The Local Law Advantage in the Euro Area: How Much of a Constraint are the Existing CACs?

Collective Action Clauses for the Euro Area were mandated, starting in January 2013.  Yes, bizarrely, even though the introduction of Euro CACs was literally the single biggest innovation in sovereign bond contract terms in the history of this market, no one seems to have a clear idea of how these CACs (contractual restructuring mechanisms) are actually going to operate.  Specifically, if a Euro area country needs to restructure some day soon (e.g., Italy?), and it has a subset of bonds with these CACs (by next year, Italy will have something close to a super majority of its bonds with these Euro CACs), is it required to use the CACs to do the restructuring or can it use other mechanisms? That is, regardless of the presence of these CACs, can the sovereign still take advantage of the fact that almost all of its multi trillion dollar debt stock is governed by Italian local law to engineer the restructuring (the "local law advantage" in the words of sovereign debt guru Lee Buchheit - see here)?

Most people I know in the European sovereign debt world take the view that the CACs will have to be used if they are in the bonds (it is a different question altogether as to what can be done with the subset of bonds without CACs and also under local law).  And, indeed, that may be why there is currently a move to reform and improve the first-generation of Euro CACs (they appear, on their face, quite vulnerable to hold outs).  But do the Euro CACs have to be used to engineer the restructuring, if the bond that needs to be restructured has them?

As an aside, some of you may remember this question recently came up in the context of measuring redenomination risk in Euro area bonds, where because of the assumption that the bonds with CACs were protected against unilateral redenomination of the currency on the bonds by the sovereign, some were trying to use the CAC bond versus No CAC bond yield differential as a measure of redenomination risk.  (See here and here, for articles from the FT along; there are many  more) [This is not at all a crazy position, since the CAC bonds require a supermajority approval of creditors (roughly) for a change to the currency of the bond; and this is indeed the view that the market appears to have taken -- see the link/graph above from the FT - but has Mark Weidemaier demonstrated that the market was wrong in a big way?  If so, that's a big deal]

To cut to the chase, our fellow slipster, Mark Weidemaier, has a superb new paper, "Restructuring Italian (or Other Euro Area) Debt: Do Euro CACs Constrain or Expand the Options?", that suggests the foregoing thinking is misguided. Best I know, Mark's paper is the first one to address this central question about Euro CACs under local law head on (although I'm optimistic that some of our students will have good papers exploring this very question in greater depth soon).  My prediction is that there are many who will disagree strongly with Mark; particularly those who see the Euro CACs as representing some sort of holy European treaty promise.  But Mark makes a powerful argument that that view is more smoke than fire.  Euro CACs, according to him, are nothing but an option for the sovereign.  That's it, he tells us; they are nothing more. The sovereign can choose not to use this option and take an alternative (easier) route to doing its restructuring.

A New Proposal for Restructuring Venezuelan Debt

The Venezuelan debt crisis has dragged on for so very long now that there are literally dozens of proposals out in the public domain (aka ssrn.com) on how Venezuela should do its restructuring.  Given how quickly the situation on the ground is changing, the plausibility of these various proposals also has been moving with great speed. 

A new and interesting one just showed up today from Daniel Osorio of Andean Capital (available here).  Daniel is someone who knows the Venezuelan situation inside out and has a lot of experience distressed debt workouts.  I don't think we agree on the optimal way to peel this onion, but Daniel is super smart and I always take his views seriously.  His proposal, as I understand it, is to do an debt exchange where investors are given what he calls Patient Capital Bonds. Basically, investors are being asked to be patient and cooperate with the Venezuelan government by giving them a lot more time to repay them (much more than say the proposals for a Venezuelan reprofiling (which would just buy the time for the IMF to do an estimate of the economic situation) have been asking for). The benefit to investors, that Daniel is positing will attract them to his proposals, is that there is a big potential upside if Venezuela is able to get economically healthy.

