Do Judgements Trump CACs?

(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.

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

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

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.

Elliott Rocks (Strikes?) Again

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

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

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).

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

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].

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

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.

Hinrichsen on Iraq’s Debt Restructuring

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

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).

Christine Chabot on "Is the Federal Reserve Constitutional?"

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?")

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?

The Puzzling Pricing of Venezuelan Sovereign Bonds

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?

Badawi & de Fontenay Paper on EBITDA Definitions

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.

Matt Levine, Insider Trading and Mr. Potato Chip

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

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?

(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).

Anderson and Nyarko's Cool New Papers on Contract Evolution

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.

Do Judges Do Contract Interpretation Differently During Crisis Times?

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.

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

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 drafting.  Even 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?

(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.

Coyle on Studying the History of a Contract Provision

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).

Ramming Bow Contracts

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.

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

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.

Reparations Claims by the Herero and Nama Against Germany

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

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).

The New Bond Thing: Sub Sovereign Masala Bonds?

Bored on my flight into Kerala, India’s southern most state, a few weeks ago, I picked up a newspaper lying on the empty seat next to me.  Most of the news was either about the Indian elections and how the nationalist BJP party had swept to power or about or India’s prospects in the cricket World Cup.  What caught my eye though was a little piece in the back section with a photo of luminaries from Kerala’s Marxist party at the London stock exchange. Kerala, for those who don’t know, has a long tradition of cycling between electing the supposedly anti-market Marxists and their pro-market Congress opponents. But here, I was seeing the Kerala Marxist party leaders at the London Stock Exchange.  My first thought was: This is a gag. Turned out not to be though.  The occasion was a five-year rupee denominated bond issued by Kerala, with a Canadian pension fund as its anchor investor (For more, see here).

The celebration at the London exchange was for Kerala having issued the first ever sub sovereign “masala” bond issue on the LSE.  Masala bonds are rupee-denominated bonds issued overseas (like Dim Sum, Samurai and Yankee bonds) and there are almost fifty of these masalas out there.  This though was the first one ever issued by an Indian state on the international market. I was intrigued for multiple reasons.

First, this was the first international sovereign bond of any variety from post-independence India that I had ever seen.  India has long had an enormous capacity to borrow on the international markets.  But its sovereign entities, state and federal, have staunchly refused tap this capacity until now.   

Second, I’ve long been fascinated by the question of why some countries borrow internationally at both the national and state (or sub sovereign) level (e.g., Spain), and others do their international borrowing only at the national level and effectively constrain the states to borrow from domestic markets (e.g., U.S.).  Here, we appear to have a new third category:  tapping the international market at the state level and not doing so at the national level. 

Third, I had had the vague impression that the Indian constitution barred the states from tapping the overseas markets (the language of the constitution, best I can tell, is not crystal clear on the matter).  And yet here it was: a bond issued by a wholly owned corporation of the state of Kerala (the Kerala Infrastructure Investment Fund Board or KIIFB), fully backed by a state guarantee with a rating from Fitch of BB.

Round 2 -- Do the Euro CACs Have to be Used if There is a Need to Restructure a Euro Area Sovereign's Debt?

The intriguing question raised by Mark Weidemaier’s superb new paper posted a few weeks ago (here) was whether, if a Euro area country hits a debt crisis, it would be mandatory for it to use the Euro CACs that are now part of the majority of Euro area sovereign bonds.  Mark’s paper says no (for more, see also Tyler Zellinger, here; and Buchta, Shan, Plambeck & Shufro, here).

About ten days ago, this question came up at a conference at the EUI organized by Franklin Allen, Elena Carletti and Jeromin Zettelmeyer. The plan for the conference hadn’t been to discuss this particular topic, but CACs and restructurings in the Euro area more broadly. But Mark’s paper had just come out and it turned out that almost everyone there had strong views about it; particularly in the context of thinking about Italian sovereign debt.

