postings by Mitu Gulati

Brazilian 5 Year Sovereign Bonds at a 2.875% Yield: Aiyiyiyi

posted by Mitu Gulati

Paul Krugman had a piece in yesterday’s NYT about the lunacy in the stock market, where a bankrupt company like Hertz is merrily issuing new stock (here).  Matt Levine of Bloomberg has similarly, and hilariously, discussed the Hertz case and other recent examples of this bizarre pandemic bubble (here). Why the rush to buy overpriced rubbish?

I have no answer to the question posed by Krugman. But it is not just the stock market. A similar lunacy is occurring in the sovereign bond markets (here). Exhibit number one: Brazil. Reading the press, it seems clear that Brazil is in deep crisis thanks to the disastrous manner in which it has handled the covid-19 pandemic so far (see here and here, for discussions of how Brazil’s response to the pandemic has been among the worst in the world).  Yet, on June 3, it issued over 3 billion dollars in five- and ten-year bonds.  The five-year bonds had a coupon of 2.875%.  (the ten-year bonds were at 3.875%). I cannot understand this yield. What sane investor could possibly look at the current state of Brazil’s response to the pandemic, the fact that its leadership seems to show no signs of reversing course, and the resulting economic forecasts, and think that Brazil is such a safe bet to repay its borrowing in just five years that it should receive funding at 2.875%. Of course, from Brazil’s perspective, why not issue even more debt, if the response of the market to worsening conditions is to offer even more and cheaper money.

It is worth, however, thinking about what will happen if and when countries like Brazil cannot repay these bonds when they mature. I suspect that investors will not remember that they deliberately anesthetized their risk instincts when they bought the bonds. Some of those investors will loudly demand payment in full -- in other words, it's Brazil's fault for having offered the bonds, not the investors' fault for ignoring the risks when they bought them. Along those lines, I wonder why official sector institutions like the IMF – who know how bleak the latest economic forecasts are -- are not urging sovereigns to take advantage of the market lunacy to put in pandemic clauses. These are clauses that would give the countries like Brazil relief in the future if it turns out that covid-19 causes so much harm to the Brazilian economy that it cannot pay back the debt. After all, if investors are willing to buy any rubbish that is put out there, why not ask for better contract terms for when the party ends?

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Italian Sovereign Debt: Time to Worry or Party?

posted by Mitu Gulati

Italian sovereign borrowing is increasing, as the costs of dealing with a stalled economy and the pandemic build.  A recipe for disaster?  Turns out that Italian yields (and spreads with the risk free benchmark rate) are actually going down; down in the vicinity of zero. (for the WSJ's treatment of this last week, see here). And at least some Italian economist friends of mine are beginning to talk about how debt/GDP levels around 180% or maybe even 200% could be sustainable.  Aiyiyiyi. That sounds loony; given that the economic fundamentals -- thanks especially to the horror of covid-19 -- are going in the opposite direction. That said, I'm no economist and I definitely do not understand the current market patterns. As further evidence of this lunacy, Brazil was able to borrow $3.5 billion a few weeks ago at lower rates than it was having to pay before the pandemic; a pandemic to which its response has been spectacularly Trumpian. (And yes, I have economist friends of mine who insist that Brazilian debt is safe and will remain sustainable because of factors such as Fed swap lines and Trump's friendship with Bolsonaro. I'll readily admit that I don't understand the swap line theory of debt sustainability. But on that other point . . . . Really dudes? You are going to bet on Trump bailing out Bolsonaro because of their special relationship?).

Not everyone, fortunately, thinks that the markets are going to continue to adequately and fully fund this covid-19 recovery.  Below is the abstract of Tyler Zelinger's new paper on preparations Italy could make in anticipation of the need to do a debt restructuring someday soon (and he is only using them as an exemplar, since they seem to be on the precipice -- despite their current borrowing costs). If things begin to tank -- as I worry they will sooner rather than later -- papers like this that do the advance preparation that governments are refusing to do, will be invaluable. Tyler even finds a silver lining in all of this for the hypothetical Italian debt restructurer.

The abstract of the paper (just posted on ssrn) is below:

As the global economy has become more integrated and increasingly complex, the need for a system that administers government default has become more and more apparent. The body of "sovereign debt law" that has emerged to fill this need in the context of the Eurozone is an amalgamation of treaty obligations, domestic law constitutional principles, and tensions between state government and supranational government actors. Using a hypothetical Italian restructuring, this paper seeks to explore how these different bodies of law operate together to create a system that protects government function as opposed to guaranteeing creditor recovery. Further, this paper explores how an exogenous shock as the COVID-19 pandemic effects the analyses undertaken at various points in the sovereign debt legal framework.

This analysis reveals a silver lining: although Italy has suffered horrible losses as the result of the COVID-19 pandemic, the effects of the pandemic will help mitigate the legal challenges faced by Italy in the course of a local-law restructuring effort and thus smooth the path to a successful post-COVID recovery.

The Drama Over the Windstream Case: Boiled Down

posted by Mitu Gulati

One the most discussed and debated corporate finance/contracts cases of 2019 was Windsteam LLC v. Aurelius (SDNY 2019) (Stephen L posted on this here).  A couple of days ago, Elisabeth de Fontenay put up her article "Windstream and Contract Opportunism" on ssrn (here) that is one of first deep dives into the implications of what happened in the case.

I find this case especially interesting because it is about contract arbitrage. Cribbing from Elisabeth's superb narrative, the saga starts when the company in question, Windstream, does a sale-leaseback transaction in violation of its bond covenants (it claims it is not actually violating the covenant because it did the transaction through a subsidiary blah blah -- but as the judge points out, its attempt to elevate form over substance falls flat). As it turns out though, none of the bondholders seem to have either noticed or cared about the violation at the time it happened. The violation only bubbles to the surface when Aurelius, a notorious hedge fund, shows up two years later and demands that the trustee declare a default. At this point, I'd have expected that Windstream would have paid Aurelius greenmail to get them to disappear and everyone would have lived happily after.  But that doesn't happen.  Instead, Windstream officials and Aurelius fund managers get into a nasty battle of words in the press and (I'm guessing) both sides decide that they will fight this to the death.

At this point, Windstream tries to retroactively cure its covenant violation by getting the non-Aurelius creditors to say that they were okay with the transaction and do not want to call the company to the carpet. In theory this should have been doable via exit consents and other familiar corporate moves.  But, in a comedy of errors, Windstream manages to screw up the retroactive cure (and the judge wasn't willing to elevate substance over form on this side of the equation).  End result: Windstream loses and goes into bankruptcy.  That is, everyone loses, including the bondholders, because the value of their bonds goes into the toilet.

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What Can One Do With 50% plus One?

posted by Mitu Gulati

Today is the final day of my Duke-NYU sovereign debt seminar with Steve Choi and Lee Buchheit, and that makes me sad.  The students have delivered in spades this term, notwithstanding the disruptions to their lives as a result of corona drama. I can't begin to express how proud I am.  And teaching with Steve and Lee (with cameos by Ugo Panizza, Mark Weidemaier, Theresa Arnold, Anna Gelpern, Jeromin Zettelmeyer, Chanda De Long, Yannis Manuelides, Anna Szymanski, Felix Salmon, Jon Zonis, Robin Wigglesworth, and Colby Smith) has been special. I’m grateful for how much I've learned from them and the students.

In preparation for today’s final presentations, I want to note a couple of ideas from the student papers that arrived last night. These ideas struck me as both intriguing and audacious.  I haven’t thought them through adequately, but they got me thinking.  So, here goes. Some preliminary thoughts.

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What to do When Your Contract is a Dog's Breakfast

posted by Mitu Gulati

Tomorrow is the first of the two days when the students in my international debt class (with Steve Choi and Lee Buchheit) present their final papers to a group of outside experts.  The students have come up with some intriguing ideas for the restructurings of Lebanese and Argentine debt, a couple of which I flag below.

  1. What to do When Your Contract is a Dog's Breakfast?

Mark and I have complained about the Lebanese sovereign bond contracts on this site before (here).  I confess that there are portions of it -- the CACs and the pari passu clauses in particular -- that utterly befuddle me.  Now, maybe this is because I'm easily confused and a more sophisticated reader would understand the contract. But let us assume for the sake of argument that this contract really is the proverbial dog's breakfast. That then raises the question of: What is a court to do when faced with a contract full of confusion? (drafting guru Ken Adams uses the following delightful expression for some especially horrid contracts that he has seen -- dumpster fire).  My sense is that New York courts generally pretend that even contracts that they suspect are the product of bad cut and paste jobs were intentionally and rationally drafted.  The theory being that this gives parties -- especially those represented by fancy lawyers -- an incentive to do a better job the next time. 

At least two student groups though (Adriana and Luke from NYU, here, and Alex, Chris & Brenda from Duke, here), suggest that there is reason to think this situation could play out otherwise.  They've identified a provision in the Lebanese bonds (23(1) c of the Fiscal Agency Agreement) that gives the authority to cure any ambiguity or appropriately supplement any provision to the issuer.  Yes, sole authority goes to the issuer with the only constraint being that the issuer cannot make changes that harm the holders of the bonds (basically, that the issuer cannot act opportunistically).  This is potentially huge for Lebanon, since I am willing to wager that it would not be that difficult to get expert testimony from a dozen or so of the most eminent sovereign debt lawyers that the contract here has some major issues.  Further, since these are standard form contracts where it is easy to figure out what the market standard for the provisions in question say, the issuer can safely fill the gaps without being at substantial risk of being found to have acted opportunistically in violation of 23(1) (the student papers do a nice job of digging into the literature and identifying the relevant market standards -- which would, as I understand the arguments in the papers, help Lebanon considerably). Game, set and match to Lebanon?

Question is: Will the Lebanese lawyers use this contractual advantage?  The above language from 23(1) was also present in the Argentine sovereign debt contracts that contained the infamous pari passu clauses that got Argentina into horrible trouble with Judge Greisa and then the Second Circuit almost a decade ago. Those provisions were widely agreed to be relics of the past that no one understood and had little contemporary value.  Yet, even though there was hushed discussion of using the Argentine equivalent of 23(1) in some circles, the Argentine lawyers never used 23(1) to help clarify the meaning of their pari passu clause.  And that makes me wonder whether there was some reason that I'm not seeing as to why the argument was not used (maybe lawyers don't like saying that contracts drafted by their predecessors were dumpster fires?).  I'll find out more tomorrow, I hope.

    2. The Necessity Doctrine in the Time of Corona

A second intriguing possibility that a number of student papers have raised, but that one student paper focuses exclusively on, is the Necessity defense from customary international law.  Simplifying, the doctrine says that nations can get temporary relief from their contractual obligations in the narrow circumstances where some exogenous event occurs that causes them to need to divert resources towards helping their populace.  Charlie, Andres and Michael (here) argue that the current pandemic is precisely the kind of rare situation the Necessity doctrine was designed for.  They are not by any means saying that Argentina is entitled to a reduction in its debt obligations under the Necessity doctrine. Instead, if I understand their paper, their argument is that current levels of uncertainty so high and the need to put resources into health care so palpable that courts should be willing to grant Argentina temporary relief from suit.  And the fact that the G20 countries have just indicated that they are indeed contemplating temporary standstills for the debt obligations of the most distressed nations around the globe (here) is some support for the argument that Charlie, Michael and Andres make on behalf of Argentina.  

As as aside, Mark and I discussed the use of the Necessity defense many moons ago in the context of the Casa Express v. Venezuela case, where we thought it was something of a long shot (here).  The reason being that there was a pretty strong argument that Venezuela's financial crisis was one of its own making.  And one could argue that Argentina's debt crisis is of its own making. But Charlie, Andres and Michael respond to this argument by reiterating that they are not asking for debt relief on account of the Coronavirus -- just a temporary standstill so that the country can help save the lives of its own people.  Question is: Can they persuade a New York court that these circumstances are so unique that the recognition of the defense will not destroy the market?  

