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Venezuela, Lebanon, and Tools to De-Fang “Rush-In” Creditors

posted by Mark Weidemaier

A follow-up on my exchange with Mitu (parts 1, 2, 3, and 4) about whether a judgment-holder is bound by the terms of a restructuring accomplished via a sovereign bond’s collective action clause (CAC). The broader concern is that “rush-in” creditors—bondholders who file suit and obtain money judgments, thereby escaping the effect of any modification vote pursuant to the CAC—might jeopardize the prospects of a successful restructuring. Again, the subtext here is Venezuela, and perhaps Lebanon as well.

Note that, although my discussion with Mitu focused on CACs, one could have the same discussion about other bond provisions. Consider acceleration provisions. For example, what if 25% of bondholders vote to accelerate the bond, and a plaintiff subsequently gets a judgment for the full amount of accelerated principal, but then a majority of creditors vote to rescind the acceleration? The short answer to both questions is that the subsequent vote has no effect on the judgment holder. As I noted in my earlier posts, that’s not to say subsequent events like these can’t have an effect; it is just that they are not likely to have one in the ordinary course of events.*

The reason is quite simple. It is that the judgment is an entirely separate source of rights from the underlying legal claim that produced it. This is a practical consequence of the “merger” doctrine, which provides that a judgment extinguishes the plaintiff’s claim (not the contract, the claim). Thereafter, the plaintiff can’t bring another action on the same legal claim but can bring a subsequent action on the judgment. (Such an action differs from judgment enforcement proceedings such as attachment and execution, but we’ll set that detail to one side.)

We can simplify--and avoid discussion of "merger" and associated legal doctrines--by focusing attention away from CACs and onto other bond provisions, which can more plausibly be modified in ways that will affect judgment holders. Consider the following sequence:

(1) The sovereign defaults and investors have a claim to bond principal (whether because the bond was accelerated or because the default was a failure to pay the principal when due);

(2) A plaintiff holding a minority in principal amount of the bonds sues and gets a money judgment for the full principal owed on those bonds;

(3) Thereafter, the issuer conducts a debt exchange in which participating bondholders vote to modify the exchanged bonds by removing the waiver of execution immunity.

Would this modification affect the judgment holder? Of course it would—at least, assuming courts do not reject this use of the exit amendment as unduly coercive.

The reason is quite simple. A waiver of execution immunity necessarily regulates the investors’ rights post-judgment. Indeed, it is entirely irrelevant unless the investor has a judgment.** Thus, unless one interprets the bond’s modification provisions to allow only prospective modifications—not an unreasonable argument, but I think it’s wrong—then the bond’s modification provisions necessarily let restructuring participants severely hamstring a judgment-holder’s right to enforce the judgment. That is the only way to give meaning to the modification provisions in this context. (Again, this assumes one interprets the bond to allow modifications that operate retroactively.)

One can’t really make a similar argument with regard to modifications to the bond’s payment terms (or votes to rescind an acceleration). That’s because, while the modification and acceleration provisions of a sovereign bond allow votes to modify the amount and timing of payments due, a judgment-holder is no longer enforcing the right to receive payment under the bond. To beat a dead horse, a judgment holder is enforcing ... a judgment.

But.... why all this focus on using the CAC against judgment holders? The problem, remember, stems from the fear that judgment holders will disrupt or prevent restructuring. But that problem exists only if judgment holders have the incentive and ability to use their rights as judgment holders in disruptive ways. And, as the waiver of execution immunity example shows, these rights can be taken away. The concern about CACs just seems a bit misplaced, like anxiety over being unable to hammer a screw into the wall.

As long as the sovereign enjoys the support of a bondholder majority, it can significantly reduce the power of judgment holders. Sure, it will still have to negotiate with them individually, but it will do so from a point of relative strength. Exit amendments that remove execution immunity waivers are one option. For most Venezuelan bonds, this would require a super-majority vote, akin to modifying payment terms, because the list of reserved matters includes changes to “the Republic’s agreement not to claim and to irrevocably waive any immunity…” But for most if not all Lebanese bonds--I confess I haven't checked them all--it would take only a majority. Alternatively, for both countries, one could add a sharing clause--effectively eliminating a judgment-holder’s incentive to enforce the judgment--with the support of only a bondholder majority.

To be clear, these paths do involve risk. In particular, the risk is that a court would find these amendments unduly coercive. But that risk seems less significant than the risk that a court would reject attempts to “modify” a judgment out of existence. The issuer will have to make a credible case that the restructuring is in the best interests of creditors as a whole and that its hard-ball tactics were necessary to implement the deal. But if it can't make that case, the barriers to restructuring aren't really legal.

*The law allows for a judgment to be modified or set aside if the judgment “was subject to modification by its own terms or by applicable law, and events have occurred subsequent to the judgment that warrant modification of the contemplated kind” and also when there has been “such a substantial change in the circumstances that giving continued effect to the judgment is unjust.” (Both quotes from section 73 of the Restatement (Second) of Judgments.) Although a money judgment will rarely provide for modification, query whether a sovereign might ask a court to put in provisions allowing the judgment to be modified in the event of a subsequent restructuring. And even if the judgment does not contemplate modification, the sovereign could of course argue that the restructuring vote is “such a substantial change” that it would be unjust to enforce the judgment. As noted in my prior posts, however, this argument has to overcome the fact that (i) the bond did not expressly provide for modifying judgments and did not adopt any other provision that would limit judgment-holder enforcement rights (such as sharing clauses) and (ii) in many cases, the restructuring will have provided sufficient debt relief that it will not obviously be “unjust” to expect the sovereign to come to terms with judgment holders (especially since their efforts may have generated momentum for the restructuring). Moreover, even if the sovereign persuaded a court to set aside the judgment, this would not necessarily oblige courts in other jurisdictions to reject the judgment holder’s enforcement efforts.

**We’re ignoring impact on bond pricing, of course, and also the other parts of the bond’s dispute resolution provisions—the consent to jurisdiction, provisions for service of process, any provisions regarding pre-judgment attachment, etc…

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