9 posts from July 2019

Ramming Bow Contracts

posted by Mitu Gulati

Have you heard of Ramming Bows? Or did you know that they describe a category of boilerplate contract provisions?  Until a couple of weeks ago, I had not either.  That was when I came across Glenn West’s two delightful blog posts at the Weil Gotshal & Manges site (here and here). Glenn is a senior partner in the Private Equity/M&A practice at Weil. And in his spare time, he writes wonderfully witty blog posts and articles about wide range of legal issues; many of which are about the bizarre world of sophisticated boilerplate contracting.  Even if you have no interest in contract law, let alone boilerplate contracts, I suspect that you will enjoy his writing.  It is insightful about the way in which contracts get produced and evolve in the real world and, even better, is funny.

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What Is "Credit"? AfterPay, Earnin', and ISAs

posted by Adam Levitin
A major issue in consumer finance regulation in mid-20th century was what counted as “credit” and was therefore subject to state usury laws and (after 1968) to the federal Truth in Lending Act. Many states had a time-price differential doctrine that held that when a retailer sold goods for future payment, the differential between the price of a cash sale and that of credit sale was not interest for usury law purposes. State retail installment loan acts began to override the time-price doctrine, however, and the federal Truth in Lending Act and regulations thereunder eventually made clear that for its purposes the difference was a “finance charge” that had to be disclosed in a certain way. 
 
Today, we seem to be coming back full circle to the question of what constitutes “credit.” We’re seeing this is three different product contexts: buy-now-pay-later products like Afterpay; and payday advance products like Bridgit, Dave, and Earnin’; and Income-Sharing Agreements or ISAs (used primarily for education financing). Each of these three product types has a business model that is based on it not being subject to some or all “credit” regulation. Whether those business models are well-founded legally is another matter.
 
Let me briefly recap what is “credit” for different regulatory purposes and then turn to its application to the types of products.

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Elizabeth Warren & the Dow Corning Bankruptcy: Nothing to See

posted by Adam Levitin

The Washington Post has a story about Senator Elizabeth Warren’s involvement in the Dow Corning bankruptcy that implies that Senator Warren was somehow working against the interests of personal injury victims. That’s rubbish, and it’s frankly irresponsible reporting that fundamentally fails to understand the bankruptcy process and leaves out a critical fact.

Bankruptcies are complicated, so let me relate the Dow Corning story and then what we know of Senator Warren’s minimal involvement. Bottom line is that this is a complete nothing burger, much like the previous Washington Post story with the shocking headline (much mocked, and now amended) that then-Professor Warren had billed [a below-market] rate of $675/hr for her legal work

Here's the properly related story in a nutshell: Senator Warren did some minimal work in support of a deal to ensure compensation for tort victims that was supported by the overwhelming majority (94%) of those tort victims and that was approved by a federal court. That’s a good thing that deserves praise, not some implicit shade.  Alas, the Post doesn't bother to mention the tort victim support for the plan. 

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Venezuelan Debt: Soft Power Matters

posted by Mark Weidemaier

Mark Weidemaier and Mitu Gulati

Last week, we did a post about a set of creative but long shot defenses that Venezuela’s Interim Government has invoked to defend against lawsuits by creditors holding defaulted debt. Basically, the government wants a stay of creditor enforcement efforts. The plaintiffs want summary judgment—i.e., a relatively quick entry of judgment, without a trial or significant fact-finding. The Interim Government’s defenses have equitable appeal but questionable (although not zero) legal merit. The defenses included the contract law defense of Impossibility and the customary international law defenses of Necessity and Comity. Impossibility rarely works, especially when the defendant’s argument boils down to, “I’m out of money and need time to work out a deal with my creditors.” Necessity and Comity may not even apply in cases arising from a sovereign’s default. However, the Interim Government’s legal team persuasively emphasized their client’s impossible situation—recognized as the legitimate representative of the country but unable to access its resources.

Judges have power, and much of this power is of the “soft” variety that comes, not from the ability to resolve substantive disputes, but from professional status and authority and from the ability to control process. Here, the judge has given the Interim Government a bit of the relief it wanted, in the form of a relatively favorable scheduling order.

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Equal Treatment in Sovereign Restructurings

posted by Mark Weidemaier

Mitu Gulati & Mark Weidemaier

Last Friday, the Venezuelan government (at least, the representatives of that government recognized by the U.S.) issued a set of broad principles it intended to follow when it conducted the debt restructuring that is going to be necessary as soon as Mr. Maduro is given the proverbial boot from office.  One of those principles is going to be “equal treatment” of the various claims denominated in foreign currency – PDVSA bonds, promissory notes, Venezuelan sovereign bonds, arbitral awards and so on.  For those who are familiar with sovereign restructurings, the use of this broad equal treatment principle is going to be familiar (for example, Greece used it in 2012 when faced with an array of different types of debt instruments).

