(Why) Are ESG Sovereign Bonds (Such) Scams?

Mark Weidemaier and Mitu Gulati

Environmental, social, and governance (ESG) investing is all the rage, with heaps of money pouring into sovereign and corporate bonds intended to finance efforts to meet climate-related goals and other worthwhile objectives. We have been skeptical of these commitments for some time, mostly because we aren’t persuaded investors care about much other than yield. And in fact, yields on ESG bonds seem to be a bit—but only a bit!—lower than yields on non-ESG bonds (the so-called “greenium”). As Matt Levine pointed out a couple of days ago, it’s not obvious how socially responsible investing will affect investors’ returns. But we are a little bit suspicious of the market for sovereign ESG bonds.

In part, we’re suspicious for the usual reasons. The basic transaction structure is that the bond issuer says it will use the proceeds for some beneficial environmental or social purpose. But the commitments are often defined so vaguely that it is hard to verify compliance. This is a pretty standard complaint, and a lot of smart people are thinking about how to define “green” investments and develop verification tools. But we’re suspicious for a more fundamental reason: The contracts are absolute b.s. Many issuers don’t commit to anything at all, or so the documentation suggests.

The Haitian Independence Debt

Mark Weidemaier and Mitu Gulati

The Haitian Independence Debt of 1825 is perhaps the most odious in the history of sovereign debt. France agreed to grant recognition to the Haitian state in exchange for a massive indemnity payment, ostensibly intended to compensate French plantation owners for losses suffered during Haitian revolution. With French gunboats lurking in port and offshore, the French imposed a massive and unpayable debt burden equal to roughly 5 times the annual French budget.

Surprisingly, the literature on odious debt pays fairly little attention to this episode. Perhaps this because the doctrine of odious debt was developed with a view towards borrowing by a despot who is subsequently overthrown. Must the populace repay money borrowed to oppress it? Thus, when Haiti does show up in the odious debt literature, the question typically involves debts incurred by the despotic Duvalier regimes. The Independence Debt, by contrast was incurred in the context of a colony escaping the control of an imperial power, and the modern odious debt literature generally ignores this context. We discuss this in a recent Clauses and Controversies podcast with the wonderful Gregoire Mallard, that should be out soon.

This semester, we asked students in our international debt class what they would say if either the French or the Haitian governments came to them today, asking for advice on whether Haiti had a viable legal claim arising from these 1825 events.

SDNY Upholds Pledge of Collateral for PDVSA 2020s

Today, Judge Failla of the Southern District of New York issued an opinion rejecting PDVSA's request for a declaration invalidating the PDVSA 2020 bonds. These bonds, which we've written about before (e.g., here, here and, here) are backed by a pledge of 50.1% of the equity in Citgo Holding. The argument for invalidating the bonds contends that the 2016 exchange offer and collateral pledge was a contract in the "national public interest," which, under Venezuelan law, required but did not receive the approval of the National Assembly. PDVSA argued, first, that under the act of state doctrine, the court had to defer to a series of National Assembly resolutions declaring the exchange offer invalid. It also argued that Venezuelan law governed disputes over the validity of the contract, even though the governing law clause in the bonds specified New York law.

The district judge rejected these arguments in a lengthy and thoughtful opinion. (There is one clear but fairly tangential mistake, when the opinion implies on p. 59 that PDVSA is neither a "foreign state" nor an agency or instrumentality of a foreign state for purposes of the Foreign Sovereign Immunities Act.*) On the governing law question, the judge ultimately decided that New York law applied because--to oversimplify a bit--New York had a significant connection to the transaction. The bonds were negotiated and paid in New York, etc. For more on this conflict of laws issue, see here.

I'd expect to see an appeal, although whether that will benefit PDVSA (even if just by giving it more time) will probably depend on whether the district judge or court of appeals issues a stay of the current order. [edit: And of course on further developments in the U.S. sanctions regime.]