A couple of questions though.  First, is Daniel being unduly optimistic in assuming that the holdout problem can be easily solved?  (after all the amount of litigation on the defaulted debt is increasing on a daily basis and specialist holdout firms are the opposite of "patient" capital). Second, can Venezuela get back to health in a reasonable amount of time without imposing significant cuts on the principal obligations on its debt stock? (maybe, if the stretch out of payments is long enough, but that then brings its own problems in terms of getting investors to be that patient).

I do agree with Daniel though that stretching out payments will ultimately have to be part of the equation and that whatever mechanism that is used will need to ensure that the majority of creditors come in voluntarily (that is, the non holdouts). I also agree with him that the post-Saddam restructuring of Iraqi debt has lessons to teach us.

Here is the abstract of Daniel's nice and short paper (six pages):

Regime change in Venezuela is imminent. The transition may take longer than what most Venezuelans would like, but when it occurs it will be faster than most expected. The challenges of the reconstruction of Venezuela and its economy will be more similar to those faced by a country after a vicious war or a violent natural disaster than the aftermath of an economic and/or political crisis. First and foremost, this reconstruction must start by addressing Venezuela’s urgent humanitarian needs. This initial phase of the normalization of Venezuela must be done in a collaborative fashion between the private and public sector as well as Venezuelans and the international community. However, this spirit of collaboration must not end there, but continue in order to meet the economic challenges that Venezuela will face.

He also talked about this on the telly, on Bloomberg News. 

The Woes of PDVSA Debt Holders

Mark Weidemaier & Mitu Gulati

Many things about the current situation in Venezuela bewilder us. Among them are parts of the new sanctions.  The one that especially puzzles us is the part that says that transfers of PDVSA debt claims by US persons are only permitted to non-U.S. persons.

What could possibly be the logic here?  To attempt to see that, our first question was: What is the likely effect of such a constraint. Answer: To kill the liquidity of the bonds and promissory notes and any other debt instruments, since US investors are likely 50% or more of this market.  And that in turn means that the price of these PDVSA instruments is going to drop precipitously.

But why hurt the market for PDVSA debt instruments so viciously?  Maybe the UST knows that there are large chunks of these instruments held by Maduro cronies who have been issuing these instruments to themselves (without paying fully for them) so that they have a nest egg in the event of a change in government.  But does that help get rid of Maduro and his cronies faster?  Not clear.  But maybe there is a story here. We'd love to know more.

Alternatively, and this is a bleaker story for the PDVSA holders, maybe the Trump administration knows that a future restructuring of Venezuelan debt under the new government is going to have to be particularly brutal.  And maybe they want to make sure that US holders have largely sold off their holdings to non US entities?  Maybe.  But if this is the case, then why are similar sale restrictions not being imposed on the bonds of the Republic?

Or maybe this bit of the new sanctions is just an error.  Maybe.

Mozambique’s Guarantees on the Tuna Bonds: Can They be Repudiated?

Mark Weidemaier & Mitu Gulati

There have recently been headline articles in the press about three loans made to state-owned security companies in Mozambique (see here, here and here) and guaranteed by the government. The reason for the attention to these loans – made originally between 2013 and 2014 by Credit Suisse and the Russian bank VTB – is that US federal prosecutors are pursuing charges against a number of bankers from Credit Suisse and government officials from the Mozambique finance ministry. (Somehow the VTB folks seem to have escaped so far.) To simplify, these individuals were allegedly involved in siphoning off funds ostensibly intended to support Mozambique’s fishing industry and enhanced security in its territorial waters. Concretely, the loan was supposed to be used for new boats: some to catch fish (hence the moniker “tuna bonds”) and others to bolster the coast guard (“maritime surveillance”).

Instead, much of the money seems to have disappeared. The loans went into default; few tuna were caught. For contemporaneous reporting, see here, here, and here.

We have been thinking about debt repudiation of late. And Tracy Alloway of Bloomberg (and formerly of FT Alphaville) specifically got us thinking about the Mozambique tuna bonds on a recent podcast for Bloomberg’s Odd Lots (Tracy is a spectacular host).  Prompted in part by Tracy, we wondered--now that the corruption on the part of the agents for the banks and agents within the Mozambique finance ministry has been revealed—whether the government can repudiate the loans on the grounds that they were infused with illegality.

