A Cautionary Tale: Argentina’s Pari Passu Debt Debacle

Mark Weidemaier & Mitu Gulati

Tim Harford of the Financial Times has a brilliant new podcast, Cautionary Tales (here). A recent episode, “Danger, Rocks Ahead!,” centers on the wreck of the Torrey Canyon, an enormous oil tanker manned by an experienced crew and captain. Sailing under clear skies, but under a deadline, the ship ran aground on an infamous reef, The Seven Stones, off the southwest coast of the U.K. Harford recounts the series of decisions leading to the disaster, each small misjudgment slowly reducing the margin of error, until none was left. The lesson for Harford is about path dependence. Having committed to a course of action, people often don’t react and adapt when new information reveals flaws in the plan. Thus the experienced Torrey Canyon crew drove their ship onto the rocks when it should have been trivially easy to recognize and avoid the looming catastrophe.

Okay – so this is perhaps not the only metaphor for Argentina, but it fits, and we wanted to mention the Cautionary Tales podcast to Credit Slips readers. Harford’s story about the Torrey Canyon also made us wonder whether Argentina’s debt debacle of 2001-2016 might offer a cautionary tale for the country’s current crisis. We think it does. In fact, one might understand the legal disaster that unfolded over 2001-2016 as the product of a series of misjudgments by Argentine officials. These misjudgments slowly reduced the country’s margin for error and gradually persuaded the U.S. federal judges overseeing litigation against the country that Argentina no longer warranted their sympathy.

We won’t recount the details of Argentina’s decade-long, and ultimately disastrous, battle with holdout creditors. The FT’s Joseph Cotterill recounted the entire saga at FT Alphaville, see, e.g., here), and Bloomberg’s Matt Levine wrote about the 2016 settlement (see here, here and here). We’ll focus instead on the mistakes made along the way.

A simple explanation for Argentina’s legal disaster is that a few U.S. federal judges interpreted an obscure term in Argentina’s bond contracts (the pari passu clause) in an unexpected way and fashioned a novel and unprecedented equitable remedy that ultimately forced Argentina to settle. There’s some truth to this story, but it focuses attention on the outcome—the ship hitting the reef—rather than on the series of missteps that turned that outcome from a remote possibility to a near certainty.

A more complete story needs to highlight the failure of various actors on the Argentine side to take some simple, cheap steps that might have avoided disaster. There were plenty of warning signs along the way. But Argentine officials repeatedly failed to take note and adapt.

Sovereign Gold Bonds in 2019: Really?

Mark Weidemaier and Mitu Gulati

For a while now, we have been meaning to write about “sovereign gold bonds,” or “SGBs,” which the Indian government has been marketing under domestic law to residents of the country since November 2015. Gold bonds were supposed to have been a thing of the past. We’ve written previously about the U.S. government’s abrogation of gold clauses in both public and private debt in the 1930s. Last seen (to our knowledge) in government and corporate debt around that time, these clauses obliged the borrower to repay in either gold or currency at the option of the holder. (For detailed treatments, see here, here and here.) The point was to protect investors against currency devaluation. Thus, the famous case of Perry v. United States concerned U.S. government bonds that provided for payment of principal and interest “in United States gold coin of the present standard of value.” As the U.S. Supreme Court recognized, the promise sought “to assure one who lent his money to the government and took its bond that he would not suffer loss through depreciation in the medium of payment.” (An investor also would not benefit from an appreciation in the value of the currency, for payment was tied to gold coin of the “present standard of value.”)

The bonds in Perry were “Liberty” bonds issued to finance the 1st World War. The government therefore marketed the bonds as patriotic investments, although then, as now, marketers favored subtlety over heavy-handed appeals to emotion.

Regrettably for investors, it also turned out to be their patriotic duty to accept less than full payment.

Dysfunctional Sovereign Debt Politics in Lebanon, Italy, and [Your Country Here]

Mark Weidemaier & Mitu Gulati

Debt, like the full moon, is known to make politicians act strangely. There have been some good examples over the last few weeks, most recently in Lebanon and Italy.

Let’s begin with Lebanon. The country has a huge foreign currency debt stock, dwindling capital reserves, and one of the highest debt/GDP ratios in the world (here, here and here). Investors are concerned, and this is reflected in yields on Lebanese bonds and in the prices of CDS contracts, which reflect an estimated 5-year default risk of around 80%. Last week, Lebanon made a large principal payment on a $1.5 billion bond that had matured, and then turned around and borrowed more, issuing two new dollar bonds with a total principal amount of around $3 billion. These moves bought time, but at the cost of further straining the country’s scarce foreign currency reserves and adding to its debt burden. Why not instead simply ask for an extension of maturities on the existing bonds, buying time to devote resources to something other than debt service?

This head-in-the-sand approach is pretty typical. Politicians often delay debt restructuring far longer than they should. No award goes to the politician who recognizes and addresses a debt problem early, when it is still manageable. A politician who utters the word “default” is likely to get tossed out of office before the benefits of timely action become clear. And while in an ideal world, international financial institutions like the IMF might help produce better decisions, that rarely happens.

But it’s not just that the Lebanese government won’t acknowledge the problem. For some years, the government has delayed obvious reforms to its bond contracts that would have made a restructuring easier to manage.

Stupid Public Debt Tricks—The Alleged Seniority of Public Debt in Italy, the U.S., and Beyond

Mark Weidemaier & Mitu Gulati

Earlier this year, we wrote an article with Ugo Panizza and Grace Willingham about an unusual type of promise made by some sovereign nations, including Spain and Greece. The promise—sometimes enshrined in the constitution, other times in basic law—is that the state will pay holders of its public debt ahead of any other claimant. It is an unusual promise to make, in part because it doesn’t seem credible. (For separate discussion, by Buchheit, Gousgounis and Gulati, see here.)

