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The "Necessity" Defense in Sovereign Debt Cases

posted by Mitu Gulati

My international debt class this week discussed the US Supreme Court’s gold clause decisions from 1935; and, in particular, US v. Perry. This is one of my favorite topics, in part because the events that occurred are so surprising to most students (as they were to me). Plus, there is some wonderful writing on the topic including a 2013 law review article by Indiana U Law School’s Gerard Magliocca (here) and a 2018 book by UCLA Economic Historian Sebastian Edwards (here).

For those who don’t know this case, basically the US imposed a massive haircut on its lenders by abrogating the gold clauses in its debt contracts via Congressional action in 1933.  Creditors yelled bloody murder and sued, and the case quickly made its way to SCOTUS.  There, the government, which didn’t have very many strong legal arguments on its side, threw itself at the court’s mercy and pled that the court deny the creditors’ claims on public policy grounds. That is, that the country was in such a deep crisis – arguably the worst it had ever seen – that extreme steps (such as the abrogation of a contract term) needed to be taken to improve general welfare.  It was a Hail Mary pass, and it worked even though the justices had to hold their noses and rule.  The Court ruled in a somewhat bizarre fashion, finding a constitutional violation but no damages.  The bottom line though was that the government won.  Better still, the US economy recovered and lenders became even more eager to lend to the US than they were before. (see here and here).

The question raised by Edwards and Magliocca though is whether we might see the use of this extreme necessity defense ever again.  And it turns out that there is a sovereign debt case going on right now, in January 2020, in a federal court in New York, where necessity is being raised as a defense. The country in question is Venezuela and the conditions surrounding Venezuela’s inability to pay are as extreme as they come (evil dictator, deep humanitarian crisis, broke government-in-exile stuck dealing with myriad lawsuits). The case is Casa Express Corp. v. Venezuela (Case 1:18-cv-11940-AT).  Question is whether, given that the crisis is occurring in a distant country as opposed to the US itself, the US federal court will find the appeal to “necessity” convincing in the same way that they did in 1935. (Venezuela is asking for a lot less relief in this case than the US was in 1935; Venezuela just wants a stay until Mr. Maduro can be induced to leave office and the IMF can help it prepare to deal with creditor claims).

As an aside, there was no discussion of an explicit “necessity” defense in the briefs in the gold clauses cases in 1935 (which is perhaps why Venezuela’s brief in the Casa Express case does not cite them).  Although the Attorney General's argument there very much sounded like a plea on the basis of necessity.  Venezuela, however, has invoked Customary International Law, which explicitly has in it a necessity defense.  I’m no expert on international law, but my impression is that this is an obscure and rarely used defense.  Still, it seems applicable to the situation.  A threshold question for the judge to consider probably will be whether CIL applies in the context of a NY law governed contract.  

My sympathies are with the Guaido legal team defending this case. But sympathy may not enough here.  Now, if the State Department were to put in an appearance on behalf of the Venezuelan people, that might sway things.

Comments

What seems worrysome from such discussion even taking place in a courthouse--well into the XXI century--is how political considerations could percolate into otherwise strictly legal / contractual debates between arm's length counterparties.

Just to be absolutely clear: conditions surrounding Venezuela’s inability to pay are anything but "extreme" or even unusual. Frontier markets are default-prone precisely because of their inability to sustain prudent macroeconomic / monetary policies in the long run, as well as a result of their tendency to leverage political control on overly populist policies.

On the other hand, playing a game of 'anything goes' may very well result on increased financing costs for the country in the very long term, once its two-decades (and still running) nightmare is finally through, and the country stabilizes toward a growth path (even a moderate one). Just ask yourself what the veredict may be on Venezuela's oil nationalization policy, looking back on the past four decades--did it really bring any structural welfare to the country and its people? didn't it hurt (even up to this date) the development prospects of its oil industry? didn't it significantly increase the financing costs for capital investments necessary for fully developing the potential of Venezuela's natural resources?

