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.

Selling CITGO--Timing and Process

Yesterday was the deadline for opening briefs regarding the writ of attachment and potential execution sale of PDVSA’s shares in PDVH, the parent company of US oil refiner CITGO. As expected, Venezuela has asked the court to set aside the writ of attachment. Other briefs argue about what an execution sale should look like, if a sale goes forward. An execution sale is typically an informal, auction-on-the-courthouse-steps kind of thing. That’s not the usual way to sell a multi-billion dollar oil company.

Here’s a very quick summary of the filings, with links to the briefs. And here’s a bit more background, focusing on the timing and process of any execution sale.

The Argentine Re-Designation Drama: Notes From Two Frustrated Readers

By Mitu Gulati and Mark Weidemaier

In 2014, after much fanfare, a shiny new set of collective action clauses was released by ICMA (the International Capital Markets Association), with the endorsement of the IMF, the US Treasury, and others. The inspiration for these clauses? The fact that Argentina, after its 2001 default, got taken to the cleaners by hedge funds who found ways to exploit ambiguities (pari passu) and oddities (FRANs) in the terms of its debt contracts. The new ICMA CACs were supposed to protect against the risk of holdouts (by letting a super-majority of bondholders quash minority holdouts) while constraining opportunistic behavior by sovereigns (by limiting the sovereign’s ability to coerce creditors into supporting a restructuring). But for all of the good intentions behind these 2014 ICMA CACs, they are long, complicated, and leave gaps for clever parties to exploit. And Argentina’s 2020 restructuring proposal may just illustrate the problem.

Many creditors are irate about Argentina’s exchange offer, so much so that some of them say they no longer want the 2014 ICMA CACs. We have been struggling to understand why the offer got them so upset. Fortunately, Anna Szymanski of Reuters Breaking Views put out a piece titled “Argentina Gets Cheeky With its Creditors” earlier today that makes the basics of the drama clear (here). Cribbing from Anna’s research, here is how we understand what is going on and why creditors are irate.

How Are So Many EM Sovereigns Issuing New Debt?

Mitu Gulati and Mark Weidemaier

We have been working on building a dataset of sovereign bonds and their contract terms. Given the economic fallout of the Covid-19 pandemic--close to 100 countries have approached the IMF for assistance--we would not have been surprised if few low- to mid-income countries had issued sovereign bonds in recent months. Instead, there have been large issuances by Guatemala, Paraguay, Peru, Chile, Philippines, Hungary, Mexico and others. 

Take Mexico, one of the biggest players in the sovereign debt market. The country has been badly hit not only by Covid-19 but by brutal drops in oil prices, tourism, and remittances. These developments surely increased the need to borrow in dollar/euro bond markets, but we would have expected investors to balk, or at least to demand punitive coupons. But that doesn’t seem to have happened.

What explains investors’ continued willingness to lend? Might they have drunk the bleach-flavored Kool-Aid and decided that there will be no deep and sustained economic downturn? Possible, we suppose, but unlikely. More plausible explanations include (i) that financial markets are so awash with QE money that investors have few places to go for yield and (ii) that investors may be betting that countries will be bailed out by an official sector desperate to prevent widespread defaults on sovereign debt.

But, because we are interested in the terms of sovereign bonds, we also wondered if investors were demanding extra contractual protections against the risk of non-payment. That would be a sensible precaution given the likelihood that many countries will be unable to make payments. Indeed, colleagues working on M&A contracts have documented a trend towards including risk-shifting clauses that explicitly address pandemic-related events (for a recent paper by Jennejohn, Talley & Nyarko, see here). With superb research assistance from Amanda Dixon, Hadar Tanne, and Madison Whalen, we wondered whether we would find a similar trend in the sovereign bond markets.

Immunity, Necessity and the Enforcement of Italian Debt in the Era of Covid-19

Mark Weidemaier & Mitu Gulati

The sovereign debt world has been debating how to design an emergency debt standstill for the poorest nations, so that they can devote scarce resources to public health rather than debt service. As we’ve discussed on this blog, the question has come up as to whether countries might be able to use the customary international law doctrine of necessity to defend against creditor lawsuits.

