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.)

Ukraine Wins Appeal in Russian Bond Case

Ukraine and Russia have been battling it out in English courts over whether Ukraine must repay a $3 billion Russian loan from 2013. The loan was unusual both in structure and in substance. For example, although essentially a bilateral loan, it was structured as a tradable Eurobond and held by the Russian sovereign wealth fund. The indenture trustee has been suing to enforce the loan. In March 2017, the High Court of Justice granted summary judgment for Russia. Although Ukraine had a number of plausible defenses to enforcement of the loan, the judge rejected them all. Here's Bloomberg, with coverage of that decision and of the ensuing appeal. Today, the Court of Appeal reversed that decision, sending the case back for discovery and a trial. Here's the decision, which Russia will appeal according to this Financial Times report.

Timing and Process in Crystallex v. PDVSA

[Updated with Crystallex's brief opposing the stay.]

In an earlier post, I noted some open questions that had to be answered before Crystallex could execute on PDVSA’s 100% ownership stake in PDV Holding (PDV-H). To recap: The federal district judge in Delaware let Crystallex attach the PDV-H shares on the theory that PDVSA is the Venezuelan government’s alter ego. The open questions relate both to timing (e.g., should there be a stay of execution pending appeal?) and process (how should an execution sale proceed)? A lot turns on the answers to these questions, as I’ll discuss below. First, however, here’s a simplified figure showing PDVSA’s corporate structure for readers who haven’t been following the dispute closely.

Some Thoughts on the Alter Ego Ruling in Crystallex

I have had a bit of time to digest the district court’s ruling that PDVSA is Venezuela’s alter ego, and here are some preliminary thoughts. The opinion is 75 pages and covers a lot of ground, but I’ll focus on perhaps the most important and least technical question: Is the case a one-off or a harbinger? Put differently, assuming the ruling stands after appeal and further proceedings in the district court, does it definitively establish that PDVSA is Venezuela’s alter ego? If so, the ruling could have important consequences for a future attempt to restructure the debts of both entities.

The answer isn’t clear. Or rather, it depends whether one wants a formal or a functional answer. Formally, the decision is a one-off; it need not have implications for future alter ego determinations. Functionally, however, the decision creates real risks for PDVSA and the government.

Court Lets Crystallex Attach Equity in CITGO Parent

[Edit: Here is the opinion, with redactions related to the OFAC license.]

Just a quick post for now, as the court is keeping its opinion under seal for the time being. Crystallex, a creditor of Venezuela, has been trying to enforce its claims by attaching PDVSA's equity interest in PDV Holding, the ultimate U.S. parent of CITGO. For more background, there have been a number of posts already here on Credit Slips. The district judge overseeing the action in Delaware has just granted Crystallex's request.

I'll have more to say once the opinion becomes public, although portions will undoubtedly be redacted in that version. The secrecy seems to be associated with an OFAC license obtained by a third party (presumably the entity financing this litigation), which Crystallex believes authorizes attachment notwithstanding U.S. sanctions against Venezuela. Those sanctions require OFAC authorization for "attachment of an equity interest in any entity in which the Government of Venezuela has a 50 percent or greater ownership interest" (see FAQ 596) and define "Government of Venezuela" broadly to include PDVSA. I assume the redactions will mostly affect this part of the opinion.

Even more important, the opinion will have to explain why Crystallex, a creditor of Venezuela, can attach PDVSA's property. Presumably the reason is that the court has found the two entities to be alter egos. If so, that's an important ruling that may have much broader consequences in any attempted restructuring of PDVSA or Republic debt.

Edit: I should add that the fact that the court has issued the writ does not necessarily mean Crystallex will immediately be allowed to execute. Leaving aside any delay associated with appeal, the district judge has previously distinguished the decision to issue the writ from the decision to allow execution. Any attempt to execute the writ will also raise new questions. For instance, must there be an attempt to sell the shares? If not, how should the shares be valued (since Crystallex is only entitled to receive the amount of its judgment plus interest)?