The Myth of Optimal Expectation Damages

posted by Mitu Gulati

Roughly eighty years ago, Lon Fuller and William Perdue (the former, then a faculty member at Duke Law, and the latter, a 3L), wrote two of the most famous articles in contract law (here). One of the puzzles they posed -- about why the law favors the expectation damages measure -- resulted in an entire body of scholarship, including the theory of efficient breach. And although there are a number of superb articles that have been written on this matter (Craswell, Scott, Goetz, Triantis, Posner, Klass and more), I confess that I have always had a strong distaste for this body of optimal damages scholarship because it was too complicated for me. I have, however, been most grateful to Fuller and Perdue because, in the wake of their famous collaboration, they set up a scholarship at Duke to fund faculty-student research collaborations that I have frequently applied for funding to. Last summer, I finally had to pay the price though, because three of my Duke students (one former and two current) asked if we could work on a legal realist examination of the Fuller-Perdue optimal damages question itself. I was resistant, but Jamie Boyle (who has written a fabulous piece linking Fuller's work in both public and private law (here)), urged that the students were right about this being a fun project. 

Jamie and the students were right about this being a fun project, in spades (we owe a special debt to Mark Weidemaier, who is a saint in terms of his generosity with comments and advice). All credit to Theresa, Amanda and Madison (errors are mine).

With thanks to Lon Fuller and William Perdue, the paper is here, and the abstract is below:

One of the most debated questions in the literature on contract law is what the optimal measure of damages for breach should be.  The standard casebook answer, drawing from the theory of efficient breach, is expectations damages.  This standard answer, once considered a major contribution of the law and economics field, has increasingly come under attack by theoreticians within that field itself. To shed an empirical perspective on the question, we look at data in one setting (prepayment clauses in international debt contracts) on what types of damages provisions parties contract for themselves. We find little evidence of a preference for the expectations damages measure.

Lebanon’s Unusual Pari Passu Clause and the Question of How to Construct Credible Priority

posted by Mitu Gulati

A few weeks ago, Mark Weidemaier and I blogged about Lebanon’s unusual pari passu clause and Collective Action Clauses. The question we were interested in – and the one our students are focused on – was how to engineer a restructuring that would be protected against the risk of holdout creditors (here).  One of the few methods available, assuming that creditors were likely to have blocking positions in a number of the Lebanese foreign law bonds, was to utilize Lebanon’s unusual pari passu clause to do an Exit Exchange.  Yesterday, one of the students in my debt restructuring class, who is working on designing a plan for Lebanon, posed the following inconvenient questions: Isn’t this clause internally inconsistent, with the second half of the clause contradicting the first half?  And if so, won’t a court disregard the second half as a scrivener’s error?

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Boer Bonds and the Doctrine of War Debts

posted by Mitu Gulati

Concentrating on just about anything during these days of the coronavirus, let alone academic writing, has been a trifle difficult.  A splendid new paper on Boer Bonds by Kim Oosterlinck and Marie Van Gansbeke (here) did, however, get me focused (for a bit).  And that’s in part because their paper has potentially turned upside down what I thought was an established part of customary international law.  That is, the law of “War Debts.”

The international law of state succession, standard treatises will tell you, is strict.  New states (and new governments) inherit the debt of predecessor states (and governments), regardless or changes in political philosophies.  One of the only exceptions to this strict rule is the doctrine of War Debts.  This doctrine, that I thought was implemented by the British Crown in 1900, in the wake of Boer War, says that debts incurred during hostilities by the losing party do not need to be taken on by the victor.  The refusal of the United States to take responsibility for the debts incurred by the Confederacy during the Civil War is another example.

The historical materials that I looked at in my prior work were lacking in clarity, to put in mildly.  And my sources – old treatises and cases -- were all secondary.  In a paper from over a decade ago, here is what my co authors (Lee Buchheit and Bob Thompson) and I conjectured that the doctrine of War Debts was (full paper is here):

The British Government did not at the time articulate the rationale for this policy. Perhaps it believed the justification to be obvious. Paying the debts of a former adversary is one thing, particularly when victory brings sovereignty over the disputed territory and resources. But paying off the very loans that both delayed and added to the cost of that victory is quite another thing.

Moreover, anyone lending to a belligerent power after hostilities have begun is placing an obvious bet—an all-or-nothing bet—on the outcome of the war. This aspect of the war-debt limitation to the doctrine of state succession is significant because it introduces into the debate the reasonable expectations of the creditor when extending the loan.

Kim Oosterlinck and Marie Van Gansbeke, both financial historians, look beyond the secondary sources to primary sources – the debates among the legal advisers to the British Crown, the archival records of the investment banks, and most importantly, the prices of the Boer bonds issuer prior to and after the hostilities with the British began. The story they conclude with is different from the one than what my co authors and I conjectured a decade ago (being careful historians, they couch their bottom line with caveats about the need for further research).

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Do CACs Constrain the ECB From Buying Even More Bonds?

posted by Mitu Gulati

Answer: No

(This post borrows heavily from the ideas of my co author, Ugo Panizza, of the international economics department of the Graduate Institute in Geneva).

Press accounts of last Wednesday’s emergency ECB Governing Council meeting report that some of the hawks on the Council are resistant to the ECB buying more Euro area sovereign bonds.  The concern being that such purchases might take the ECB’s holdings of particular bond issues to more than a third. If this happens, the ECB would have a blocking minority in any future debt restructuring negotiations where the sovereign is seeking to use its Collective Action Clauses (CACs) to engineer that restructuring.  And (some claim) because voting for a restructuring would amount to monetary financing, the ECB would be forced to vote no and block the restructuring.   Hence, no buying above 33.33% of a bond issue should be done.

This is nuts. Let’s first state the obvious: large ECB interventions will reduce the likelihood that a restructuring will be needed. The reactions of sovereign spreads to President Lagarde’s botched comment that the ECB is “not here to close spreads” and to the successive ECB announcements make this clear.

But let us assume that, even with vigorous ECB intervention, a restructuring is needed and let us take the case of Italy which is what everyone is really talking about.  Close to 99% of Italian sovereign debt is governed by Italian local law. That gives Italy the so-called “local law advantage” (here we focus on Italy, but the local law advantage applies to most bonds issued by euro area sovereigns except Greece and Cyprus).  Translated, it means that Italy has a wide variety of strategies it could use to restructure its debts. 

The collective action clause or CAC mechanism – one where the debt can be restructured in a fashion that is binding on dissenting creditors if a super majority of creditors votes in favor of the restructuring -- is but one of many options that Italy could use to restructure its debt (we describe these options here; see also Weidemaier (2019), here). CACs may be the most market friendly of the various restructuring options, since it requires the approval of a super majority of creditors to work. But it is neither the easiest nor the cleanest restructuring technique for a country that enjoys the local law advantage.  More important, to answer those hawks on the ECB governing council, the restructuring could occur without the need for the ECB to vote one way or the other.

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From the Vault: Lee Buchheit on "How to Restructure Greek Debt" Videos

posted by Mitu Gulati

My sovereign debt class is discussing the March 2012 Greek debt restructuring on Tuesday afternoon.  The magic here was in significant part the product of Lee Buchheit's genius. That said, I do not wish to discount the contributions of his star studded team, which had debt gurus like Andrew Shutter and Andres de la Cruz who played invaluable roles.  

In class, we are thinking a lot about how Lee used the "local law advantage" in Greece. The reason being that we are (to put it mildly) somewhat focused on strategies that could be used to get Italy significant debt relief in the midst of this current crisis -- especially if the ECB drops the ball in terms of providing adequate financial assistance.  Lee just announced his retirement, a few months ago. I'm hoping that he comes back out of it. (Hopefully, we can get him to answer questions via zoom on Tuesday).

From the vault, here are some amazing videos of Lee from both before and after the March 2012 restructuring. They are amazing because they give us a sense of how his thinking evolved as his strategy moved from a hypothetical thought experiment that had no chance of being implemented to the one plausible strategy left on the table.

Videos:

Lee – Plan B (June 21, 2010) (Pre Greek Restructuring) – start watching at 20 minute point in:

https://www.youtube.com/watch?v=w8Zvfn3DjdY

 

Lee -- The Options Now (in the wake of the Greek debt restructuring) (Nov. 6, 2012)

https://www.youtube.com/watch?v=Q6G14SF4-sQ

 

The Options Now (Part II) (Q&A)

https://www.youtube.com/watch?v=e8bBWbKCdT8&t=26s

 

Lee, with an introduction by Ugo Panizza -- European debt restructuring/Greece (and some talk of Argentina) (Nov. 26, 2013) 

https://www.youtube.com/watch?v=nLZrTzvNBT0

Puerto Rican Debt and Force Majeure

posted by Mitu Gulati

Among other things, the Coronavirus and the near global shutdown, has gotten contracting parties scrambling to read their force majeure clauses.  But what about if the parties in question didn’t explicitly contract for an “act of god” clause that covered unexpected pandemics? The question, as we’ve discussed on this blog before, would become one of whether such a clause was implicit in the contract (here).  That, in turn, will in part be a function of the contract’s governing law (here).  Puerto Rico, already mired in a debt crisis, is going to need even more relief now.  Question is: Does the fact that its debt contracts are almost all governed by local Puerto Rican civil law embed a source of temporary relief for it?

My casual impression is that the leading common law jurisdictions for contract law, such as New York and England, would be reluctant to find an implied force majeure term in contracts among sophisticated parties.  By contrast, civil law jurisdictions such as France, the Netherlands and Spain, sometimes have such a clause baked into the civil law and also appear more willing to find such a provision implicit (for discussions of the common law v. civil law approaches, see these memos from White & Case and Cleary Gottlieb memos, here and here).

Particularly intriguing in the context of a sovereign or quasi sovereign debt, is the possibility that an implication of the civil law jurisdiction in question having force majeure as part of the civil code means that the relevant government can, through legislation, make it clear that a particular event (Coronavirus) satisfies the conditions for force majeure (here).  China has apparently done just that, even issuing force majeure certificates in some cases (here and here).

A reason I’ve been thinking about implied force majeure clauses is that my seminar with Guy Charles has been discussing Puerto Rico’s debt crisis.  (Two of our recent guests to the seminar were David Skeel and Sam Erman, both of whom had fascinating papers on the topic of Puerto Rico).  Puerto Rico is, unlike most of the US,  a civil law jurisdiction.  Better still, almost all of its debt is under local Puerto Rican law (now, in the case of anything redone under PROMESA, with an overlay of that federal law). 

One has to concede up front that the Puerto Rican debt crisis is not the product of some exogenous event such as a hurricane or the coronavirus.  But surely everyone would agree that the virus has the potential to push Puerto Rico (back) over the financial brink, just as its seems to be getting back its sea legs (see here). And, so the question is, does Puerto Rico, as part of the implicit terms of any debt contract made locally, have the right to temporary relief from having to perform as a result of the enormous economic slowdown that the virus is already causing.  I haven’t been able to track down anything specific in the Puerto Rican civil code, but the Puerto Rican code has its origins in the Spanish civil code. And the Spanish code has force majeure baked in (for discussions, see here and here).

Hmmm . . . Some years ago, a wonderful group of students did find some promising avenues for Puerto Rican debt relief buried deep in its civil code (here).

*Note (in response to the first few email comments - that I'm most grateful for):  The question of what precise law the new agreements are governed by is thorny.  Best I can tell, it seems to be PROMESA and, to the extent not inconsistent with PROMESA, Puerto Rican law. But what in the world does that mean with respect to what we care about: force majeure for pandemics such as coronavirus?  I don't think there is any federal contract law on that matter; and, if so, that strikes me as pointing to Puerto Rican local law, which in turn might point us to the Spanish civil code. But maybe there is an argument there about how federal law has something to say about force majeure in the context of a pandemic that is escaping me. The actual language of the new governing law clauses is fascinating if you are as obsessed with governing law provisions as Mark W and I have been as of late.  John Coyle of UNC is the leading scholar of governing law clauses in the whole wide world (see here). And he is a contracts guru as well.  Maybe I can get him to opine.  I will try to do so and report back.

Do Italian Sovereign Bonds Have an Implicit Force Majeure Clause?

posted by Mitu Gulati

"Are There Force Majeure Clauses in Italian Sovereign Bonds?"

That’s a question one of the students in my sovereign debt class asked a couple of days ago. After reading about some of Christine Lagarde’s recent statements, she was worried about the possibility that the European authorities might not adequately support the Italian authorities in dealing with Covid19 with financial assistance needed to tackle the crisis (for discussions, here and here).  And, if not, she asked:  Could Italy use the force majeure clauses in its bonds to delay payment on its bonds until the crisis was handled?

