377 posts categorized "Sovereign Debt"

Episode Two of Clauses and Controversies: Imperial Chinese Bonds

posted by Mark Weidemaier

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.

Continue reading "Episode Two of Clauses and Controversies: Imperial Chinese Bonds" »

Clauses and Controversies podcast

posted by Mark Weidemaier

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.

Back to the Future (Again): Horatio Gadfly and Those Imperial Chinese Bonds

posted by Mitu Gulati

FT Alphaville has had a long line of quirky and brilliant reporters over the years, something that I've always enjoyed (Joseph Cotterill, Tracy Alloway, Colby Smith, Cardiff Garcia and more). And I've especially liked the pieces that do deep dives into obscure and arcane sovereign debt matters.

The latest such piece is from Izabella Kaminska, on the the topic of antique imperial Chinese bonds and the possibilities for recovery (from about ten hours ago, here).  The likelihood of using purely legal methods and recovering on these today is near zero.  But near zero is not zero and periodically, as a means to get students engaged on the thorny questions of statutes of limitations and sovereign immunity, Mark Weidemaier and I will assign them the task of figuring out which of the defaulted imperial sovereign bonds have the best chance of recovery. The assignment is usually framed in terms of a set of bonds that Mr. Horatio Gadfly inherited (here) (Joseph Cotterill's hilarious piece on Mr. Gadfly's adventures is here)).

This past semester, a group of our students -- Michael Chen, Charlie Fendrych, and Andres Paciuc, dug deep and found a small subset of bonds that maybe, just maybe, had a long shot. Their fun paper, "The Emperor's Old Bonds" (soon to appear in print in the Duke Journal of Comparative and International Law) is here.

Izabella's article today makes a deeper point, which is that these legal claims -- while implausible if viewed in purely legal terms -- can acquire muscle as a function of political context.  Is this such a time?  Maybe.  Coronavirus, trade talks, election rhetoric, Taiwan, and given that some of Trump's supporters have lots of these old Chinese bonds and Trump is . . . well, Trump may have changed the equation from what it has been for the past century.  Steve Bannon, of all people, has talked about imperial Chinese bonds on his War Room show multiple times (e.g., this War Room episode at about 40:50. . . Aiyiyiyi . . . here).  

If you are intrigued and want to go down the rabbit hole, this question of politics and antique Chinese bonds has come up before -- see Tracy Alloway's piece on Bloomberg (here), Cardiff Garcia on NPR (here) and Mark Weidemaier on creditslips (here and here). 

Izabella is (I hope) not done with her writing on this topic and there might be more on Alphaville soon (today's teaser was in the main paper).  This topic connects to so many other fun topics relating to historic wrongs too -- like the fact that the British museum holds the Elgin Marbles and the British crown holds the Koh-i-Noor diamond (US museums undoubtedly have lots of these sorts of items as well). If Chinese imperial bonds need to get paid, maybe it is time to give the Elgin Marbles and the Koh-i-Noor back? Come to think of it, maybe it is time to give them back regardless of the bonds? Sovereigns are infinitely lived, which means that their obligations are too -- if someone can figure out a way to get around the statutes of limitations.

The US Government Mumbles Something in Support of Venezuela

posted by Mark Weidemaier

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.

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Some Confusion About Argentina’s Power to Reverse an Acceleration

posted by Mark Weidemaier

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.

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

posted by Mark Weidemaier

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.

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Selling CITGO--Timing and Process

posted by Mark Weidemaier

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.

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Brazilian 5 Year Sovereign Bonds at a 2.875% Yield: Aiyiyiyi

posted by Mitu Gulati

Paul Krugman had a piece in yesterday’s NYT about the lunacy in the stock market, where a bankrupt company like Hertz is merrily issuing new stock (here).  Matt Levine of Bloomberg has similarly, and hilariously, discussed the Hertz case and other recent examples of this bizarre pandemic bubble (here). Why the rush to buy overpriced rubbish?

I have no answer to the question posed by Krugman. But it is not just the stock market. A similar lunacy is occurring in the sovereign bond markets (here). Exhibit number one: Brazil. Reading the press, it seems clear that Brazil is in deep crisis thanks to the disastrous manner in which it has handled the covid-19 pandemic so far (see here and here, for discussions of how Brazil’s response to the pandemic has been among the worst in the world).  Yet, on June 3, it issued over 3 billion dollars in five- and ten-year bonds.  The five-year bonds had a coupon of 2.875%.  (the ten-year bonds were at 3.875%). I cannot understand this yield. What sane investor could possibly look at the current state of Brazil’s response to the pandemic, the fact that its leadership seems to show no signs of reversing course, and the resulting economic forecasts, and think that Brazil is such a safe bet to repay its borrowing in just five years that it should receive funding at 2.875%. Of course, from Brazil’s perspective, why not issue even more debt, if the response of the market to worsening conditions is to offer even more and cheaper money.

It is worth, however, thinking about what will happen if and when countries like Brazil cannot repay these bonds when they mature. I suspect that investors will not remember that they deliberately anesthetized their risk instincts when they bought the bonds. Some of those investors will loudly demand payment in full -- in other words, it's Brazil's fault for having offered the bonds, not the investors' fault for ignoring the risks when they bought them. Along those lines, I wonder why official sector institutions like the IMF – who know how bleak the latest economic forecasts are -- are not urging sovereigns to take advantage of the market lunacy to put in pandemic clauses. These are clauses that would give the countries like Brazil relief in the future if it turns out that covid-19 causes so much harm to the Brazilian economy that it cannot pay back the debt. After all, if investors are willing to buy any rubbish that is put out there, why not ask for better contract terms for when the party ends?