Neither logic nor history suggests that a country in debt crisis will really treat public debt claims as senior to basic social obligations such as salaries for government doctors, police, and firefighters. When push comes to shove, responsible state actors have reason to favor the needs of the populace over the claims of financial creditors. And if this happens, it is not clear that local courts will step in to ensure that the government prioritizes debt payments.

On the other hand, perhaps these promises have some value? Even if financial creditors don’t get paid in full and ahead of other claimants, perhaps these promises lead them to anticipate slightly higher payouts in the event of a debt crisis and restructuring. Our article with Ugo and Gracie tries to test this hypothesis by asking whether governments that make such promises lower their borrowing costs. We find no evidence that they do. So why make the promise in the first place? There seems to be little upside, and the downside risk is that disappointed financial creditors will assert claims that could delay resolution of a debt crisis.

Speaking of which, we were going to talk about Italy, with its public debt of roughly 2.7 trillion euros. Here’s Article 8 of the Consolidated Act governing the public debt, in English translation available on the Department of the Treasury’s website:

The payments of public debt are not reduced, paid late or subject to any special levy, not even in case of public necessity.

Oh right, sure. If there is a dire need to restructure the public debt, Italian officials will calmly explain to the populace that public services will be slashed to the bone because the claims of financial creditors simply “are not reduced.”

Interpreting Argentina’s “Uniformly Applicable” Provision and Other Boilerplate

Mark Weidemaier & Mitu Gulati

Over the past week, we’ve discussed various uncertainties over how to interpret the new “uniformly applicable” standard added to aggregated Collective Action Clauses starting in 2014 (here and here). Anna Gelpern’s recent post neatly clarifies some of the issues and provides crucial background on the “uniformly applicable” provision. Oversimplifying, the “uniformly applicable” standard was an attempt to assuage creditor fears that sovereigns would exploit aggregated voting to discriminate among bondholder groups. The intent of the clause was to ensure bondholders got roughly—but as Anna points out, not literally—the same treatment. Our prior posts have focused on how the text of the standard might be stretched to forbid certain unanticipated restructuring scenarios, especially when courts perceive the sovereign to be acting irresponsibly or vindictively. That’s precisely the situation in which courts are willing to stretch the meaning of contract text. It’s what happened to Argentina in the pari passu litigation.

In this post, we focus on the broader question of how courts should approach the interpretation of bond clauses like this one. When presented with disputed but plausible interpretations of a text, courts normally try to uncover the intent of the contracting parties and interpret the contract consistently with that intent. (This is a generalization, but accurate enough for our purposes.) But bonds and other (largely) standardized contracts are different. For the most part, the point of standard language is to ensure standard meaning. That goal isn’t served, and can be undermined, when courts inquire into the subjective intentions of the parties to any particular contract. But if their intent isn’t relevant, whose is? Greg Klass, in a new article “Boilerplate and Party Intent,” offers an insightful way of thinking about these problems.

Argentina’s “uniformly applicable” standard offers a good example of the difficulty. The government officials responsible for negotiating sovereign bond deals generally want to adhere to a set of “market standard” non-financial terms. They have only a vague sense of the specific language of most contract terms. Likewise, many investors have told us that they paid little attention to the “uniformly applicable” language in Argentina’s bonds until Argentina went into crisis. They knew the bonds had CACs and, more concretely, that the clauses featured aggregation provisions. But, beyond that, they didn’t know the details. So a search for the intent of the parties—defined as the bondholder and the government—won’t turn up much of value. (In theory, underwriters are part of the equation, but their incentives are to get the deal done – and using standard forms helps get deals done.)

Can Argentina Discriminate Against Bonds Issued Under Macri?

Mark Weidemaier and Mitu Gulati

We hope readers will forgive our trafficking in rumors, but this one is interesting and raises some fun and wonky questions about the relationship between Argentina’s different bonds. We talked about those differences in our last post. Basically, bonds issued 2016 or later are easier to restructure than bonds issued in the country’s 2005 and 2010 debt exchanges. This Bloomberg article explains the differences. Interestingly—and here’s the underlying driver of the rumor—the exchange bonds were issued during the presidencies of Cristina Kirchner and Nestor Kirchner, while Mr. Macri was in office when the 2016 and later bonds were issued. The rumor—relayed to us by some of our friends in the investor community—is that the new government has signaled that it might restructure the Macri bonds, or perhaps just default on them, while leaving the Kirchner bonds untouched.

We’re skeptical that the government really intends to do this, for two reasons. First, the plan sounds insane. That’s not exactly proof that the new Kirchner government won’t do it. But maybe some officials just believe that the government can improve its negotiating position if it seems willing to consider crazy stuff. That might not be sound negotiation theory or whatever, but maybe some in the new government take this view.

The second reason for our skepticism is that we’re not sure Argentina’s bond contracts give it a practical way to engage in this type of discrimination. But this question is actually quite complicated and highlights some ambiguities in Argentina’s bonds. Contractual ambiguities are our caviar and champagne, so that’s what we want to talk about here.