Epic Systems and the Atomization of Employment Disputes

Millions of American workers are parties to arbitration agreements that require them to bring claims against their employers in individualized arbitration proceedings (rather than as part of a class or collective action, as authorized by some federal and state laws regulating the workplace). In Epic Systems v. Lewis, a 5:4 majority of the Supreme Court held today that these agreements must be enforced even though the federal National Labor Relations Act declares it an unfair labor practice for an employer to interfere with the ability of employees to engage in “concerted activities for the purpose of collective bargaining or other mutual aid or protection.” The decision is not unexpected, but it is consequential given the number of affected employees.

The case—really, several consolidated cases—was weird for a number of reasons. The NLRB had concluded that employers who insisted on individualized arbitration were engaged in unfair labor practices. Then, in September 2017, the Board fell under Republican control, and many wondered whether it would continue to defend that position. It did, but the administration worked hard to undermine it. In fact, the Solicitor General, which had previously supported the Board in seeking Supreme Court review, later filed a brief disagreeing with it on the merits.

Approaching the Middle of the Beginning of the End in Venezuela

Though none of it is earth-shaking, there has been a lot of news out of Venezuela recently, so it seemed an appropriate time for an update. The election looms. Henri Falcón leads some polls, though those are presumably unreliable indicators, given what Reuters slyly labels Maduro’s “institutional advantages.” A Falcón victory would increase the odds of a restructuring in the near future. A Maduro win might prompt additional U.S. sanctions; the Wall Street Journal (here, also linked above) speculates that these might finally target oil exports.

A Series of Proposals to Restructure Venezuelan Debt

Mitu Gulati and Mark Weidemaier

About two weeks ago, we held a small conference at the University of North Carolina School of Law: How Best to Restructure the Venezuelan Debt. The conference focused on proposals developed this semester by students in our joint UNC-Duke class on international debt finance. Some proposals started fresh; others took an existing idea and built on it. Four student groups presented their work and got feedback from a group of about twenty experienced lawyers, bankers and policy-makers. This was—to our minds—an exceptional group, extraordinarily knowledgeable about sovereign debt markets and with particular insight into Venezuela. Included were Lee Buchheit, Chanda DeLong, Brett House, Fulvio Italiani, Hongtao Jiang, Ruth Krivoy, Trevor Messenger, Siobhan Morden, Katia Porzecanski, and a list of others who we will leave unnamed for confidentiality reasons. We are immensely grateful to all of them for their generosity to us and our students.

After the student presentations, our visiting guests offered their perspectives about the Venezuelan debt crisis. It was a treat for us and our students to hear such experts—all of whom have given a great deal of thought to the crisis—discuss solutions to one of the most complicated restructuring problems in recent history. Not all of the discussion was intended for public consumption, but we have permission to post this video of a terrific conversation between Lee Buchheit and Brett House.

After incorporating feedback from the conference, our students have posted their proposals on SSRN. We are really proud of their work. We pushed them hard, at least as hard as we have pushed any prior class, and they responded in spades. Like every proposal, these have flaws (and some are more plausible than others on the risk-reward continuum). But with that caveat, each represents an immense amount of work and contains new ideas:

PDVSA’s Hail Mary: A Chapter 15 Bankruptcy Solution (Samantha Hovaniec, Ryan Nichols, Matthew Taylor, Heather Werner & Rich Gittings)

Lien-ing on PDVSA: The Positive Side of Negative Pledge (Matt Cramer, Kelsey Moore, Andrea Kropp & Charlie Saad)

The Enduring Legality of Exit Consents: A Realist’s Guide (Steven Diaz, Stephanie Funk, Isabelle Sawhney, Gavin Kim & Austin Rogers)

Oil For Debt: A Unique Proposal For the Unique Problem that is Restructuring Venezuela’s Debt (Aditya Mitra, Andres Ortiz, Bernard Botchway, Evaristo Pereira, Shane O’Neil & Will Curtis)

These papers build on a long line of students papers on topics related to sovereign debt restructuring, some of which have made it to publication. Last year, Dimitrios Lyratzakis and Khaled Fayyad got their proposal, Restructuring Venezuela’s Debt Using Pari Passu, published in the Duke Journal of Comparative and International Law. And sometimes, when the proposals are especially creative or insightful, they manage to get the attention of reporters at the Financial Times, Bloomberg, Reuters, and elsewhere.

Venezuelan Debt: Further Thoughts on “Why Not Accelerate and Sue Venezuela Now?”