*Technically, the court said only that neither party argued that PDVSA was such an entity. The court made this point to help it distinguish FSIA cases that supported PDVSA's position. But this is no distinction at all. It is beyond dispute that PDVSA is an agency or instrumentality of Venezuela (or is indistinguishable from the government if treated as its alter ego). In either case, the FSIA unquestionably applies to PDVSA, so it is not obvious why cases under the FSIA would be irrelevant to the dispute.

The Sideshow about Venezuela's Prescription Clause

Mark Weidemaier and Mitu Gulati

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

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

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

Episode Two of Clauses and Controversies: Imperial Chinese Bonds

Mark Weidemaier & Mitu Gulati

To prepare for later discussions about how to address the looming debt crisis caused by Covid-19, our first few episodes of Clauses and Controversies look backwards, albeit to historical events with current salience. Episode Two is our first official episode and is about pre-PRC Chinese bonds that have been in default since before World War II. One of us (Mitu) loves this topic and the other (Mark) increasingly flies into a rage whenever it comes up.

Our guests are the wonderful Tracy Alloway of Bloomberg (whose article about these bonds last year went viral), sovereign debt guru Lee Buchheit (who knows more about the history of these types of bonds than anyone – here’s the FT's Robin Wigglesworth on Lee), and Alex Xiao, a former student who is working on a paper on this topic.

The subject of defaulted Chinese bonds is back in the news, largely in connection with U.S.-Chinese trade talks. (Are there trade talks?) A group of ardent Trump supporters have apparently accumulated a bunch of these bonds. Izabella Kaminska of the FT wrote about this a recently, and so did Fox Business a couple of days ago. (The Fox Business piece was a bit more enthusiastic, shall we say, than the others.) Previous lawsuits seeking to enforce them have failed on sovereign immunity and statute of limitations grounds, so these investors are lobbying the President to negotiate a recovery for them as part of his trade talks. And there is some reason to think the administration might be interested. The President is inclined to anti-China and anti-Chinese rhetoric, and these defaulted bonds are an opportunity to indulge that impulse further. Plus, Chinese institutions hold huge amounts of U.S. government debt, and some have floated the loony idea that these defaulted Chinese bonds could be used to offset some of that debt. For a deeper dive, here is a fun piece, The Emperor’s Old Bonds, by three former students.

So, why do we have a love hate relationship with these bonds? Here are the remarks we sent our expert guests as a prelude to asking for their views.

Clauses and Controversies podcast

Mark Weidemaier & Mitu Gulati

Both of us are teaching 1L Contracts online this semester and fear we also may have to do the same for our joint Duke/UNC sovereign debt class next semester. One silver lining is that we have been forced to think of ways to break up the normal class routine. One of these ways is that we are creating a podcast titled "Clauses and Controversies." Thanks to our superb producer, Leanna Doty, the first three episodes are up on iTunes, and Soundcloud, and Overcast. We wanted to come up with something to expose students to ideas and topics that excite us, while giving them a chance to hear conversations with our favorite commentators who study and work on contracts and sovereign debt. The timing seemed right, too, as the economic fallout of Covid-19 may cause many sovereign debt defaults and restructurings.

There is no global mechanism for efficiently and fairly handling a global wave of sovereign financial distress and default. The wave almost hit this past March, when the financial system hit a sudden stop as people seemed to finally recognize the pandemic. Since then, massive infusions of Official Sector capital have allowed government borrowing to continue. But another sudden stop may be in the offing, and even if not the long-term economic damage of the pandemic may tip governments into insolvency.

The first episode is an introduction, which sets out what we hope to do with the series and then gets into the ongoing dispute over whether investors can seize Venezuela’s prize oil refinery in Texas. The absence of a handful of words in the PDVSA governing law clause might make all the difference. But we don’t think it should. (For anyone seeking a deeper dive into the issue, see here.)

We owe an immense debt to our friends in the business who have been so generous in giving us their time, energy, and insight. We also owe a debt to Dave Hoffman and Tess Wilkinson-Ryan for providing us with inspiration with their brilliant contract law podcast series, “Promises, Promises." Fair warning: they are much more brilliant and hilarious than we are. It must be a treat to be in their classes.