Could the government simply default on the Macri bonds while continuing to pay the Kirchner bonds? Sure, but doing so would eventually trigger the cross-default provisions of the Kirchner bonds. Here is a summary of the relevant provisions, which we extract from the 2010 prospectus. The discussion is simplified, but includes the key details:

Argentina’s [Insert Adjective Here] Debt Crisis

Mark Weidemaier & Mitu Gulati

Okay, everybody ready? Argentina? Check. Debt crisis? Check. Cristina Kirchner and crew back in office to, um, right the ship of state? Check. Last time round, their plan involved hurling insults at a U.S. federal judge. Like Spider Man: Far From Home, it was briefly amusing, lasted far too long, and ended badly. Argentina eventually caved in 2016, paying handsome sums to creditors who had sued it in U.S. courts. We won’t rehash the details, but there is great coverage by Joseph Cotterill, Matt Levine, Felix Salmon, Robin Wigglesworth and others. We also covered it extensively here on Credit Slips.

Yes, sure, it would be nice to have a break of more than three years between the formal end of an Argentine debt crisis and the start of a new one. But here we are. Argentina has again borrowed many billions USD under New York law. This time, the legal issues will be a bit different, because Argentina’s debt stock has different legal characteristics. Below, we offer a few preliminary thoughts.

Voluntary Reprofiling

On August 28, Argentina announced a plan to conduct a “voluntary reprofiling” of debt (here). Reprofiling is a fancy term for maturity extension. That sounds gentle—just a flesh wound!—but a long maturity extension can impose a significant NPV cut. Plus, reprofiling might be just the first step on a path that leads to a brutal debt restructuring. Creditors will distrust rosy predictions that a reprofiling will fix the problem. Many will refuse to participate. What happens then? 

Last time around, after its 2001 default, Argentina’s NY-law bonds required the unanimous approval of all the creditors before any alterations to the payment terms could be made. That requirement, of course, magnifies the risk of holdouts. And in fact, Argentina spent the next 15 years engaged in various legal battles (e.g., here).

This time, Argentina’s bonds have collective action clauses, or CACs, which let a super-majority of creditors bind a dissenting minority. If Argentina gets the requisite proportion of creditors to agree, it can impose a reprofiling on the entire group. Of course, the devil is in the fine print.

A Mini Q&A on Venezuela’s Possible Defense to Foreclosure on the PDVSA 2020

Mark Weidemaier & Mitu Gulati

Along with Ugo Panizza of the Graduate Institute in Geneva, we’ve put up a couple of posts in recent days asking whether Venezuela might have a legal basis for challenging its obligations on the PDVSA 2020 bond (here and here). A large payment of close to a billion dollars is due in a few weeks and there is no money to pay it.  Most important, the bond is collateralized by a pledge of a majority stake in CITGO Holding.

The possible basis for the legal defense is that the bonds, and especially the pledge of collateral, were not properly authorized under Article 150 of the Venezuelan constitution. (This matter has also received press attention over the past few days—e.g., here and here).

As background, provisions in the Venezuelan constitution (Art. 312) and related Venezuelan laws require the passage of a “special law” (our translation) to authorize public indebtedness, but exempt PDVSA from the requirement. However, a separate constitutional provision, Article 150, requires “approval” from the National Assembly for contracts of national interest. We don’t know of situations in which the provision has been invoked. With apologies for possible mistranslations here and elsewhere in this post, here is the text:

Article 150. The entering into of national public interest contracts will require the approval of the National Assembly in the cases determined by law. 

No municipal, state, or national public interest contract can be entered into with States or foreign official entities or with companies not domiciled in Venezuela, not being assigned to them without the approval of the National Assembly.

The law may require in public interest contracts certain conditions of nationality, domicile or any other kind, or require special guarantees

For a Caracas Chronicles piece on this, see here.

We have gotten numerous questions in response to our two pieces, one at Project Syndicate and one here. There were many excellent questions. And since we find this topic fascinating (we are working on an empirical paper on governing law provisions in sovereign debt contracts), we decided to go down the rabbit hole of trying to answer them. 

The caveat here is that while we know a good bit about sovereign bond contracts, we have no expertise in Venezuelan constitutional law. Here goes:

Can Creditors Seize CITGO? Enforcing the PDVSA 2020 Bond Collateral

Mark Weidemaier & Mitu Gulati

Writing with Ugo Panizza, we have a piece out today on Project Syndicate (Should Creditors Pay the Price for Dubious Bonds?) discussing the collateralized bond issued by Venezuelan state oil company PDVSA (the PDVSA 2020 bond). We have written here previously about the bond as well. In 2016, when PDVSA was near default, it conducted a debt swap in which investors exchanged short-maturity bonds for the longer-maturity PDVSA 2020. To sweeten the deal, the PDVSA 2020 bond was backed by collateral in the form of a 50.1% interest in CITGO Holding, the immediate parent company of U.S. oil refiner CITGO Petroleum.

A payment of nearly $1 billion is coming due in the next few weeks on the PDVSA 2020 bond. The Maduro regime—no longer recognized as the legitimate government of Venezuela—can’t pay it. And the government-in-exile led by Juan Guaidó—though it desperately wants to retain control of CITGO—presumably can’t afford to pay. If there is a default, and bondholders seize the collateral, the loss of CITGO may significantly disrupt Venezuela’s ability to recover from its current economic and humanitarian catastrophe. To be sure, the prospects of recovery are dim while Mr. Maduro remains in power, but if he leaves, the loss of CITGO will be a major blow.

The Project Syndicate article describes how, under Venezuelan law, the National Assembly must approve contracts of national interest. That didn’t happen here. Venezuela might therefore challenge the issuance of the PDVSA 2020 bond, and the grant of collateral, as lacking proper authorization under Venezuelan law. Ugo and we examine the potential justification for such a challenge at Project Syndicate.