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Italian Sovereign Debt: Time to Worry or Party?

posted by Mitu Gulati

Italian sovereign borrowing is increasing, as the costs of dealing with a stalled economy and the pandemic build.  A recipe for disaster?  Turns out that Italian yields (and spreads with the risk free benchmark rate) are actually going down; down in the vicinity of zero. (for the WSJ's treatment of this last week, see here). And at least some Italian economist friends of mine are beginning to talk about how debt/GDP levels around 180% or maybe even 200% could be sustainable.  Aiyiyiyi. That sounds loony; given that the economic fundamentals -- thanks especially to the horror of covid-19 -- are going in the opposite direction. That said, I'm no economist and I definitely do not understand the current market patterns. As further evidence of this lunacy, Brazil was able to borrow $3.5 billion a few weeks ago at lower rates than it was having to pay before the pandemic; a pandemic to which its response has been spectacularly Trumpian. (And yes, I have economist friends of mine who insist that Brazilian debt is safe and will remain sustainable because of factors such as Fed swap lines and Trump's friendship with Bolsonaro. I'll readily admit that I don't understand the swap line theory of debt sustainability. But on that other point . . . . Really dudes? You are going to bet on Trump bailing out Bolsonaro because of their special relationship?).

Not everyone, fortunately, thinks that the markets are going to continue to adequately and fully fund this covid-19 recovery.  Below is the abstract of Tyler Zelinger's new paper on preparations Italy could make in anticipation of the need to do a debt restructuring someday soon (and he is only using them as an exemplar, since they seem to be on the precipice -- despite their current borrowing costs). If things begin to tank -- as I worry they will sooner rather than later -- papers like this that do the advance preparation that governments are refusing to do, will be invaluable. Tyler even finds a silver lining in all of this for the hypothetical Italian debt restructurer.

The abstract of the paper (just posted on ssrn) is below:

As the global economy has become more integrated and increasingly complex, the need for a system that administers government default has become more and more apparent. The body of "sovereign debt law" that has emerged to fill this need in the context of the Eurozone is an amalgamation of treaty obligations, domestic law constitutional principles, and tensions between state government and supranational government actors. Using a hypothetical Italian restructuring, this paper seeks to explore how these different bodies of law operate together to create a system that protects government function as opposed to guaranteeing creditor recovery. Further, this paper explores how an exogenous shock as the COVID-19 pandemic effects the analyses undertaken at various points in the sovereign debt legal framework.

This analysis reveals a silver lining: although Italy has suffered horrible losses as the result of the COVID-19 pandemic, the effects of the pandemic will help mitigate the legal challenges faced by Italy in the course of a local-law restructuring effort and thus smooth the path to a successful post-COVID recovery.

Keeping Cosy by the Dumpster Fire: Argentina Reads Its Contracts ... Twice ... Quel Scandale!

posted by Anna Gelpern

Argentina's capacity to trigger outrage in sovereign debt circles is to behold. After nine defaults, thousands of lawsuits, and enough intrigue and screaming matches to break Big Data, wouldn't you think that someone somewhere would learn to yawn at another Argentina debt drama. And yet ... on the eve of tomorrow's debtapalooza, the internet is hopping mad again about a restructuring proposal from Bueons Aires--not the money (that's regular old mad), but the red-hot-appalling abuse of the shiny new Collective Action Clauses (CACs) in the 2016 bond indenture. The government again managed to tick off both its private creditors, who discovered that their contracts let the debtor gerrymander bond voting pools after the vote, and the well-wishing policy wonks watching their baby--decades of international bond contract reform--swirl down the drain with this one deal's bathwater. Because much of the technical ground was ably covered by my colleagues earlier this evening (don't miss the link to Rodrigo Olivares-Caminal), I have the luxury of using the rest of this post to speculate about the implications of the brouhaha for sovereign debt policy and sovereign debt markets.

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

posted by Mark Weidemaier

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.

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Keeping Cosy by the Dumpster Fire: A Sovereign Debt Series

posted by Anna Gelpern

Lest anyone thought they could quarantine or protest in peace, no such luck in the sovereign debt world.

Remember when everyone thought a standstill starting May 1 was a great idea, at least through the rest of 2020? For all the good will, May 1 has come and gone, with few takers and fewer givers.

On the subject of give-and-take -- with another default in the rear view mirror, Argentina's government and its creditors are edging closer to a deal this week ... unless their talks get bogged down in extreme distrust, undo more than two decades' worth of sovereign debt contract reform, and drag the rest of the world off the cliff with them ... which would surprise exactly no one who has ever followed that dysfunctional marriage. 

Speaking of no one -- no one seems to have a handle on who owes what to whom on what terms -- not with any precision, in any event -- which is an awkward place to be when pitched warnings of a mega-debt crisis migrate from research volumes to the New York Times.  And no, it is not all China's fault, it's a structural problem with this ecosystem.

Meanwhile, fears of worldwide sovereign debt distress seem to be driving comparisons to the 1980s, which in turn mean different things to different people -- a banking crisis and a Lost Decade to some, market-based (aka publicly subsidized) debt operations to others, and giant shoulder pads to the rest. 

And yet--against predictions and barring classification error--markets have been lending up a storm to vulnerable countries without bothering too much about their contracts.

All this begs two questions--what gives, and what do we do now? -- that are the subject of what should be an excellent Sovereign Debt Forum panel on Wednesday morning, led by Rosa Lastra at Queen Mary, co-sponsored with Georgetown IIEL, and including all the usual suspects. Of course I have no answers, but I will try to noodle these and related questions here in the next few days. In particular, I want to unpack what might have gone wrong with the G-20 call for a standstill, ask whether Argentina's debt restructuring threatens international financial architecture, and yell a bit about our collective obsession with Default ... among other things that will surely come up in the next 24 hours. 

How Are So Many EM Sovereigns Issuing New Debt?

posted by Mark Weidemaier

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.

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

posted by Mark Weidemaier

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.

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

posted by Mark Weidemaier

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.”

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State Bankruptcy

posted by Stephen Lubben

So Senate Majority Leader Mitch McConnell says States should be able to file for bankruptcy, to get out of their pension obligations. He'd rather that than give them a federal bailout, given current conditions.

I have long argued that States don't need bankruptcy, because they have stronger sovereign immunity (under the Eleventh Amendment) than most actual sovereigns. But put that to one side.

Why does McConnell think that such a bankruptcy will be limited to single class of creditors? Indeed, I doubt such a bankruptcy system would be consistent with the Bankruptcy Clause.

And quite frankly, I suspect bondholders understand this (even if anti-union activists don't). That is why you never see the municipal bond managers advocating for "State bankruptcy." The bankruptcy of any of the 50 states would look more like Puerto Rico's, where haircuts to bondholders are most definitely on the table. The only question is "how much?"