Mitu Gulati and Mark Weidemaier

Earlier, we posted about whether holders of Venezuelan bonds would be better off accelerating and obtaining judgments sooner rather than later. In a nutshell, here was the point:

When a restructuring comes (and it will), the two primary weapons the restructurer is likely to use are CACs and Exit Consents. A bondholder who obtains a money judgment, as best we can tell, escapes the threat of either CACs or Exit Consents being used against her.

We heard from a number of people with questions prompted by the post. Here are some of them, and our conjectures as to answers.

Stormy Daniels, Donald Trump, and the Role of Arbitration in Ensuring Silence

[Edited to correct names; too many aliases involved in this one]

For readers who haven't been following along: Stephanie Clifford, aka Stormy Daniels, is an adult film star who allegedly had a sexual relationship with Donald Trump in the mid-2000s. She recently sued Trump and other defendants, seeking to invalidate a settlement agreement in which she was paid to keep silent about the details of the alleged relationship. Here is her complaint, which includes the settlement agreement as an exhibit. And here is some coverage of background details.

The settlement agreement includes an arbitration clause, which should prompt some reflection about the use of arbitration to silence victims of sexual assault (a topic that has attracted attention in the wake of revelations about Harvey Weinstein). On the other hand, people are often too quick to blame arbitration for unrelated problems, so I hope this (long-ish) post can offer a bit of clarity. The short version: Whoever drafted the agreement between Clifford and "David Dennison" gets an A for cynicism, but would have to beg for a C in my arbitration class. (I’m guessing the draftsperson would fail professional responsibility...)

Why Not Accelerate and Sue Venezuela Now?

Mark Weidemaier and Mitu Gulati

People have been asking for months when investors will accelerate PDVSA and Venezuela bonds that have fallen into default. Rumor has it that some investors have already done so. But there seems to be a consensus that investors aren't in a hurry. U.S. sanctions prohibit a debt restructuring, and few investors are eager for the legal battle that would follow acceleration. But we’re wondering if this view misses something important and unique to the Venezuelan crisis. It seems to us that investors who file suit may be able to negate most of the Republic's and PDVSA's restructuring tools, significantly enhancing leverage when a restructuring finally does occur and making it easier to hold out. So we’re a bit puzzled why some of the more aggressive investors aren’t already rushing to get judgments.

Strip, Swap, Restructure

Mitu and I have been posting jointly of late about restructuring options for PDVSA and Venezuela. Alas, I’ll have to write this one myself, because it’s time to talk about an idea that Mitu and Lee Buchheit have proffered for restructuring much of PDVSA’s debt. Their proposal has important similarities to one by Adam Lerrick (also described briefly here and in more detail in the Financial Times), so I’ll cover both.

Both proposals are laudably clear-eyed about some fundamental aspects of the Venezuelan debt crisis. First, if it ever made sense to view PDVSA and the Republic as separate credits, that time is long past. Second, for a restructuring plan to be feasible, it must simplify an enormously complicated debt stock and encompass more than bond creditors. Thus, while neither creates a mechanism for encompassing all of PDVSA’s liabilities, both the Lerrick and Buchheit/Gulati proposals envision a restructuring of both bond debt and the pesky promissory notes that PDVSA has issued to trade creditors. The latter instruments are especially problematic from a restructuring perspective, because they lack contract-based mechanisms for modifying their terms. Finally, both proposals recognize that something must be done to protect oil-related assets, including future receivables, from holdouts.

These shared assumptions result in similar proposals. The difference is in the details, which turn out to be important. Let’s call the Lerrick proposal Strip, Swap, Restructure.

PDVSA's Debt Restructuring: The Chapter 15 Option

Mitu Gulati and Mark Weidemaier

This past week, Bob Rasmussen of USC Law gave a talk at Duke on “Puerto Rico and the Netherworld of Sovereign Debt Restructuring.” Luckily for us, he also took a detour to UNC to talk to our International Debt students about whether PDVSA might use Chapter 15 of the Bankruptcy Code to restructure its debts. Our foil for that discussion was a recent paper by Rich Cooper (Cleary Gottlieb) and Mark Walker (Millstein & Co.) proposing Chapter 15 as a possible solution to PDVSA’s woes. This is one of a number of extant restructuring proposals for Venezuela and PDVSA; Lee Buchheit (working with Mitu) has published several others (here, here, and here). The Cooper and Walker proposal is the only one to explore the Chapter 15 possibility in detail, and it thoughtfully makes the case for that restructuring option. In very condensed form, the proposal is for Venezuela to pass a new bankruptcy law governing PDVSA and other public sector entities, for PDVSA to restructure its debts using that process, and then for PDVSA to ask courts in the U.S. to recognize that bankruptcy under Chapter 15.