Here, we focus on a more wonky question: Is the validity of the PDVSA 2020 bond and the pledge of collateral to be judged under Venezuelan law or New York law? And would the outcome change depending on which law governs? The answers turn out to be more complicated than one might think. But, given the court battle that we expect, rather important.

Enough With the Old Chinese Debt Already

Mark Weidemaier and Mitu Gulati

We may be partly to blame for the fact that stories keep surfacing about whether the U.S. government might help holders of pre-revolutionary, defaulted Chinese debt monetize their claims. Here’s Tracy Alloway of Bloomberg, with a good assessment of the political and legal basis for this kind of intervention. The bonds have been in default since the 1930s. China won’t pay these pre-PRC debts. Taiwan sends its regrets. But a vocal contingent of American bondholders is lobbying for the U.S. government to intervene. The precise manner of intervention is not clearly defined, but the basic idea is that the bondholders could assign their rights to the U.S. government, which could then use the bonds to offset U.S. debts to China. As Alloway quotes the President of the American Bondholders Foundation (a bondholder group): “What’s wrong with paying China with their own paper?”

Look, we’re torn here. Expressed like that, the idea is bonkers. No, it’s worse. If you’ll forgive an obscure theater reference: compared to a bonkers idea, this idea is lying “in the gutter looking up in wide-eyed admiration.” Sure, the US government could try to “pay” China with defaulted Chinese bonds. It could also try to pay with toilet paper or chewing gum.* We have to assume this would be a credit event triggering CDS contracts issued on the U.S. And to be fair, from a certain armchair perspective, that would be…entertaining?

Third Circuit Affirms Crystallex Attachment Order

Today, the U.S. Court of Appeals for the Third Circuit affirmed the order allowing jilted Canadian mining company Crystallex to attach PDVSA's equity stake in PDV-Holding (the corporate parent of CITGO). Here's the unanimous opinion. (For prior coverage of the attachment ruling see here.) It's possible proceedings in the District Court might be delayed further if Venezuela seeks Supreme Court review, while the district judge resolves outstanding procedural questions (see here), or because of lingering uncertainty about whether the U.S. sanctions now in place will prevent an actual execution sale. So it's not exactly over. But on the core question--whether Venezuela's control over PDVSA was so extensive as to make the entity the government's alter ego--the Court of Appeals resoundingly rejected Venezuela's argument: "Indeed, if the relationship between Venezuela and PDVSA cannot satisfy the Supreme Court’s extensive-control requirement, we know nothing that can."

India to Issue its First Foreign Currency Sovereign Bond?

Mitu Gulati & Mark Weidemaier

The two of us are beginning a project to build a dataset of foreign currency sovereign bonds and their contract terms. The dataset of bond issuances has a conspicuous absence: India.

Turns out India has never issued a foreign currency sovereign bond. Some state-owned enterprises have ventured onto the foreign markets in search of investors, but not the sovereign. This is a bit puzzling because India certainly has the economic growth and financial prospects to attract foreign investors. Countries like the Philippines, Turkey, Argentina, Mexico, Brazil, Russia, and China regularly tap the international markets. Indeed, closer to home, many of India’s smaller neighbors, such as Sri Lanka, Pakistan and even little Maldives, have tapped the foreign currency sovereign markets. We also know from our research that there is considerable appetite for Indian sovereign issuances from big investors in places like Singapore and Canada. The interest is such that foreign funds buy Indian domestic currency issuances despite the inflation risks they pose. Presumably, these funds would jump at the opportunity to buy a foreign currency issuance.

So, why not India?  Or, perhaps we should ask: Why now India? There are conflicting reports, but the government appears to be considering issuing an international, foreign-currency bond, likely yen- or euro-denominated. In a recent budget speech, the Finance Minister of India announced the plan (see here, for a recent Bloomberg story). Other reports, however, indicate that the office of Prime Minister Narendra Modi has developed cold feet about the plan (see Bloomberg here). The Economic Times of India (here; and also this Money Control article) also describes how the senior bureaucrat who was in charge of the issuance has been transferred from the Finance Ministry to a less prominent position and is seeking to retire early.

Pre-Revolutionary Chinese Debt: An Investment for the Truly Stable Genius

Mark Weidemaier & Mitu Gulati

About a year ago, an unusual securities action was brought against a pastor at one of the largest Protestant churches in the country and a financial planner. The accusation was that the two, Kirbyjon Caldwell and Gregory Smith, had duped elderly investors into buying participation rights in bonds issued by the pre-revolutionary Chinese government. The bonds have been in default since 1939. Here is the SEC’s press release; Matt Levine at Bloomberg talked about the case here. Among other things, the SEC accused Caldwell and Smith of violating the registration requirements of the federal securities laws and of committing fraud.

This case got a fair amount of attention because Mr. Caldwell is no ordinary pastor. He leads one of the largest congregations in the country, with roughly 14,000 members, and was a spiritual adviser to George W. Bush and Barack Obama (see here).

The core of the fraud case seems to be that Caldwell and Smith promised investors safe, quick returns. Allegedly, the plan was to sell the bonds for a profit or to get the Chinese government to pay up. From the SEC’s perspective, this was like promising to squeeze water from a stone; since the communist takeover in 1949, Chinese governments have steadfastly refused to pay the bonds.

It all sounds rather daffy. Also, weirdly specific. It can’t be easy to persuade people to open their pocketbooks for antique Chinese sovereign bonds. Still, we were struck by the SEC’s characterization of the bonds, in both the press release and the complaint, as “defunct” and as “collectible memorabilia with no meaningful investment value” (here and here). The characterization presumes the answer to a question that has long fascinated us, which is whether a sufficiently motivated claimant could enforce these bonds against China.