The US Government Mumbles Something in Support of Venezuela

Mark Weidemaier & Mitu Gulati

Judicial outcomes are determined by a variety of factors beyond precedent, statutory text, and other purely legal inputs. One factor, especially in cases involving foreign governments, is the preference of the U.S. government. In the middle of the 20th century, the government’s preferences often were dispositive, because the State Department had final say over whether U.S. courts could exercise jurisdiction over foreign states. The State Department eventually tired of being caught in the middle of  these disputes and Congress passed the buck to the judiciary, which now makes immunity determinations in accordance with the Foreign Sovereign Immunities Act.

Still, U.S. administrations periodically put a thumb on the scale in favor of a foreign state. On occasion, this happens even when relations with the foreign state aren’t especially friendly. Foreign sovereign immunity tends to be reciprocal, and the government worries that an overly assertive approach by U.S. courts will prompt courts in other countries to retaliate by asserting expansive jurisdiction over the United States. Still, what’s happening in the Crystallex litigation is a bit unusual. Until now, U.S. sanctions have been the primary tool by which the government has protected Venezuelan assets in the United States. Thus, the U.S. largely sat idle while the federal judiciary ruled that Venezuela and state-oil company PDVSA were alter egos, such that assets formally belonging to PDVSA could be attached by creditors of the Republic itself. Because of that holding, the District Court in Delaware is currently busy trying to figure out whether and how to conduct an execution sale of PDVSA’s equity in PDV Holding, the ultimate parent company of Citgo. (For more, see here and here).

And then, as Anna Szymanski describes in her piece for Reuters that went up earlier today (here), the U.S. government filed a "statement of interest" in the matter.

Some Confusion About Argentina’s Power to Reverse an Acceleration

Mark Weidemaier and Mitu Gulati

As negotiations between the Argentine government and its creditors have gotten increasingly acrimonious, some have begun talking about litigation. Because Argentina’s bonds have collective action clauses, it can impose restructuring terms on dissenting creditors as long as it has the support of a supermajority. Even if it doesn’t have supermajority support to do the cram down, it still has weapons.

One important weapon that often gets overlooked in discussions of the cram down power is the power to rescind or reverse a decision by creditors to accelerate the debt. In effect, this is a power to create a standstill. Argentina’s bonds have some relatively unusual provisions in this regard. One possible interpretation of these provisions is that Argentina is about to lose the ability to reverse an acceleration. We think this interpretation is wrong, but we have heard it raised with some frequency and want to address it here.

PDVSA’s 2020 Bonds: When and Why Does Venezuelan Law Matter?

Mark Weidemaier and Mitu Gulati

In 2016, the Maduro government bought some time through a debt exchange in which holders of maturing bonds issued by state oil company PDVSA swapped them for new bonds due in 2020. The new bonds were collateralized by a 50.1% interest in the U.S. parent company of Citgo. Now that the U.S. no longer recognizes the Maduro administration, the new Venezuelan government sued in the Southern District of New York asking to invalidate the bonds and the collateral pledge. It points to Venezuelan law requiring legislative approval for contracts in the “national public interest,” which didn’t happen here. For background, see our posts from last October, here and here.

The initial briefs have been filed, and not surprisingly the parties disagree about the relevance of Venezuelan law. The PDVSA 2020 bonds are governed by New York law. Venezuela argues that this does not matter, that Venezuelan law determines whether the bonds are valid. The indenture trustee argues that Venezuelan law is irrelevant, that New York law is all that matters, and that under New York law the bonds are enforceable. We’ve seen similar disputes a lot of late, including in connection with debt issued by Ukraine, Mozambique, and Puerto Rico. A government issues foreign-law debt that it later claims was unlawful under its own law. What law governs the dispute?

We have been mulling this question for some time now. At first, we thought it was straightforward, and we suspect many market participants feel the same way. But it is more complicated than a simple foreign versus domestic binary. The end result is this paper, Unlawfully-Issued Sovereign Debt.