The Pari Passu Strategy in Venezuela

Mark Weidemaier & Mitu Gulati

Should Venezuela worry that holdout creditors will use the strategy that NML Capital and other holdouts successfully used against Argentina? In this article, The Pari Passu Fallacy—Requiescat in Pace, Lee Buchheit and Andrés de la Cruz at Cleary Gottlieb argue not. Lee in particular has made no secret of his distaste for the “ratable payment” interpretation of the pari passu clause. (As many readers know, he is also Mitu’s longtime collaborator.) When interpreted to require ratable payments, the pari passu clause requires a government to pay holdouts in full if it intends to pay restructuring participants in accordance with the terms of their debt instruments. In Argentina’s case, the injunction resulted in another massive default, as the government refused to pay holdouts but could not find a way around the injunction.

Lee and Andrés argue that NML’s pari passu strategy was essentially killed by the person who gave it life, the late Judge Griesa. To oversimplify a bit, the judge’s initial decision--and a decision years before in Brussels in a case involving Peru and Elliott Associates--strongly implied that selective nonpayment is enough to violate the pari passu clause. That is, a government violates the clause simply by paying some equally-ranked creditors but not others. And, crucially, he remedied this breach by issuing an injunction barring everyone with any connection to the United States from cooperating in the continuing violation of the pari passu clause. Without that remedy, Argentina would simply have defied his ruling and continued to stiff holdout creditors.

Venezuela Errata: Airline Deposits and Administration Posts

By Mitu Gulati and Mark Weidemaier

The new semester has begun, and we are excited about the International Debt class we teach together, with students from both UNC and Duke thinking about the Venezuelan debt crisis. Their first task—and ours—is figuring out how much Venezuela owes, to whom, and under what contract terms. This year, we have been especially unreasonable, asking students, in just a few weeks, to find, read, and code all relevant contract terms for the entire unmatured bond debt of Venezuela and PDVSA. And the bond debt is only part of the story. For instance, another category of debt, which we haven’t encountered before, consists of local currency (bolivar) bank deposits of international airlines that fly routes to and from Venezuela, which the airlines are not-so-patiently waiting to convert into other currencies.

The Hausmann Addendum to the Roosevelt Corollary to the Monroe Doctrine

Mark Weidemaier & Mitu Gulati

Ricardo Hausmann, Harvard economist and former Venezuelan Planning Minister, has been a thorn in the side of the Maduro administration. His blog posts at Project Syndicate condemning the Maduro administration’s continued payment of bondholders while the people of Venezuela starve may well have deterred new lending to the regime. Among other things, Hausmann-induced opprobrium at Goldman Sachs’s infamous "hunger bond"—now trading at a deep discount--has scared many in the market. For more background, check out Cardiff Garcia’s FT podcast interview with Hausmann.

Hausmann’s latest Project Syndicate post goes well beyond complaining about the ethics of Wall Street bond investors. Hausmann first sets out his view of the political realities, in which Maduro’s manipulation of elections and co-option of the military negate any realistic chance for the political opposition to overthrow the regime, notwithstanding U.S. economic sanctions. Given the severe humanitarian crisis, astonishing depletion of national wealth, rampant inflation, widespread corruption, and other harms inflicted or exacerbated by the Maduro regime, Hausmann advocates military action by the United States and like-minded nations. The other nations presumably include countries like Peru, Colombia, Honduras, Argentina, and Chile, all signatories to the Lima declaration condemning the Maduro regime. 