Venezuelan Debt: Soft Power Matters

Mark Weidemaier and Mitu Gulati

Last week, we did a post about a set of creative but long shot defenses that Venezuela’s Interim Government has invoked to defend against lawsuits by creditors holding defaulted debt. Basically, the government wants a stay of creditor enforcement efforts. The plaintiffs want summary judgment—i.e., a relatively quick entry of judgment, without a trial or significant fact-finding. The Interim Government’s defenses have equitable appeal but questionable (although not zero) legal merit. The defenses included the contract law defense of Impossibility and the customary international law defenses of Necessity and Comity. Impossibility rarely works, especially when the defendant’s argument boils down to, “I’m out of money and need time to work out a deal with my creditors.” Necessity and Comity may not even apply in cases arising from a sovereign’s default. However, the Interim Government’s legal team persuasively emphasized their client’s impossible situation—recognized as the legitimate representative of the country but unable to access its resources.

Judges have power, and much of this power is of the “soft” variety that comes, not from the ability to resolve substantive disputes, but from professional status and authority and from the ability to control process. Here, the judge has given the Interim Government a bit of the relief it wanted, in the form of a relatively favorable scheduling order.

Equal Treatment in Sovereign Restructurings

Mitu Gulati & Mark Weidemaier

Last Friday, the Venezuelan government (at least, the representatives of that government recognized by the U.S.) issued a set of broad principles it intended to follow when it conducted the debt restructuring that is going to be necessary as soon as Mr. Maduro is given the proverbial boot from office.  One of those principles is going to be “equal treatment” of the various claims denominated in foreign currency – PDVSA bonds, promissory notes, Venezuelan sovereign bonds, arbitral awards and so on.  For those who are familiar with sovereign restructurings, the use of this broad equal treatment principle is going to be familiar (for example, Greece used it in 2012 when faced with an array of different types of debt instruments).

Our question is why.  The different debt instruments that Venezuela has – PDVSA bonds, sovereign bonds, Prom Notes, etc. – have different legal terms.  Some have stronger creditor rights and others have weaker ones. And that probably means that the current investors paid different amounts to buy them.  If investors paid different amounts for stronger versus weaker legal rights, doesn’t it stand to reason that the ones with the stronger rights should be offered a higher payout in a restructuring? And if they are not paid different amounts, isn’t that an invitation to the ones with stronger rights to engage in holdout behavior?

In Greece, for example, both the local-law governed Greek sovereign bonds and the foreign-law ones were offered the same deal.  Almost of the local-law bondholders took the deal, but relatively few of the foreign ones did. End result: Greece paid out the foreign-law bonds that refused the offer in full.  The same was true for a bunch of the Greek guaranteed debt. 

In Barbados, in the restructuring that is ongoing, the domestic-law bonds have taken the offer made by the government. But that same offer has been turned down the foreign-law bondholders; presumably because they think their instruments are worth more because of their stronger legal rights.  Wouldn’t it be efficient to offer the foreign holders more rather than getting mired in years of litigation?

There is undoubtedly a logic to the equal treatment principle.  We are wondering what it is. Efficiency? Maybe the logic is that if, for example, Venezuela were to offer the sovereign bonds requiring 100% of the creditors to approve of the restructuring a few cents more on the dollar than the ones requiring 75%, the whole process would get mired in disputes over whose bonds had stronger or weaker legal rights? Or maybe the logic is that investors will either hold out or not. Put differently, maybe there really is no marginal investor (i.e., one who, in exchange for a few extra pennies, might choose not to hold out and sue). Investors either have an appetite for litigation (in which case they aren’t interested in accepting restructuring terms) or they don’t (in which case there is no need to compensate them for rights they don’t have the appetite to assert). But again, we are speculating.

As a final puzzle, why are some bonds exempt from the equal treatment principle? The restructuring guidelines say that bonds backed by collateral will receive different treatment. But why? Why is a right to collateral different from a 100% voting right? Perhaps it is because some collateral pledges are relatively easy to enforce, such as the pledge of shares in U.S. entities. The PDVSA 2020 bonds are the primary example here. By contrast, a 100% voting right ensures the right to sue but doesn’t do much to help an investor enforce the judgment. However, the guidelines released by the Guaido team may have in mind something more than just the 2020s.

Evaluating Venezuela’s Guidelines for Debt Restructuring

Mark Weidemaier & Mitu Gulati

As reported in the Financial Times, Reuters, and elsewhere, Juan Guaido’s economic and legal team has released a report setting out guidelines for a restructuring of Venezuelan debt. The report, attached here, describes a process that can only happen if/when Maduro loses power and the U.S. government lifts the current sanctions regime, which effectively forbids most transactions in Venezuelan debt. The report is a brief three pages, but it offers intriguing clues about what a restructuring might look like.

Proposals to restructure the Venezuelan debt must accommodate certain basic realities:

- The country is experiencing a dire humanitarian crisis, which demands immediate attention.

- The debt stock is utterly, needlessly complex. Venezuela has somewhere in the range of $200 billion in external liabilities. Virtually all creditors are unsecured, and every creditor’s repayment prospects are tied directly to the government’s ability to monetize one asset: oil. For all practical purposes, every creditor is in the same position. Yet the debt is spread across multiple obligors (the government, PDVSA, etc.) and a bewildering array of obligations (bonds, promissory notes, trade credits, arbitration awards, and who knows what else).