The panel of CAC/sovereign debt experts was: Yannis Manuelides, Anna Gelpern, Aitor Erce and Giampaolo Galli.  And the discussion – helped by interventions from experts in the audience who included Jeromin Zettelmeyer, Ignacio Tirado, Richard Portes, Lee Buchheit and Elena Carletti -- was fascinating.  Bottom line:  While experts have strong views about this topic, there is zero clarity in terms of what the policy intent was -- we are all reading the tea leaves.  Mark’s view is that the existing Euro CACs are but an option; and he makes a strong argument for that position (one that I buy).  Ignacio, however, is equally convinced of the opposite position; that the Euro area countries are stuck using the CACs if they hit a debt crisis and need to restructure (this does not mean that he thinks this is the efficient solution; just the legal mandated one).  And I have learned over the years that Ignacio is a very careful thinker and knows his European treaty law better than almost anyone.  Yannis, for his part, was – as he always is – nuanced and took a position somewhere in between.  Put differently, he refused to say whether he agreed with Mark or Igancio.  Anna too, didn’t take a side on this (although she knows the history of what was originally intended by the policy makers better than anyone).  Perhaps most interesting – especially since I had not heard his views before – was the wonderfully gracious and wise Giampaolo Galli (Economics Dept, Cattolica University, Roma), who talked explicitly and in detail about the debt situation in Italy.  For those who don't know him yet, here is his Wikipedia page (it is an understatement to say that he has had an impressive career).

My reason for putting up this post is that Giampaolo has just posted his conference draft, “Collective Action Clauses and Sovereign Debt Restructuring Frameworks: Why and When is Restructuring Appropriate” to ssrn.com (here).  The draft both addresses the question raised by Mark in a nuanced way (while also reporting the views of those in the legal department of the Italian Treasury) and goes further to ask whether the primary task of the Italian government now should be thinking of restructuring techniques or figuring out ways to improve growth and get spending under control.  Giampaolo argues persuasively that focus should be on the latter problems and not the former.  Clever restructuring techniques, he explains, may eventually be needed. But they are not the solution to the problem with the giant Italian debt.

Given the strong disagreements on this matter, and the utter lack of clarity as to what was intended by Euro area policy makers in the first place, it sure would be helpful to have some kind of legislative history as to what was intended when the Euro CACs were adopted in late 2012.   Alternatively, maybe the European authorities could tell us what they were thinking?  Or what they are thinking now about what they should have been thinking then?

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.

 

Catch Veinte Dos

A few days ago, Mark and I put up a post on the possibilities of using Chapter 15 bankruptcy for Venezuela's state-owned company, PDVSA.  In response, we received a number of terrific comments, both via email and in the comments section.

One of the particularly interesting points that was made to us (both in email and in one of the comments), that we had not raised was the following: 

PDVSA is not just a Venezuelan company; it is the Venezuelan company -- the company responsible for generating 95% of the foreign currency earnings of the entire country.  Placing the fate of PDVSA into the hands of a bankruptcy judge poses an existential risk to the economy and to the government as the sole owner of the company unless, of course, the government can control the outcome of the insolvency proceeding.  But insolvency proceedings in which the equity owner of the bankrupt enterprise can control the outcome are not proceedings likely to be recognized or enforced by foreign courts.

Catch Veinte Dos?

The foregoing also brings up a slightly different question that Bob Rasmussen asked when he was visiting us last week, which was whether the bankruptcy proceeding could be conducted in a manner such that the 100% equity holder (who would normally have to turn over control to the debt holders in an insolvency) could retain all or almost all of the equity.  After all, it does seem clear that Venezuela is not going to accept giving up full control of PDVSA.  Bob did have some very interesting thoughts as to how this might be done in a purely domestic context.  The question that remained though was whether something similar could be engineered for the foreign state-owned company context that wasn't going to give up any control of the process.  But more on this later

 

Trump’s “Draining the Swamp” Scorecard: One Year In

Donald Trump came into office promising, among other things, to “drain the swamp” and get rid of all that corruption.  One year in, how are things looking in terms of swamp draining? 