Implications of the Third Circuit’s Crystallex Decision

Mark Weidemaier & Mitu Gulati

On Wednesday, the Third Circuit granted Venezuela a victory in its ongoing settled-but-not-settled litigation with Crystallex. The case deals with a limited issue: Whether Delaware law imposes liability for the fraudulent transfer of an asset on an entity that is not itself a debtor.  We want to use this post to speculate a bit about the implications the decision may have for the bigger Venezuelan debt drama. If the new decision is important, it is because it signals something about the receptivity of US courts toward claims that Venezuela, PDVSA, and perhaps US entities like CITGO are “alter egos.” We disagree a bit about that question. But first, some background on this aspect of the Crystallex case.

Battle of the Bonds: PDVSA Versus Venezuela

Mitu Gulati and Mark Weidemaier

Over at Bloomberg, Katia Porzecanski notes that investors in Venezuelan debt are “worried they’re getting ghosted.” Overdue coupons are piling up, and no one is sure whether it is because the government is done paying or because U.S. sanctions have made financial intermediaries slow to process payments. Meanwhile, the government has maintained radio silence about the restructuring it purported to announce six weeks ago. The fact that a few PDVSA coupons have been paid in the meantime prompts Porzecanski to ask whether Venezuela is capitalizing on bondholder inertia to “quietly, selectively default,” and whether the government “may ultimately prioritize PDVSA’s debt over its own.” This Reuters article by Dion Rabouin answers the latter question in he affirmative, opining that Venezuela is more likely to default on its own bonds than on PDVSA’s, for two related reasons. First, PDVSA’s oil revenues are the government’s main source of foreign currency; second, a PDVSA default may prompt creditors to seize oil-related assets abroad, potentially including CITGO.

(Updated) About That Mysterious Crystallex Settlement

[Update: Here is the unsealed letter describing the settlement between Crystallex and Venezuela. As expected, it reveals nothing of note, simply explaining that the settlement's terms require confidentiality and redacting portions discussing the settlement itself. Also, note that the first paragraph of the original post (below) has been edited for clarity.]

We have covered Crystallex’s attempt to enforce its $1.2 billion judgment against Venezuela a bunch here on Credit Slips (for example, here, here, here, here, and here). In late November, the parties reached a settlement, shortly before a December 5 hearing in Crystallex's lawsuit seeking to attach assets belonging to PDVSA. The hearing was to address Crystallex's argument that PDVSA is the government's alter ego, and PDVSA’s cross motion to dismiss. A ruling in Crystallex’s favor would have let it look to PDVSA’s assets to satisfy its judgment against the government. As noted in the Financial Times, a pro-Crystallex ruling might also have had broader implications, potentially letting “holders of defaulted Venezuelan sovereign bonds ... seek to seize PDVSA assets, potentially including those of Citgo.”

Commerce Without Law

Mitu Gulati and Mark Weidemaier

We are gearing up to teach our joint class on sovereign debt next term and, as usual, are mulling over background readings to provide context for the work we ask of students—which typically involves designing a restructuring plan. To do this, students must read many long bond indentures and other financial contracts. Occasionally, we show students historical examples of such contracts, often from the era of absolute sovereign immunity, when sovereigns couldn’t be sued in national courts. Often, students ask why lawyers bothered with such extensive documents when there were no courts to interpret and enforce them. Which gives us an opportunity to talk about reputational and other non-legal mechanisms for enforcing promises, which we and many others have written about, probably more than is, strictly speaking, necessary.

Nothing in the sovereign debt literature, however, is as interesting and immediate as Barak Richman’s new book, Stateless Commerce, which explores how a robust system of international commerce can work for hundreds of years without any state involvement. His exemplar, building on classic work by Lisa Bernstein, is the diamond trade. In theory, opportunistic breach of contract should be endemic, given the ease of theft, the highly subjective nature of quality assessments, and the need for credit to acquire such expensive products. So one might expect the trade to flourish only if there are strong legal institutions capable of rigorously enforcing deals. Instead, the enormously profitable global diamond market has operated for decades largely independent of the state.

Domination Isn't (Always) Fraud: Venezuela Edition

I made a joke in the comments to Mitu’s post about whether the arrest of Citgo executives strengthened the argument for treating Citgo as Venezuela’s alter ego. The joke wasn’t very good; I called Venezuela a “typical activist shareholder.” But Mitu generously took it seriously, asking whether this is the kind of behavior creditors should have expected. His question highlights some interesting legal questions. One is whether a creditor who knows about shareholder misconduct before voluntarily dealing with a corporation should be able to enforce its claims against shareholder assets. A second has to do with the legal standard for finding a corporation and its shareholder to be alter egos.  