My first response was that I was optimistic that the EU would provide Italy with any necessary assistance.  And my second response was that Lagarde and the ECB have walked back/clarified the statement in question. Plus, if memory serves, there is a mechanism for emergency financing to be provided via the ESM for adverse shocks beyond the particular country’s control.  Further, the ECB could probably do even more bond buying of Italian bonds in these circumstances.  That said, this is an event that is impacting multiple countries at the same time and it is perhaps worth it for individual countries to consider what they can do on their own if external help is not adequate.

To start with, it isn’t exactly clear what a force majeure clause is.  I’m no expert, but I believe that this is a French concept that is often referred to as an “act of god” provision.  That, on its face is not exactly a helpful description if you, like me, are unclear on what exactly acts of god are.  The basic idea is that the clause helps allocate the risk of contractual non performance when big cataclysmic events occur that are not the fault of one or the other of the parties and make performance extremely difficult. (for a helpful memo from Shearman & Sterling, see here)  The presence of such a clause in the contract, especially if it addressed the risk of Covid19, would help because it would show where the parties wanted that risk allocated. But, of course, no one knew about Covid19 until quite recently.

In the Italian case, best I know, none of their bonds say anything about which side bears the risk of a big unexpected cataclysmic event (here, the covid19 pandemic).  They are, in other words, no force majeure clauses.  Further, my casual examination of a few dozen bonds today suggests that these clauses are absent from sovereign bonds generally. So, the question is one of filling the silence in the contract.

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The Choice of Advisers for the Lebanese Restructuring

posted by Mitu Gulati

An article from a couple of days ago in L'Orient-Le Jour (here) provides a rare window into the process by which financial and legal advisers are chosen for a sovereign restructuring deal. This is the sort of stuff that people talk about quietly in back rooms -- e.g., about how there were shenanigans in the choice of advisers by the sovereign (someone's nephew getting special treatment or something else like that).  But this is the first detailed press account that I've seen.

What I was hoping for, that I didn't get from the piece though, is a sense of what restructuring strategies the different teams offered to provide the Lebanese government when they made their respective pitches. The article suggests that the different teams provided their CVs and the cost of their services.  But the article says nothing about the plans that they proffered. I'd think that if strategy A from Lazard provides for savings of $40 billion with minimal risk of litigation and only a small penalty for future borrowing and strategy B from Rothschild gets you $50 billion in savings, but a high risk of litigation and a 10 basis point higher cost to future borrowing for a couple of years, the way in which the Lebanese high command made the comparison would be the most interesting bit of the saga.  It would give us a window into what calculations the government is making about the future (and they haven't exactly covered themselves in glory on this front during the run up to this crisis).

Alas, there was no mention of the proffered strategies. Instead, the article suggests that all that these various teams brought to the table were their CVs and billing rates. Surely, that cannot be all. These are highly sophisticated lawyers and bankers and they must have planned out strategies ahead of time.

Maybe the folks at L'Orient-Le Jour will do a follow up piece.  And yes, I'm being selfish, because being able to compare the plans in class would be a wonderful learning exercise.

Paper Dragons

posted by Mitu Gulati

Last Saturday evening the Prime Minister of Lebanon announced that the country would not be paying a $1.2 billion Eurobond scheduled to mature today, March 9. As recently as six weeks ago the March 9 bond was trading at 90 cents on the dollar. Today, Lebanon's foreign bonds are deep in the toilet at 18-19 cents.

The London-based hedge fund Ashmore is reported to have bet heavily that the Lebanese authorities would in the end capitulate and pay the bond in full rather than risk a default that could quickly ripple through the country's stock of external debt. Ashmore is said to have admonished the authorities about the deeply unpleasant consequences of such a default, a position that reportedly incurred the wrath of some of the country's other creditors.

This is the second time inside the past few months that a large international investor has played a game of chicken with a sovereign or sub-sovereign bond issuer. In February, the Province of Buenos Aires sought the consent of holders of bond maturing in 2021 bond to delay a $277 million payment due on January 26 for just four months. The justification? Insufficient funds.

When the holders balked, the Province sweetened the offer by proposing to pay 30 percent of the principal of the instrument in addition to the coupon due on January 26. Most holders seemed to disposed to accept that offer but one large institution, Fidelity, held out (here and here). And because Fidelity held a blocking position in the bond, the Province's consent solicitation failed.

The worst outcome in a sovereign debt restructuring is for the issuer to plead poverty, announce the urgent and inescapable need for a debt rearrangement, and then pay the debt in full if the creditors balk at agreeing to the deal. That, however, is exactly what the Province of BA wound up doing. The lasting impression in the market is that the Province's bluff was decisively called. Fidelity, at risk of being perceived as a maverick breaking faith with its fellow lenders, ended up in the position of an equestrian Saint George with its lance deeply embedded in the scales of a paper dragon.

Fidelity won its game of chicken in Argentina; Ashmore apparently did not fare as well in Lebanon. Damage control in Argentina must now take the form of convincing the external creditors of the Republic of Argentina -- who are owed around $100 billion -- that while the Province of BA may have been caught bluffing, the Republic won't be when it announces the terms of its debt restructuring sometime in the next 10 days.

What, I wonder, will damage control look like at Ashmore? If, as widely reported, Ashmore controls more than 25 percent of the outstanding principal of one or more series of Republic of Lebanon bonds, the firm is presumably in a position single-handedly to call for an acceleration of those series. Here is where pride and credibility may play a part. If Lebanon's default on March 9 is NOT followed by the terrible swift sword of creditor enforcement actions, Ashmore's dire warnings to the Lebanese authorities may also take on the character of a paper dragon. I'm betting that Ashmore can't, or won't, let that happen.

At the end of the day, as Lebanese debt guru Anna Szymanski put it in her report on Reuters Breaking Views a few hours ago (here), it will all boil down to what Lebanon’s contracts say and how strong the legal rights of holdouts are.  And, if anyone could actually manage to understand the contractual terms (these are some of the most opaque contracts I’ve ever come across), I think that they will discover that Ashmore has the ability to draw a considerable amount of blood.  

More on the contracts over the next few days, if I can manage to read more than a paragraph of that gibberish without getting a headache. On the other hand, the ACC tournament is starting tomorrow.

Figuring Out the Terms in the Lebanese Bonds (and Why Do the Agents in Sovereign Bonds Suck?)

posted by Mitu Gulati

My students have been valiantly trying to track down the Fiscal Agency Agreements (FAA) for Lebanon that tie in to the offering documents. Those are crucial for anyone trying to figure out a restructuring strategy for the government, which is one of our projects for the term.  And, although I am optimistic that my students will figure out a way to get them, they have so far been met by a brick wall.  None of the various parties who have the documents, such as the Fiscal Agent or the Ministry of Finance or the various advisers to the Lebanese government will do the least bit to help my students.  At the end of last week, some of my students even called the FA's offices to say that they were willing to take a little side trip from their spring break visit to Europe this week to go over to the FA's offices in Luxembourg to copy this precious document in person. The response: The person on the other end hung up. Really?  Is the government really so confident in the restructuring plan that it can afford to have its agent hang up on people willing to delve through the fine print of these documents for free to see if they can come up with helpful suggestions? Maybe Lebanon already has a kickass plan from its expensive advisers and does not need any help. Wait, I forgot that they have no plan.

Continue reading "Figuring Out the Terms in the Lebanese Bonds (and Why Do the Agents in Sovereign Bonds Suck?)" »

Skeel on the Puerto Rico Oversight (NOT Control) Board

posted by Mitu Gulati

I have long been a fan of both David Skeel's research and him as a person. Not only was his book Debt's Dominion key to some of the earliest research I did on Collective Action Clauses, but he was always willing to answer my stupid questions about basic concepts (something that fancy tenured professors at Ivy League schools do not often do).  Over the years, as he has gotten fancier and fancier, I have continued to burden him with my stupid questions about bankruptcy and restructuring matters and he has never ceased to be generous; the proverbial gift that keeps on giving and never ever taking.

Last week, to penalize him yet further for his kindness over the years to me, I asked him to please come to talk to the students in my debt class about his work on the Puerto Rico oversight board (e.g., here). In our class, we read his work and it occurred to me that although it was a long shot, it would be cool to be able to talk to David in person.  And he said yes -- and that was even though I warned him that some of our seminar questions would be a tad bit hostile, in terms of pressing him about all the things that the control board had done vis-a-vis pensions, the lack of accountability of the board, imperialism, insular cases, etc., etc.

The session was amazing. The students did not disappoint in terms of relentlessly asking him tough and incisive questions (I was so very proud of them).  And he answered them in the way only he can do: in a generous and candid fashion. Alas, I cannot repeat the details of what he said, since we promised him that we would not report on any of that.  But I can lay out what I think are some of the key questions that I hope David will address in the book that I hope he will write when this is all over.

First, why was the choice made to treat Puerto Rican debt as if it were domestic municipal debt instead of treating it more like sovereign debt?  The fact that Puerto Rican debt circa 2012, when the @#@# hit the fan first, was all under local law meant that Puerto Rico could have used the "local law" advantage that Lee Buchheit's team used in both Greece and Barbados (on the latter, see Andrew Shutter's cool new article in the Capital Markets Law Journal, here).  Yet, Puerto Rico and its advisers decided to go down the municipal bankruptcy route, only to get themselves tied up in expensive legal losses for years.  My guess is that there was some political reason for the choices that were made to try and pretend that Puerto Rican debt was more like state debt than sovereign debt.  But I want to know more.

Second, why was assistance from the IMF not used?  As I understand it, the Oversight Board basically does the kind of job that the IMF does when it goes in to help over indebted countries.  The IMF has developed a lot of expertise in this exercise over the years.  Why aren't there are bunch of ex IMF stalwarts on the Oversight Board, helping out David and his colleagues?  

Third, while I'm full of admiration for some of the aggressive moves that the Oversight Board took vis-a-vis the creditors in terms of, for example, questioning the validity of 2012 and 2014 issuances that were arguably done in violation of certain debt limits, what calculations were made about how much this strategy would impact Puerto Rico's future cost of borrowing?  After all, one of the key objectives of the Oversight Board is supposed to be to return Puerto Rico to the capital markets. Someday, I'd love to see that the report that the financial advisers provided on this. (It probably pointed to the research showing that the sovereign and municipal debt markets have a notoriously short memory).

Fourth, what is the world is happening with the Aurelius case? I thought that we'd have a decision on that, in terms of the legality of the Oversight Board under the Appointments Clause, months ago.  Does the delay mean that those of us who predicted -- based on what happened at oral argument -- that the court was going to rule quickly in favor of the Oversight Board were perhaps wrong? Maybe the delay means that the Court is indeed going to deal with the ugly legacy of the Insular cases, something that they did not seem to want to do in November at the argument? (Yes, I know that David does not have special insight into what the justices are thinking, but I'm curious anyway).

I can't wait for David's book to come out.  I'll assign it in class and ask him to come back to talk to us again!

Odd Lots Podcast on Iraq's Astonishing Debt Restructuring (Next: Ecuador's Dodgy Buyback?)

posted by Mitu Gulati

For sovereign debt fans, there is a very nice podcast from Bloomberg's Odd Lots that was put up a couple of days ago (here).  The title says it all: "How Iraq Pulled Off One of the Biggest Sovereign Debt Restructurings of All Time".  It is a pity that there has not been more writing about the Iraqi debt restructuring because this is one from which there are many lessons to be learned. Lessons that are relevant for Venezuela in particular.

Plus, it was so creative and there were so many colorful characters involved (I loved the podcast, but I wish that they had talked more about the cast of characters and some of the individual stories like those of the neo cons, the US President, LCB, the NGOs, Alexander Sack and so on).

The guest for the podcast was LSE Econ Historian, Simon Hinrichsen (especially impressive that the basis of the podcast is a chapter from his dissertation -- I cannot imagine anything that I wrote in grad school being worthy of much more than toilet paper).