The following is based on work with my super co author, Stephen Choi, of NYU Law School.

To answer (at least partially) the question posed at the start, we have analyzed data on Securities and Exchange Commission (SEC) enforcement actions under the Foreign Corrupt Practices Act – the primary U.S. statute that gets at, among other things, bribes to influence foreign officials with payments or rewards. 

We report data that compares SEC enforcement actions against public companies and subsidiaries of public companies under the FCPA from both the final year of the Obama administration and the first year of the Trump administration. We focus on public companies and subsidiaries of public companies because these are the larger economic actors that affect the economy. The Department of Justice also has authority to bring actions, but there were 0 actions brought by the DOJ against public companies and subsidiaries of public companies during the period we examined (although the DOJ has brought several actions against non-U.S. reporting issuers including a number of prominent foreign companies).

Figure I, we think, speaks for itself. On the graph, actions brought during the Trump months (from January 20, 2017 to January 31, 2018—roughly Trump’s first year) are in red, those during the Obama months (January 1, 2016 to January 19, 2017) are in blue. As compared to SEC enforcement activity under the Obama administration, the SEC under the Trump administration, appears to have taken a pause from FCPA swamp cleaning activities. For those who saw our report on partial year information (up to the end of September 2017) here, some months ago – the story has only become clearer with the passage of more time).  

The data is from the Securities Enforcement Empirical Database (SEED),a collaboration between NYU and Cornerstone Research.  It tracks SEC FCPA actions from January 1, 2016 to January 31, 2018. SEED defines a public company as a company with stock that trades on the NYSE, NYSE MKT LLC, NASDAQ, or NYSE Arca stock exchanges at the start date of the SEC enforcement action (note that this includes both U.S. incorporated and foreign incorporated companies). 

There, of course, are caveats as to what else might be going on.

An Update on the Lerrick Nomination

Among the multiple offline comments that I received on our post yesterday was a piece of information updating us on the Lerrick nomination and the drama with the Irish SPV that held Argentine debt (the one where a local children's charity was a trustee).  Two sources emailed to say that that the Irish SPV issue may be a thing of the past given that folks have discovered that the US Exim Bank has used the identical structure for virtually every major aircraft financing over the last 25 years (apparently this is publicly available information). 

This is not to say that the nomination is now going to sail through.  New drama can always show up (daily drama seems to be the defining characteristic of this administration).

Is Poland on its Way to Being Expelled From the EU?

Poland has been thumbing its nose at key European Union norms for some time now (refusal to comply with environmental commitments, unwillingness to take refugees, and so on). The most recent and egregious norm violation being the reforms of the judiciary being pushed by the current right-wing ruling party that will (in the view of critics) enable it to stack the judiciary with judges favoring it. These were signed into law by President Duda roughly ten days ago.

The European Commission, the EU’s principal administrative body, viewing these latest actions as inconsistent with basic democratic commitments of all EU nations to rule of law principles (independence of the judiciary and so on), has recommended that Article 7 proceedings be initiated. That could end up stripping Poland of its voting rights in EU matters; something that would be unprecedented in EU history. As a practical matter this is not likely to happen, because the removal of voting rights requires a unanimous vote of the remaining 27 members of the EU, and Hungary (with a government of similar inclinations to the Polish one) is one the members. But in a community that values collegiality and cooperation to a very high degree, this is a big deal (at least to this outsider).

There is a broader question here, that some in the press are already asking, which is whether, at some point soon, Poland’s (and perhaps Hungary’s) refusals to act consistently with EU values can constitute enough of a justification for the rest of the EU to expel them? As I explain below, an argument can be made that no member of the EU can ever be expelled, given that there is no explicit process contemplated in any of the EU treaties for expulsion. But can that really be the case?