- The government therefore needs time—time to focus on humanitarian needs, time to rehabilitate the oil sector, time to stabilize the political situation, time to determine the full scope of its debts, time for a new government to come up with a credible economic plan for recovery, time to persuade key foreign companies that they won’t be expropriated again if they come back and help in the recovery, and time to come to terms with its creditors. But…

- It may not have much time. Many creditors have been patient. But a few have already reduced claims to judgment and initiated attachment proceedings against crucial government assets, including U.S. oil operations. It is surprising that the litigation floodgates have not opened, but that could happen any day now.

- The next government is going to be highly vulnerable to creditor lawsuits, and particularly so in the United States. It cannot right its economy without selling oil abroad (and sales in the U.S. are typically the cheapest, given refineries and distances). But these sales generate assets in foreign jurisdictions, where creditors will try to seize them. This vulnerability, paired with the complexity of its debt stock, makes Venezuela more akin to Iraq than to more recent crises.

- Finally, the U.S. government may prove a fickle ally. The most effective way to buy time for a Venezuelan restructuring would be for the U.S. and other key jurisdictions to block creditors from attaching Venezuelan assets while the government was engaged in good faith restructuring negotiations. This is what happened for Iraq, but will the Trump administration be able to collaborate with other key nations (China, Russia) to produce a solution similar to that designed for Iraq?  We don’t know.

These facts make for a very messy debt restructuring scenario. But that doesn’t mean the restructuring plan must be complicated. To the contrary, the proposal released by Mr. Guaido’s team attempts to simplify. (Note that the plan does not address debts owed to other nations, presumably including state-owned companies):

Timing and credibility: As noted, Venezuela needs time to address pressing humanitarian needs and, more broadly, to get its house in order. It also needs to persuade its creditors that it has accurately estimated its liabilities and repayment capacity. But the byzantine debt stock created by the Maduro regime, combined with the government’s long-standing refusal to engage with the IMF, means that creditors have little reason to accept the government’s estimates. Not surprisingly, then, the proposal envisions that the IMF will both provide emergency humanitarian assistance and play its usual role in assessing the country’s growth and repayment prospects.

Venezuelan Debt Restructuring: Making Impossibility Possible?

Mark Weidemaier & Mitu Gulati

There have been relatively few recent developments regarding Venezuela’s debt, as Maduro hangs on to power and U.S. government sanctions bar trading or restructuring of Venezuelan debt by U.S. persons. However, at least one important development has mostly escaped attention. Venezuela-watchers know that the U.S. government, along with many others, has recognized Juan Guaido’s team as the legitimate government of Venezuela. This had immediate implications for creditor lawsuits against Venezuela in U.S. courts. The first involved disputes over which legal team—the lawyers selected by Maduro or those selected by Guaido—had the dubious honor of representing the Venezuelan government. The answer (sensibly enough) seems to be that Guaido’s legal team calls the shots. But Mr. Guaido and his team represent a government in exile, without meaningful resources or real levers of power. Plus, no one denies that Venezuela has failed to pay its creditors. Normally, those facts lead courts to enter judgments in creditors’ favor and to let creditors attach government assets. What legal basis could a Guaido-led government have for resisting these lawsuits?

Court papers defending against the two latest creditor lawsuits reveal an intriguing and innovative strategy. The two cases are Pharo Gaia Fund Ltd et al. v. Venezuela & Casa Express Corp. v. Venezuela.  Both are pending before Judge Analisa Torres in federal court in the Southern District of New York. In filings made a couple of weeks ago (June 21, 2019), the lawyers for Venezuela (Arnold & Porter) raised three doctrines that one rarely sees in modern sovereign debt litigation for the simple reason that these ordinarily have little chance of success: impossibility, necessity and comity.

How Chaotic Would an Italian Debt Restructuring Be? (Not Very)

Mark Weidemaier & Mitu Gulati

Wolfgang Munchau’s column in the FT yesterday identifies a possible Italian debt crisis as one of the biggest worries for the Eurozone. This makes sense, given Italy’s huge debt stock (upwards of 130% of GDP), seemingly irresponsible politicians, and low growth. An Italian debt restructuring would be the biggest in history, yet it might prove necessary. Munchau highlights the economic consequences of a debt restructuring (e.g., for Italian and other European banks) and also asserts that Europe’s “legal systems are not prepared.” The general sense is that an Italian debt crisis will be a disaster.

It won’t be good, that is for sure. But if planned properly, an Italian debt restructuring can be done relatively smoothly. Why? Because Italy has an enormous “local law advantage,” combined with an enormous set of captive (aka local) holders who have been, to quote an old friend in the sovereign restructuring business, “rolling over their Italian bonds since Hadrian died.”

One might ask, Didn’t Greece have the same local law advantage and wasn’t that a chaotic restructuring? Our reply is that the source of chaos in the Greek case was the unwillingness of key institutions to acknowledge that the debt was unsustainable until very late in the process. The restructuring itself was relatively smooth (for more, see here). In any case, the restructurers this time can learn from the Greek experience. Plus, the local law advantage is significantly bigger in Italy.

Students in our joint class on sovereign debt worked intensely this semester on what an Italian debt restructuring might look like, and they have recently posted their work to ssrn.com. From our informal conversations with European colleagues and friends, we understand that lawyers at various official sector institutions take the position that they do not have the power to do the things our students suggest. But we have yet to hear convincing reasons for this position. Indeed, our impression is that these lawyers are mostly worried that they will spook investors if they publicly acknowledge having the power to restructure (on the theory that investors might take this as a sign that restructuring is likely).