Necessity in the Time of COVID-19

posted by Mark Weidemaier

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.

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Now That Everyone Is on the Standstill Bandwagon ... Where to? Part I

posted by Anna Gelpern

A sovereign debt standstill might not cure COVID-19, but it sure seems like the one thing we can all agree on.

In the run-up to last week's all-virtual IMF-World Bank-G-20 meetings, a chorus of private and public sector, NGO, think tank and academic voices (me included) had called for some version of a pandemic-themed pause on sovereign debt payments. Hardly anyone opposed the idea in public, but relief proposals ran the gamut from ambitious to cosmetic, and it took intense negotiations to get the G-20 to agree on a relatively modest NPV-neutral eight-month respite for the world's poorest countries.  Perhaps most importantly, Saudi Arabia was in the chair and China signed on, signaling that the new(ish) creditor cohort might be taking ownership of the global sovereign debt regime alongside the old bilateral and multilateral creditors. If they follow through, it is a major achievement, and a long overdue first step. The fact that a big financial industry group worked closely with the G-20 and is on board with the outcome is also a good sign. All that's left is ... elaborating the substance and implementing the thing. In this post, I try to sort out what problems a standstill might solve, and how these fit with the G-20 statement. Part II offers three ideas on implementation.

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What Can One Do With 50% plus One?

posted by Mitu Gulati

Today is the final day of my Duke-NYU sovereign debt seminar with Steve Choi and Lee Buchheit, and that makes me sad.  The students have delivered in spades this term, notwithstanding the disruptions to their lives as a result of corona drama. I can't begin to express how proud I am.  And teaching with Steve and Lee (with cameos by Ugo Panizza, Mark Weidemaier, Theresa Arnold, Anna Gelpern, Jeromin Zettelmeyer, Chanda De Long, Yannis Manuelides, Anna Szymanski, Felix Salmon, Jon Zonis, Robin Wigglesworth, and Colby Smith) has been special. I’m grateful for how much I've learned from them and the students.

In preparation for today’s final presentations, I want to note a couple of ideas from the student papers that arrived last night. These ideas struck me as both intriguing and audacious.  I haven’t thought them through adequately, but they got me thinking.  So, here goes. Some preliminary thoughts.

Continue reading "What Can One Do With 50% plus One?" »

Lebanon’s Vexing Modification Clause

posted by Mark Weidemaier

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.

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What to do When Your Contract is a Dog's Breakfast

posted by Mitu Gulati

Tomorrow is the first of the two days when the students in my international debt class (with Steve Choi and Lee Buchheit) present their final papers to a group of outside experts.  The students have come up with some intriguing ideas for the restructurings of Lebanese and Argentine debt, a couple of which I flag below.

  1. What to do When Your Contract is a Dog's Breakfast?

Mark and I have complained about the Lebanese sovereign bond contracts on this site before (here).  I confess that there are portions of it -- the CACs and the pari passu clauses in particular -- that utterly befuddle me.  Now, maybe this is because I'm easily confused and a more sophisticated reader would understand the contract. But let us assume for the sake of argument that this contract really is the proverbial dog's breakfast. That then raises the question of: What is a court to do when faced with a contract full of confusion? (drafting guru Ken Adams uses the following delightful expression for some especially horrid contracts that he has seen -- dumpster fire).  My sense is that New York courts generally pretend that even contracts that they suspect are the product of bad cut and paste jobs were intentionally and rationally drafted.  The theory being that this gives parties -- especially those represented by fancy lawyers -- an incentive to do a better job the next time. 

At least two student groups though (Adriana and Luke from NYU, here, and Alex, Chris & Brenda from Duke, here), suggest that there is reason to think this situation could play out otherwise.  They've identified a provision in the Lebanese bonds (23(1) c of the Fiscal Agency Agreement) that gives the authority to cure any ambiguity or appropriately supplement any provision to the issuer.  Yes, sole authority goes to the issuer with the only constraint being that the issuer cannot make changes that harm the holders of the bonds (basically, that the issuer cannot act opportunistically).  This is potentially huge for Lebanon, since I am willing to wager that it would not be that difficult to get expert testimony from a dozen or so of the most eminent sovereign debt lawyers that the contract here has some major issues.  Further, since these are standard form contracts where it is easy to figure out what the market standard for the provisions in question say, the issuer can safely fill the gaps without being at substantial risk of being found to have acted opportunistically in violation of 23(1) (the student papers do a nice job of digging into the literature and identifying the relevant market standards -- which would, as I understand the arguments in the papers, help Lebanon considerably). Game, set and match to Lebanon?

Question is: Will the Lebanese lawyers use this contractual advantage?  The above language from 23(1) was also present in the Argentine sovereign debt contracts that contained the infamous pari passu clauses that got Argentina into horrible trouble with Judge Greisa and then the Second Circuit almost a decade ago. Those provisions were widely agreed to be relics of the past that no one understood and had little contemporary value.  Yet, even though there was hushed discussion of using the Argentine equivalent of 23(1) in some circles, the Argentine lawyers never used 23(1) to help clarify the meaning of their pari passu clause.  And that makes me wonder whether there was some reason that I'm not seeing as to why the argument was not used (maybe lawyers don't like saying that contracts drafted by their predecessors were dumpster fires?).  I'll find out more tomorrow, I hope.

    2. The Necessity Doctrine in the Time of Corona

A second intriguing possibility that a number of student papers have raised, but that one student paper focuses exclusively on, is the Necessity defense from customary international law.  Simplifying, the doctrine says that nations can get temporary relief from their contractual obligations in the narrow circumstances where some exogenous event occurs that causes them to need to divert resources towards helping their populace.  Charlie, Andres and Michael (here) argue that the current pandemic is precisely the kind of rare situation the Necessity doctrine was designed for.  They are not by any means saying that Argentina is entitled to a reduction in its debt obligations under the Necessity doctrine. Instead, if I understand their paper, their argument is that current levels of uncertainty so high and the need to put resources into health care so palpable that courts should be willing to grant Argentina temporary relief from suit.  And the fact that the G20 countries have just indicated that they are indeed contemplating temporary standstills for the debt obligations of the most distressed nations around the globe (here) is some support for the argument that Charlie, Michael and Andres make on behalf of Argentina.  

