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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.

The circumstances here are unusual enough that the plea for mercy of the Guaido lawyers might just work to give them limited relief. If so, the big implication is that the relief would amount to a temporary standstill or stay on creditor litigation until Maduro is out of office and the Guaido folks have assumed power.

We take the defenses in turn, starting with the most plausible (impossibility) and ending with the least (comity).

Impossibility

The doctrine of impossibility (or impracticability) excuses a party’s non-performance of its contract obligations when some event outside of that party’s control, and not foreseen at the time of the contract, makes it difficult or impossible to perform, unless the non-performing party assumed the risk of such events. For instance, a blight might excuse a farmer’s obligation to deliver grain (unless the contract assigned this risk to the farmer).  

Borrowers who cannot repay loans almost never succeed in arguing impossibility. The reason is that the law typically assigns the risk of non-payment to the borrower, no matter the reason for the borrower’s inability to pay. A possible exception, which one of us has written about on Credit Slips (e.g., here, here, and here) and elsewhere (here), involves the loan dispute between Ukraine and Russia. Although the English courts have not accepted the defense, Ukraine’s impracticability argument was at least plausible. But that is an exceptional case. Is Venezuela also an exception?

Perhaps. As we understand the Guaido team’s argument, it is that the government should at least temporarily be excused from paying because its responsible officials—as conclusively recognized by the U.S. government—are in exile and are unable to control the government or its resources. The argument is clever. Arguably, the current situation has resulted from events that were unforeseeable and that resulted from foreign policy decisions made by the Trump administration that were not caused by the (rightful) Venezuelan government. And the argument has a certain equitable appeal. Why not give the government a break until its rightful leaders, as determined by the U.S. government, are in control?

But there is a problem, and it seems a rather big one. In the typical impracticability case, but for the supervening event, the non-performing party would be able and willing to perform. In the blight example, the impracticability argument succeeds if the farmer could have performed, were it not for the blight. But what if, before the blight, the farmer had promised to sell (to multiple buyers) far more grain than she could realistically produce? And what if, to make matters worse, she sort of forgot to water the fields, so that crop yields would have been very low? If an unexpected blight subsequently destroyed the few remaining crops, we doubt a court would excuse her obligations.

The analogy is a bit tortured, but we hope readers will see the parallel. Venezuela has immense debts that it clearly cannot pay, both because it borrowed too much under the best of circumstances and because it has compounded its difficulties by running state oil company PDVSA into the ground. It can’t pay, and this has nothing to do with the fact that its recognized government is in exile. Thought experiment: If everyone agreed that the Maduro government was legitimate, could it assert impracticability as a defense? Of course not. When (really, if) the Guaido folks assume power, they will be in that exact position.

We don’t deny the equitable appeal of the impossibility argument. Even with a legitimate government, Venezuela will need breathing room to tackle an immense humanitarian crisis and eventually to restructure its debt. To the extent small groups of creditors interfere with these imperatives, we think courts in the U.S. and elsewhere have a role to play in restraining their activities. Our point here is only that the impracticability argument, while clever, needs to grapple with the fact that government could not perform its obligations even if Mr. Guaido held the reins.

Necessity

The other defenses, necessity and comity, have roots in international law. Necessity posits that the country cannot both pay financial/trade creditors and address the pressing humanitarian crisis. Thus, it must sacrifice the lesser interest (debt service) to preserve the greater one (providing humanitarian relief). As a factual matter, the argument has clear merit given the dire humanitarian crisis. Legally, however, things are more complicated. On the plus side (for the Guaido team), the necessity defense typically works only if the state raising it is not at fault. Here, the Trump administration’s recognition of Mr. Guaido as the legitimate representative of the Venezuelan government strengthens the argument that Venezuela is not to blame for the crisis. Still, there are multiple legal barriers to overcome.

First, we suspect that federal courts in New York will be reluctant to rule that financial exigency, no matter how serious, excuses repayment of a loan. That is particularly so in a world where sovereigns sometimes explicitly establish payment priorities by contract, legislation, or constitution. (See here for evidence on the prevalence and types of such promises; and on the history of necessity as a defense to financial crisis, see Michael Waibel’s paper here).

Second, at least some take the view that doctrine of necessity applies only to disputes between states and not to investor-state disputes (for the German constitutional court ruling on this matter, in the context of Argentina having raised the defense, see here).

Third, necessity is a doctrine of Customary International Law, which necessarily means that it is grounded in vague and contested historical practice. We doubt a U.S. federal judge will be eager to embrace a doctrine with such vague parameters.

Again, the equitable basis for Venezuela’s argument is clear, given the dire humanitarian crisis and the refugee crisis it has precipitated. But some judicial creativity will be required if this defense is to work.

Comity

International comity is a rather vague principle. In grossly simplified form, the doctrine provides a basis for U.S. courts to defer to decisions made by foreign lawmakers, to the actions or jurisdiction of foreign courts, and to the preferences of foreign governments as litigants. But the doctrine provides no principled grounds for determining when a court should defer, or what form its deference should take. We assume the Guaido legal team will ask for a stay in deference to the fact that Mr. Guaido cannot presently take steps to resolve the crisis or to resolve disputes with creditors. Again, we see the equitable argument for such a stay, although we wonder how long it will take before the court loses patience (surely the stay should not be maintained if it seems likely that Maduro will remain in power). Here, we suspect the U.S. government has an important role to play. If the U.S. were to file briefs supporting the request for a stay, we imagine this would carry a lot of weight. (Though it would also be an example of judicial deference to the executive branch, rather than comity.) So far, however, the U.S. government has shown little willingness to provide support like this.

In any event, it seems clear that the Guaido legal team is trying to create plausible legal grounds for delay, in the hope that a sympathetic court thinks Mr. Guaido should have a bit more time. So the immediate question is whether Judge Torres sees enough in these arguments to deny the creditors immediate relief. Even an extended briefing schedule (plus time to rule and perhaps write an opinion) could buy valuable time.

Comments

Buying time can be indeed of great value for Venezuela's position overall, provided that an actual and feasible plan for an orderly reorganization exists and is consistent with the stay of creditor actions (yes, there might be bigger considerations and concerns regarding the country's extremely delicate humanitarian situation than just a reorganization of its external debt--but perhaps it is wise to embrace the notion that some deeply rooted issues might be well beyond the scope of what can be actually addressed at a refinancing negotiation table). Hopefully the incentives for both the country and its creditors could remain somehow aligned in the sense that some sort of recovery and stabilization should work to the benefit of pretty much everybody at this point.

From the dictionary -- to bar: to prevent or forbid (someone) from doing something.

U.S. government sanctions DO NOT bar trading, it just puts some limits to bond transactions -- e.g. US persons can only divest bonds.

As a practical matter, compliance officers prefer to just bar trading in their respective institutions rather than do the homework and get a factual analysis that states trading/brokering is not forbidden.

OFAC has the wrong idea that as trading is very limited then potential vulture investors will not have the ability to accumulate bonds and disrupt the future restructuring. Nothing is further from the truth which is that limited trading (between other factors) pushed prices down which now is enticing vulture investors -- i.e. the exact opposite of the intended effect.

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