Puerto Rico: Unexpectedly Hilarious Gifts From YouTube

HT: Joseph Blocher & Rich Schmalbeck

Joseph Blocher and I were talking to our tax guru friend and colleague, Rich Schmalbeck, yesterday about the provisions in the new tax bill relating to Puerto Rico and, specifically, how it was that the Puerto Rico could be treated as "foreign" for certain purposes (e.g., taxes on intellectual property).  The context being that these taxes will likely cause some employers to move operations from Puerto Rico to the mainland or elsewhere, thereby worsening the economic crisis on the island.  The answer, best we can tell, goes back to the horribly racist Insular Cases from the early 1900s that allow for Puerto Rico to be treated as "foreign in a domestic sense" (i.e, not on its way to incorporation into the United States - and therefore not worthy of full constitutional protections) -- something that Joseph and I have been railing about (here).

During that conversation, Rich asked us whether we remembered a tourism jingle that ended with "Puerto Rico -- a vacation . . . that lasts a lifetime . . . "   So, of course, Joseph and I went looking for it on YouTube (Rich has a brilliant sense of humor and we knew that we'd laugh if we could find it) . . . we didn't find it (still searching though), but we found a truly hilarious (unofficial, surely) government video touching on many of our favorite topics (debt, colonialism).  For my friends who work on Puerto Rican debt -- this will make you laugh as well, I think --  the video is here

Of course, going down that the YouTube path, takes one back to John Oliver's hilarious riff on the second class status of Puerto Rico, here

And if you watch that, you get taken to this one on the territories.

And then this (the Trump response to Hurricane Maria). For this one, all I can say is Aiyiyiyiyi

John Oliver is able to do harsh social commentary and humor in a way few others can.

And now, I'm watching cat videos.

Aurelius v. The Control Board: What is Going On? (Part II)

First, thanks to all of you who emailed and commented with possible answers as to what the Aurelius strategy in challenging the constitutionality of the Puerto Rican Control Board might be (the subject of Part I).  My favorite answer was the simple: “Create Chaos”.  That was followed by another answer: “Once the sheep start panicking, they become easy pickings for the wolves.”  I’m not sure that I understand either strategy, but that’s why I’m not running a multi-billion dollar hedge fund (if I were an investor, I suspect that I’d be one of the sheep trying to avoid being eaten by the wolves).

Second, I want to ask the “What is going on?” question from a different direction this week.  I’ve read or skimmed almost all of the anti-Aurelius briefs in the Aurelius v. The Control Board case now (for background on this, see here). Two things puzzle me about them.  I should say at the outset though that my being puzzled may stem directly from not understanding how these fancy constitutional law cases play out.

1. Puzzle One: None of the anti-Aurelius briefs provide a clear and coherent explanation of exactly what would be at stake for Puerto Rico, financially, if the Control Board were to be deemed unconstitutional. More crassly, they don’t answer the following question at the outset: How much is it going to cost Puerto Rico if Aurelius wins? 

I'm a realist in thinking about what courts do in tough cases (as contrasted with the “legalist” who thinks doctrine does the overwhelming majority of work in predicting outcomes in all cases).  To my reading, the research tends to show that courts care a great deal about the social costs or policy implications of their decisions.  Yes, of course, they care about doctrine too.  But judges care a great deal about the impact of their decisions on real people (and how their decisions will be viewed in hindsight).

So, if a decision ruling that the Control Board is unconstitutional would impose a huge additional cost on the people of Puerto Rico (who have already suffered so much), and the law isn’t crystal clear, would it not be good legal strategy for the anti-Aurelius lawyers to emphasize that?  Clearly, I’m wrong, since that’s not what the all-star group of lawyers on the anti-Aurelius side have done.  But it puzzles me.

My thinking on this borrows heavily from my brilliant political scientist colleague, Georg Vanberg (see "Financial Crises and Constitutional Compromise”).

