The Sideshow about Venezuela's Prescription Clause

Mark Weidemaier and Mitu Gulati

We’ve written before about the perplexing prescription clause that appears (in one form or another) in Venezuela’s bonds. A common version of the clause says something like this:

Claims in respect of principal and interest will become void unless presentation for payment is made within a period of ten years in the case of principal and three years in the case of interest from the Relevant Date, to the extent permitted by applicable law.  “Relevant Date” means whichever is the later of (i) the date on which any such payment first becomes due and (ii) if the full amount payable has not been received by the Fiscal Agent on or prior to such due date, the date on which, the full amount having been so received, notice to that effect shall have been given to the Bondholders.

The clause is weird. Because Venezuela’s default in the payment of interest is now approaching its 3-year anniversary for some bonds, some investors worry that, unless they file suit, claims to recover those missed payments will become void. Seeking to reassure them, the interim government has released a statement saying not to worry. In the interim government’s view, the clause “addresses situations where the Fiscal Agent holds amounts paid by the Republic that are unclaimed by, or otherwise not distributed to, bondholders.” The statement asserts that the prescription period has not started to run because the fiscal agent hasn’t yet received the funds.

Argentina-Inspired Reforms to Sovereign Debt Contract Terms (Yes, Again)

In terms of innovations in the boilerplate of sovereign debt contract terms, Argentina is the gift that keeps on giving (and giving and giving).  At least within my lifetime, its behavior has inspired more contract innovation than any other country (even Ecuador, that probably comes a close second).

Here is the abstract of a wonderful new paper by two sovereign debt legal experts from White & Case (London), Ian Clark and Dimitrios Lyratzakis (White & Case has a long history of innovation in sovereign debt contracts; it was one of the firms at the forefront of Collective Action Clause innovations way back in the 1980s):

The Collective Action Clauses published by the International Capital Markets Association in 2014/2015 aim to facilitate orderly and consensual sovereign debt restructurings. The clauses were designed to give sovereigns flexibility in structuring and consummating a transaction that would be capable of attracting broad creditor support, while safeguarding the integrity of the process and the rights of creditor minorities. The recent restructurings of Argentina and Ecuador presented the first opportunities for the ICMA CACs to be tested in practice, but the “re-designation” and “PAC-man” strategies first seen in the Argentine restructuring revealed shortcomings in the ICMA contractual architecture.

Argentina’s and Ecuador’s creditors responded by negotiating tailored refinements to the standard CACs that would mitigate the risk that a sovereign could compel a restructuring that is not supported by the requisite creditor supermajorities. The qualified restrictions on “re-designation” and “PAC-man” adopted by Ecuador and Argentina enhance the ICMA architecture and provide strong incentives for a sovereign to engage constructively with its private creditors in a consensus-building process that results in a restructuring proposal capable of achieving supermajority support.

The paper, "Toward a More Robust Sovereign Debt Architecture: Innovations from Ecuador and Argentina" (forthcoming in Capital Markets Law Journal) is particularly interesting because Ian and Dimitrios are two of the creditor-side lawyers who were involved in creating the innovations that they discuss. (Much of the writing in this area has tended to be from the debtor side). Now, it remains to be seen how the market responds to these innovations. In particular, will other deals embrace the changes that have been made in the Ecuador and Argentine restructuring documents or will there be yet more experimentation?

I'm particularly intrigued by some rather crucial differences in deal documents that seem to correlate to the governing laws (NY v. England).  Informally, there has been much chatter about whether those differences were the product of drafting goofs in the model clauses on one or the other sides of the Atlantic or intentional (Each side asserts that the other has goofed -- albeit in a very polite and passive aggressive fashion). Given that debate, and the unwillingness of anyone to openly talk about the issues, I wonder whether those differences will continue out of a sheer unwillingness to admit error. (Of course, this is a topic that Dimitrios and Ian diplomatically and cleverly avoid).

Trump's Personal Guaranties and Liquidity

The revelations about Donald Trump's taxes might hold in them an explanation for why he didn't divest from his businesses when he became President, despite the obvious political problems that was going to create:  he couldn't afford divesting.  

Trump seems to have personally guarantied hundreds of millions of dollars of corporate borrowing. That's not uncommon for someone in his position, but I would imagine that at least some of those personal guaranties have key man provisions that require him to remain involved with the business. If he doesn't, the loan (and guaranty) might be in default and callable. And there are surely cross-default clauses in some of the borrowings, so it wouldn't be just one loan that could come due, but a bunch of them. It's pretty clear that in 2016 Trump didn't have the liquidity (and perhaps not even the assets) to deal with that sort of situation. 

Now let's be clear. There might have been other motivations for Trump to retain control over his businesses. But to that list, we should add the possibility that he had boxed himself in and couldn't divest even if he had wanted to without ending up broke. 