So, I have a request to Joe Weisenthal and Tracy Alloway.  If you are listening, could you guys continue with your historical excavation series and do one on Ecuador's Dodgy Buyback from 2008-09? One of the themes in their discussion with Simon on Iraq was the decision taken ultimately (contrary, I have heard, to the preferences of the US President) to not use the Odious Debt defense.  That probably helped Iraq, but maybe hurt the international system in that that was a wonderful opportunity to change international law for the better.  But it is not the case that no country has run with that defense successfully.  Ecuador in 2008-09 is one. And China, with respect to its Imperial debt is another one.

In class in NY last week, we had some of the folks who worked on the post-buyback resuscitation of Ecuador's reputation in the international markets come and discuss how that had been engineered. It is an amazing story because Ecuador is now a regular and respectable issuer in the EM space. How the hell did that happen so quickly?  Unfortunately, I promised to keep mum about what was said in class last week.  But fabulous reporters like Joe and Tracy could unpack this on a podcast.  And then those of us who study this topic would benefit.

Why Are Those Lebanese Fiscal Agency Agreements So Hard to Find?

posted by Mitu Gulati

Often, the final assignment in my sovereign debt finance class is for the students to try and design a restructuring plan for whatever sovereign is in crisis that year.  This year, we have a number of available candidates: Argentina, Lebanon, Venezuela, Italy(?).

A crucial part of the assignment is for the students to figure out what the relevant contractual documents are that they need to delve into.  There are some students who fail to realize until the end of the term that the offering circulars and prospectus supplements are not in fact the relevant contractual documents and, at best, contain summaries of some of the relevant terms.  To the extent that the language of the offering documents is inconsistent with that in the actual contracts, and the students fail to see this, it can be a disaster – as Andrea Kropp’s excellent forthcoming article “Restructuring Italy’s New York Law Bonds” explains (here).

The majority of students though do figure out that they need the relevant trust indentures or fiscal agency agreements to be able to design a plausible restructuring plan.  The question then is how to find those documents. And that is often not easy. Now, as a matter of pedagogy, I think it is good for the students to learn how to use the various databases such as Bloomberg, Thomson One Banker, Filings Expert, Dealogic and so on to find key financial and legal data.  Enterprising law students often also find other sources, such as the websites of the ministries of finance and the databases of the various exchanges on which these documents are listed. 

Finding these elusive documents is a skill that was invaluable for me at my law firm eons ago because most of the other associates had no clue as to how to find these financial documents (law schools certainly didn't provide training in how to dig up financial contracts). But these above mentioned sources, while providing a good start, rarely have the actual contracts. Instead, what they provide are the sales documents that, at best, contain summaries of the key terms.  And, as noted, those summaries can sometimes be very wrong from a legal perspective because for us the specific wording of clauses can be especially important. 

So, should the public expect for these documents to be readily accessible? I think so. These are the debt contracts of sovereign issuers, often for many billions of dollars that taxpayers are on the hook to repay. One would think that their terms would be a matter of public record so that the public can see what sorts of preparations the governments have made to handle the eventuality of a debt restructuring (in Lebanon’s case, I worry that the answer might be: precious few).  Yet, the reality is that it can sometimes be very difficult – near impossible in some cases – to dig up this stuff. And I’m finding that Lebanon is a prime example.  Indeed, the sales documents for Lebanon's sovereign debt are particularly obtuse in terms of having buried much of the crucial information in the Fiscal Agency Agreement, which no one seems to be able to get access to unless one is an actual holder of the bonds who is willing to show up at the Fiscal Agent's office in Luxembourg or something else altogether ridiculous.  Now, there are ways to figure this stuff out, which my students inevitably do. But why make this exercise so difficult when what we are talking about are public debt documents?

Maybe my friends at the IMF and World Bank will remedy this problem as part of the various "transparency" initiatives they periodically trot out at fancy conferences on the beach in Mauritius, Bali or the Seychelles. But right now, today, I'm willing to bet that they themselves don't have the relevant Lebanese Fiscal Agency Agreements.  At least the unnamed person from one of these institutions who just emailed me to ask whether my students had been able to dig up the Lebanese documents didn't have a clue as to how to find them. I was so very tempted to ask him, in response to his question, how his last transparency initiative conference on whatever beach had gone (he'd have likely responded: "Wonderfully! Pity you couldn't make it").

Aiyiyiyi

The Emperor's Old Bonds

posted by Mitu Gulati

Inspired by Tracy Alloway's recent piece on antique Chinese bonds (here), a group of my students has gone deep down the rabbit hole of the question of how one might recover on them (or, from the Chinese government’s perspective, how one would block recovery).  If I’m reading Michael, Charlie and Andres correctly, they think that the probability of recovery via litigation is near zero on almost all of the antique Chinese bonds.  All except one special bond issue that no one has brought litigation on yet.  I'm not saying that there is a real possibility of recovery here (if one is a legal realist, one would be deeply skeptical), but we are in the era of Trump.

I love their title, "The Emperor's Old Bonds".  But there is much more to this fun paper (here) than the title. The abstract is below:

Tracy Alloway’s recent article in Bloomberg has suggested that Trump’s trade war may finally provide relief to American holders of defaulted, pre-1950s Chinese bonds. Here, we examine the hurdles set before these bondholders, namely establishing jurisdiction over the People’s Republic of China as sovereign and the long-lapsed statute of limitations. We also evaluate the Chinese government’s possible recourse. 

The key takeaways from our investigation: To establish jurisdiction in the U.S., the bond must be denominated in U.S. Dollars or state a place of performance within the country. To overcome the long-expired statute of limitations, and win an equitable remedy, it must be shown that the PRC not only violated an absolute priority or pari passu clause, but also that they are a “uniquely recalcitrant” debtor. Finally, despite China’s commitment to the odious debt doctrine, the doctrine is unlikely to provide meaningful legal protection in the event of an otherwise successful suit. 

Overall, it is a difficult suit to bring, but through our investigations we have discovered one issue in particular which holds the greatest danger—or perhaps the greatest promise: the 1919 Gold Bond.

Pre-1949 Chinese Bonds: How Much of a Litigation Threat Do They Pose?

posted by Mitu Gulati

As part of the international debt class that I'm teaching this term with Steve and Lee, we spent a couple of sessions discussing the various lawsuits that have been brought in US courts over China's defaulted pre-1949 debt.  The discussions have been a lot of fun because the students have had interesting perspectives on the question of whether the governments of mainland China and Taiwan need to continue to be concerned about these irritating lawsuits popping up (especially in the age of Trump, given that some of his ardent supporters in Tennessee appear to be big and vociferous holders of these antique debt instruments).

Among the interesting issues that were discussed were whether China's persistent refusal to even engage the debt holders amounted to the kind of "uniquely recalcitrant" debtor behavior that resulted in the New York granting an injunction against Argentina in the infamous NML litigation in 2011 and 2012. This is important because an NML type argument, via the priority clauses in a number of the old Chinese loans (particularly those that were issued in US dollars and via US banks), could be the key to resuscitating these old claims.

Reading cases such as Jackson v. PRC, and especially the US Statement of Interest that was filed there, are enough to convert even the most ardent legal formalists into realists. And, if so, the fact that the present inhabitant of the white house has (maybe, kinda . . .) shown more sympathy towards these holders of antique Chinese bonds than any prior US president in over a half century may be quite relevant.

I've asked our students, if they are willing, to post their views on these matters in the comments (and maybe even links to their papers).  They are quite interesting.

Judgements, CACs and Civil Procedure Quicksand

posted by Mitu Gulati

Mark's post below on whether obtaining a judgement is a clever way of getting around the threat of a cram down via a CAC is unsurprisingly superb.  Pharo's strategy, Mark says, is not at all crazy.  If he is right -- and I have learned over the years of working with Mark that he is almost always right -- then this strategy is going to be relevant not only in Venezuela, but in Argentina as well. It creates the problem, to quote Steven Bodzin of REDD Intelligence, of Rush-ins (as opposed to holdouts).

Interestingly, thanks to an old friend who has a doctorate in international civil procedure and follows these things, I discovered an old IMF paper where the IMF legal gurus (Thomas Laryea and Sean Hagan, most likely) had flagged this issue of judgements potentially undermining CACs for their board as far back as 2003--04. Paragraph 43 of the March 22 Report to the Board titled "Recent Developments in Sovereign Debt Litigation" basically supports Mark's view and warns the Board of precisely the complications we are discussing fifteen years later.  If one wants to go down the rabbit hole here, as I suspect the folks from Pharo have gone, the implications for the resuscitation of an Elliott-style pari passu attack via a judgement are significant. But I'm not wading into that quicksand now.

Now, to return to the question of whether Judgements do indeed quash CACs and to continue the discussion with Mark (with the caveat that he knows best), I have a simple minded query for those who are confident about that conclusion (I'm not confident either way). Take the following:

You and I enter into a contract to lend $100 to Mark. The contract also says that if Mark does not pay on the maturity date, you will refund $50 to me out of your own pocket.

Mark doesn't pay and you get a judgment against him.

Have you avoided paying me the $50?

Sharpened, the issue is whether a CAC is a form of intercreditor undertaking by which each holder promises to all the others that it will accept a supermajority decision about the treatment of the credit in a distressed situation.

After all, the clause does not say the modification "will be binding on all holders until the moment they receive a judgment". It says "binding on all holders".

And if Griesa/Baer are right that the bond continues to have legal vitality even after the awarding of a judgment, is this really so far-fetched?

Do Judgements Trump CACs?

posted by Mitu Gulati

(Thanks to Steven Bodzin of REDD Intelligence for flagging this matter; he has an aptly titled piece on this out today “Venezuela Bondholders Seek Judgement Ahead of Collective Action Clause Activation”).

A few weeks ago, I put up a post on the what I thought was an interesting and innovative set of arguments being raised by Juan Guaido’s team in the Casa Express/Pharo Gaia v. Venezuela litigation in New York (here).  I was especially interested in the argument that an obscure customary international law doctrine of necessity (i.e., things are really really bad in my country, so I can’t pay just yet) justified the court granting a stay in the litigation.  This argument was tried in a series of arbitral proceedings under bilateral investment treaties by Argentina in the wake of its 2001 crisis and it had mixed success.  But it has never before been raised in a New York court, under a garden variety New York law governed contract.  So, the judge will have to decide whether this international law defense is even admissible in this context or whether the only excuse defenses allowable are those from New York contract law (e.g., impracticability, duress, unconscionability, etc.). And then, assuming the judge rules in the affirmative, the question will be whether the necessity defense applies in this context. 

At the end of last week, the creditors submitted their counter arguments.  As expected, they expressed outrage and shock that the debtor would seek to bring in a defense from the outlandish world of customary international law into their precious New York law contract dispute arena.  But buried in between the outrage was a point that may well open pandora’s box. 

On page 5 of the creditor submission, in explaining why the grant of a stay would harm them and, therefore, should not be granted, the creditors say:

[The] threat [of prejudice to the creditors’ ability to recover] is magnified here by the collective-action-clauses in the 7.75% 2019 bonds which allow a supermajority to bind nonconsenting creditors to the terms of restructured bonds. . . . A judgment would protect the Pharo Plaintiffs who hold beneficial interests in the 7.75% 2019 bonds – from such compulsory restructuring of their debts. (emphasis mine).

The last sentence is worth reading again.

Continue reading "Do Judgements Trump CACs?" »

216 Jamaica Avenue and the Prospect of Breathing Life Into Antique Chinese Bonds

posted by Mitu Gulati

One of the more fun discussions we have had in my international debt class this term has been the question of whether a clever plaintiff's lawyer might be able to breathe life into defaulted Chinese bonds from the period 1911-1948. (Our thanks to Tracy Alloway's delightful piece in Bloomberg on this matter (here)).

Part of our inspiration for this discussion, however, was also reading an enormously fun 2008 Sixth Circuit opinion from Judge Jeff Sutton, in the 216 Jamaica Avenue case (here). The context of the case was the abrogation of gold clauses 1933 that we've discussed before on this site (here, here and here).  What we have not talked about, however, is what impact the removal of that 1933 prohibition on the use of gold clauses in 1977 had.  For long-term contracts that were written in the early 1900s that then had their gold clause index provisions abrogated in 1933, the 1977 law arguably re activated them.  Congress tried to stop most of the attempts at reactivation.  But for the cleverest of lawyers, there was always going to be a way.  For these contract arbitrageurs, scouring old contracts for lottery tickets through the re activation of these old clauses that everyone else has long forgotten is fun. It certainly was fun for us to read about (Congrats, Cooper & Kirk, who note their victory in this case on their website (here)).