1. Puzzle Two: Isn’t it a high-risk strategy to base key parts of one’s argument (as some of the anti-Aurelius briefs do) on cases that are, for want of a better word, “odious”? The cases here are the Insular Cases, that are an embarrassment. My guess is that many lawyers would at least balk at, if not outright refuse, to cite cases like Plessy or Korematsu as their primary support. And most judges, I’d think, would be mortified at having to turn to those cases for support for their decisions (and would like to be shown less yucky ways to getting to the right outcome by the lawyers).

There is a cool article here on the “Anti-Canon” in constitutional law, by Jamal Greene. Getting more specific, in terms of judges who are likely to be faced with these the Aurelius case on appeal, Judge Torruella of the First Circuit has a wonderful set of articles on the yucky Insular cases (and a thundering speech delivered at Harvard Law, where the key ideas for these awful cases were developed in the early 1900s).  A little more distant: Judge Lynch of the First Circuit has a fascinating recent piece talking about Korematsu (a star member of the Anti-Canon).

Odious Debts: A New Book

Classes are over, which means that I get to finally open some of the fun books that I've been meaning to read. Most of what I read is too low brow for me to have the courage to mention here. Plus, Mark tells me that the books in question have to have at least a distant relationship to credit and law.

A couple of days ago, Mark and I talked about Barak Richman's wonderful "Stateless Commerce".

Here is my next recommendation: Jeff King, The Doctrine of Odious Debt in International Law: A Restatement.

Jeff, who teaches at University College in London, was one of the pioneers in the rejuvenation of the Odious Debt literature in 2003-04, when Saddam's government in Iraq was overthrown.  Indeed, it was his co authored article for a Canadian think tank - the Center for International Sustainable Development Law, that jump-started the literature.  Now, thanks to Jeff and his co authors (and to Saddam too, I guess), there is a large and robust modern literature on the topic.  Along the way, in the years that have followed, Correa in Ecuador and Maduro in Venezuela have helped keep interest in the Odious Debt idea alive through their shenanigans. Indeed, Mr Maduro may end up rivaling Saddam in his contributions to the revival of this doctrine whose origins go back to the days of the Czarist regime in Russia in the early 1900s. As an illustration, sovereign debt gurus Ugo Panizza and Ricardo Hausmann have a nice recent piece in Project Syndicate on the relevance of Odious Debt concepts in the context of Venezuelan debt (they have an idea for an Odiousness rating system).

Slipsters are familiar with the Odious Debt debate, I suspect, since Anna G was one of its pioneers.  Plus, it is fascinating.  Basically, it is a doctrine of international law that says that the debts of "odious" regimes that are utilized for the private illicit purposes of the rulers (and where the creditors almost surely knew this was the case), do not have to be repaid by successor governments. The problem with this doctrine though -- to my mind, and to that of many others like Andrew Yianni, Anna, Mark W, Anupam Chander, Adam Feibelman, Sarah Ludington, Lee Buchheit, Eric Posner, Paul Stephan  -- is that it simply does not exist anywhere in international law (or that the basis for it is very very thin). There are some bits and pieces of historical precedent that one could arguably cobble together; but it strikes me as implausible that any modern court would accept the existence of a doctrine of Odious Debt today -- it is just too outlandish for them to do so without a more solid signal from the international community. At least, that was my view until Jeff's book showed up.

Jeff, in his superb book, argues otherwise -- he thinks there is much more of a basis for a doctrine of Odious Debt (and he very politely calls me out for having my head up my backside).  And while I can't quite bring myself to go over completely to his side, I found myself nodding in agreement with a great deal of his analysis. It is nuanced, careful and thoughtful.  Darn it! I don't think I've changed my mind, but that might simply be because I'm too stubborn.

Aurelius v. Puerto Rico's Control Board: What's the Game?

