« The Texas Three-Step | Main | FTX Bankruptcy Plan: What's with the "Consensus" Interest Rate? »

The Judgment Holder Problem in Sovereign Debt Workouts

posted by Mark Weidemaier

Some time ago, Mitu and I had an exchange (here are parts 1, 2, 3, and 4) about judgments and collective action clauses (CACs). The question was this: Assume that a bondholder “rushes in” to court (in Steven Bodzin’s apt phrase) and gets a judgment before its fellow bondholders can vote, pursuant to the CAC, to restructure the debt. Does the “rush in” creditor escape the restructuring? The subtext was and remains Venezuela, where a number of bondholders already have obtained judgments. As Mitu put it:

For the better part of two decades the hopes and dreams of the official sector for an orderly sovereign debt workout mechanism … have resided, pretty much exclusively, in the widespread use of collective action clauses (CACs) … A concern, all through this period, however, has been that clever holdouts will figure out some loophole to bypass the CACs.

In theory, rushing in to court could be that loophole. I doubt it is a big loophole, or one that is likely to be used with any frequency. But the possibility has concerned official sector actors. And in fact, several bondholders have proceeded to judgment against Venezuela, and one has tried to do the same against Sri Lanka. This worried the U.S. government enough to submit a fairly extraordinary brief asking the court to stay the lawsuit in deference to Sri Lanka’s restructuring negotiations.

My colleague Andy Hessick and I just posted a new paper, The Judgment-Holder Problem in Sovereign Debt Workouts, which uses a Venezuelan debt restructuring as an example in thinking through this topic. The abstract is below the jump, but our primary argument goes something like this:

  • Existing analyses focus on the legal doctrine of merger and bar. They ask whether the bond “merges into” a court’s judgment and posit that, if it does, bondholders are not bound by a restructuring concluded through the CAC.
  • This is not a helpful way to think about the problem. The doctrine of merger and bar (better understood as claim preclusion) is largely irrelevant. Instead, one needs to ask two separate questions, both of which have clear answers.
  • First, does a modification vote conducted pursuant to the CAC also modify a previously-entered judgment of a federal court? The answer is clear: No. A judgment creditor may enforce the judgment even if this allows it to recover more than the issuer is obliged to pay restructuring participants.
  • However, question one isn’t as important as it seems. Question two is more important: Can restructuring participants modify the bond to impair a judgment creditor’s ability to enforce a judgment? Despite some legal uncertainties, which we discuss in the paper, we think they can, and we explain why.

tl;dr – A bondholder who cannot block a restructuring vote and races to obtain a court judgment can rest assured that the judgment will remain intact despite the restructuring vote. Whether it will be able to enforce the judgment is another matter entirely.

Abstract below:

Sovereign bond restructurings depend on collective voting mechanisms called Collective Action Clauses (CACs) in bond contracts. CACs let a bondholder supermajority modify the bond and bind dissenters to the outcome. But what if dissenters can avoid being bound by rushing to court and getting a judgment? Existing analyses suggest that the legal doctrine of merger and bar might cause the CAC to “merge” into a court’s judgment, effectively allowing judgment holders to escape the restructuring. Other bondholders would be unable to stop judgment holders from enforcing their judgments. Policymakers have long worried that this risk might undermine the contractual architecture for restructuring sovereign debt obligations. That concern also has prompted the U.S. and other governments to intervene in extraordinary ways in recent sovereign debt litigation.

We consider whether a judgment indeed has this effect. We begin by dispensing with the doctrine of merger and bar — it is largely irrelevant — and instead focus attention on two issues. First, we explain that a modification vote under the CAC cannot affect the previously-entered judgment of a federal court. To that extent, observers are right to worry that judgment creditors will escape the effect of a sovereign debt restructuring. However, we also explain that, while they cannot modify a court’s judgment, a bondholder majority or supermajority still can modify the bond to impair a judgment holder’s ability to enforce a judgment. Using Venezuelan sovereign debt as an example, we illustrate how this might work and highlight legal risks. We conclude that, although the risk is not zero, the existing contractual architecture includes tools for dealing with any risk posed by judgment holders.

Comments

The comments to this entry are closed.

Contributors

Current Guests

Follow Us On Twitter

Like Us on Facebook

  • Like Us on Facebook

    By "Liking" us on Facebook, you will receive excerpts of our posts in your Facebook news feed. (If you change your mind, you can undo it later.) Note that this is different than "Liking" our Facebook page, although a "Like" in either place will get you Credit Slips post on your Facebook news feed.

Categories

Bankr-L

  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless ([email protected]) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.

OTHER STUFF