As a general matter, courts don't tend to be very sympathetic to lawyers trying to reactivate old clauses to earn giant lottery payouts.  But in 216 Jamaica Avenue, that's precisely what happened. The opinion is an absolute delight, not only because of the wonderful facts and analysis of basic contract law matters such as "meeting of the minds" that befuddles most first-year students (and me), but also because it is written in a style that is reminiscent of the classic Richard Posner opinions; short, incisive and witty.   

I'm hoping that my students, if they find interesting ways in which to overcome the significant barriers to bringing suit on the antique Chinese bonds -- namely, the statute of limitations and jurisdictional hurdles -- will post about them in the comments.  The barrier is high though, despite Mr. Horatio Gadfly's optimism some years ago (here and here).

I do wonder though whether the Chinese (and Russian) governments will some day soon decide that they should just enter into global settlement with the owners of these antique bonds for pennies on the dollar and stop the periodic pesky lawsuits. Otherwise there will come a day where someone somewhere figures out a way to do a set off or restart the statute of limitations. 216 Jamaica Ave points in that direction.

Daniel Schwarcz on the Evolution of Insurance Contracts

posted by Mitu Gulati

I shudder even as I write these words, but I’m increasingly fascinated by insurance contracts.  If you are interested in the processes by which standard form contracts evolve – which I am -- then you can’t help but be sucked into this world. Coming from the world of sovereign bonds, the insurance world strikes as bizarre. Among the wonderful authors whose worked has sucked me in are Michelle Boardman (here), Christopher French (here) and Daniel Schwarcz (here).

There are a handful of major players who dominate the insurance industry and everyone seems to use the same basic boilerplate terms tied a core industry-wide form. Further, courts aggressively use an obscure doctrine, contra proferentem (basically, construing terms against the drafter/big bad wolf), that is often ignored in other areas such as the bond world where figuring out who did the actual drafting is a near impossible task.  Finally, while contracts in this world are often sticky and full of long buried flaws, they are also sometimes highly responsive to court decisions. In other words, there is much to be learned about the how and why of contract language evolution as a function of court decisions (a process about which most law school contracts classes make utterly unrealistic assumptions and assertions) by examining insurance contract evolution and comparing it to contract evolution in other areas that don’t share the same characteristics.

My reason for this post, is to flag a wonderful new paper by Daniel Schwarcz of U. Minnesota Law. The paper, “The Role of Courts in the Evolution of Standard Form Contracts” (here) is on the evolution of insurance contract terms in response to court decisions.  Unlike much of the prior literature on standard form contracts where each paper examines no more than a handful of terms and often finds that contracts are not very responsive to particular court decisions, Daniel examines a wide range of terms (basically, everything) over a long period of time (a half century) and finds a great deal of responsiveness to court decisions.  The question that raises is whether there are features of the insurance industry that are different from, for example, the bond world.  Or whether Dan just studied a lot more changes than anyone before this had done; and, therefore, he was able to see further than prior scholars.

Continue reading "Daniel Schwarcz on the Evolution of Insurance Contracts" »

Elliott Rocks (Strikes?) Again

posted by Mitu Gulati

Holdout hero Elliott Management, the king of holding out until it gets what it wants, scored itself a nice Christmas bonus. The hedge fund won a long game of chicken with Ireland’s government over junior bonds issued by Anglo Irish Bank by getting its money back in full. If you understand the law, it pays to be stubborn, writes the FT’s Rob Smith (here).

I have written critically about Elliott Associates and their creative use of the pari passu weapon against Argentina. But I cannot help but admire their skills.  Plus, from a long term perspective, maybe they do force us all to pay more attention to the terms in our contracts -- because, if we don't, they will eat our lunch. Everyone who took the deal offered by Allied Irish got 20 cents on the dollar.  According to Smith's piece, Elliott got 100 cents. Wow.

There is a lesson here for whoever is designing Argentina's latest restructuring.

The Bajan Debt Restructuring - 2018-19

posted by Mitu Gulati

Following in the footsteps of their mammoth restructuring of Greek Debt in March 2012, Andrew Shutter, Jim Ho, Lee Buchheit, and their team utilized the same "local law advantage" to design the restructuring of the Bajan debt in 2018-19.  Andrew, one of the gurus of the sovereign debt field, has just put up a super paper on this (here). The paper describes not only how the restructuring was engineered, but also the ways in which the strategy utilized was different from that used for Greece. There is also the use of an innovative "hurricane" clause in the new post-restructuring bonds that is worthy of a whole article in and of itself (some of the other Caribbean borrowers that Andrew and Lee worked with in recent years have also used this clause, but others could sure have used it as well -- and I'm thinking of Puerto Rico in particular here).

I'm particularly interested in how the holders of foreign-law bonds were induced to enter the deal, without significant holdout problems.  My guess is that they were paid a pretty penny.  But on that specific question, Andrew does not show all of his cards.

To this date, there has been precious little writing about this very cool operation in Barbados.  So, as someone who teaches in this area, I'm especially grateful to Andrew.  I'm also jealous that he probably got to go to Barbados a lot. 

 

 

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).

Continue reading "The "Necessity" Defense in Sovereign Debt Cases" »

Argentina’s Hundred-Year Bond and its Make-Whole Premium: A Spanner in the Works?

posted by Mitu Gulati

Argentina is on the brink of attempting a restructuring of its sovereign debt.  And, of course, that has attracted the birds of prey.  An article in Bloomberg a couple of days ago (here) reported that potential holdout creditors had hired expert lawyers to examine the fine print in Argentine contracts in the hope of finding a vehicle to support their litigation strategies.

Assuming that it is not going to be long before Argentina is in full restructuring mode, my question is whether an unusual clause in one of the Argentine bonds, combined with a recent case out of the Southern District of New York, might interfere with the Argentine government’s restructuring plans?

The clause is the Optional Redemption provision in the $2.75 bn hundred-year bond that Argentina issued in June 2017, with the hefty coupon of 7.125%.  Optional Redemption clauses, as my co authors (Amanda Dixon, Madison Whalen and Theresa Arnold) discovered in an analysis of over 500 recent sovereign and quasi sovereign issuances, are rare creatures in this market.  Fewer than 20% of all the sovereign issuers use them. Some, like Mexico, are frequent users. But others, such as Argentina, have used them only on rare occasion.

Oversimplifying, these provisions typically allow the issuer to call the bonds at a supra compensatory amount (somewhat misleadingly called the “make-whole” amount).  Our data suggests that such provisions were largely absent from the sovereign market in the period between the mid 1990s and 2010.  Somewhere around 2010 though, Issuer Call provisions with their “make-whole” premia began migrating into the sovereign world from the high-yield corporate bond market.  Precisely why the Issuer Call provisions are set at a supra compensatory amount is something of a mystery to me (Marcel Kahan and I discuss the mechanics of these clauses here).

What I’ve heard from lawyers and bankers in the interviews that Marcel and I did for our piece (here) is that high-yield corporates sometimes need to retire their old bonds to they can escape onerous covenants (for example, to engage in a lucrative merger).  And to do that they are willing to pay a high amount – that is, a supra compensatory “make-whole” premium. In the sovereign context though, not only is there not going to be any lucrative merger, but the covenants are not all that onerous such that issuers would want to pay a big premium to get out of them.  But maybe there are countries that think that their current borrowing costs are unduly high (e.g., the 7.125% coupon on Argentina’s 100-year bond) and that these costs will surely go down some day in the future.  That, in turn, will make the redemption option valuable to that optimistic issuer. And, maybe, like Argentina was in June 2017, the issuer will be willing to promise pay a high amount to creditors if conditions ever become so positive that it wants to retire substantial amounts of its high coupon debt. Alexander Hamilton certainly thought so in the Report on Public Credit in 1790 (here).  Things haven’t quite worked out for Argentina in the manner that they did for Hamilton and the US.  But a hundred years is a long time. 

Now, you might ask, why is an Optional Redemption clause relevant in the context of an attempted sovereign restructuring?  After all, an Issuer Call option and should only be relevant where the issuer chooses to exercise the option.  And Argentina is seeking to get creditors to take haircuts, rather than exercise its redemption option.  Remember, the redemption option typically requires the issuer to pay a supra compensatory amount (because it is intended to operate in a state of the world where things have improved so dramatically for that issuer that it wishes to retire the debt) – which is the opposite of the haircut that Argentina needs to impose currently (because things have turned terrible for Argentina).

The answer has to do with a New York case from late 2016, Cash America v. Wilmington Savings.  Drawing from a blog post that Marcel Kahan and I did for the Columbia Law School Blue Sky Blog a couple of days ago, here is the story of the case:

Bond indentures [for high-yield corporate issuers in the US] commonly contain what are called “make-whole” provisions that give the issuer of the bonds the option to redeem the bonds, at a premium over par. Bond indentures also contain an acceleration clause that gives bondholders the option, upon an Event of Default, to demand immediate payment of the principal amount and receive par. To reiterate, redemption is an option of the issuer while acceleration is an option for bondholders.

In Cash America [v. Wilmington Savings], the issuer was found to have violated a covenant in the bond indenture, thereby generating an Event of Default.  The court ruled that when the issuer engaged in a “voluntary” covenant breach, holders are entitled to receive as a remedy the amount they would have received upon redemption, that is a premium over the amount receivable under the acceleration clause.  [And that redemption amount was a supra compensatory “make-whole” amount].

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Buybacks as a Sovereign Debt Restructuring Strategy: Why the Disfavor?

posted by Mitu Gulati

The ideas in this post are drawn from work with Stephen Choi.  Errors are mine.

Last week was the first session in our International Debt Finance class, both at Duke and at NYU.  This is an exciting time to be teaching this material, given the many sovereign and quasi sovereign issuers that are struggling with over indebtedness.  Among them are Argentina, Lebanon, Venezuela, Italy (maybe) and, locally, Puerto Rico.

For day one, inspired by the provocative recent article by Julia Mahoney and Ed Kitch on the possible need to restructure the multi-trillion dollar US debt stock, we assigned both the Mahoney-Kitch (2019) piece (here) and Alexander Hamilton’s 1790 Report on Public Credit (here).

Hamilton’s Report on Public Credit is an astonishing document, since it is essentially a proposal to do a brutal debt restructuring (see here) for a new nation that, while significantly reducing the nation’s debt stock, would (hopefully) also serve as a building block for a solid reputation for this new debtor.  Somehow, it worked.  In what follows, we focus on only one aspect of Hamilton’s report: Hamilton’s views on the possibility of reducing the US debt stock--some of which was trading at pennies on the dollar--by doing a market buyback prior to the announcement of his plan.  In discussing possible strategies to reduce the public debt, he flags the possibility of doing a buyback of the debt at the current market prices.  Hamilton writes of this strategy:

Fourthly. To the purchase of the public debt at the price it shall bear in the market, while it continues below its true value. This measure, which would be, in the opinion of the Secretary [i.e., Hamilton, speaking of himself in the third person], highly dishonorable to the government, if it were to precede a provision for funding the debt, would become altogether unexceptionable, after that had been made. (emphasis added).

In other words, Hamilton says that doing a buyback before the government makes public its plan to fund the debt, would be wrong.  Why?  We don’t know exactly why.  But reading between the lines, AH would perhaps explain that the sovereign debtor should not be the beneficiary of its own misconduct (the default), particularly at the expense of its own citizens (the sellers of the paper at a discount). 

Question is, given that we have an additional 200 years plus of experience of sovereign restructurings since Hamilton, was he right to disfavor the buyback strategy? As a practical matter, in terms of the playbook of the modern sovereign debt restructurer, Hamilton’s admonition seems to have held sway. That is illustrated by this 2019 IMF publication on “How to Restructure Sovereign Debt: Lessons From Four Decades” which mentions buybacks only in a footnote (note 3, here) that suggests that prevailing economic wisdom is that they don’t work particularly well as a restructuring strategy.