As as aside, Mark and I discussed the use of the Necessity defense many moons ago in the context of the Casa Express v. Venezuela case, where we thought it was something of a long shot (here).  The reason being that there was a pretty strong argument that Venezuela's financial crisis was one of its own making.  And one could argue that Argentina's debt crisis is of its own making. But Charlie, Andres and Michael respond to this argument by reiterating that they are not asking for debt relief on account of the Coronavirus -- just a temporary standstill so that the country can help save the lives of its own people.  Question is: Can they persuade a New York court that these circumstances are so unique that the recognition of the defense will not destroy the market?  

Lebanon’s Unusual Pari Passu Clause and the Question of How to Construct Credible Priority

posted by Mitu Gulati

A few weeks ago, Mark Weidemaier and I blogged about Lebanon’s unusual pari passu clause and Collective Action Clauses. The question we were interested in – and the one our students are focused on – was how to engineer a restructuring that would be protected against the risk of holdout creditors (here).  One of the few methods available, assuming that creditors were likely to have blocking positions in a number of the Lebanese foreign law bonds, was to utilize Lebanon’s unusual pari passu clause to do an Exit Exchange.  Yesterday, one of the students in my debt restructuring class, who is working on designing a plan for Lebanon, posed the following inconvenient questions: Isn’t this clause internally inconsistent, with the second half of the clause contradicting the first half?  And if so, won’t a court disregard the second half as a scrivener’s error?

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Boer Bonds and the Doctrine of War Debts

posted by Mitu Gulati

Concentrating on just about anything during these days of the coronavirus, let alone academic writing, has been a trifle difficult.  A splendid new paper on Boer Bonds by Kim Oosterlinck and Marie Van Gansbeke (here) did, however, get me focused (for a bit).  And that’s in part because their paper has potentially turned upside down what I thought was an established part of customary international law.  That is, the law of “War Debts.”

The international law of state succession, standard treatises will tell you, is strict.  New states (and new governments) inherit the debt of predecessor states (and governments), regardless or changes in political philosophies.  One of the only exceptions to this strict rule is the doctrine of War Debts.  This doctrine, that I thought was implemented by the British Crown in 1900, in the wake of Boer War, says that debts incurred during hostilities by the losing party do not need to be taken on by the victor.  The refusal of the United States to take responsibility for the debts incurred by the Confederacy during the Civil War is another example.

The historical materials that I looked at in my prior work were lacking in clarity, to put in mildly.  And my sources – old treatises and cases -- were all secondary.  In a paper from over a decade ago, here is what my co authors (Lee Buchheit and Bob Thompson) and I conjectured that the doctrine of War Debts was (full paper is here):

The British Government did not at the time articulate the rationale for this policy. Perhaps it believed the justification to be obvious. Paying the debts of a former adversary is one thing, particularly when victory brings sovereignty over the disputed territory and resources. But paying off the very loans that both delayed and added to the cost of that victory is quite another thing.

Moreover, anyone lending to a belligerent power after hostilities have begun is placing an obvious bet—an all-or-nothing bet—on the outcome of the war. This aspect of the war-debt limitation to the doctrine of state succession is significant because it introduces into the debate the reasonable expectations of the creditor when extending the loan.

Kim Oosterlinck and Marie Van Gansbeke, both financial historians, look beyond the secondary sources to primary sources – the debates among the legal advisers to the British Crown, the archival records of the investment banks, and most importantly, the prices of the Boer bonds issuer prior to and after the hostilities with the British began. The story they conclude with is different from the one than what my co authors and I conjectured a decade ago (being careful historians, they couch their bottom line with caveats about the need for further research).

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ECB + CACs: Fig Leaf Aflutter

posted by Anna Gelpern

Further to Mitu's post about the European Central Bank's bond-buying bellyache, let us linger on the rationale for the 33.33% limit on the central bank's holdings of a euro area sovereign bond series. 

In the middle of the Greek sovereign debt crisis, euro area policy makers agreed to adopt functionally identical collective action clauses (CACs) in member state sovereign bonds, with two amendment options for important financial terms: (1) series-by-series voting or (2) aggregated voting, pooling two or more series. In a series-by series vote, two-thirds of the principal amount outstanding can override opposition by a third. In an aggregated vote, amendment requires at least two-thirds of the total principal amount outstanding in the voting pool plus at least half of each series in the pool.* 

The ECB has taken the position that "in the context of a restructuring subject to CACs, it will always vote against a full or partial waiver of its claims" to comply with the European treaty framework. This means that, if the ECB held more than one-third of a bond series, it would single-handedly block a single-series restructuring. If the ECB held more than half of a series, it could force it to drop out of an aggregated restructuring as well. To avoid being the holdout, the ECB adopted the 33.33% bond purchase limit in 2015 (see Article 5 of this and this excellent piece by Sebastian Grund). Of course, no matter how little sovereign debt it holds, the ECB makes life easier for other holdouts with its pre-commitment to vote against restructuring -- the others need to buy that much less to free ride.

It is unclear whether the 33.33% series limit was motivated by the mere possibility that a government would restructure its debt by written consent* using series-by-series CACs--or a view that this approach was most likely, or even required. Perhaps 33.33% was the the lowest plausible limit, since it is hard to predict how pooling and aggregated voting would work in any given case. Who knows? The only certainty is that in 2015, the ECB voluntarily subjected itself to some oddly-reasoned bond buying caps, and that today, these could knee-cap Italy.

The limit makes even less sense in light of the 2018-2019 commitments by euro area policy makers to adopt so-called "single limb" aggregated stock-wide voting.  Under the latest market standard (due to take effect in the euro area in 2022), a government need not even poll individual series. Now add the likelihood that a country like Italy would restructure using domestic statutes, rather than CACs, as explained in Mitu's post and his article with Ugo Panizza, and 33.33% begins to look mighty random. 

To be sure, it is politically and maybe legally awkward to say that a government would ignore CACs and use domestic law in a restructuring after pushing those clauses as the be-all for years.  It would be more awkward still to say that a government would ignore contracts, statutes, and any other law that might get in its way in an emergency, because aside from peacetime liability management operations, most sovereign debt restructurings could make out a pretty decent case for emergency/necessity rule.

