maintenance of corporate existence," which mandates that the issuer maintain all its rights, titles, licenses, etc. unless those things are "in good faith" no longer needed for the regular conduct of business. Both of these suggest that stripping or pledging PDVSA's assets could be seen as a violation of contracts, opening up the company to litigation.

The real problem in trying to tackle the promissory note issue and fit all of the PDVSA debt into a "simple" and "neat" solution, is that we don't know if these clauses exist in other promissory notes, how many are out there, and if there are holders who will use these clauses to holdout. Any comprehensive restructuring plan will have to address the promissory notes, but in doing that it may lead us away from a simpler solution.

[Bernard]

Like the author and other commentators, i believe that the simplicity of both plans is an advantage. People are more likely to gravitate towards a restructuring plan they understand (or think they do). Also i doubt that PDVSA would sue for its concession being taken away like Crystallex did in its case.

However, i am hesitant about both the stripping away of assets in the Lerrick proposal, and the granting of the security interest in the Buchheit/Gulati proposal . The granting of the security interest is likely to be seen as "stripping" especially in this case where the Republic and PDVSA may have shown some bad faith in fraudulent transfers(huge dividend payouts the got money from the US to Venezuela). Courts are also less likely to smile at a strategy by which a majority shareholder uses a scheme to raise its priority over other creditors. Venezuela is not the most sympathetic creditor for a court to ignore such a bold step.

Also, both of stripping and pledging would i fear may seem like under handed moves. Moves that will make it more difficult for a post restructuring Venezuela to return to the capital markets under friendly conditions. Like Mitu once said to me, its not just what you do, whether rights or wrong. Its also how it looks, the aesthetics of it. Both to the market and to the citizens of the country.

[Steven Diaz]

Eliminating holdouts entirely is unlikely, and they will flood courts with alter ego arguments once they are able. The Republic and PDVSA should prepare to have the veil pierced. But straightening up and flying right couldn't hurt, either here or in other New York litigation that they will inevitably face.

If a post-Maduro government has institutional support and growing international legitimacy, a judge may look past some of those past actions in the name of comity and reciprocity (at least implicitly). The focus may narrow to the fraud prong in relation to restructuring actions. The government might then not tempt fate by transferring debt obligations from PDVSA to the Republic. But the transfer has the benefit of reducing complexity, is probably better than alternative PDVSA debt restructuring options, and the veil may be pierced anyways.

Pledge, swap is less wrongful control than strip, swap: the control action is sanctioned by bond and promissory note contracts. A pledge, swap plan should include measures to ensure proper execution of reimbursement payments and response to holdout foreclosure attempts. These post-execution measures would not be necessary merely as an attempt to avoid veil piercing, but as protection regarding other New York litigation.

[Andres Ortiz]

The two proposals are quite similar. Both of them look for a clear and simple way to restructure Venezuela debt, "swap and restructure." For me, it looks like Buchheit/ Gulati give legal viability to Lerrick's proposal that would have ended in courts holding Venezuela liable for PDVSA debts. Surely, by doing that, they make substantive changes that were needed. Therefore, they changed "strip" for "pledge." Buchhei/Gulati interpretation of permitted liens sub-part 23 is reasonable; however, as Andrea pointed out, I think 4.01(c) could be a problem for this proposal.

I believe that is important to address the principal reasons why a bondholder or promissory note holder will accept an exchange like this. Surely the expectation of being paid at least some of what they were first offered should outweigh the amount and probability of enforcing the bond contract in court. Therefore, any exchange should at least give certainty to the holders that the new debtor would be able to fulfill the new bonds payment terms.

In the case of Venezuela, that is extremely hard. Venezuela is not in the position of paying its external liabilities without obtaining new debt. The possibilities of Venezuela to access such funds without showing debt sustainability is low. Moreover, the lenders willing to provide some resources probably will impose specific priorities other than using the majority of it to pay an old external debt. Would PDVSA holders be willing to accept Republic bonds for then those bonds to be restructured in uncertain future terms that could leave them in worst position? Probably not. The chances of this happening are less if holders buy the argument that the veil separating Venezuela and PDVSA can be pierced.

[Will Curtis]

As many commenters have stated above, the simplicity of both proposals is one of their best features. Unlike the bankruptcy option we have previously looked at, these proposals have some precedent in other restructuring. (At least with respect to their basic mechanisms). I think one of the most important parts, especially of the Lerrick proposal, is the government stripping the rights to extract oil in Venezuela. In the mechanism of the plan that seems to be an underrated reason that holdouts would take the swap deal. It is a threat that has always lingered in the background of the PDVSA bond issues, and one that might provide an incentive to take any swap and restructuring deal. Why would I want to litigate against a company with no assets, an uncertain outcome on the veil piercing claim, and an offer to get paid by the sovereign eventually. Perhaps a simplistic view (and doesn't address all issues) but simple seems better. The complicated nature of debt issues, economic reality, and political issues in Venezuela insures that any restructuring is going to push the boundaries of previous restructuring's and leave the plan open to litigation at many points along the way. With that in mind, these plans seem a good start on a path to one which may just work.