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Hinrichsen on Iraq’s Debt Restructuring

posted by Mitu Gulati

Iraq’s debt restructuring a decade and a half ago was one of the few things that went right with the US incursion into that country in 2003.  Thanks to a combination of an expensive war with Iran, mismanagement and corruption on the part of Saddam and his henchmen, and the debilitating effect of international sanctions on the economy, Iraq in 2003 found itself with one of the largest sovereign defaulted debt stocks in history.  Worse, thanks to the sanctions regime, much of the unpaid debt had, by the time of Saddam’s removal, matured into judgements and attachment orders.  That makes a debt restructurer's job much more difficult than in a normal sovereign restructuring.  And unlike other defaulting sovereigns in the past, who had precious few assets available for creditors in foreign jurisdictions to seize, the new Iraq had oil revenues that it desperately needed to use in order to try and get back to some semblance of normalcy and growth.

The fascinating story of how the debt was accumulated and then restructured has been told in bits and pieces.  But economic historian Simon Hinrichsen is the first, to my knowledge, to attempt to tell the full story. His draft article, “Tracing Iraqi Debt Through Defaults and Restructurings”, hot off the presses, is available on the LSE Econ History website here.  Among the most interesting aspects of the story are the use of UN Security Council Resolutions and US Executive Orders to immunize Iraqi oil assets (hence, neutralizing the risk of attacks by holdout creditors) and the attempted resuscitation of the ancient doctrine of Odious Debts. The former succeeded and the latter failed.  Many of these same issues are going to come up again when Venezuela embarks on its post-Maduro restructuring (see here and here).  I wonder how they will play out.

Simon's abstract is as follows:

In 1979 Iraq was a net creditor to the world, due to its large oil reserves and lack of external debt. Fifteen years later, its government debt-to-GDP was over 1,000%. At the time of the U.S. invasion in 2003, Iraq was saddled with around $130 billion in external debt that needed to be restructured. How does a country incur so much debt, so fast, and how does it get out of it? In answering this question, the paper makes two key contributions. First, I reconstruct the build-up of Iraqi debt through the 1980s and 1990s using mainly secondary sources. This paper is the first to create a debt series going back to 1979. The rise in Iraqi indebtedness was a consequence of global geopolitical trends in the 1980s where political lending trumped solvency concerns. Second, through primary sources and interviews with key actors involved, I use oral history to tell the story the Iraqi restructuring. It was one of the largest in history, yet no clear and detailed historical account exists. The restructuring was permeated by politics to inflict harsh terms on creditors at the Paris Club, at a time when creditor-friendly restructurings were the norm. In going for a politically expedient deal, however, the restructuring missed an opportunity to enshrine a doctrine of odious debt in international law

 

Yadav on Dodgy Debt Buybacks

posted by Mitu Gulati

I’ve long been fascinated by debt buybacks by issuers, in large part because they seemed to occupy a loophole in the securities disclosure laws.  A company could do a buyback of bonds and, because bondholders are not owed fiduciary duties by the company, there was no requirement for disclosure. That means that the company, to the extent it was in possession of secret information (the discovery of a gold mine, for example), could screw over the bondholders by buying back their securities before the news got out and the price went up.  Of course, the gold mine situation doesn’t occur all that often. But in the area that I do most of my research in, sovereign bonds, there are often large asymmetries of information between issuers and creditors. And yet, one rarely sees large scale buybacks of debt. (for the classic piece on sovereign buybacks, by Bulow and Rogoff, see here).

For years though, I’ve thought that this topic was of interest to no more than the three or four people in the legal academy who found bonds interesting (Marcel Kahan, Bill Bratton and a couple of others).  But just a few days ago I came across a wonderful new article by Yesha Yadav on precisely this topic. The draft article, “Debt Buybacks and the Myth of Creditor Power” is available here.  Yesha argues that the dramatic increase in corporate debt buybacks in recent years (apparently in the trillions of dollars) should be concerning not just because of the aforementioned disclosure loophole, but because these buybacks undermine corporate governance (when they are done in order to strip covenants) and allow shady behavior by banks seeking to increase the value of their loans at the expense of bondholders.

The story Yesha tells is more than plausible and she gives lots of vivid examples that support her arguments.  Since my particular interest is in flaws in the bond contract drafting process, the questions that her article raised for me have to do with why private contracting has not fixed the problem she identifies.  After all, the parties involved in these deals are super rich and sophisticated (with the fanciest of Wall Street law firms at their beck and call).

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Christine Chabot on "Is the Federal Reserve Constitutional?"

posted by Mitu Gulati

I hate to admit that I'm beginning to find constitutional law interesting. First, there was the Puerto Rico v. Aurelius case that was argued at the Court a few weeks ago.  And then, a few days ago, I came across Christine Chabot's “Is the Federal Reserve Constitutional? An Originalist Argument for Independent Agencies” (here).

The background here is that a number of scholars have, in recent years, raised the question of whether the manner in which some FOMC members are appointed conflicts with the dictates of Article II's Appointments Clause (yes, the same clause that is central to the Puerto Rico v. Aurelius battle). Chabot's wonderful article unpacks the history of the obscure Sinking Fund Commission to show that, even under an originalist perspective, the current structure of the FOMC holds up.

Even if you have no interest in the constitutional debate, the historical and institutional origins of the open markets purchasing authority are fascinating -- I did not know that Alexander Hamilton had set up the federal open market committee to support the price of US debt. This first FOMC had Hamilton, Thomas Jefferson, John Adams and John Jay conducting independent monetary policy. Wow.

Here is the abstract:

The President’s inability to control the Federal Reserve’s monetary policy decisions raises significant constitutional concerns. The Federal Reserve’s Federal Open Market Committee executes critical statutory mandates when it buys or sells U.S. securities in order to expand or contract the money supply, and yet the Committee’s twelve voting members check one another instead of answering directly to the President. The President cannot remove Committee members who refuse to carry out his monetary policy directives. Seven of the Committee’s twelve voting members are Federal Reserve governors who enjoy for-cause protections from removal by the President. Congress delegated power to supervise and remove the remaining five voting members, who are presidents of regional Federal Reserve banks, to the governors rather than the President. Further, the President has no say in the appointment of regional bank presidents to the Committee. While the Committee’s independence and appointments process would likely pass muster under current precedent, a growing chorus of originalists have argued that the Constitution requires greater executive control and a more expansive application of Article II’s Appointments Clause requirements.

This paper demonstrates that existing originalist accounts are incomplete. They do not account for the structural independence of an obscure agency known as the Sinking Fund Commission. This Commission was proposed by Alexander Hamilton, passed into law by the First Congress, and signed into law by President George Washington. One would expect all of these actors to have a clear grasp on the original public meaning of the Constitution, as well as a strong dedication to the structural commitments established therein. Their decisions to form a Sinking Fund Commission with multiple members to check one another — and to include the Vice President and Chief Justice as Commissioners who cannot be replaced or removed by the President — belie the notion that an independent agency structure violates the newly minted Constitution. The Sinking Fund Commission directed open market purchases of U.S. securities pursuant to a statutory mandate. It provides a direct historical analogue to the Federal Open Market Committee’s independent purchases of U.S. securities pursuant to a statutory mandate. This analysis shows that the structure of the Open Market Committee is not a novel invention of the twentieth century. Rather, the independence stemming from the Committee’s multi-headed structure and protections from removal has an impeccable originalist provenance which dates all the way back to Alexander Hamilton and the First Congress.

Aurelius v. Puerto Rican Control Board (or "Do Activist Hedgies Add Value?")

posted by Mitu Gulati

This post draws considerably from research on Puerto Rico and its current constitutional status with Joseph Blocher (see here).

Tuesday was oral argument day at the Supreme Court in the battle between the Puerto Rican Control Board and a big bad hedge fund, Aurelius.  Aurelius, zealous defender of the constitution that it is, had brought a challenge to the constitutionality of the Control Board. The claim being that the failure of President Obama and the then Congress to follow the strictures of the Constitution for the appointment of principal officers of the federal government (nomination by the President, followed by Senate confirmation) made the Board and all its actions invalid.

I am not a constitutional scholar and don’t have any desire to be one.  Still, the basic issue here seems fairly simple:  Are the members of the Control Board principal federal officers?

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The Puzzling Pricing of Venezuelan Sovereign Bonds

posted by Mitu Gulati

by Mark Weidemaier & Mitu Gulati

Venezuela’s sovereign bonds differ in ways that should, in theory, be reflected in market prices. For example, depending on the bond, the vote required to modify payment terms through the collective action clause (CACs) varies from 100% (requiring each holder to assent), to 85%, to 75%. Bonds with higher voting thresholds are harder to restructure and one would think prices would reflect this. Two bonds issued by state oil company PDVSA also have legal features that one might expect to have pricing implications. One bond benefits from a pledge of collateral (the PDVSA 2020) and, in consequence, should be priced higher than otherwise-comparable bonds. A second was issued at a particularly large original issue discount (OID); this is a potential legal defect that should lower its price. This is the so-called “Hunger bond” (PDVSA 2022 —see here, here and here for more)).

Although these differences seem like they should matter, reports from the European markets (where the bonds can still be traded) indicate that bid prices for Venezuelan sovereign bonds range from around 13.0 to 13.5 cents on the dollar, while ask prices range from about 14.5 to 15.5. Moreover, prices on the bonds with different voting thresholds are identical. That is, the bonds that cannot be restructured except with each creditor’s assent are trading the same as bonds that allow a creditor majority of 85% or 75% to force restructuring terms on dissenters. But why? Venezuela is in full-fledged default, when legal protections should matter the most.  Shouldn’t these non-US investors (US investors can’t buy, given OFAC sanctions) be offering higher prices for bonds with better terms?

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Badawi & de Fontenay Paper on EBITDA Definitions

posted by Mitu Gulati

I confess that, on its face, this did not strike me as the most exciting topic to read about (and that comes from someone who writes about the incredibly obscure world of sovereign debt contracts).  After all, who even knows what EBITDA definitions are?  Sounds like something from the tax or bankruptcy code.  But don’t let the topic be off putting.  This is a wonderfully interesting project; and elegantly executed (here).  By the way, EBITDA stands for earnings before interest, taxes, depreciation blah blah. Turns out it is especially important for young companies, where potential investors want to know about the cash flow being generated (Matt Levine has been writing about it recently in the context of the WeWork debacle - here). It is also very important because it generally ties into the covenants in the debt instrument and can impact whether or not the covenants are violated.

Using machine learning techniques, Adam and Elisabeth look at the EBITDA definitions in thousands of supposedly boilerplate debt contracts.  And they find a huge amount of variation in this supposedly boilerplate term; variation that can end up making a big difference to the parties involved. (For those interested, there is a nice prior study by Mark Weidemaier in the on how supposedly boilerplate dispute resolution terms in sovereign bonds are often not really all that close (here); and John Coyle’s recent work on choice-of-law provisions in corporate bonds is also along these lines (here))

The question that naturally arises here is whether the variation in these EBITDA definitions is the product of conscious and smart lawyering or just random variation that arises as contracts are copied and pasted over generations. (for more on this, see here (Anderson & Manns) and here (Anderson)). My understanding of the results is that these definitions are definitely not the product of random variation; instead, there seems to be a lot of sneaky lawyering to inflate the supposedly standard EBITDA measure.

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Matt Levine, Insider Trading and Mr. Potato Chip

posted by Mitu Gulati

Matt Levine is my favorite financial journalist to read on a regular basis because he is so darn funny (yes, there is lots of substance too, but I'm shallow and want to be entertained). Today's piece though, especially to someone who used to teach the law on insider trading, was priceless.

I want to cut and paste the entire piece here, because it made me smile and laugh out loud at the same time.  But I worry that Bloomberg might get annoyed and chase after me for stealing their content.  The link is here -- hope you find it as funny I did.

 

Two New Podcasts: Succession/Slate Money and The Business Scholarship Podcast

posted by Mitu Gulati

I loved the first season of HBO’s Succession.  Superb acting, great sets, and a story about a totally dysfunctional family (that makes me think that my own dysfunctional one is relatively functional).  Plus, the really really rich and despicable people in the show (modeled on actual really really rich people – see here) are miserable – and I can’t help but be entertained by that. All of that said, I did not realize, until I heard the wonderful and brilliant combination of Felix Salmon, Emily Peck and Anna Szymanski discuss the show on their Slate Money podcast a few weeks ago, how much of the show connected to interesting corporate law questions. Long story short, for those of you who love Succession and teach business law stuff, I think you will enjoy the combination of watching the show and listening to the special Slate Money podcasts about the show (this is just a season 2 thing).  Actually, you don’t need to give a rat’s ass about corporate law to enjoy the combination of watching Succession in the late evening and listening to Slate Money the next morning.  In fact, there have been occasions where I’ve enjoyed the podcast more than the particular episode of Succession.