But even if you assume that all euro area sovereign bonds have CACs (they do not) and that they would use them in the unlikely event of a restructuring (they would not), a 33.33% ex ante purchase cap makes little sense. It does not prevent the ECB from helping holdouts, or even from being the main holdout. It does not protect the ECB from losses in the event it is outvoted or suffers a default. It looks like a skimpy formalistic fig leaf covering up for real problems in the underlying treaty framework and short-sighted pre-commitments, at the cost of potentially impeding the ECB's monetary policy efforts at a critical time. The central bank (and the world) would be better off if it were disenfranchised altogether or at least confined to a separate voting pool. Besides, disenfranchisement and confinement are so au courant.

 

*The thresholds are different for votes taken in a meeting (25%+) and by written consent (33.33%+).

Do CACs Constrain the ECB From Buying Even More Bonds?

posted by Mitu Gulati

Answer: No

(This post borrows heavily from the ideas of my co author, Ugo Panizza, of the international economics department of the Graduate Institute in Geneva).

Press accounts of last Wednesday’s emergency ECB Governing Council meeting report that some of the hawks on the Council are resistant to the ECB buying more Euro area sovereign bonds.  The concern being that such purchases might take the ECB’s holdings of particular bond issues to more than a third. If this happens, the ECB would have a blocking minority in any future debt restructuring negotiations where the sovereign is seeking to use its Collective Action Clauses (CACs) to engineer that restructuring.  And (some claim) because voting for a restructuring would amount to monetary financing, the ECB would be forced to vote no and block the restructuring.   Hence, no buying above 33.33% of a bond issue should be done.

This is nuts. Let’s first state the obvious: large ECB interventions will reduce the likelihood that a restructuring will be needed. The reactions of sovereign spreads to President Lagarde’s botched comment that the ECB is “not here to close spreads” and to the successive ECB announcements make this clear.

But let us assume that, even with vigorous ECB intervention, a restructuring is needed and let us take the case of Italy which is what everyone is really talking about.  Close to 99% of Italian sovereign debt is governed by Italian local law. That gives Italy the so-called “local law advantage” (here we focus on Italy, but the local law advantage applies to most bonds issued by euro area sovereigns except Greece and Cyprus).  Translated, it means that Italy has a wide variety of strategies it could use to restructure its debts. 

The collective action clause or CAC mechanism – one where the debt can be restructured in a fashion that is binding on dissenting creditors if a super majority of creditors votes in favor of the restructuring -- is but one of many options that Italy could use to restructure its debt (we describe these options here; see also Weidemaier (2019), here). CACs may be the most market friendly of the various restructuring options, since it requires the approval of a super majority of creditors to work. But it is neither the easiest nor the cleanest restructuring technique for a country that enjoys the local law advantage.  More important, to answer those hawks on the ECB governing council, the restructuring could occur without the need for the ECB to vote one way or the other.

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From the Vault: Lee Buchheit on "How to Restructure Greek Debt" Videos

posted by Mitu Gulati

My sovereign debt class is discussing the March 2012 Greek debt restructuring on Tuesday afternoon.  The magic here was in significant part the product of Lee Buchheit's genius. That said, I do not wish to discount the contributions of his star studded team, which had debt gurus like Andrew Shutter and Andres de la Cruz who played invaluable roles.  

In class, we are thinking a lot about how Lee used the "local law advantage" in Greece. The reason being that we are (to put it mildly) somewhat focused on strategies that could be used to get Italy significant debt relief in the midst of this current crisis -- especially if the ECB drops the ball in terms of providing adequate financial assistance.  Lee just announced his retirement, a few months ago. I'm hoping that he comes back out of it. (Hopefully, we can get him to answer questions via zoom on Tuesday).

From the vault, here are some amazing videos of Lee from both before and after the March 2012 restructuring. They are amazing because they give us a sense of how his thinking evolved as his strategy moved from a hypothetical thought experiment that had no chance of being implemented to the one plausible strategy left on the table.

Videos:

Lee – Plan B (June 21, 2010) (Pre Greek Restructuring) – start watching at 20 minute point in:

https://www.youtube.com/watch?v=w8Zvfn3DjdY

 

Lee -- The Options Now (in the wake of the Greek debt restructuring) (Nov. 6, 2012)

https://www.youtube.com/watch?v=Q6G14SF4-sQ

 

The Options Now (Part II) (Q&A)

https://www.youtube.com/watch?v=e8bBWbKCdT8&t=26s

 

Lee, with an introduction by Ugo Panizza -- European debt restructuring/Greece (and some talk of Argentina) (Nov. 26, 2013) 

https://www.youtube.com/watch?v=nLZrTzvNBT0

Puerto Rican Debt and Force Majeure

posted by Mitu Gulati

Among other things, the Coronavirus and the near global shutdown, has gotten contracting parties scrambling to read their force majeure clauses.  But what about if the parties in question didn’t explicitly contract for an “act of god” clause that covered unexpected pandemics? The question, as we’ve discussed on this blog before, would become one of whether such a clause was implicit in the contract (here).  That, in turn, will in part be a function of the contract’s governing law (here).  Puerto Rico, already mired in a debt crisis, is going to need even more relief now.  Question is: Does the fact that its debt contracts are almost all governed by local Puerto Rican civil law embed a source of temporary relief for it?

My casual impression is that the leading common law jurisdictions for contract law, such as New York and England, would be reluctant to find an implied force majeure term in contracts among sophisticated parties.  By contrast, civil law jurisdictions such as France, the Netherlands and Spain, sometimes have such a clause baked into the civil law and also appear more willing to find such a provision implicit (for discussions of the common law v. civil law approaches, see these memos from White & Case and Cleary Gottlieb memos, here and here).

Particularly intriguing in the context of a sovereign or quasi sovereign debt, is the possibility that an implication of the civil law jurisdiction in question having force majeure as part of the civil code means that the relevant government can, through legislation, make it clear that a particular event (Coronavirus) satisfies the conditions for force majeure (here).  China has apparently done just that, even issuing force majeure certificates in some cases (here and here).