While most of the sovereign debt world is focused on Mr. Maduro’s shenanigans in Venezuela, a fascinating litigation is playing out in federal district court in Puerto Rico.  Aurelius, a hedge fund known to many of us because of the role it played in the legendary pari passu litigation against Argentina, is challenging the constitutionality of the Control Board that was put in place to run Puerto Rico’s debt restructuring (and, essentially, key aspects of its fiscal affairs). 

Elsewhere, Joseph Blocher and I have written about why this suit is exciting for us in the context of our other work on Puerto Rico’s problematic (okay, shameful) second-class status.  Specifically, this Aurelius case, has the potential to get the federal courts to confront the question of what the legal validity today is of a set of infamous cases from the early 1900s (the Insular Cases). We hope that the courts, when faced with arguments that derive their authority from these cases, will clearly say – and there is enough of a basis for them to do so – that the actions and developments of the past 100 years have effectively overruled these cases. These cases, for anyone unfamiliar, are a set of stunningly racist cases produced by many of the same judges who ruled in favor of “separate but equal” in Plessy v. Ferguson.  Oversimplifying, these cases ruled that Puerto Rico and its people, partly because they were not deemed to be civilized enough in the early 1900s, constituted an “unincorporated” territory (that is, so very foreign that they were not on their way to eventual statehood).

So, in a sense, I find myself in the bizarre position that while I am not rooting for Aurelius to win, I hope that their lawsuit ends up getting the Insular Cases condemned, once and for all, as an awful relic of an ugly past.  That said, what puzzles me about this case though is its economics, particularly from the perspective of Aurelius.  What do they get by undermining the Control Board? My assumption here is that a ruling that the Control Board is unconstitutional and that all of the actions it has taken so far are void will be hugely expensive for Puerto Rico’s debt restructuring effort.  After all, one of the key aspects of the Control Board is that it has been given the power to solve the traditional collective action problem that bedevils every sovereign or quasi-sovereign debt restructuring.  Remove the Control Board, and we go back to square one where the creditors are fighting with each other about who has what level of priority and how to avoid giving the holdouts a disproportionate share of the pie. End result: Lawyers get paid a lot, but both the people of Puerto Rico and the creditors (including Aurelius) have a much smaller pie to divide up.

Mr. Maduro Writes an Exam Question on Veil Piercing

It is that time of the year; where one of the excuses I use to escape Thanksgiving dinners that have degenerated into to food fights over our current president is: "I have to go write my exam questions".

This year though, for those writing Corporations exams, Mr. Maduro has written an exam question whose facts I could not have imagined.  I don't know the answer, but this is a topic that Mark W has written a brilliant article on already (even he didn't quite imagine these facts though) and Anna G has thought about too (and maybe has an article in the offing). So, I'm throwing this out in the hope that they might answer it.

Put simply, the question is:

Has the risk of the corporate veil of PDVSA (Venezuela's state-owned oil company) being pierced increased significantly after Mr. Maduro fired six of the top executives of Citgo, the refining arm of PDVSA (Citgo a Delaware corp, wholly owned by PDVSA).  Officially, the charges are of corruption; but it is quite possible that they are trumped up (at least, let us assume that for purposes of the hypothetical exam question). Reality, the NYT suggests, is that Mr. Maduro is trying to use the arrests of the executives (four of whom are US citizens) to build political support. His administration has described the alleged corruption as "putrid" (that's a new one).

As background, creditors of Venezuela who have been defaulted on, have already been trying to get at PDVSA's assets, by arguing that PDVSA and the Republic are, for all purposes, one and the same and should be viewed that way.  And at least one such creditor, Crystallex (a Canadian company) has made considerable progress in its suit.

Put another way: Have Crystallex's chances of victory suddenly increased?

My two cents is a Yes. The more Mr. Maduro uses these subsidiaries as his playthings for non-corporate purposes (and particularly purposes that were not disclosed to creditors ex ante), the more likely is a court likely to decide the veil piercing is appropriate. After all, if Mr. Maduro won't respect that separate status of the subsidiaries, why should the court?