One of the three loans is worth treating separately from the others. This loan was made specifically for tuna boats. It involved an $850m bond for a company called Ematum—allegedly a sham—which has since been converted from a state-guaranteed bond to a sovereign Eurobond. For the other two loans, the repudiation question—since the borrower companies seem to have no assets—is whether the state can withdraw its guarantee on account of the corruption. There is a good argument that the answer is “yes.” Contract law in many key legal jurisdictions makes contracts infected by corruption and bribery voidable.

Some years ago, one of us analyzed this question in an article with Lee Buchheit, where we analyzed the question of “corrupt debts” (here – at pp 1234-39). We quoted this illustrative language from a 1960 New York Court of Appeals case: “Consistent with public morality and settled public policy, we hold that a party will be denied recovery even on a contract valid on its face, if it appears that he has resorted to gravely immoral and illegal conduct in accomplishing its performance.” Jeff King, in his new book on Odious Debts (here – at pp 119-23), has a section on sovereign obligations infected by corruption and makes much the same point under English and a number of other laws. And Jason Yackee tackles the corruption defense for sovereigns in the BIT context here. Bottom line: There is a pretty good defense here.

Congolese Elections and the Opportunity for the International Community to do the Right Thing

The Congo held elections yesterday; elections that the ruling party has kept finding excuses to postpone over the past two years.  International pressure though, forced them to be held (albeit in an incomplete fashion).  Now, the question is whether the vote counts will be done with some modicum or propriety and whether the current kleptocrats will nevertheless find some way to hold on to power in this resource rich nation with a tragic history.  The latest reports are telling us that there is already chaos and that the internet has been shut down (from the Washington Post, see here).

My interest in the Congo was spurred by a question about its sovereign debt (of course). My Duke colleague and frequent co author, Joseph Blocher, who has worked in Africa and knows my obsession with sovereign debt–and particularly the question of what is to be done about the sovereign debts incurred by despotic leaders (the “Odious Debts” problem)--got me hooked on the history of the Congo some years ago by telling me the story of the debt of the Congo Free State from the late 1800s. The debt was incurred by, and proceeds subsequently stolen by, one of the worst despots in history–King Leopold of Belgium.  He issued bonds in the millions of francs in the name of the Congo Free State and then, in 1908, when the international community forced him out because of the genocide he had engineered, the debts he had incurred in the name of his vassal state were put by the international community on to the backs of the Congolese people. When it comes to the Congo, the rest of the world has so much to be ashamed about (there is a super episode from the BBC’s The Foreign Desk here). But maybe we will do the right thing this time?

Drawing from work that Joseph and I have been doing on the Congo and the infamous 1908 forced transfer of sovereignty (here), here are some thoughts on the parallels between the events of today and of a century ago.

The scene in the Congo today is, sadly, is familiar. An unaccountable leader treats Congo as personal property, enriching himself as untold millions of Congolese labor to extract resources needed for the world’s latest technological boom. What will the international community do?

Today, the despot holding power is Joseph Kabila, the resource is coltan (used in cell phones), and the international response remains uncertain. Kabila has agreed to hold elections and step down, but he and his henchmen seem to keep finding excuses to postpone the transfer of power. 

In 1908, the leader was King Leopold, the resource was rubber (made valuable by the development of vulcanization), and the international response was extraordinary: On November 15, 1908, in response to intense pressure, Belgium bought the Congo Free State from its own king.

Today, as the world is understandably focused on the present and the future of the Congo, we should not forget the lessons of its past.

A Contract Lawyer's X-mas Greeting

This arrived this morning from a dear friend, who knows what makes me laugh.  I hope it makes you chuckle, if not laugh out loud, as it did me:

Dear Mitu (a term deemed to include your assigns, heirs and successors),

We (including our officers, directors, agents and employees) send (for the avoidance of doubt, "send" shall mean authorize, execute and deliver) our warmest (measured on the Fahrenheit scale) best (understood to mean the wishes we extend on an unsecured basis to our most creditworthy correspondents) wishes (with no warranty of any kind, express or implied, as to outcome) to you and your family (including those to the second degree of consanguinity) for a Merry Christmas (without limiting the generality of the foregoing, this extension of best wishes shall be understood to include, on a pari passu basis, a Happy Christmas).