Our discussion hasn’t focused on any particular jurisdiction, although we have implicitly assumed that much of the litigation would take place in New York. Now, let us switch gears to assume (plausibly, we think) that Italy is one of the countries that might need a debt standstill. It has been among the worst hit by COVID-19 and will likely soon have a debt/GDP ratio upwards of 150%. To quote a scary new report out from Schroders (here): “Italy is the prime candidate for being the first [Eurozone] casualty [from the Covid-19 crisis]. Its high indebtedness and lack of economic growth require policies that are either illegal in the eurozone, or politically unpalatable domestically.” 

Our work on the mechanics of an Italian debt restructuring—see here (Mark) and here (Theresa Arnold, Ugo Panizza, and Mitu)—has not discussed necessity or other defenses to enforcement. That’s because most of Italy’s debt is subject to Italian law, and our focus was on how Italy might change this law to enable a restructuring. But let us say that Italy does not take this approach. Perhaps it continues to pretend that a debt restructuring is simply inconceivable. It does not lay any legal groundwork for a restructuring. Instead, Italian politicians simply pray for some magical combination of high growth (unprecedented) and a no-strings-attached bailout package from European authorities. In that event, it is conceivable that a sudden spike in interest rates might prevent Italy from making payments. Assuming no immediate European bailout (Italy’s politicians have demonstrated a distaste for any of the conditionality that would come with ESM funding), that means some risk of having to defend the non-payment against creditor lawsuits.

Further Thoughts on Necessity as a Reason to Defer Sovereign Debt Obligations

Mitu and I posted some preliminary thoughts about the defense of necessity, which might be raised as a basis for allowing sovereign borrowers to defer debt service during the crisis. I wanted to follow up on some of the open issues. A few are technical, addressing some potential objections to the defense. I’ll deal with these first and close with a more fundamental question: What good does this potential defense really do for a sovereign? In thinking through that question, my premise is that many sovereigns will need a temporary standstill on debt service during the crisis. For proposals to this effect, see here, here, and here. (Others will eventually need a debt restructuring, but that’s a topic for another day.) But of course private creditors must agree to a standstill on payments. Those who don’t might sue or file arbitration claims, which will potentially put the sovereign's assets at risk and will certainly consume time and resources to defend. [Last sentence edited for clarity.]

Some background

Necessity is a rule of customary international law. As expressed in Article 25 of the International Law Commission’s draft Articles on Responsibility of States for Internationally Wrongful Acts, a state can invoke necessity to excuse its non-performance of an “international obligation” if non-performance is the only way to address “a grave and imminent peril,” as long as non-performance does not seriously impair an essential interest of the “State or States towards which the obligation exists.” Even if these conditions are satisfied, the state cannot invoke necessity to excuse the violation of an international obligation that “excludes the possibility of invoking necessity.” (Put differently, the doctrine purports to treat necessity as a default rule.) Nor can a state invoke the defense if it has contributed to the state of necessity. Finally, even if the defense is available, non-performance is excused only while the threat persists. The state must resume performance when the crisis ends, and it may have to pay compensation for any loss caused by its non-compliance.

It may not be obvious, but this is a remarkably crabbed conception of “necessity.”

Necessity in the Time of COVID-19

Mark Weidemaier and Mitu Gulati

COVID-19 has wrought an unprecedented economic crisis, which will most severely impact the poorest countries. Anna has written insightfully (here and here) about the G-20’s agreement to a temporary debt standstill for a subset of poor countries. And there have been numerous proposals (e.g., here and here) for a broader standstill to allow all countries the ability to devote necessary financial resources to the crisis. The basic idea behind these proposals is that countries should have the option to defer debt payments to both official and private creditors during the time of the crisis. A limitation of these proposals is that their efficacy depends on high levels of voluntary participation by private creditors. What is to stop less public-spirited creditors from insisting on full payment, even filing lawsuits or arbitration claims to enforce their debts? One answer to this question is that borrower governments could invoke the defense of necessity—long recognized as a rule of customary international law—as a defense to such lawsuits. We want to address that defense here briefly, recognizing that the topic deserves a lengthier treatment than we can give it here.

To clarify, here is how we understand the necessity defense: If successfully invoked, a sovereign could defer payment of any principal and interest that came due during the crisis, although it would have to make the payments once the crisis ended. It might also (although this is less clear) have to pay some compensation, likely in the form of interest on the delayed payments. But any compensation would reflect a below-market interest rate. In this sense, investors would suffer a real loss. They would be subsidizing the crisis response, although this does not make them unique. So is every other person with a claim on the sovereign’s resources, including the citizens and residents for whose welfare the state is responsible.