A New Development on the CAC v. No-CAC Question in Euro Area Sovereign Bonds

Mitu Gulati and Mark Weidemaier

We have previously discussed how Euro area sovereign bonds with Collective Action Clauses or CACs (issued after Jan 1, 2013) and without CACs (issued prior to Jan 1, 2013) potentially differ in their vulnerability to debt restructuring. For anyone trying to draw up plans to tackle a future Euro area sovereign debt crisis (e.g., in Italy), it will be crucial to decide whether the CAC and no-CAC bonds are in fact different from a restructuring perspective. Conversely, for investors trying to predict which bonds to avoid and which to buy, the matter is equally important – and indeed, should be reflected in prices (for recent empirical papers, see here, here and here).

Last week, a research note by two Dutch researchers made its way to our desks (via reporters who found the claims intriguing). These researchers, looking into investment treaties entered into by the EU with Singapore, Canada and Vietnam, were concerned about two aspects relevant to future sovereign debt restructurings (among other things). To quote their abstract:

On the eve of the vote in the European parliament on the new investment treaty between Singapore and the European Union, SOMO publishes an analysis on the risks for managing government bonds and money flows. The analysis explains how the EU-Singapore Investment Protection Agreement (IPA) negatively impacts the policy space the EU, EU member states and Singapore have to manage financial instability and prevent financial crises.

(Note:  As per the Dutch research note, the EU-Singapore Investment Agreement has not been ratified by the EU parliamentary authorities yet). The issues of concern were:

First, the treaty seemed to include government bonds within its ambit (which is not the case in all such bilateral investment treaties).

Second, the treaty has specific vote requirements that differ from other treaties (e.g., 75% in the EU- Singapore agreement; 66.67% in the EU-Canada one) and that, if not followed, allow investors to bring treaty-based claims.

One concern raised by the report is that such treaties – perhaps inadvertently, perhaps intentionally – can make future restructurings of Euro area sovereign bonds harder by granting investors in certain countries additional rights that could enable them to block restructuring attempts.

Here are our preliminary thoughts, focusing on the EU-Singapore treaty:

Republic and PDVSA Bonds: No Trades With Friends and Family

Mark Weidemaier and Mitu Gulati

A few days ago, we wondered why the U.S. government had constrained U.S. holders of PDVSA debt instruments to sell only to non-U.S. parties. The constraint would likely kill liquidity for these bonds and impose losses on bondholders. But why? And why impose the constraint on PDVSA bonds but not the Republic’s bonds?

On Friday, the Treasury apparently amended the sanctions order to impose the same constraint on the Republic’s bonds. Now these too can only be sold to non-U.S. persons.

But again, why?  Venezuela hasn’t issued new bonds for a while, so why kill the secondary market for existing bonds? 

Here are four possible explanations; we’d be grateful to hear others from readers:

1.    Cut Off Oxygen: Venezuela has made a habit of issuing bonds and then parking them in domestic financial institutions, for later sale when the government is low on cash. Counterparties have been willing to accept these bonds in the hope that a future government will pay, even if the current one won’t. Perhaps the U.S. government believes Venezuela still has a stockpile of these parked bonds and is trying to eliminate this last source of oxygen for the Maduro government.

2.    What’s Coming is Brutal: Perhaps the U.S. government expects a brutal restructuring and wants to give U.S. holders an opportunity to escape by selling to non-U.S. parties. But query: If this is the story, why would anyone want to buy? (Ans: They wouldn’t, thereby reducing liquidity even further).

3.    Don’t Want Irate Bondholders Calling and Yelling at US Treasury Officials: This explanation is a version of the first one (Oxygen denial) and says that the U.S. wants to dramatically reduce the value of Venezuelan bonds in the short run, but not to zero, so that U.S. holders who really need to exit will still have a small escape window.

4.    Cut Venezuela Out of the Index: Nearly two years ago, Harvard economist Ricardo Hausmann urged JP Morgan to remove Venezuelan bonds from its index (see here, for Hausmann’s now-famous “Hunger Bonds” article). Venezuela needed to solve a humanitarian crisis, not pay coupons to foreign bondholders. Hausmann understood that many investors would view Venezuelan bonds less favorably if the bonds were removed from JP Morgan’s index. Indirectly, the U.S. government might be trying to bring about this result. To stay in the index, a bond must be traded to some minimal degree. If the sanctions prevent this, Venezuelan bonds may be removed from index. But why would this matter to the U.S. government? Hausmann was worried about coupon payments being made to foreign creditors in lieu of assistance to the people of Venezuela. But Venezuela is not paying any coupons these days (except on the one collateralized PDVSA bond).

Explanations one and three seem most plausible to us. Perhaps the U.S. government is hoping for regime change in the near future. If so, the pain bondholders feel will be temporary and offset by gains once a reasonable government is in place. But if Maduro retains power, then the pain for U.S. holders of these instruments will be significant.

Euro Area Sovereign Bonds: CACs or no-CACs?

Mitu Gulati and Mark Weidemaier

Beginning January 1, 2013, Euro Area authorities required member countries to include “collective action clauses,” or “CACs,” in sovereign bonds with a maturity over one year. CACs are a voting mechanism by which a bondholder supermajority (e.g., 66.67% or 75%) can restructure bond terms in a vote that binds dissenters. Before 2013, the vast majority of sovereign bonds issued by Euro area countries not only lacked CACs; they essentially said nothing about restructuring. For much more on CACs, European and otherwise, see here, here and here.

Because of this policy change in 2013, almost every Euro Area sovereign has two sets of bonds outstanding: CAC bonds and no-CAC bonds. Is either type of bond safer for investors to hold in the event of a restructuring?