And, while on the subject of podcasts, I recently came across an excellent podcast that discusses new financial law papers. It is run by Andrew Jennings at Stanford Law (here). Andrew is unfailingly polite, but he clearly has thought about the papers in question and asks tough questions.  I’ve only listened to a couple of episodes so far, but I plan to try and listen to them all.  I especially liked the podcast about Cathy Hwang’s 2019 paper on “Faux Contracts” and the roles that contracts can play even when there is no enforcement possibility (podcast is here; paper is here). I’m especially intrigued by Cathy’s concept of intra-deal reputation that constrains parties from acting opportunistically – something that she documents with detailed interviews. This intra-deal effect (it isn’t quite reputation; but something in the vein of reciprocal fairness) seems to operate on parties in individual deals even though the parties are not trying to preserve any sort of longer-term repeat-player reputation. Clearly a paper, I need to read.

Trump, Denmark and Greenland:  What Next?

posted by Mitu Gulati

(This post draws directly from ideas from co authored work with Joseph Blocher; and particularly the numerous discussions we have had about the incentives that a market for sovereign control might create for nations to take better care of their minority populations in outlying areas (e.g., the US and Puerto Rico).  Mistakes in the discussion below, however, are solely mine).

It seems like forever ago, but it has only been a few weeks since the news came out that our esteemed chief executive wanted the US to purchase Greenland.  The notion was widely ridiculed in the press and provided wonderful fodder for comics around the globe.  But as people looked beneath the surface, it quickly became apparent that there was nothing in international law that prohibited the purchase and sale of sovereign control over a territory.  Where Trump was wrong was in his assumption that he needed to purchase Greenland from the Danes.  Under post World War II international law, however, a former colony such as Greenland has the right of self determination.  To quote the Danish prime minister, responding to Trump, “Greenland is not Danish. Greenland belongs to Greenland.”

The Danish PM also said “I strongly hope that this is not meant seriously.”  And, from her perspective of apparently wanting to keep the status quo of Greenland being part of Denmark, it makes sense that that’s what she hopes.  But let us focus on the words “Greenland is not Danish. Greenland belongs to Greenland.” If one thinks about those words just a little, they mean that Trump’s purchase (and maybe he should start calling this a “merger”, since that seems more polite) is perhaps a lot easier to execute than he initially thought.

Trump and any other suitors that Greenland might have (Canada, China, Iceland, Russia, etc.) need to only focus their attention on making the Greenlanders happy; they don’t need to worry about the Danes. No need for Trump to do diplomatic trips to Copenhagen. Trips should be to Nuuk instead. After all, it is the approval of the 55,000 Greenlanders that he needs.

How many Greenlander votes, specifically? (assuming that there would need to be a referendum first). International law doesn’t clearly say; but surely more than a majority – and ideally with a voting mechanism designed in such a way that the rights of the minority that might not want to be part of the merger being appropriately protected.

The point is that if DJT and his supporters remain committed to the Greenland strategy – and it appears they do (see here) – the next step is will be to persuade the people of Greenland that this merger is in their interest. That way, the next time Trump offers a merger deal to the roughly 55,000 Greenlanders, they will react with enthusiasm rather than horror.  One would expect, therefore, to see the US taking steps to mount the charm offensive in Greenland. And, as it turns out, preliminary steps in this direction have already been announced with the US planning to open a consulate in Greenland and engage in various outreach programs as part of its broader arctic charm strategy (here).

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Anderson and Nyarko's Cool New Papers on Contract Evolution

posted by Mitu Gulati

Two of the contracts papers I’ve been most looking forward to this fall have just been posted on ssrn. They are are Rob Anderson’s “An Evolutionary Perspective on Contracting: Evidence From Poison Pills” (here) and Julian Nyarko’s “Stickiness and Incomplete Contracts” (here).

Both papers aim at deepening our understanding of how contracts evolve and, in particular, why they evolve in ways so very different from the standard model used in law schools where parties are assumed to negotiate for an optimal set of terms for their relationships.

One would predict a very different set of contract terms for parties if one takes the contract production process seriously and thinks of contract provisions as products (ala Barak Richman, here) or product attributes (ala Doug Baird, here).  Specifically, Rob and Julian both use models of contract production where new contracts are constructed by building on pre-existing templates.

In this world, one should expect a high degree of path dependence in the data.  And that is precisely what Rob and Julian demonstrate, looking at two very different areas of commercial contracting – poison pill and choice-of-forum provisions. The implications of their papers, both of which are studying the most sophisticated and well-heeled of all contracting parties, for the one of the core exercises in contract law – how should judges interpret contracts – are considerable.  That said – and this is not meant to take away from the two papers at all -- these papers are more about empirically documenting and understanding the phenomena than normative questions of what judges should be doing.

There is an enormous amount of new material in both papers and I will not do more than scratch the surface in terms of their respective contributions.  Here, however, are a couple of things about each of the papers that stood out to me.

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Do Judges Do Contract Interpretation Differently During Crisis Times?

posted by Mitu Gulati

Scholars of constitutional law and judicial behavior have long conjectured that judges behave differently during times of crisis. In particular, the frequently made claim is that judges “rally around the flag”.  The classic example is that of judges being less willing to recognize civil rights during times of war (for discussions of this literature, see here, from Oren Gross and Fionnuala Aolain; and here, for an empirical analysis of the topic from Lee Epstein and co authors).

But what about financial crises?  Are judges affected enough by big financial crises to change their behavior and, for example, rule more leniently for debtors who unexpectedly find themselves being foreclosed on? In a paper from a few years ago, Georg Vanberg and I hypothesized that a concern with needing to help save the US economy from the depression of the 1930s may have been part of the dynamic explaining the Supreme Court’s puzzling decision in the Gold Clause cases (here).

A fascinating new paper from my colleague, Emily Strauss (here), analyzes this question in the context of the 2007-08 financial crisis.  Emily finds that lower courts judges, in a series of mortgage portfolio contracts cases during the crisis and in the half dozen years after, made decisions squarely at odds with the explicit language of the contracts in question.  From a pragmatic perspective, it is arguable that they had to; the contracts were basically unworkable otherwise.  But, as mentioned, this conflicted with the explicit language of the contracts. And judges, especially in New York, like to follow the strict language of the contracts (or so they say).   Then, and I think this is the most interesting bit of the story, Emily finds that, starting in roughly 2015 (and after the crisis looked to have passed), the judges change their tune and go back to their strict reading of the contract language.

Here is Emily’s abstract that explains what happened better than I can:

Why might judges interpret a boilerplate contractual clause to reach a result clearly at odds with its plain language? Though courts don’t acknowledge it, one reason might be economic crisis. Boilerplate provisions are pervasive, and enforcing some clauses as written might cause additional upheaval during a panic. Under such circumstances, particularly where other government interventions to shore up the market are exhausted, one can make a compelling argument that courts should interpret an agreement to help stabilize a situation threatening to spin out of control.  

This Article argues that courts have in fact done this by engaging in “crisis construction.” Crisis construction refers to the act of interpreting contractual language in light of concurrent economic turmoil. In the aftermath of the financial crisis, trustees holding residential mortgage backed securities sued securities sponsors en masse on contracts warranting the quality of the mortgages sold to the trusts. These contracts almost universally contained provisions requiring sponsors to repurchase individual noncompliant loans on an individual basis. Nevertheless, court after court permitted trustees to prove their cases by sampling rather than forcing them to proceed on a loan by loan basis.

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My Favorite Contract Metaphors: Skeuomorphs, Sea Squirts, Barnacles and Black Holes

posted by Mitu Gulati

I love contract metaphors. I’m especially fond of metaphors for the phenomenon of antiquated and useless contract provisions that find a way to persist over the decades in boilerplate contracts.  Philip Wood, the legendary English lawyer, uses the metaphor of barnacles on a ship’s hull to describe how more and more of these useless provisions can accumulate over the years, eventually severely impacting the efficiency of the ship. If you like boats and hate barnacles (perhaps because one of your most hated chores in the summers was for you to attempt to scrape barnacles off the hull of your uncle’s fishing boat), this metaphor may work especially well for you (sorry, Uncle Marvin). Another favorite of mine, that does not bring up memories of unpleasant chores, is Doug Baird’s skeuomorph.  To quote Douglas, who in the course of his explaining why we should not be surprised that suboptimal contract terms both emerge and then persist, has some wonderful examples:

To take a[n] . . .  example, maple syrup is often sold in a glass bottle with a small handle that serves no discernable utilitarian purpose. This is a relic of the time when maple syrup came in jugs and the handles were large enough to be useful. This phenomenon—of a product feature persisting when incorporated in a new environment in which it no longer serves a function—is well known and has a name: skeuomorph.

Douglas goes on to explain that these skeuomorphs can bizarrely become desired features of the product in question (and remember he is drawing an analogy to contract drafting). He writes, while continuing with the maple syrup bottle example:

Buyers of maple syrup want to see a small handle on the bottle. It serves no purpose, but it is what consumers have come to expect. Blue jeans are no longer made for working men who carry pocket watches, but buyers of blue jeans want a watch pocket all the same, even though they have no idea of the purpose it serves and have no use for it. Everyone expects Worcestershire Sauce bottles to come wrapped in paper even though the reason for doing this has long disappeared. Tagines took a particular shape for functional reasons when they were made of clay, and they retained this shape when made of aluminum even though there was no longer a functional reason for doing so. Skeuomorphs can be found everywhere on the “desktops” of personal computers

In short, the idea that a clause could be added to a contract and remain there merely because everyone expected it to be there suggests nothing special about either pari passu clauses in particular or contract terms more generally. The same forces are at work as with ordinary product attributes. Crafting legal prose is hard, and few contracts are ever written from scratch. Lawyers almost always start with a template taken from someplace else. For this reason, those who draft contracts are likely to import features from earlier contracting environments, even when they serve no purpose, merely because they are familiar. To give another example involving financial instruments, the first railway bonds were based on real estate mortgages. They still bear some of the attributes of real estate mortgages, and not always for the better.

If you like this topic, I recommend Douglas’ piece “Pari Passu Clauses and the Skeuomorph Problem in Contract Law” (you should of course ignore all the bits of this brilliant piece that are critical of my paper with Bob Scott and Steve Choi on Contractual Black Holes (yes, another metaphor I’m very fond of) that Douglas’ piece was a comment on).

Last but not least is the Sea Squirt, a close cousin of the barnacle.  This one comes from M&A guru, Glenn West who was speaking on a panel at UT in 2018 on M&A Contracting.  The title of his presentation was: “Have Sea Squirts Invaded Your Contract?—Avoiding Mindless Use of So Called ‘Market’ Terms You May or May Not Understand”.  Below I’ve excerpted some priceless language from an August 2017 blog post by Glenn on MAC clauses in M&A agreements.  And yes, Glenn is talking about M&A contracts containing brainless bits of language; the contracts drafted by the most elite among all transactional lawyers.

As an aside, there are a number of excellent recent papers arguing over how brainless M&A contracts are; see here (Anderson & Manns) and here (Coates, Palia & Wu).

From Glenn’s blog post, here goes:

The sea squirt is an animal that begins life with a brain and a tail.  Immediately after it is born, it uses its brain and tail to propel itself through the water until it finds some rockto attach itself.  Once it attaches itself to that rock it consumes its brain, absorbs its tail, and thereafter never moves again; it lives out its remaining life as a brainless water filter.

Many of the standard terms of M&A agreements also began their existence with a brain—the brain of a smart lawyer who perceived an issue that needed to be addressed and drafted a clause to address it.  And then other smart lawyers recognized the value of that newly drafted clause, and adapted and improved it until it became a standard part of most M&A agreements.  But once that clause became attached to the “market” it became divorced from the brain or brains that created it, and soon everyone was using it regardless of whether they truly understood all the reasons that prompted its draftingEven worse, market attachment is so strong that even after a standard clause has been repeatedly interpreted by courts to have a meaning that differs from the meaning ascribed to that clause by those who purport to know but do not actual know its meaning (mindlessly using the now brainless clause), it continues to be used without modification.  Such is the case for many with the ubiquitous Material Adverse Change (“MAC”) or Material Adverse Effect (“MAE”) clause.