A reason I’ve been thinking about implied force majeure clauses is that my seminar with Guy Charles has been discussing Puerto Rico’s debt crisis.  (Two of our recent guests to the seminar were David Skeel and Sam Erman, both of whom had fascinating papers on the topic of Puerto Rico).  Puerto Rico is, unlike most of the US,  a civil law jurisdiction.  Better still, almost all of its debt is under local Puerto Rican law (now, in the case of anything redone under PROMESA, with an overlay of that federal law). 

One has to concede up front that the Puerto Rican debt crisis is not the product of some exogenous event such as a hurricane or the coronavirus.  But surely everyone would agree that the virus has the potential to push Puerto Rico (back) over the financial brink, just as its seems to be getting back its sea legs (see here). And, so the question is, does Puerto Rico, as part of the implicit terms of any debt contract made locally, have the right to temporary relief from having to perform as a result of the enormous economic slowdown that the virus is already causing.  I haven’t been able to track down anything specific in the Puerto Rican civil code, but the Puerto Rican code has its origins in the Spanish civil code. And the Spanish code has force majeure baked in (for discussions, see here and here).

Hmmm . . . Some years ago, a wonderful group of students did find some promising avenues for Puerto Rican debt relief buried deep in its civil code (here).

*Note (in response to the first few email comments - that I'm most grateful for):  The question of what precise law the new agreements are governed by is thorny.  Best I can tell, it seems to be PROMESA and, to the extent not inconsistent with PROMESA, Puerto Rican law. But what in the world does that mean with respect to what we care about: force majeure for pandemics such as coronavirus?  I don't think there is any federal contract law on that matter; and, if so, that strikes me as pointing to Puerto Rican local law, which in turn might point us to the Spanish civil code. But maybe there is an argument there about how federal law has something to say about force majeure in the context of a pandemic that is escaping me. The actual language of the new governing law clauses is fascinating if you are as obsessed with governing law provisions as Mark W and I have been as of late.  John Coyle of UNC is the leading scholar of governing law clauses in the whole wide world (see here). And he is a contracts guru as well.  Maybe I can get him to opine.  I will try to do so and report back.

Subordinating Holdouts in a Lebanese Restructuring

posted by Mark Weidemaier

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.

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Do Italian Sovereign Bonds Have an Implicit Force Majeure Clause?

posted by Mitu Gulati

"Are There Force Majeure Clauses in Italian Sovereign Bonds?"

That’s a question one of the students in my sovereign debt class asked a couple of days ago. After reading about some of Christine Lagarde’s recent statements, she was worried about the possibility that the European authorities might not adequately support the Italian authorities in dealing with Covid19 with financial assistance needed to tackle the crisis (for discussions, here and here).  And, if not, she asked:  Could Italy use the force majeure clauses in its bonds to delay payment on its bonds until the crisis was handled?

My first response was that I was optimistic that the EU would provide Italy with any necessary assistance.  And my second response was that Lagarde and the ECB have walked back/clarified the statement in question. Plus, if memory serves, there is a mechanism for emergency financing to be provided via the ESM for adverse shocks beyond the particular country’s control.  Further, the ECB could probably do even more bond buying of Italian bonds in these circumstances.  That said, this is an event that is impacting multiple countries at the same time and it is perhaps worth it for individual countries to consider what they can do on their own if external help is not adequate.

To start with, it isn’t exactly clear what a force majeure clause is.  I’m no expert, but I believe that this is a French concept that is often referred to as an “act of god” provision.  That, on its face is not exactly a helpful description if you, like me, are unclear on what exactly acts of god are.  The basic idea is that the clause helps allocate the risk of contractual non performance when big cataclysmic events occur that are not the fault of one or the other of the parties and make performance extremely difficult. (for a helpful memo from Shearman & Sterling, see here)  The presence of such a clause in the contract, especially if it addressed the risk of Covid19, would help because it would show where the parties wanted that risk allocated. But, of course, no one knew about Covid19 until quite recently.

In the Italian case, best I know, none of their bonds say anything about which side bears the risk of a big unexpected cataclysmic event (here, the covid19 pandemic).  They are, in other words, no force majeure clauses.  Further, my casual examination of a few dozen bonds today suggests that these clauses are absent from sovereign bonds generally. So, the question is one of filling the silence in the contract.

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The Choice of Advisers for the Lebanese Restructuring

posted by Mitu Gulati

An article from a couple of days ago in L'Orient-Le Jour (here) provides a rare window into the process by which financial and legal advisers are chosen for a sovereign restructuring deal. This is the sort of stuff that people talk about quietly in back rooms -- e.g., about how there were shenanigans in the choice of advisers by the sovereign (someone's nephew getting special treatment or something else like that).  But this is the first detailed press account that I've seen.

What I was hoping for, that I didn't get from the piece though, is a sense of what restructuring strategies the different teams offered to provide the Lebanese government when they made their respective pitches. The article suggests that the different teams provided their CVs and the cost of their services.  But the article says nothing about the plans that they proffered. I'd think that if strategy A from Lazard provides for savings of $40 billion with minimal risk of litigation and only a small penalty for future borrowing and strategy B from Rothschild gets you $50 billion in savings, but a high risk of litigation and a 10 basis point higher cost to future borrowing for a couple of years, the way in which the Lebanese high command made the comparison would be the most interesting bit of the saga.  It would give us a window into what calculations the government is making about the future (and they haven't exactly covered themselves in glory on this front during the run up to this crisis).

Alas, there was no mention of the proffered strategies. Instead, the article suggests that all that these various teams brought to the table were their CVs and billing rates. Surely, that cannot be all. These are highly sophisticated lawyers and bankers and they must have planned out strategies ahead of time.

Maybe the folks at L'Orient-Le Jour will do a follow up piece.  And yes, I'm being selfish, because being able to compare the plans in class would be a wonderful learning exercise.

Making (Non)Sense of The Lebanese Fiscal Agency Agreement

posted by Mark Weidemaier

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.

Continue reading "Making (Non)Sense of The Lebanese Fiscal Agency Agreement" »

Paper Dragons

posted by Mitu Gulati

Last Saturday evening the Prime Minister of Lebanon announced that the country would not be paying a $1.2 billion Eurobond scheduled to mature today, March 9. As recently as six weeks ago the March 9 bond was trading at 90 cents on the dollar. Today, Lebanon's foreign bonds are deep in the toilet at 18-19 cents.