Lebanon’s Vexing Modification Clause

Mark Weidemaier and Mitu Gulati

We posted earlier about Lebanon’s befuddling fiscal agency agreement. Understanding what exactly the modification provision in this contract means to say is key because Lebanon is in the process of trying to restructure its obligations to bondholders. 

To recap, the chief oddity is that the agreement seems to have only one voting threshold for modifying the bonds (75%).  That makes it relatively easy for dissident investors to block a restructuring. A typical sovereign bond has two voting thresholds, a higher one for payment-related and other “core” terms and a lower one for non-core terms (usually 50%, but sometimes 66.67%). If Lebanon’s bonds lack a lower voting threshold for non-core terms, this would negate the government’s most feasible restructuring strategy, which would involve the use of exit consents to discourage holdouts.  Now, in theory, it is possible that Lebanon and its creditors consciously negotiated a special type of sovereign debt contract totally precluding the use of exit consents. But if that were the case, we’d think that everyone involved (creditors, debtors, rating agencies and so on) would have been aware and this matter would have been prominently flagged on the front pages of the offering document.  Best we can tell, none of that happened.

So, assuming there is no evidence that this was a specially designed anti-exit consent vehicle, the next question to ask is what arguments can be made for enabling the use of the technique. We see two arguments—closely related but distinct—for allowing the government to modify non-core terms at a voting threshold lower than 75%. Apologies; this will be a bit technical.

Subordinating Holdouts in a Lebanese Restructuring

Mark Weidemaier & Mitu Gulati

Our prior post expressed frustration with the drafting of Lebanon’s fiscal agency agreement, and particularly the collective action clause. The CAC both lacks the aggregation features that are now standard in the market and potentially blocks the use of exit consents. Creditors with a 25% stake in a Lebanese bond issuance would therefore have the whip hand in restructuring negotiations. We noted that this was not the necessary reading of the FAA, but it was certainly plausible given the contract’s idiosyncratic drafting.

But there are other unusual attributes of the FAA that work in the government’s favor, including one that seems to give the government power to subordinate holdout creditors to restructuring participants and other favored creditors.

The oddity appears in the pari passu clause in the Lebanese FAA. This is the same clause, of course, that gave Argentina so much trouble between 2012-2016. Oversimplified, the clause is a relatively ambiguous promise that creditors will be treated equally with other similarly-situated creditors. In Argentina’s case, federal courts in New York interpreted the clause to prohibit the government from legally subordinating one set of bondholders (holdouts) to another (restructuring participants). Argentina violated that prohibition by, among other things, enacting a law in 2005 that forbade the government to pay or negotiate with holdouts. Six years later, the courts ruled that Argentina had violated the clause and issued an injunction that forbade the country to service its restructured debt unless it also paid holdouts in full. (More details here and here.)

Lebanon’s pari passu clause is pretty much the polar opposite of Argentina’s.

Making (Non)Sense of The Lebanese Fiscal Agency Agreement

Mark Weidemaier & Mitu Gulati

After trying but failing to locate the fiscal agency agreements underlying Lebanese bond issues, we finally managed to get our hands on this one. We had hoped that the FAA would clarify the respective legal positions of the Lebanese government and its investors. Nope. Our review of the FAA leaves us scratching our heads. The original contract dates from 1999—this is the 3d amended version from 2010—and was one of the first post-Brady-era bonds issued under New York law to include a collective action clause. We were eager to see it and had even heard it had been carefully designed to minimize the risk of holdouts in the event of a restructuring. Certainly the government has reason to fear holdouts, such as London-based hedge fund Ashmore.

This may be the weirdest CAC ever. Taken as a whole, the FAA also includes just about the weakest set of anti-holdout tools we have seen. The Lebanese government may have to get creative to restructure.

Let’s start with the CAC. For background, Ashmore is rumored to hold over 25% in aggregate principal amount of multiple Lebanese bond issues (here). That’s enough to block a restructuring vote in most first-generation CACs (i.e., those that first took hold in the NY market around 2003). Lebanon’s CACs are even older; it adopted them at a time when CACs virtually never appeared in NY-law bonds.

For reasons not obvious to us, Lebanon’s lawyers were New York specialists but operated out of London. For reasons that are also not entirely clear, they designated New York law to govern but then bolted on modification provisions (the CAC) derived from the template then in use in the English law market. The end result is confounding.