Contractual Lunacies

My friend, Glenn West, who knows my obsession with boilerplate contract terms whose meaning the parties themselves don’t seem to know, sent me a lovely present today:  A link to an article in the ABA Journal by legal writing guru Bryan Garner on “Trying to Decipher Provisions that Literally Make No Sense”.  I realize that my sense of humor is warped, but I was laughing out loud at reading this.

Here is my favorite bit:

The lunacies [of contract drafting] involve using pastiche forms riddled with wildly inconsistent ways of expressing simple duties, absurd archaisms whose purpose few lawyers can explain, and repellent typographic practices that still today make many if not most contracts grotesque to read.

What I’d like to explore in this column is the curiosity of “busts”—the prevalence of contractual provisions, sometimes perpetuated in deal after deal, that make no literal sense at all. That they exist at all is something of a marvel. After all, you’d think that transactional lawyers would adopt a protocol of reading and rereading each contract that goes out the door. Given that critical thinking and close reading are prized habits for lawyers, contradictory or outright nonsensical provisions should be exceedingly rare. Alas, they’re not.

Most experienced lawyers can recall anecdotes of contractual monstrosities. One involves a malpractice claim against a law firm: A mortgage had somehow been prepared in the early 1980s with a crucial line dropped. The sentence made no sense. The firm had prepared dozens if not hundreds of mortgages with the same language missing, resulting in an incomplete sentence that made little sense—and the sense it did seem to make resulted in a disposition that no sane drafter could have wanted. It seems that a typist had simply skipped a line and continued typing. Nobody caught the error—until a problem erupted in the early 2000s.

By that time, the faulty contract had long since become entrenched as the “firm form.” A secretarial error from a generation before had become permanently ensconced in the form.

Aurelius v. Puerto Rican Control Board (and "What Possibly Could be the Logic Behind Puerto Rico Being in the First Circuit?")

Last Monday, December 3, the First Circuit heard an oral argument that I have been looking forward to for ages.  The case involves an infamously aggressive hedge fund making an audacious challenge to the constitutionality of the Puerto Rican Control Board—an argument that is framed (hilariously, I think) as rescuing the Puerto Rican people from tyranny.  The events that followed did not disappoint in terms of drama. 

Though complex to answer, question in the case is easily put: Did the process by which the Puerto Rican Control Board was put in place violate the Appointments Clause of the US constitution? 

The lawyering was superb, which was not surprising, given that two legendary former SGs, Ted Olson and Don Verrilli, were at the lectern. But the First Circuit judges were ready and raring to go, and it barely took a minute before they launched into tough questions.  Judge Juan Torruella was especially on target; he knows the intricacies of the history and case law relating to Puerto Rico’s status better than almost anyone else and it was a treat to listen to his exchanges with the superstar lawyers.  (There were other lawyers making arguments as well, but the First Circuit panel was primarily interested in the Olson-Verrilli positions.)The audio file is available here, and is well worth a listen.

Venezuelan Bonds: The Game is Afoot

Venezuela began defaulting on its bonds about fifteen months ago and is now in default on almost all of its outstanding bonds (except one that is backed by collateral).  The creditors, for these many months, have shown remarkable forbearance in refraining from accelerating the bonds and seeking judgments. 

The restraint on the part of the creditors for these past many months, I suspect, was not out of any especially benevolent feelings the creditors have towards the Venezuelan government.  Part of the explanation has to do with the different interest rates that applies to unpaid claims if one has an ordinary unpaid claim versus one that has been converted into a judgment (the latter is significantly lower).  On the flip side, the legal protections that apply to a judgment are much stronger (no need to worry about CACs or Exit Consents, and one can grab assets before anyone who has refrained from judgement).  Plus, the reality of most sovereign debt restructurings is that unpaid claims on interest usually don’t get paid out to anyone anyway (since the sovereign can’t even pay the base claims).  For those who want to know more about this, Mark and I talked about these matters here and here, when we were teaching our class on the Venezuelan sovereign debt some months ago.

