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Judgments > CACs

posted by Mark Weidemaier

Mitu’s post from two-days ago frames an important question. An investor holds a defaulted sovereign bond that includes a collective action clause, sues, and gets a final judgment for the full amount of the outstanding principal. Later, a majority of the remaining bondholders vote to restructure the bond’s payment terms—say, by accepting a 50% haircut. Is the judgment-holding investor somehow bound by this decision? If not, doesn’t this allow prospective holdout investors to circumvent the CAC by rushing to court to get a judgment? Let’s call this the judgment-trumps-CAC argument. Mitu’s post nicely highlights the importance of this question and some of the legal uncertainties. He also describes the judgment-trumps-CAC argument—tongue partially in cheek?—as “not crazy.”

Indeed, the judgment-trumps-CAC argument is not crazy. It is super-duper not-crazy, to the point of being unquestionably correct.* So it seems to me, anyway. Conceivably, a sovereign could use the bond’s subsequent modification as a basis for seeking relief from the judgment, though I wouldn’t fancy its odds of success. But absent such a development—which, importantly, requires judicial intervention—the judgment-holder can enforce the judgment.**

Without getting bogged down in detail, here are just a few reasons why.

First, it strikes me as odd—just purely as a textual matter—to interpret the modification provisions in a typical sovereign bond as having anything whatsoever to say about court judgments. A typical modification clause says something like this:

Upon the affirmative vote of holders of not less than X% in aggregate principal amount of the Bonds, the issuer may modify, amend, or supplement the terms of the Bonds; provided, however, that no such action may, without the consent of holders X+Y% in aggregate principal amount of the Bonds, reduce the principal amount of any Bond.

If I wanted to write a contract allowing parties to retroactively modify or negate court judgments, this is … not how I would do it. A bond is a contract, a source of private rights. A judgment is a judicial decree entitling the judgment-holder to invoke the coercive legal machinery of the state. These are entirely separate things, as lawyers know well, and a straightforward reading of the typical modification clause would lead one to think that the clause has nothing to say about judgments.

Even if the bond’s modification clause was intended to have an effect on previously-entered judgments, it’s not clear how one would operationalize that intent. Consider this relatively simple scenario:

(1) Holdout gets money judgment against sovereign for 100% of bond principal from federal district court in the Southern District of New York.

(2) Holdout successfully persuades a court in the U.K. (where the sovereign has assets) to enforce this judgment. (In practice, this means filing a lawsuit treating the U.S. judgment as an unpaid debt, but the U.K. court will not revisit the underlying merits.)

(3) Sovereign persuades the majority of its remaining bondholders to accept a 50% haircut to principal.

In this scenario, what does it even mean to say that the holdout is bound by the modification vote? The holdout creditor is the proud owner of two judgments, one in the U.S. and one in the U.K. Must courts in both jurisdictions grant a request by the sovereign to set aside their respective judgments (whatever the law in each jurisdiction might have to say about judgment finality)? What if the holdout has obtained an arbitration award, which national courts are obliged by treaty to enforce without review of the merits?

In the abstract, this strikes me as an interesting and important subject. In broad, theoretical terms, the question is whether contracting parties should have the power to specify, ex-ante, procedures for modifying or negating the effect of court judgments. The argument against recognizing such a power might begin by noting that courts are heavily subsidized. Perhaps there is something unseemly about allowing parties to accept that subsidy, only to negate or modify the result (along with whatever public goods it generates). Analogous practices—such as settlements conditioned on the court’s withdrawal of an opinion—have drawn similar objections. On the other hand, a money judgment in favor of a bondholder produces few public goods. Plus, as a practical matter, parties always have the power to negate a judgment’s effect ex post. A settlement, for instance, might have the judgment debtor voluntarily pay a lesser amount in exchange for the judgment creditor marking the judgment as fully satisfied. So what’s wrong with agreeing ex ante to a process that might produce such a result?

There are also interesting technical questions, hinted at by the example in which a holdout receives multiple judgments. If the intent of a CAC is to bind judgment holders, how can that intent be operationalized given the predictable need to coordinate the behavior of legal actors in multiple jurisdictions? This seems like a solvable problem to me, at least to a degree. But there would always be uncertainty, because any effective solution would require judges in multiple jurisdictions to coordinate their behavior, and that can never be assured.

Anyway, this is all speculation. It seems obvious to me that the standard modification clause in a sovereign bond does not purport to address the rights of judgment holders at all, much less to do so in a way that would mitigate the coordination problems inherent in this context. Nor am I convinced that this is much of a problem. I mean, yes, sure, the CAC is a bit less useful if the vote doesn’t bind judgment-holders. But not that much less useful. Median time from filing to disposition in a civil case filed in a U.S. federal court is just under a year. Despite their relative simplicity, sovereign debt cases take longer, generally because judges bend over backward to accommodate foreign states (at least initially). That leaves plenty of time for the sovereign to put together enough support to trigger the CAC. If a few holdouts get judgments, the solution is to pay them in full. There’s nothing particularly unseemly about that. It used to be the norm—for instance, before there were CACs. Even if a lot of holdouts get judgments, the world won’t end. After all, there was a world before CACs, and it wasn’t really all that bad. To be sure, if every creditor holds a money judgment, restructuring will be even more complicated than in past cases, because the government will have no contractual tools to encourage participation. But we are nowhere near that scenario at the moment. [Edit: And even if we were, the country would effectively be in the position of a sovereign with significant debts to trade creditors--or, say, to holders of promissory notes (like Venezuela). The need to negotiate with every creditor would be a complication. But that hardly warrants the pretense that CACs somehow assimilate all creditors into the group of voting bondholders.] 

tl;dr  Judgments > CACs.

 *Mitu’s post discusses two more recent cases, Ex-Im Bank and NML v. Argentina, discussing the so-called “merger” doctrine. I don’t think these have any bearing here. Both cases involved the question whether a judgment-holder could file a new lawsuit asserting a violation of the pari passu clause in the underlying bond, based on the government’s alleged, post-judgment violation of the clause. Terminological confusion aside (“merger,” “bar,” “preclusion,” bleh…), this is simply a question of claim preclusion. If a plaintiff has multiple potential claims against a defendant, but asserts only some of those claims in a lawsuit that proceeds to a final judgment, it cannot later raise the omitted claims in a new lawsuit. In both cases, the bondholders argued that they could not have asserted the pari passu claim in the prior lawsuit, because the violation occurred later. Both courts agreed. But this issue of claim preclusion has nothing at all to do with the question whether a contract should be interpreted to require a previously-entered money judgment to be modified or set aside. That is the question implicated by the argument that a CAC vote binds a judgment holder.

**Look, it’s a big world out there. Lots of stuff can happen, and the law leaves every door at least partially cracked. So, for instance, judgment enforcement proceedings are equitable in nature. Can I imagine a judge refusing to let a judgment creditor attach the sovereign’s assets on the basis that attachment would be “inequitable” now that the bonds have been modified? Sure, but then I can imagine quite a bit. The point is that, absent relatively exceptional judicial intervention, the judgment creditor can enforce the judgment.


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