As a Venezuelan I very much dread shortsighted tactics, which ignore the big picture and have a tendency to come back and bite the whole country in the rear. We need bridges for statemanship, clear-headed strategy, capacity to handle multiparty (and complex) negotiations, and humbly acknowledging the shortcomings of Venezuelan society as a whole (as well as its political leadership) for many decades now. Hopefully the leadership will be up to such daunting task.

As mentioned in the post, since application of necessity doctrine to economic and financial crises seems very rare, even international court and tribunal decisions may not provide us sufficient guidance. However, from 4 cases brought before ICSID against Argentina by investors after 2001-2002 crisis in which Argentina invoked necessity defense, in three cases it was held that the necessity doctrine was in applicable. The tribunals basically interpreted the necessity as requiring Argentina to show that its actions were the only way to respond to the crisis. In one case the Tribunal made an assessment more like a “good faith” review. Thus, the applicability of this doctrine to the Venezuela case would depend on how narrowly (or broadly) the court interprets it.
But on top of that, it seems there is a debate on the status of customary international law in U.S. courts. Will the Court apply this ICL doctrine? The majority opinion is that customary international law—like all treaties and other international agreements—should be treated as rules of federal law so that it preempts the inconsistent state law (Banco Nacional de Cuba v. Sabbatino, 376 U.S. 398, 1964). However, here the situation is somewhat unique. The Court is required to make a macroeconomic assessment whether the conditions suffice to apply the necessity doctrine; which it may not be willing to do so. The court may be reluctant to take a role to decide about a sovereign in this case or see it as interference to the power of federal government to determine the foreign relations. There are also other hurdles for the applicability of this defense. The "stay" can be a temporary relief, so will the Guaido team be able to convince the Court about if/when Mr. Maduro will leave office?

There is no question that Venezuela is in a dire situation. But the Guaido “administration’s” ability to invoke the necessity defense is questionable, at best. While Guaido may be the de jure leader of Venezuela, he does not actually hold power. And with more than two decades having passed since Chavez was elected, claims of Chavismo’s imminent implosion have as much currency as predictions that the Kim and Castro dynasties will soon collapse.

It is unreasonable to ask creditors to indefinitely delay repayment until democracy is miraculously restored at some unknown point in the future. Further, since Guaido does not hold power, he is presently unable to do anything to alleviate Venezuela’s problems.

Guaido’s best argument is that a stay on the proceedings is consistent with important US foreign policy interests. But this argument works only if the US government itself intervenes in the case and makes its position explicit.

It’s unlikely that courts will view this situation as they did in the Gold Bond cases. That was a case in which many US creditors sued the US government in US courts. Today, creditors and decision-makers are insulated from the suffering of the Vzn people, so there will be no popular pressure (as there was in the 1930s) to acknowledge the necessity of abrogation.

As long as debtors’ economic dire straits are localized, and the bond funds and judges sit in wealthy countries thousands of miles away, the judiciary will not be as sensitive as they were to for the Gold Bonds.

In its brief, Venezuela invokes necessity as a reason why the court should stay the proceeding. But this argument puts the cart before the horse. Based on the cases we read in International Law, the necessity defense is invoked by a State after it violates an international obligation. In other words, the doctrine acts as shield from liability for some prior wrongful act. But in seeking a stay, Venezuela is not asking the court to excuse its prior act; rather, Venezuela is asking the court itself to act. A more natural sequence would be for Venezuela first to fail to appear, and then invoke necessity when moving to vacate the default judgment. A risky strategy, indeed, but fortunately it has other good arguments in support of the stay.

A more interesting question, however, is whether Venezuela can invoke the necessity defense to shield it from liability for failing to timely pay its debt. I think it would depend at least in part on whether a court were to find Venezuela contributed to its economic crisis. Under Art. 25 of the Articles on State Responsibility, necessity may not be invoked if the State has contributed to the situation of necessity. This could be problematic for Venezuela because in its brief it readily acknowledges that the Chávez and Maduro governments “systematically destroyed [the economy] through nationalizations, expropriations, over-indebtedness, and kleptocracy.” If, under the theory of state succession, Guaido’s government is responsible for the acts and obligations of the preceding governments--i.e. the Chávez and Maduro governments--then a court may have no choice but to find that Venezuela contributed to its own economic crisis. In that case, Venezuela might be foreclosed from invoking the necessity defense.