Our question is why.  The different debt instruments that Venezuela has – PDVSA bonds, sovereign bonds, Prom Notes, etc. – have different legal terms.  Some have stronger creditor rights and others have weaker ones. And that probably means that the current investors paid different amounts to buy them.  If investors paid different amounts for stronger versus weaker legal rights, doesn’t it stand to reason that the ones with the stronger rights should be offered a higher payout in a restructuring? And if they are not paid different amounts, isn’t that an invitation to the ones with stronger rights to engage in holdout behavior?

In Greece, for example, both the local-law governed Greek sovereign bonds and the foreign-law ones were offered the same deal.  Almost of the local-law bondholders took the deal, but relatively few of the foreign ones did. End result: Greece paid out the foreign-law bonds that refused the offer in full.  The same was true for a bunch of the Greek guaranteed debt. 

In Barbados, in the restructuring that is ongoing, the domestic-law bonds have taken the offer made by the government. But that same offer has been turned down the foreign-law bondholders; presumably because they think their instruments are worth more because of their stronger legal rights.  Wouldn’t it be efficient to offer the foreign holders more rather than getting mired in years of litigation?

There is undoubtedly a logic to the equal treatment principle.  We are wondering what it is. Efficiency? Maybe the logic is that if, for example, Venezuela were to offer the sovereign bonds requiring 100% of the creditors to approve of the restructuring a few cents more on the dollar than the ones requiring 75%, the whole process would get mired in disputes over whose bonds had stronger or weaker legal rights? Or maybe the logic is that investors will either hold out or not. Put differently, maybe there really is no marginal investor (i.e., one who, in exchange for a few extra pennies, might choose not to hold out and sue). Investors either have an appetite for litigation (in which case they aren’t interested in accepting restructuring terms) or they don’t (in which case there is no need to compensate them for rights they don’t have the appetite to assert). But again, we are speculating.

As a final puzzle, why are some bonds exempt from the equal treatment principle? The restructuring guidelines say that bonds backed by collateral will receive different treatment. But why? Why is a right to collateral different from a 100% voting right? Perhaps it is because some collateral pledges are relatively easy to enforce, such as the pledge of shares in U.S. entities. The PDVSA 2020 bonds are the primary example here. By contrast, a 100% voting right ensures the right to sue but doesn’t do much to help an investor enforce the judgment. However, the guidelines released by the Guaido team may have in mind something more than just the 2020s.

Yannis Manuelides Paper on the Limits of the "Local Law Advantage" in Eurozone Sovereign Bonds

posted by Mitu Gulati

Sovereign debt guru and Allen & Overy partner, Yannis Manuelides has a new paper (here) out on the “local law advantage” in Euro area sovereign bonds.  This paper, along with Mark Weidemaier’s paper from the beginning of the summer (here – and a prior creditslips discussion about it here), helps shed light the thorny question of which European local-law sovereign bonds should be valued more by investors: Ones with CACs or ones without them.  Given that there are billions of euros worth of these bonds with and without CACs being traded every day, one might have thought that there would be clear answers to these questions from the issuing authorities themselves.  There are not.  Further, some of the folks at the various government debt offices take the bizarre (to me) view that answering this question might somehow scare the market.

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Evaluating Venezuela’s Guidelines for Debt Restructuring

posted by Mark Weidemaier

Mark Weidemaier & Mitu Gulati

As reported in the Financial Times, Reuters, and elsewhere, Juan Guaido’s economic and legal team has released a report setting out guidelines for a restructuring of Venezuelan debt. The report, attached here, describes a process that can only happen if/when Maduro loses power and the U.S. government lifts the current sanctions regime, which effectively forbids most transactions in Venezuelan debt. The report is a brief three pages, but it offers intriguing clues about what a restructuring might look like.

Proposals to restructure the Venezuelan debt must accommodate certain basic realities:

- The country is experiencing a dire humanitarian crisis, which demands immediate attention.

- The debt stock is utterly, needlessly complex. Venezuela has somewhere in the range of $200 billion in external liabilities. Virtually all creditors are unsecured, and every creditor’s repayment prospects are tied directly to the government’s ability to monetize one asset: oil. For all practical purposes, every creditor is in the same position. Yet the debt is spread across multiple obligors (the government, PDVSA, etc.) and a bewildering array of obligations (bonds, promissory notes, trade credits, arbitration awards, and who knows what else).