[Ryan Nichols]

These proposals offer a simple way to restructure the bonds. However, as many have stated already, they both raise serious concerns. Specifically, I think they overstate the unlikelihood of holdout creditors. I find it unlikely that PDVSA bondholders would agree to this exchange, particularly because it could leave them in a weaker position. Additionally, veil piercing seems more likely in this scenario because the government is exerting its control over its instrumentality to assert a priority position.

Regardless, veil piercing may happen anyway so this may be an easy way to restructure. However, it would be better if this restructuring is consummated after a chapter 15 bankruptcy is filed, because bankruptcy gives some protections against veil piercing.

[Isabelle Sawhney]

A slight, like significant difference between the two proposals is that Lerrick's giving the assets to the Republic is a clear indication of an alter ego status - which hurts the effectiveness of his plan, whereas Buchheit and Gulati's proposal at least attempt to place some form of an illusion that the Republic is treating PDVSA's assets as its own because they are using the negative pledge provision to go about it. But even that seems to be unlikely to be enough to prevent a court from finding an alter ego. And it doesn't seem as though any subsequent actions would actually make a difference since it would effectively mean that the court turns a blind eye to years of how PDVSA operated under the control of the Republic.

As to the Hunger bonds, the bonds are essentially bonds issued by a "bad regime" where the payments go to investors instead of feeding Venezuelans. I think the real question is whether the courts should, not will, look at these debts differently. Under international law, the nature of the regime appears to be largely irrelevant – a future government would still have to pay the debts of the old "bad" government (i.e. Apartheid Africa). But this view can be dangerous since it provides the bad regime with the access to the market to borrow money for their bad actions since investors know that - under international law - they will be paid.

Instead, I think that Gulati's solution (as discussed here: https://www.youtube.com/watch?v=kJG9dcMspZE) about using the domestic law of each country to invalidate these contracts is a prime solution. In essence, every country has a law such that an agent cannot get debts unless they are representing their people. So when the bad regime engages in an action like hunger bonds, it is unlikely that any court (i.e. NY court) would find that they are acting as their people's agent, and therefore the debts are invalid. Thus, investors would need to consider the political dynamics of the country and that will help them understand the risk of the debt being invalidated. So, if a country is starving its people while paying out billions of dollars to investors, investors will be less likely to exploit these hugely discounted "hunger bonds" since there will be a good chance that they will not be paid.

[Austin]

Mark's analysis was spot on in almost all respects. That said, as a pedantic note, I don't know that Lee/Mitu "mitigate the risk that the Republic will be treated as PDVSA's alter ego." To be sure, they might make an alter-ego finding less of a slam dunk than Lerrick's proposal; but if their pledge tactic were carried out, it would lend further support to an already-forceful finding that the Republic is PDVSA's alter ego. And since Mitu/Lee acknowledge that an alter-ego finding would eviscerate their entire plan of its value-as Mark observes, in footnote two-their proposal strikes me as an effort in sawing off the branch upon which it sits. I don't necessarily think that Mitu/Lee fail to sufficiently engage with the risk, as Mark puts it; they instead acknowledge that, if there were to be a finding of alter ego, then their proposal is toast. They engage with this risk directly, but highlight that their proposal might rest upon precarious foundations.

I agree with Mark that the proverbial horse is probably out of the barn. That said, Steven aptly noted above that a legitimate successor regime might put VZ on favorable footing with a judge. If a successor regime did have institutional support and drastically distanced VZ from PDVSA, a judge might view the Maduro regime's antics as odious enough to allow VZ to prevail on the legal challenges sure to flow forth from M/L's proposal. It seems to be unlikely at present, though.

Finally, two questions remain from the proposals: Is there enough consideration for these proposals not to be farces? Further, what implications should PDVSA's Impairment Clauses have on our analysis of the legitimacy of these proposals?

There are certainly merits to the proposals as well. I had not considered Aditya's comment above-regarding the value of the entities remaining separate-when writing my proposal critique last week, and I think it is an incisive one. Yet, since both proposals pool the debt in VZ, they do have the virtue of bringing creditors to the table in a more uniform fashion and, hence, facilitating a deep, incipient restructuring. Restructuring all Republic bonds at once would foster greater buy-in. The proposals also seem to be some of the best out there so far; and yes, they are elegant and simple. But for now, too much would have to be assumed--from M/L's proposal, as well as Lerrick's--for the proposals to be feasible as they stand.