Much like in the gold clause cases, the New York court finds itself in a difficult situation. Given the current sanctions on Venezuela, and Guaido's formal recognition by the US (and many other) government(s) as Venezuela's legitimate leader, it feels like this issue should be preempted by foreign policy concerns, and that the State Department should be involved in some capacity.
Instead, the court must reach a decision with potentially serious foreign policy implications.

Even if necessity is accepted as a valid defense, I agree with Chris' above comment that Guaido's exiled government lacks the requisite agency to provide any effective response to the problem. Simply put, there is little to no guarantee that the requested stay will actually do anything for the Venezuelan people on whose behalf necessity is being invoked. On the other hand, while it's true that attaching the available assets for creditor recompense may be a messy proposition, it does at least guarantee that some repayment will be available.

On a humanitarian level, the struggles of the Venezuelan people certainly outweigh creditors' rights. In this case, however, the court's capacity is limited to securing some repayment for disgruntled creditors. The choice it faces is between doing that, or doing nothing. Perhaps some degree of waiting is warranted, as a token of good faith towards Guaido's government. However, there is little to no guarantee it will yield any constructive results.

Just given the Court's reaction to Perry, it seems unlikely that it will allow a necessity defense. However, since Perry does not explicitly address necessity, it is interesting to look back on the beginnings of crisis defenses in U.S. common law. For example, Home Bldg. & Loan Assn. v. Blaisdell illustrates that police power does allow for a "temporary and conditional restraint" on "the immediate and literal enforcement of contractual obligations" where "vital interests would otherwise suffer . . . ." This seems relevant. Application in the Venezuelan context depends on a similar constitutionally granted police power, but more importantly on whether the restraint on contract obligations sought is temporary and conditional enough. As noted above, arguing that relief is temporary is hard, given that there is no real end in sight for the stay Venezuela seeks. Regardless, I imagine the Justices would have an easier time justifying this than Perry. Ultimately, however, I doubt that the U.S. will be so generous considering that this relief benefits foreign interests and not our own.

Methinks necessity is a stretch. The majority and the concurrence seemed to go out of their way not to take the necessity/exception bait thrown at them by the parties. The majority's use of purchasing power and the government's own gold measures is weirdly mechanistic and circular -- the plaitiffs had no claim for damages because they had no use for gold (the government banned it) and because they did not lose purchasing power (deflation). Meanwhile, the concurrence would not choose between contact power and money power. Both boil down to sovereignty. If you have sovereignty, who needs necessity? (Compare Blaisdell and latent police power of the states.) To be sure, Perry and co. were big in Argentina - https://ir.lawnet.fordham.edu/cgi/viewcontent.cgi?article=1005&context=jcfl -- maybe bigger than in the US. This book is an awesome comparative overview of different approaches to emergency, economic and other -- useful context for the Depression-era US cases: https://www.cambridge.org/core/books/law-in-times-of-crisis/974A70D71A5F4599717675E87CA935DC

Putting doctrinal issues aside, there is a functional difference between the US and Venezuela cases that arguably makes the gold clause cases inapposite to the current litigation.

I read the abrogation of the gold clauses by the FDR government as part of a one-time structural adjustment in response to the decline of the interwar international monetary system. Once the international coordination game failed, each country (the US, Britain, France, etc.) had no choice but to grope its way to a new equilibrium.

Moreover, to the extent that the US could not thereafter credibly commit to enforcing its commitment to a gold standard, so much the better for the US! -- or so scholars have argued. (See, e.g., Eichengreen 1996). To the extent the abrogation created externalities, they were *positive.*

These features distinguish the US in the 1930s from the current crisis in Venezuela, which (as Daniel notes above) the Guaido government apparently concedes was the product of unilateral domestic policies. If that’s right, then making that concession strikes me as a costly mistake, as Venezuela now has a steeper hill to climb to address concerns about the moral hazard effects of granting it the relief it seeks.

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