Once one set of creditors accelerates though, then that puts everyone else who has not done so at a disadvantage because these first guys have an advantage in the litigation/attachment game.  And before today, only a few arbitration claim holders and one Promissory Note had begun the litigation game.  This had been causing anxiety among the bondholders I’ve been chatting with, but they had not made the move to coordinate into blocks of sufficient size to demand acceleration (most of the bonds have a requirement for acceleration of 25% of the holders in principal amount).

Today’s news from Reuters is big though. A group of hedge funds has put together the necessary number of bonds in the Venezuelan bond due 2034.  This is a rather special bond, if memory serves, because an attempt by the sovereign to force a restructuring can be blocked by 15% of the holders (in principal amount) rather than the typical requirement of 25%.  Bottom line: this bond is more litigation friendly.

Almost Citizens -- by Sam Erman

For those of you, who like me have been following the Puerto Rican debt drama, this wonderful new book by Sam Erman of USC might be of interest.  There are many wonderful and insightful stories in this book that I was altogether unaware of, despite having spent a lot of time reading about Puerto Rico's bizarre constitutional status.  Ultimately though, the most intriguing and insightful aspect of the book, to me, was the connection that Sam draws between the strange "foreign in a domestic sense" status of Puerto Rico and the events surrounding Reconstruction from the same period of time.

Sam was supposed to come to Duke last year to present this to the seminar that I run on Race, Law & Politics with Guy Charles, but we got hit by a snow storm on the day of his talk.  My initial thought had been to cancel the discussion and move on to the next paper.  But the students in the seminar (and Guy) had liked the draft of the book so much that they asked whether we might have a session to discuss it despite the fact that Sam was not going to be able to make it to Durham any longer.  We ended up having a fun discussion with my two wonderful con law colleagues, Walter Dellinger and Joseph Blocher. Indeed, that was perhaps our best session of the term (notwithstanding my general distaste for con law discussions). 

Next week, I hope to -- after talking to Walter and Joseph more -- do a little post on the recent oral argument in the first circuit about the constitutionality of the Puerto Rican Control Board.  That case, if it comes out the way I think it might, could turn the apple cart upside down.  But I need to listen to that oral argument tape again.

Here is the official book blurb for Sam's book:

"Almost Citizens lays out the tragic story of how the United States denied Puerto Ricans full citizenship following annexation of the island in 1898. As America became an overseas empire, a handful of remarkable Puerto Ricans debated with U.S. legislators, presidents, judges, and others over who was a citizen and what citizenship meant. This struggle caused a fundamental shift in constitutional jurisprudence: away from the post-Civil War regime of citizenship, rights, and statehood and toward doctrines that accommodated racist imperial governance. Erman’s gripping account shows how, in the wake of the Spanish–American War, administrators, lawmakers, and presidents, together with judges, deployed creativity and ambiguity to transform constitutional law and interpretation over a quarter century of debate and litigation. The result is a history in which the United States and Latin America, Reconstruction and empire, and law and bureaucracy intertwine."

My Favorite Two Sentences From a Recent Case . . .

Over the past few days, I've been struggling with trying to understand a new NY case involving secured debt. The fact that I had to struggle to understand the transaction made me feel insecure enough (on occasion,  I purport to teach corporate debt), but then when I tried to delve deeper into the case by looking at the underlying contracts (the "Collateral Pledge" Agreement - yuck), I got even more confused and insecure because I found the darn thing utterly incomprehensible.  Indeed, a whole half of that document seemed like it had been drafted for an entirely different type of transaction and the crucial provision that I was looking for didn't even seem to be there. But since I couldn't understand it, I couldn't be sure.  Maybe that provision was buried in some other provision that I couldn't figure out . . .