Old Wine in New Bottles: Geopolitics and Venezuela's Debt

Mark Weidemaier & Mitu Gulati

 

Robin Wigglesworth and John Paul Rathbone have an insightful piece in the Financial Times on how China, Russia, and the US are jockeying for position in Venezuela, which needs debt relief. The other governments are in a position to either facilitate or impede this, with conditions. Very roughly speaking, Russia wants regional influence, China wants oil, and the US wants regime change (ideally, while limiting Russian and Chinese influence in the region).

 

Finance has long been both a tool of, and a pretext for, foreign intervention in Latin America. For example, historian Emily Rosenberg and others have written about “dollar diplomacy”—the US government’s early-20th century practice of tying loans to control over customs and taxing authorities. The practice was justified by narratives about the benefits of financial expertise and professionalization, but of course it also served to protect the interests of US lenders while limiting the influence of European powers. Venezuela is no stranger to this history, having endured heavy-handed and often brutal interventions by western powers in the early 1900s.

Confusion in Venezuela; Alter Egos in Delaware

Confusion reigns. Venezuela might plan to default, but maybe it's just pretending so it can buy bonds back on the cheap. Then again, it could be a "giant money laundering operation." If there are restructuring talks, U.S. investors can attend, and listen. Except that the talks will likely be hosted by a drug "kingpin," and investors can't have any "transactions or dealings, directly or indirectly" with that person. And don't ask whether PDVSA's late(ish?) payment was a credit event, or what the CDS payout will be on bonds that have experienced a credit event despite having been paid in full.

Thankfully, the law is clear, right? Here's PDVSA motion to dismiss the lawsuit Crystallex has filed in federal court in Delaware, alleging that PDVSA is Venezuela's alter ego and seeking to enforce an arbitration award against the government by attaching PDVSA's equity stake in the ultimate U.S. parent of CITGO. Here's a summary of the arguments the parties have made thus far. The case matters, first, because if successful Crystallex will sever PDVSA's indirect ownership stake in CITGO. It also matters because, as we've discussed here repeatedly, any debt restructuring will implicate questions of alter ego liability. For instance, many restructuring proposals begin by urging Venezuela to withdraw PDVSA's right to exploit oil reserves, so as to better insulate oil-related assets from creditors. This short article explains some of the issues of alter ego liability raised by these and other proposals.

CFPB Arbitration Rule Overturned

By a 51-50 vote, with Vice President Pence breaking the tie, the Senate has voted to overturn the Consumer Financial Protection Bureau's rule forbidding the use of contract terms (in covered consumer loan products) barring consumers to bring or participate in class actions. The affirmative vote was supported by the usual narratives: Class actions make credit more expensive, arbitration is a better and more efficient means for resolving consumer disputes, class action lawyers are greedy parasites, etc. The truth of these narratives is irrelevant, it seems. For instance, though it is possible arbitration might be used to efficiently and effectively vindicate consumer rights, there isn't much evidence that it does so in practice, and there is evidence to the contrary. As a mechanism for collecting consumer debts, the history of arbitration is uglier still. And even if the availability of class actions increases the cost of credit--emphasis on if--it's not obvious this would be bad. If class actions deter lender misconduct--not that there's any history of bank misconduct!--, and if this increases some lenders' costs and ultimately the cost of their financial products, then... I don't know. Who cares, I guess? Why should consumers victimized by fraudulent lender conduct subsidize cheaper credit for others? The contrary narrative--that class actions are just so darn expensive to defend that banks settle even the bogus ones for large sums of money--is so implausible that it should not be taken seriously without credible supporting evidence.  

Catalonian Bonds, Anyone?

Joint post by Mitu Gulati and Mark Weidemaier.

Sovereign bonds issued under the government's own law are supposed to be riskier than bonds issued under foreign (typically, English or New York) law. The logic is simple: Local-law bonds can be restructured with the stroke of a legislator's pen; with foreign bonds, it's not so easy. One would expect that difference in risk to show up in bond yields, which should be higher for local-law bonds, especially in times of uncertainty. There's quite a bit of research to back up that intuition (e.g., Bradley et al. (2017), Nordvig (2015), Chamon et al. (2014), Clare & Schmidlin (2014), Choi et al. (2014)). 