J. Screwed - A Paper

A number of months ago now, I listened to a fun podcast episode on Planet Money titled "J. Screwed" about contract shenanigans by J.Crew, as it was making its way into deep financial distress.  I'm fascinated by the exploitation of contract loopholes in debt contracts. So, of course, I wanted to know more. I went digging into the world of Google.  But I couldn't find anything good in the literature that explained to me the details of what was going on (the contract term in question, how widespread this problem was, how the market had reacted, etc., etc.). The best I found was a blog post that fellow slipster, Adam Levitin, kindly pointed to me.

But now there is a wonderful article up on ssrn by the author of that post (a former student of Adam at Georgetown Law, I believe).  The appropriately titled article, "The Development of Collateral Stripping By Distressed Borrowers" by Mitchell Mengden, is here.

The abstract reads as follows:

In the past decade, private equity sponsors have taken a more aggressive stance against creditors of their portfolio companies, the most recent iteration of which has come in the form of collateral stripping. Sponsors have been using creative lawyering to transfer valuable collateral out of the reach of creditors. This Article delves deeper into the issue by examining the contract terms and litigation claims raised by these transactions.

The lack of protective covenants and ease of manipulating EBITDA and asset valuations are key conditions that permit collateral stripping. Each of these conditions were present in the past decade, primarily due to the protracted expansionary stage of the credit cycle. Lenders, however, can protect themselves from collateral stripping by negotiating stricter covenants and tighter EBITDA definitions, as well as pursuing ex post litigation for fraudulent transfers, illegal distributions, and claims for breach of fiduciary duty.

Contractual opportunism and creative lawyering will almost certainly continue to pervade credit markets. This Article provides a roadmap of ways that lenders can protect themselves from opportunism during contracting and throughout the course of the loan. As this Article concludes, ex post litigation claims are often an inadequate remedy, so lenders should seek to tighten EBITDA definitions and broaden protective covenants—even if to do so requires other concessions—to avoid litigation.

Bankruptcy, Credit, and Finance Panels at Upcoming AALS Meeting

As with (almost) all events now, the 2021 AALS Annual Meeting is going forward as a virtual conference at the beginning of January. Deadlines for calls for papers are approaching soon. For our professor readers, the Section on Financial Institutions and Consumer Financial Protection and the Section on Commercial & Consumer Law have calls that may interest you. Details about each below the break.

Congressional testimony on Small Business Lending regulation

I am testifying later today (virtually) before the House Small Business Committee on "Transparency in Small Business Lending."  My written testimony is here.

Here's the background: consumer credit is governed by an extensive regulatory regime, starting with disclosure regulation, but extending to some substantive term regulation, and regular supervision (inspections) of lenders. There is no equivalent system for business lending.

The lack of protections for businesses is because they are presumed to be more sophisticated entities, but the range of financial and legal sophistication among businesses varies considerably. In particular, small businesses are often much more similar to consumers, and in fact their borrowing is often based on the owner's personal credit and guarantied by the owner and collateralized by the owner's personal property.

This leaves small businesses vulnerable to abusive practices that were prohibited in the consumer credit markets in the 1960s, 70s, and 80s:  disclosure of credit costs in non-standardized and misleading terms (e.g., quoting daily interest rates, rather than annual percentage rates, as required for consumer credit by the Truth in Lending Act), and confessions of judgment (prohibited for consumers by the FTC Credit Practices Rule). 

The Committee's chairwoman, Rep. Nydia Velázquez, has proposed a bill that would extend some consumer credit protections to loans for under $2.5 million made to small businesses, as well as create a system for regulating brokers of small business loans. The bill is an important step forward. While there are some tweaks I'd like to see to it, I very much hope it advances and becomes law. 

 

D-DebtCon 2020 Starts in Pretoria Labor Day Monday 9 AM EDT

DebtCon4 (aka the 4th Interdisciplinary Sovereign Debt Research and Management Conference) was all set to meet at the European University Institute tomorrow ... then #2020 tried to one-up snowzilla. But DebtCon does not quit--certainly not when exports crater, inflows turn into outflows, and debt levels go through the roof around the world--DebtCon doubles down, marches on, and smites the plague with a truly humbling show of global cooperation.

When DebtCon4 in Florence had to be postponed to 2021, ten host committees around the world miraculously reconstituted as the first-ever virtual Distributed DebtCon (#DDebtCon), a two-week sovereign debt-a-thon spanning nine countries,* five time zones, and every continent save for Australia and Antarctica. 

*We counted - (1) Argentina, (2) Barbados, (3) China, (4) Italy, (5) Singapore, (6) South Africa, (7) Switzerland, (8) UK, (9) US - plus global and regional host organizations, including III (also co-sponsoring the event), CEPR, and ABFER.