I've rambled enough, but a quick word about hunger-bond debt: I agree with Shane above that the hunger bonds were bargained for by "sophisticated" parties--I miss the days when being a "sophist" was pejorative--but the consideration could be so disproportionate as to be unconscionable (to use an imprecise term). That may not be dispositive, but amid other, dire circumstances the Republic has faced--circumstances that undoubtedly induced the transactions--the disproportionate bargaining positions/leverage should at least call into question the validity and primacy of the hunger-bond debt.

[Stephanie Funk]

One question that we should consider is what will happen to the bonds issued by PDVSA and purchased by Goldman Sachs at a steep discount in May 2017. Economist Ricardo Hausmann, has labeled these bonds “hunger bonds” because the Venezuelan government has prioritized servicing the bonds over importing food for the Venezuelan people, resulting in country population that has lost an average of 19 pounds per person.

Some experts have begun to explore the question of whether these hunger bonds could be labeled “odious debt” and whether the “odious debt doctrine” could result in the repudiation of the bonds. Stephanie Collet and Kim Oosterlinck explain in their article “Denouncing Odious Debts” that historically, debt has been declared odious, where a government proves that: 1) “the debts have been issued without the population’s consent,” 2) “the population would have received no benefit from the debt issue,” and 3) “lenders knew that the proceeds would not be used for the population and that the population was opposed to the debt.” They point out that because of the practical difficulties in proving the elements of this definition, that the focus has “shifted from odious debts to odious regimes.”

Collet and Oosterlinck provide an example of debt they believe would be labeled odious, that takes the form of Russian bonds purchased by French investors in 1906. The circumstances surrounding the Russian bonds parallel many of the attributes of the Venezuelan hunger bonds we are considering today. Russia and Venezuela were both appealing to investors because of their vast natural resources. Further, both countries were experiencing “extreme internal tensions” during period of the bond issuance. In Russia, “a country with accumulated deficits and on the brink of insolvency, a country without freedom, parliament or industry,” the opposition party “threatened to repudiate the loan should the come to power.” Further, the head of the Socialist Revolutionaries’ stated that the “Russian nation would not recognize the debts which helped the Tsar crush the revolution.” The bonds were described as “a hostile act against the Russian population.”

Similarly, in Venezuela, Julio Borges (president of the National Assembly) wrote that the hunger bonds proceeds “provides resources to the regime to purchase instruments of war that will be used to savagely repress the hundreds of thousands of peaceful protesters demanding free and fair elections and democracy in our country.” He further stated that the National Assembly would investigate the transaction and “will move expeditiously to make sure our country’s future democratic government and economy is not saddled with this astronomical debt, at usurious rates, entered into by a highly unpopular and illegitimate regime.”

How then, should we deal with the hunger bonds? Assuming the Maduro regime is replaced, should the new regime be accountable for the debt in the inevitable restructuring?

International law has long held that the nature of the regime is irrelevant, for example, even the African National Congress repaid the debts of the former Apartheid regime. Ricardo Hausmann and Ugo Panizza have proposed a sliding-scale rating for odiousness of debt to serve courts as a tool to determine how to enforce debt contracts. Mitu Gulati has proposed instead of focusing on the odious doctrine, that we focus on the circumstances in which the bonds were issued, and consider whether in issuing the bonds, the entities bypassed domestic law approval. He points out that PDVSA manipulated the market by artificially increasing the principle amount and reducing the interest rates, this incentivized investment because in default situations, lenders want large principle amounts because that is how the payments are calculated. Ricardo Hausmann has also proposed in the meantime that JPMorgan Chase & Co. remove the bonds from the indexes. The yields on the bonds are very high compared to the market because of the risk involved in investing in the Venezuelan market. Because fund managers are incentivized to stay above the market, they are pressured to invest in the hunger bonds despite the moral implications. Hausmann argues that removing the bonds from the index would lift the moral burden off the shoulders of the investors, where the Venezuelan government is prioritizing the servicing of bonds over buying food for its people.

Given the difficulty of proving an odious regime, Gulati's proposal of examining whether regimes bypass their own laws in issuing debt may be a more practical avenue. In the meantime, Hausmann’s suggestion of removing the bonds from the index seems like a simple solution to mitigate further harm, however, it is unclear whether investors will be receptive to the solution or whether they will dismiss the role that they play in the crisis.

[Heater Werner]

I agree with others and praise the simplicity of these approaches, but that may also be a weakness because the veil piercing concern is so blatant. I do not feel like either approach gave a credible way to overcome the threat of veil piercing. Sure separating the entities would be a best-case scenario but it seems very unlikely to succeed. The attempts to separate PDVSA could backfire and lead to worsening financial concerns or make the veil piercing argument even weaker. Not to mention the potential bad-faith concerns that might encourage more holdouts, which might lead to more law suits with judges who may feel inclined to find against Venezuela. The proposal is lovely in its simplicity but might need to address a few of these concerns.