Catalonian bond yields have been rising, thanks to jitters over the secession vote. But Nicolas Schmidlin, a fund manager (who worked on this topic as a graduate student and wrote the paper linked above), noticed something odd about bond yields.

Do Sanctions Prevent Venezuela From Restructuring CAC Bonds?

This is a joint post by Mitu Gulati and Mark Weidemaier.

At the end of last week, press reports noted that Mr. Maduro has given the green light for restructuring talks to begin with holders of Venezuelan debt. Curiously, the Russians may lead the talks. One question is whether bondholders subject to US jurisdiction can participate in a restructuring given recent sanctions levied by the Trump administration. Press accounts suggest that the sanctions were intended to prevent this. Bloomberg reports the sanctions were "designed to prevent investors from engaging in liability management, and, if Venezuela can't pay its debt, a restructuring." The Financial Times reports likewise, quoting a senior analyst who thinks the sanctions will work: "If these sanctions stay in place, then Venezuela cannot restructure."

We accept that the sanctions were intended to block a restructuring. But they don't seem to actually do this. There is a rather large loophole that would allow Venezuela to employ a common restructuring technique.

How Easily Can Creditors Reach Venezuelan Oil Receivables?

Among emerging market countries that have needed to restructure in recent decades, Venezuela is uniquely dependent on external commercial ties, especially oil exports to the United States by state oil company PDVSA. Because of this, many wonder whether holdout creditors pose a unique threat to the country's restructuring prospects. Unlike, say, Argentina, which could keep most valuable assets away from creditors, Venezuela must worry that holdouts will seize oil receivables. PDVSA's assets include money due from U.S. customers. These intangible assets are located in the United States, where courts can easily divert them to satisfy judgments obtained by holdouts. Note that this logic assumes that courts treat PDVSA as Venezuela's alter ego--a topic discussed several times on this blog--but the assumption is plausible.

But even if we assume that courts will ignore the boundaries between PDVSA and the government, is the risk of asset seizure really so great? The scenario described above presumes that Venezuela structures oil sales to U.S. entities in implausibly straightforward ways. Suppose, for instance, that PDVSA sells oil directly to U.S. buyers in exchange for a promise to pay on delivery. In that case, sure; creditors of both PDVSA and the government will have a field day. But while I am no expert on how PDVSA structures its operations, I would be stunned if things were so simple.

Venezuela is Like... PDVSA's Alter Ego, and Vice Versa?

And so it begins. As Anna notes, Venezuela is in dire straits, yet its stubborn insistence on paying bondholders puts it in the running for "world's slowest train wreck." When the wheels finally leave the tracks, expect a free-for-all in which competing claimants (bondholders, arbitration claimants, etc.) fight to recover as much as possible, both from the government and from state-owned oil company PDVSA. The major players will include creditors holding billions of dollars in arbitration awards against Venezuela. These creditors, unlike those holding government or PDVSA bonds, need not fear a debt restructuring. They will, however, have to find attachable assets that can be seized to satisfy their claims.

Enter Canadian mining company Crystallex, which has been trying to enforce a $1.2 billion arbitration award against Venezuela, so far without success. A few days ago, it tried a new tack--one with broader implications for any restructuring of Venezuela's or PDVSA's debt. Crystallex asked a federal court in Delaware to attach the shares of PDV Holding, Inc., a Delaware company that is the ultimate U.S. parent of CITGO petroleum. PDV Holding is owned by PDVSA, which, in turn, is owned by Venezuela.

Kindred Nursing Centers--More on Arbitration and State Contract Law

Today, the U.S. Supreme Court decided Kindred Nursing v Clark, an arbitration case in which the Kentucky Supreme Court declined to enforce arbitration agreements between a nursing home and two patients. The agreements had been executed by relatives holding powers of attorney granting broad authority to enter contracts, but the Kentucky Supreme Court held that a power of attorney must specifically grant the authority to agree to arbitration. It was clear--as it often is--that the U.S. Supreme Court would reverse. The Kentucky rule just can’t be squared with governing federal arbitration law. Put simply, state law can't say that a broadly-worded power of attorney grants authority to enter contracts generally, except for arbitration clauses. Not surprisingly, then, the U.S. Supreme Court reversed in a 7 to 1 opinion authored by Justice Kagan.* The dissent wasn’t on the merits, either; Justice Thomas does not believe the Federal Arbitration Act applies to proceedings in state court.