My friend at UNC Chapel Hill, John Coyle, has an article coming out soon on “Contract as Swag”.  I’m eager to see how that metaphor will work. I like swag and I want learn how to get more of it.

Trump Wants to Buy Greenland for the U.S. – But Who Is the Relevant Seller?

posted by Mitu Gulati

(This post draws from my prior work with Joseph Blocher and the many conversations we have had about this topic over the years; he bears no responsibility for errors and sarcasm)

According to a flurry of news reports from the WSJ, CNN, Bloomberg, the NYT and many more, our eminent chief executive has an interest in the possibility of buying Greenland.  Most reactions to this news of DJT’s latest whim have boiled down to incredulity, while also generating a fair amount of mirth (see here, here and here).  What has interested us the most, though, are the articles that have concluded that the U.S. cannot buy Greenland. Bloomberg’s Quick Take ran the title – “Can Trump Actually Buy Greenland – The Short Answer is No”. 

But is that really the case? The relevant international law seems to present no explicit barrier to nations buying and selling territory (here). Indeed, much of today’s United States was acquired through the purchase of territory.  The barrier that most commentators see as insurmountable is not legal, but rather the lack of a willing seller.  Maybe so.  But a handful of quotes from government officials and politicians in Denmark and a few from politicians in Greenland (see here and here) is not necessarily enough to conclude that this trade could never work.

Before jumping to the foregoing conclusion, one needs to first ask how such a sale would work.

Continue reading "Trump Wants to Buy Greenland for the U.S. – But Who Is the Relevant Seller?" »

Coyle on Studying the History of a Contract Provision

posted by Mitu Gulati

The way many of us teach interpretation in Contract Law, there is little role for history (admittedly, this is just based on casual observation). The meaning of a clause is a function of the words that make up that clause.  The parties to the transaction are assumed to have drafted it to document the key aspects of their transaction, to balance risks and rewards blah blah.  If a dispute arises, we might have an argument as to whether a strict textualist reading of the words accurately represent what the parties really meant by them or whether we need to also examine the context of the relationship. What we do not ever do, however, is to delve into the history of the clause from before these parties contemplated using it – that is, of what prior drafters of the original versions of this clause might have meant in using it.

The foregoing makes sense in a world in which the contracts for each deal are drafted from scratch. But does anyone draft contracts from scratch?  What if we live in a world where 99.9% of contracts are made up of provisions cut and paste from prior deals; provisions that are assumed to cover all the key contingencies, but not necessarily understood (or even read)? In this latter world, where there are lots of provisions that the parties to the transaction never fully focused on (let alone understood), might there be an argument – in cases where there are interpretive disputes -- for the use of a contract provision’s history? Might that history not sometimes be more relevant than the non-understandings of the parties as to what they did or did not understand they were contracting for? (Among the few pieces that wrestle with this question are these two gems: Lee Buchheit's Contract Paleontology here and Mark Weidemaier's Indiana Jones: Contract Originalist here)

I’m not sure what the answer to the foregoing question is. But it intrigues me.  And it connects to a wonderfully fresh new body of research in Contract Law where a number of scholars have been studying the production process for modern contracts.  The list of papers and scholars here is too long to do justice to and I’ll just end up making mistakes if I try to do a list.  But what unites this group of contract scholars is that for them it isn’t enough to assume that contracts show up fully formed at the time of a deal, purely the product of the brilliant minds of the deal makers who anticipate nearly every possible contingency at the start.  Instead, understanding what provisions show up in a contract, and in what formulation, requires understanding the contract production process. (Barak Richman's delightful "Contracts Meet Henry Ford" (here) is, to my mind, foundational).

It is perhaps too early to tell whether this research will catch on and revolutionize contract law. I hope it does, but I’m biased.

One of my favorite papers in this new body of contract scholarship showed up recently on ssrn. It is John Coyle’s “A History of the Choice-of-Law Clause” (here). I have rarely found a piece of legal scholarship so compelling.  The paper is not only a model of clarity in terms of the writing, but it is brave. It is completely unapologetic in not only taking on an entirely new mode of research (a painstaking documentation of the historical evolution of the most important terms in any and every contract), but in coming up with a cool and innovative research technique for unpacking that history (this project would have been impossible to do without that innovation).

Continue reading "Coyle on Studying the History of a Contract Provision" »

Ramming Bow Contracts

posted by Mitu Gulati

Have you heard of Ramming Bows? Or did you know that they describe a category of boilerplate contract provisions?  Until a couple of weeks ago, I had not either.  That was when I came across Glenn West’s two delightful blog posts at the Weil Gotshal & Manges site (here and here). Glenn is a senior partner in the Private Equity/M&A practice at Weil. And in his spare time, he writes wonderfully witty blog posts and articles about wide range of legal issues; many of which are about the bizarre world of sophisticated boilerplate contracting.  Even if you have no interest in contract law, let alone boilerplate contracts, I suspect that you will enjoy his writing.  It is insightful about the way in which contracts get produced and evolve in the real world and, even better, is funny.

Continue reading "Ramming Bow Contracts" »

Yannis Manuelides Paper on the Limits of the "Local Law Advantage" in Eurozone Sovereign Bonds

posted by Mitu Gulati

Sovereign debt guru and Allen & Overy partner, Yannis Manuelides has a new paper (here) out on the “local law advantage” in Euro area sovereign bonds.  This paper, along with Mark Weidemaier’s paper from the beginning of the summer (here – and a prior creditslips discussion about it here), helps shed light the thorny question of which European local-law sovereign bonds should be valued more by investors: Ones with CACs or ones without them.  Given that there are billions of euros worth of these bonds with and without CACs being traded every day, one might have thought that there would be clear answers to these questions from the issuing authorities themselves.  There are not.  Further, some of the folks at the various government debt offices take the bizarre (to me) view that answering this question might somehow scare the market.

Continue reading "Yannis Manuelides Paper on the Limits of the "Local Law Advantage" in Eurozone Sovereign Bonds" »

Reparations Claims by the Herero and Nama Against Germany

posted by Mitu Gulati

About two years ago, in 2017, an intriguing lawsuit was filed under the Alien Tort Claims Act in New York. It was filed by members of the Herero and Nama tribes for the genocide of their ancestors that took place in what is now known as Namibia. In March this year, Judge Laura Taylor Swain, who readers of this blog may know from the Puerto Rican financial drama, ruled that the claims against Germany were barred by that nation’s right of sovereign immunity. As an aside, having oversight of the Puerto Rican debt debacle is not Judge Swain’s only connection to sovereign debt lore – she also sits in the judgeship vacated by none other than Judge Thomas Griesa of pari passu infamy. For accounts of the above mentioned class action by the Herero and Nama, see here and here. (Lawsuits on roughly similar grounds had been attempted earlier as well; see here).

This outcome is probably not surprising for anyone who has followed the fate of human rights litigation over the past few years brought under the Alien Tort Claims Act. Basically, under the direction of the Supreme Court, the possibilities for victims of human rights violations that took place overseas to foreigners with no more than minimal connections to the US (in terms of the claims themselves) have been severely curtailed.

My reason for bringing this up is that this is a history that I knew little about until I started coming across references to the genocide in Namibia in accounts of the Congo where, similar horrors were taking place in the 1890s and early 1900s under King Leopold of Belgium (Joseph Blocher and I have been working on the question of contemporary implications for international law of the transfer of control that took place after the genocide in the Congo (here)). Still though, these references didn’t give me anything close to a sense of how horrific things had been there.

That is, until I came across this case and began reading the filings in more detail. And one of the most interesting pieces I’ve found is by German scholar Matthias Goldman that both uses original archival research to describes the events that took place and uses them to question our contemporary understanding of the law of sovereignty. The law of sovereignty, as with all of customary international law, is based on assumptions (often faulty – as Matthias shows in this case) about history. The article, “The Entanglement of Property and Sovereignty in International Law”, is short and eminently readable (here). Matthias, who many slipsters know because of his work on sovereign debt matters, has not only been writing on the topic of the genocide in South Western Africa but has also been involved in the court case (he filed an affidavit in the Herero and Nama lawsuit).

I hope that Judge Swain’s decision is not the end of the road for the claims of reparations by the Herero and Nama. Maybe they will have better fortune with a filing in a German court?

The Mad Mad World of "No Contest" Provisions in Wills

posted by Mitu Gulati

It has been almost twenty-five years since I got hooked on the puzzle of why boilerplate financial contracts, even among the most sophisticated parties, have inefficient terms. Steve Choi and I were taking Marcel Kahan’s Corporate Bond class and we couldn’t understand why the classical model with its highly informed repeat players (with everyone hiring expensive lawyers) wasn’t working to produce the optimal package of contract terms. Marcel presented a very coherent set of explanations for this phenomenon of contract stickiness having to do primarily with network and learning externalities.  And under that model, it was plausible to have equilibria where sophisticated commercial parties and their lawyers could know that they had suboptimal contract terms and yet be somehow unable to change them easily (thereby creating the phenomenon of “sticky” contracts).  Marcel though repeatedly emphasized to us that he had but scratched the surface of a topic worthy of much more investigation (for the classic Kahan & Klausner (1997) paper and its equally wonderful predecessor by Goetz & Scott (1985), see here and here).

Over the past two decades, since the publication of Kahan & Klausner’s sticky boilerplate paper, there have been a number of advances to our thinking about the phenomenon of sticky boilerplate. Most of them, however, have been focused on the worlds of mass market contracts of sophisticated finance or transactions where one of the sides to the transaction is a big repeat player (corporate bonds, sovereign bonds, M&A contracts, insurance). 

A wonderful new boilerplate paper though takes on an altogether unexpected area where I had always thought of the contract-type instruments as being highly tailored: that of Wills. The paper is “Boilerplate No Contest Clauses” posted about a month ago by David Horton (UC Davis) and Reid Weisbord (Rutgers). 

The paper identifies a persistent inefficiency in Wills – an area that I suspect most contract boilerplate scholars are utterly unaware to. That itself is interesting. But this paper goes beyond the traditional boilerplate contract scholarship which, as noted, identified the stickiness problem in mass market contracts.  Wills, as I understand the story that David and Reid tell, tend to always have both an element of tailoring for the individual client and an element of blind unthinking cutting and pasting from prior standard forms. What David and Reid show beautifully in their paper is that the boilerplate portion of the contract (and specifically, the “No Contest” provision) can often undermine the tailored portion that more specifically reflects the intent of the party making the Will.

For those not familiar with these clauses, the following is typical:

If any beneficiary under this Will in any manner, directly or indirectly, contests or attacks this Will or any of its provisions, any share of interest in my estate given to that contesting beneficiary under this Will is revoked . . . . “

Basically, this says: Don’t you dare challenge this Will. If you do, you might lose everything.

Problem is, as David and Reid explain, that there are situations where complications arise with the Will and someone has to go to court to get the complications resolved. That then presents the risk that some dastardly beneficiary will claim that the No Contest clause has been triggered vis-à-vis the innocent beneficiary who is just trying to solve a problem with the Will that the testator didn’t take into account. End result: The intentions of the testator are undermined. Even if the court ultimately tosses the challenges being made on the basis of the No Contest clause, time and money gets wasted.

Why does this clause persist?  The answer given by Reid and David is straightforward: These clauses are cut and paste from prior Wills without thought. They are part of the boilerplate that neither the lawyers nor their clients pay any attention to.  But why not?  The standard explanations from the boilerplate literature such as network/learning externalities, first mover disadvantages, negative signaling, status quo bias, inadequate litigation, etc., do not seem to apply particularly well.  Nor do explanations about big firms who are repeat players exploiting innocent customers who are one shot players.  So, given that the standard explanations do not work, why is the subset of the market for legal services not working?  Are the lawyers not being paid enough to read the boilerplate portions of the Wills and think through the contingencies?  (Best I can tell, the lawyers do actually understand the problem, since there has been lots of litigation over these types of clauses).

Continue reading "The Mad Mad World of "No Contest" Provisions in Wills" »

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