The London-based hedge fund Ashmore is reported to have bet heavily that the Lebanese authorities would in the end capitulate and pay the bond in full rather than risk a default that could quickly ripple through the country's stock of external debt. Ashmore is said to have admonished the authorities about the deeply unpleasant consequences of such a default, a position that reportedly incurred the wrath of some of the country's other creditors.

This is the second time inside the past few months that a large international investor has played a game of chicken with a sovereign or sub-sovereign bond issuer. In February, the Province of Buenos Aires sought the consent of holders of bond maturing in 2021 bond to delay a $277 million payment due on January 26 for just four months. The justification? Insufficient funds.

When the holders balked, the Province sweetened the offer by proposing to pay 30 percent of the principal of the instrument in addition to the coupon due on January 26. Most holders seemed to disposed to accept that offer but one large institution, Fidelity, held out (here and here). And because Fidelity held a blocking position in the bond, the Province's consent solicitation failed.

The worst outcome in a sovereign debt restructuring is for the issuer to plead poverty, announce the urgent and inescapable need for a debt rearrangement, and then pay the debt in full if the creditors balk at agreeing to the deal. That, however, is exactly what the Province of BA wound up doing. The lasting impression in the market is that the Province's bluff was decisively called. Fidelity, at risk of being perceived as a maverick breaking faith with its fellow lenders, ended up in the position of an equestrian Saint George with its lance deeply embedded in the scales of a paper dragon.

Fidelity won its game of chicken in Argentina; Ashmore apparently did not fare as well in Lebanon. Damage control in Argentina must now take the form of convincing the external creditors of the Republic of Argentina -- who are owed around $100 billion -- that while the Province of BA may have been caught bluffing, the Republic won't be when it announces the terms of its debt restructuring sometime in the next 10 days.

What, I wonder, will damage control look like at Ashmore? If, as widely reported, Ashmore controls more than 25 percent of the outstanding principal of one or more series of Republic of Lebanon bonds, the firm is presumably in a position single-handedly to call for an acceleration of those series. Here is where pride and credibility may play a part. If Lebanon's default on March 9 is NOT followed by the terrible swift sword of creditor enforcement actions, Ashmore's dire warnings to the Lebanese authorities may also take on the character of a paper dragon. I'm betting that Ashmore can't, or won't, let that happen.

At the end of the day, as Lebanese debt guru Anna Szymanski put it in her report on Reuters Breaking Views a few hours ago (here), it will all boil down to what Lebanon’s contracts say and how strong the legal rights of holdouts are.  And, if anyone could actually manage to understand the contractual terms (these are some of the most opaque contracts I’ve ever come across), I think that they will discover that Ashmore has the ability to draw a considerable amount of blood.  

More on the contracts over the next few days, if I can manage to read more than a paragraph of that gibberish without getting a headache. On the other hand, the ACC tournament is starting tomorrow.

Figuring Out the Terms in the Lebanese Bonds (and Why Do the Agents in Sovereign Bonds Suck?)

posted by Mitu Gulati

My students have been valiantly trying to track down the Fiscal Agency Agreements (FAA) for Lebanon that tie in to the offering documents. Those are crucial for anyone trying to figure out a restructuring strategy for the government, which is one of our projects for the term.  And, although I am optimistic that my students will figure out a way to get them, they have so far been met by a brick wall.  None of the various parties who have the documents, such as the Fiscal Agent or the Ministry of Finance or the various advisers to the Lebanese government will do the least bit to help my students.  At the end of last week, some of my students even called the FA's offices to say that they were willing to take a little side trip from their spring break visit to Europe this week to go over to the FA's offices in Luxembourg to copy this precious document in person. The response: The person on the other end hung up. Really?  Is the government really so confident in the restructuring plan that it can afford to have its agent hang up on people willing to delve through the fine print of these documents for free to see if they can come up with helpful suggestions? Maybe Lebanon already has a kickass plan from its expensive advisers and does not need any help. Wait, I forgot that they have no plan.

Continue reading "Figuring Out the Terms in the Lebanese Bonds (and Why Do the Agents in Sovereign Bonds Suck?)" »

Skeel on the Puerto Rico Oversight (NOT Control) Board

posted by Mitu Gulati

I have long been a fan of both David Skeel's research and him as a person. Not only was his book Debt's Dominion key to some of the earliest research I did on Collective Action Clauses, but he was always willing to answer my stupid questions about basic concepts (something that fancy tenured professors at Ivy League schools do not often do).  Over the years, as he has gotten fancier and fancier, I have continued to burden him with my stupid questions about bankruptcy and restructuring matters and he has never ceased to be generous; the proverbial gift that keeps on giving and never ever taking.

Last week, to penalize him yet further for his kindness over the years to me, I asked him to please come to talk to the students in my debt class about his work on the Puerto Rico oversight board (e.g., here). In our class, we read his work and it occurred to me that although it was a long shot, it would be cool to be able to talk to David in person.  And he said yes -- and that was even though I warned him that some of our seminar questions would be a tad bit hostile, in terms of pressing him about all the things that the control board had done vis-a-vis pensions, the lack of accountability of the board, imperialism, insular cases, etc., etc.

The session was amazing. The students did not disappoint in terms of relentlessly asking him tough and incisive questions (I was so very proud of them).  And he answered them in the way only he can do: in a generous and candid fashion. Alas, I cannot repeat the details of what he said, since we promised him that we would not report on any of that.  But I can lay out what I think are some of the key questions that I hope David will address in the book that I hope he will write when this is all over.

First, why was the choice made to treat Puerto Rican debt as if it were domestic municipal debt instead of treating it more like sovereign debt?  The fact that Puerto Rican debt circa 2012, when the @#@# hit the fan first, was all under local law meant that Puerto Rico could have used the "local law" advantage that Lee Buchheit's team used in both Greece and Barbados (on the latter, see Andrew Shutter's cool new article in the Capital Markets Law Journal, here).  Yet, Puerto Rico and its advisers decided to go down the municipal bankruptcy route, only to get themselves tied up in expensive legal losses for years.  My guess is that there was some political reason for the choices that were made to try and pretend that Puerto Rican debt was more like state debt than sovereign debt.  But I want to know more.