Then, while wallowing in insecurity, I came across this from a recent bankruptcy case out of the Third Circuit (thank you. Third Circuit blog for making me feel better):

The Third Circuit affirmed a ruling leaving in place a tenant’s favorable lease terms after the landlord declared bankruptcy and was purchased free and clear. Best line: “The Lease is long and neither simple nor direct. Indeed, it is an almost impenetrable web of formulas, defined terms, and cross-references–a ‘bloated morass,’ in the words of the Bankruptcy Court.”

I'm turning now to reading the briefs for the Aurelius v. Puerto Rican Control Board/Commonwealth of Puerto Rico case (oral argument on Monday).  As compared to that Collateral Pledge Agreement, these briefs read like a beautiful novel.  The briefs on both sides are beautifully written, in clear, short and comprehensible sentences.  Maybe litigators should be the ones drafting contracts?

Holiday Reading Recommendation and a Research Question on the 1MDB Case

The 1MDB case has been on the front pages of the financial papers on a number of occasions recently. The reason: The US justice system is investigating the scam and senior executives from everyone’s favorite ethical investment back, Goldman Sachs, including Lloyd Blankfein, have been caught up in it. And this leads me to my recommendation for holiday reading, if you like reading financial fraud books. The book is The Billion Dollar Whale, by Bradley Hope and Tom Wright of the WSJ. At first, I thought that the book was about the London Whale, but it turns out to be about the rise and fall of a Wharton educated Malaysian named Jho Low – a fascinating character who appears to have engineered one of the biggest financial frauds of the century, while also throwing the most ostentatious parties ever. If you want more background, there is a fun discussion of the book on my favorite financial podcast, Slate Money (Emily Peck, Anna Szymanski and Felix Salmon are a brilliant, and often hilarious, combination). Indeed, I picked up the book after listening to their podcast on it.  There is also a short, but on the money, review in the New Yorker by Sheelah Kolhatkar. Among the many colorful characters involved in the version of the story told in The Billion Dollar Whale are Gary Cohn (of Goldman and the Trump’s economic advisory team), Leo DiCaprio, and the Wolf of Wall Street (both the movie and the main character, Jordan Belfort).

Savings Plans and Chapter 13

David Jones, Chief US Bankruptcy Judge of the Southern District of Texas, has just posted a nifty empirical study of the effects of savings plans on the success of Chapter 13 filings. And, yes, part of the cool study is figuring out how to measure what counts as success in a bankruptcy filing.  The study takes advantage of a natural experiment in the Texas courts and has a bunch of fascinating findings, including about the impact of lawyers and legal culture on the choices that end up being made by the subjects of the bankruptcy proceedings.

Part of the reason I know about this study is that David was doing a graduate degree at Duke (in the judicial masters program) and I got to see the project at its inception stage in the thesis workshop that I run with Jack Knight. All of the credit goes to David though (and his wonderful advisor, John de Figueiredo) -- a fact that will be obvious to my fellow slipsters who know that I don't know squat about Chapter 13. But this is a fun study in terms of the design and findings regardless of whether you love Chapter 13 (okay, I realize that everyone else who reads this blog probably does in fact like or love Chapter 13).  It takes a basic fact about the inevitable fluctuations in expenses that almost everyone has to deal with, and tests what happens when these provision is made for these fluctuations ahead of time (versus when it is not).  Savings plans do indeed seem to make a difference; but a bunch of other factors also appear to matter - some of them quite surprising.  Clearly, as David emphasizes at the end of the paper, there is a lot here that is worthy of further investigation (and maybe legislative change).

The abstract for the draft on ssrn (that is forthcoming in the American Bankruptcy Institute's journal) reads:

This paper examines the effects of debtor savings on the viability of chapter 13 bankruptcy plans. The paper further examines the impact of lawyer culture, debtor participation in the bankruptcy process, and judicial activism in the use of the savings program by chapter 13 debtors. Using a data set of randomly selected chapter 13 bankruptcy cases filed in the Southern District of Texas, the analysis demonstrates that while savings has a direct positive impact on the success of chapter 13 plans, the degree of that success is significantly influenced by the views held by debtors' lawyers, chapter 13 trustees, and judges.