- The government therefore needs time—time to focus on humanitarian needs, time to rehabilitate the oil sector, time to stabilize the political situation, time to determine the full scope of its debts, time for a new government to come up with a credible economic plan for recovery, time to persuade key foreign companies that they won’t be expropriated again if they come back and help in the recovery, and time to come to terms with its creditors. But…

- It may not have much time. Many creditors have been patient. But a few have already reduced claims to judgment and initiated attachment proceedings against crucial government assets, including U.S. oil operations. It is surprising that the litigation floodgates have not opened, but that could happen any day now.

- The next government is going to be highly vulnerable to creditor lawsuits, and particularly so in the United States. It cannot right its economy without selling oil abroad (and sales in the U.S. are typically the cheapest, given refineries and distances). But these sales generate assets in foreign jurisdictions, where creditors will try to seize them. This vulnerability, paired with the complexity of its debt stock, makes Venezuela more akin to Iraq than to more recent crises.

- Finally, the U.S. government may prove a fickle ally. The most effective way to buy time for a Venezuelan restructuring would be for the U.S. and other key jurisdictions to block creditors from attaching Venezuelan assets while the government was engaged in good faith restructuring negotiations. This is what happened for Iraq, but will the Trump administration be able to collaborate with other key nations (China, Russia) to produce a solution similar to that designed for Iraq?  We don’t know.

These facts make for a very messy debt restructuring scenario. But that doesn’t mean the restructuring plan must be complicated. To the contrary, the proposal released by Mr. Guaido’s team attempts to simplify. (Note that the plan does not address debts owed to other nations, presumably including state-owned companies):

Timing and credibility: As noted, Venezuela needs time to address pressing humanitarian needs and, more broadly, to get its house in order. It also needs to persuade its creditors that it has accurately estimated its liabilities and repayment capacity. But the byzantine debt stock created by the Maduro regime, combined with the government’s long-standing refusal to engage with the IMF, means that creditors have little reason to accept the government’s estimates. Not surprisingly, then, the proposal envisions that the IMF will both provide emergency humanitarian assistance and play its usual role in assessing the country’s growth and repayment prospects.

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Venezuelan Debt Restructuring: Making Impossibility Possible?

posted by Mark Weidemaier

Mark Weidemaier & Mitu Gulati

There have been relatively few recent developments regarding Venezuela’s debt, as Maduro hangs on to power and U.S. government sanctions bar trading or restructuring of Venezuelan debt by U.S. persons. However, at least one important development has mostly escaped attention. Venezuela-watchers know that the U.S. government, along with many others, has recognized Juan Guaido’s team as the legitimate government of Venezuela. This had immediate implications for creditor lawsuits against Venezuela in U.S. courts. The first involved disputes over which legal team—the lawyers selected by Maduro or those selected by Guaido—had the dubious honor of representing the Venezuelan government. The answer (sensibly enough) seems to be that Guaido’s legal team calls the shots. But Mr. Guaido and his team represent a government in exile, without meaningful resources or real levers of power. Plus, no one denies that Venezuela has failed to pay its creditors. Normally, those facts lead courts to enter judgments in creditors’ favor and to let creditors attach government assets. What legal basis could a Guaido-led government have for resisting these lawsuits?

Court papers defending against the two latest creditor lawsuits reveal an intriguing and innovative strategy. The two cases are Pharo Gaia Fund Ltd et al. v. Venezuela & Casa Express Corp. v. Venezuela.  Both are pending before Judge Analisa Torres in federal court in the Southern District of New York. In filings made a couple of weeks ago (June 21, 2019), the lawyers for Venezuela (Arnold & Porter) raised three doctrines that one rarely sees in modern sovereign debt litigation for the simple reason that these ordinarily have little chance of success: impossibility, necessity and comity.

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Libra and Financial Inclusion

posted by Adam Levitin

Facebook’s proposed Libra cryptocurrency project has truly stirred up a hornet’s nest of controversy.  Critics have generally focused on Libra as a currency and the power of Facebook in society and its appropriation of users’ privacy.  

I think that discussion misses a key point.  Libra will be, first and foremost, a payment system.  It will be a payment system that happens to operate using a currency index, rather than a single country’s currency, and clear using blockchain rather than other clearing software, but it’s still a payment system, that is a system for moving value between parties.  The payment system aspect is what both makes me incredibly skeptical about Libra’s financial inclusion claims and about Libra’s prospects for success. 

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