On the Attachability of Blocked Venezuelan Assets

Mark Weidemaier and Mitu Gulati

We gather that there is still activity in the U.S. government to think through the implications of the recent expansion of sanctions against Venezuela. Here’s the original version of the most relevant Executive Order. In brief, it provides: “All property and interests in property that are in the United States, that hereafter come within the United States, or that are or hereafter come within the possession or control of any United States person of the following persons are blocked and may not be transferred, paid, exported, withdrawn, or otherwise dealt in…” The new sanctions add PDVSA to the blocked list.

One question is whether this stops the Crystallex attachment proceeding in its tracks. After all, shares in PDV-H are an interest in property owned by PDVSA, and an execution sale is nothing if not a transfer of assets. To spin this out even further, what about the shares in CITGO-H, which were pledged as security for the PDVSA 2020 bonds? If the sanctions extend to property owned by entities controlled by PDVSA, then the sanctions would also seem to block holders of the PDVSA 2020s from foreclosing (without first getting a special license). These complexities will require clarification; perhaps Treasury will provide it soon.

More broadly, let’s assume that the effect of the sanctions is to divert a significant pool of assets into some blocked accounts in the U.S. As we said in our prior post, we are skeptical that there is a big pool of assets, but we might be wrong. Let’s further assume that the U.S. administration eventually declares that Juan Guaidó and associates, as the officially-recognized leaders of Venezuela, have access to the funds. Are the funds now attachable by Venezuela’s creditors (like Crystallex)? At least as a formal matter, the answer would seem to be “yes.” The assets would no longer be blocked, and would also seem to belong to the government. Creditors with claims against the government would be entitled to assert claims (subject to the law of foreign sovereign immunity). Yet this can’t be the intended result—or so we hope. It would effectively divert government assets to a handful of creditors, enabling them to achieve disproportionate recoveries (compared to other creditors) at the expense of the Venezuelan people. We hope the administration will make clear this is not the intent.

What is the U.S. Government’s Strategy in Venezuela?

Mark Weidemaier and Mitu Gulati

Even by the eccentric standards of its ongoing debt crisis, weird things are afoot in Venezuela. Opposition leader Juan Guaidó has declared himself president and been recognized by the U.S. and other governments. That’s not especially weird. What’s odd is that the political convulsions in Venezuela are manifesting in part as a battle over control of the CITGO board. Guaidó has said he plans to appoint a new board. Rumors are circulating that this is part of a plan, assisted by the U.S. government, not just to cut off the flow of oil revenues to the Maduro regime but to redirect that flow towards opposition coffers. As the Wall Street Journal previously reported: “U.S. officials say they want to divert oil money--as well as control over other assets like gold reserves--away from Mr. Maduro to the new interim president without stopping crude exports from the country.” That’s also consistent with a recent statement recently put out by the U.S. Treasury. 

Since these reports, the U.S. administration announced new sanctions, which don’t direct funds to opposition coffers but which do appear intended to prevent CITGO from remitting oil-related payments to Venezuela. Instead, the funds must be held in blocked accounts in the U.S. Here’s Bloomberg on the sanctions, and the Wall Street Journal, and Reuters, and the New York Times.        

What’s going on here?

Puerto Rico’s Audacious Move: Can it Cut its Debt by $6 bn?

Mitu Gulati & Mark Weidemaier

Last week, the Government of Puerto Rico, acting through the Financial Oversight and Management Board (and in conjunction with the creditors’ committee), filed a claims objection seeking to invalidate roughly $6 billion of its General Obligation debt. The reason is that the government allegedly borrowed in violation of the Debt Service Limit and the Balanced Budget Clause of the Puerto Rican constitution. Stephen’s recent post on this subject discusses the merits of this argument in some detail. In this post, we are especially interested in the question of restitution. The Commonwealth doesn’t get much benefit from invalidating loans unless it also avoids the obligation to pay restitution (i.e., return the purchase price). So the objectors make the additional argument that bondholders have no equitable right to restitution under a theory of unjust enrichment.

There is some precedent for the objectors’ arguments in similar contexts, although not a lot of it. Some of the important cases, such as Litchfield v. Ballou (1885), are also very old. However, at least one law review article—a student note in the North Carolina Banking Institute journal (here)—squarely addresses Puerto Rico’s argument, ultimately concluding:

How can Puerto Rico’s penalty for illegally borrowing above its means be that it is allowed to declare the debts void and keep the money for itself? Despite the manifest unfairness of such a result, the applicable law indicates that this is likely the proper legal result.

Who Went to Caracas Last Week?

Mitu Gulati & Mark Weidemaier

More and more creditors are filing lawsuits against Venezuela, and we had been planning to do a post on how the dominos were falling. 

But then we came across a piece by Ben Bartenstein of Bloomberg about how some investors appear to be pursuing an alternate strategy, allowing bondholders to be compensated from oil-related activities. One can understand why creditors would rather have a future claim to oil revenues than litigate over unpaid bond debt. After all, Venezuela has huge oil reserves, and the current Venezuelan government is sure to lose power eventually. Although it may take a while, a government will eventually be in place capable of resuming oil production, and in that event, investors could make a bundle.

Good for investors, but terrible for the future government and the people of Venezuela. Having finally rid themselves of Maduro, they would have to deal with the fact that he and his cronies had either stolen the country's assets or pledged them in exchange for a temporary reprieve from creditors. This is not a new issue. It implicates the problem of odious debts, for which Venezuela is quickly becoming a poster child. (Ugo Panizza and Ricardo Hausmann have a nice piece about the need for Odiousness Ratings in the Venezuelan context.)