I teach contracts and arbitration law, among other classes, and I find it increasingly frustrating to teach arbitration cases. So many involve plausible applications of contract law (like Kindred) but get the arbitration law flatly wrong. Others involve questionable applications of contract law or related doctrines, seemingly to avoid the effect of arbitration law. Here’s a recent case by the Maryland Court of Appeals, Cain v Midland Funding, which falls into the latter camp.

More Thoughts on Ukraine

Having had a few days to digest the ruling awarding summary judgment to the trustee (suing at the direction of the Russian government), I wanted to elaborate on my earlier thoughts about the court's reasoning. As Anna points out, the ruling may be appealed, and in any event the dispute will not be settled for some time. But the recent ruling may be the most significant to come out of the case, so it's worth talking about in a bit more detail. I have already described the defenses Ukraine raised in response to the lawsuit, so I'll skip those details here. In brief, however, Ukraine argued that the loan was made under duress, that the government lacked capacity to enter it, and that the loan included implied terms equivalent to the doctrines of prevention or impracticability--i.e., that Russia implicitly promised not to seek repayment if its own conduct (annexation of Crimea and military intervention in the east) made it difficult or impossible to repay.

Ukraine's Defenses to Russian Bond Claims Rejected

The judge hearing Russia's lawsuit to enforce its $3 billion loan to Ukraine issued an opinion today, rejecting Ukraine's defenses to the lawsuit. Bloomberg and the Financial Times both have coverage of the decision. We've discussed the loan quite a bit here on Credit Slips, and also Ukraine's defenses to enforcement (e.g., here, and here, and here). The lawsuit is fascinating, in part because Ukraine's defenses ask the judge to use traditional contract law doctrines to police what is clearly an international dispute between sovereigns who have been engaged in armed conflict. As I have explained in more detail elsewhere, Ukraine's contract-law arguments were actually quite plausible, though by no means a sure thing. Among others, the defenses included duress (always a bit of a stretch, in my view), lack of capacity, and what would typically be called prevention and impracticability under U.S. law (characterized as implied terms of the contract by Ukraine).

Inter-Creditor Duties in Sovereign Debt

This is a joint post by Mitu Gulati and Mark Weidemaier

As we discussed in a couple of earlier posts, we have been thinking recently about the use of exit consents to restructure sovereign debt, especially in the context of Venezuela and PDVSA, the state oil company. Though focused on corporate workouts, Bill Bratton and Adam Levitin's new paper, The New Bond Workouts, raises questions that also matter in the sovereign context. Bratton and Levitin give a detailed account of the Second Circuit's Marblegate opinion, a 2-1 decision that seems to authorize very aggressive use of the exit consent technique. (Creditors were essentially given a choice between accepting the restructuring plan or being left with claims against an entity that was nothing more than an empty shell.) Bratton and Levitin generally approve of the Second Circuit's decision, but also suggest that courts should revive the doctrine of intercreditor good faith to police against coercive workouts of bond debt.

Scotexit and Allocating the UK's Debt

This is a joint post by Mitu Gulati and Mark Weidemaier.

Scotland voted 62% in favor of remaining in the EU in last June's Brexit vote. Now, with nationalism on the rise in Britain, Scotland has begun to rethink the decision to stay in the UK. Fears of a so-called "hard exit," in which Britain foregoes easy access to the common market, have Scottish leaders like Nicola Sturgeon demanding another referendum on Scottish independence. Which has us wondering: What happens to the (rather large) pile of UK debt if one of its members decides to exit?

It seems like voters in Scotland ought to care about the answer, if given another chance to vote on UK membership. More broadly, one would think voters would want some idea how the UK's assets and liabilities would be divvied up. Things like the public debt, the crown jewels, pension obligations to veterans, the nuclear arsenal, Balmoral castle, and so on. The UK has a lot of stuff. How should it be divided?