Second, why was assistance from the IMF not used?  As I understand it, the Oversight Board basically does the kind of job that the IMF does when it goes in to help over indebted countries.  The IMF has developed a lot of expertise in this exercise over the years.  Why aren't there are bunch of ex IMF stalwarts on the Oversight Board, helping out David and his colleagues?  

Third, while I'm full of admiration for some of the aggressive moves that the Oversight Board took vis-a-vis the creditors in terms of, for example, questioning the validity of 2012 and 2014 issuances that were arguably done in violation of certain debt limits, what calculations were made about how much this strategy would impact Puerto Rico's future cost of borrowing?  After all, one of the key objectives of the Oversight Board is supposed to be to return Puerto Rico to the capital markets. Someday, I'd love to see that the report that the financial advisers provided on this. (It probably pointed to the research showing that the sovereign and municipal debt markets have a notoriously short memory).

Fourth, what is the world is happening with the Aurelius case? I thought that we'd have a decision on that, in terms of the legality of the Oversight Board under the Appointments Clause, months ago.  Does the delay mean that those of us who predicted -- based on what happened at oral argument -- that the court was going to rule quickly in favor of the Oversight Board were perhaps wrong? Maybe the delay means that the Court is indeed going to deal with the ugly legacy of the Insular cases, something that they did not seem to want to do in November at the argument? (Yes, I know that David does not have special insight into what the justices are thinking, but I'm curious anyway).

I can't wait for David's book to come out.  I'll assign it in class and ask him to come back to talk to us again!

Odd Lots Podcast on Iraq's Astonishing Debt Restructuring (Next: Ecuador's Dodgy Buyback?)

posted by Mitu Gulati

For sovereign debt fans, there is a very nice podcast from Bloomberg's Odd Lots that was put up a couple of days ago (here).  The title says it all: "How Iraq Pulled Off One of the Biggest Sovereign Debt Restructurings of All Time".  It is a pity that there has not been more writing about the Iraqi debt restructuring because this is one from which there are many lessons to be learned. Lessons that are relevant for Venezuela in particular.

Plus, it was so creative and there were so many colorful characters involved (I loved the podcast, but I wish that they had talked more about the cast of characters and some of the individual stories like those of the neo cons, the US President, LCB, the NGOs, Alexander Sack and so on).

The guest for the podcast was LSE Econ Historian, Simon Hinrichsen (especially impressive that the basis of the podcast is a chapter from his dissertation -- I cannot imagine anything that I wrote in grad school being worthy of much more than toilet paper).

So, I have a request to Joe Weisenthal and Tracy Alloway.  If you are listening, could you guys continue with your historical excavation series and do one on Ecuador's Dodgy Buyback from 2008-09? One of the themes in their discussion with Simon on Iraq was the decision taken ultimately (contrary, I have heard, to the preferences of the US President) to not use the Odious Debt defense.  That probably helped Iraq, but maybe hurt the international system in that that was a wonderful opportunity to change international law for the better.  But it is not the case that no country has run with that defense successfully.  Ecuador in 2008-09 is one. And China, with respect to its Imperial debt is another one.

In class in NY last week, we had some of the folks who worked on the post-buyback resuscitation of Ecuador's reputation in the international markets come and discuss how that had been engineered. It is an amazing story because Ecuador is now a regular and respectable issuer in the EM space. How the hell did that happen so quickly?  Unfortunately, I promised to keep mum about what was said in class last week.  But fabulous reporters like Joe and Tracy could unpack this on a podcast.  And then those of us who study this topic would benefit.

Why Are Those Lebanese Fiscal Agency Agreements So Hard to Find?

posted by Mitu Gulati

Often, the final assignment in my sovereign debt finance class is for the students to try and design a restructuring plan for whatever sovereign is in crisis that year.  This year, we have a number of available candidates: Argentina, Lebanon, Venezuela, Italy(?).

A crucial part of the assignment is for the students to figure out what the relevant contractual documents are that they need to delve into.  There are some students who fail to realize until the end of the term that the offering circulars and prospectus supplements are not in fact the relevant contractual documents and, at best, contain summaries of some of the relevant terms.  To the extent that the language of the offering documents is inconsistent with that in the actual contracts, and the students fail to see this, it can be a disaster – as Andrea Kropp’s excellent forthcoming article “Restructuring Italy’s New York Law Bonds” explains (here).

The majority of students though do figure out that they need the relevant trust indentures or fiscal agency agreements to be able to design a plausible restructuring plan.  The question then is how to find those documents. And that is often not easy. Now, as a matter of pedagogy, I think it is good for the students to learn how to use the various databases such as Bloomberg, Thomson One Banker, Filings Expert, Dealogic and so on to find key financial and legal data.  Enterprising law students often also find other sources, such as the websites of the ministries of finance and the databases of the various exchanges on which these documents are listed. 

Finding these elusive documents is a skill that was invaluable for me at my law firm eons ago because most of the other associates had no clue as to how to find these financial documents (law schools certainly didn't provide training in how to dig up financial contracts). But these above mentioned sources, while providing a good start, rarely have the actual contracts. Instead, what they provide are the sales documents that, at best, contain summaries of the key terms.  And, as noted, those summaries can sometimes be very wrong from a legal perspective because for us the specific wording of clauses can be especially important. 

So, should the public expect for these documents to be readily accessible? I think so. These are the debt contracts of sovereign issuers, often for many billions of dollars that taxpayers are on the hook to repay. One would think that their terms would be a matter of public record so that the public can see what sorts of preparations the governments have made to handle the eventuality of a debt restructuring (in Lebanon’s case, I worry that the answer might be: precious few).  Yet, the reality is that it can sometimes be very difficult – near impossible in some cases – to dig up this stuff. And I’m finding that Lebanon is a prime example.  Indeed, the sales documents for Lebanon's sovereign debt are particularly obtuse in terms of having buried much of the crucial information in the Fiscal Agency Agreement, which no one seems to be able to get access to unless one is an actual holder of the bonds who is willing to show up at the Fiscal Agent's office in Luxembourg or something else altogether ridiculous.  Now, there are ways to figure this stuff out, which my students inevitably do. But why make this exercise so difficult when what we are talking about are public debt documents?

Maybe my friends at the IMF and World Bank will remedy this problem as part of the various "transparency" initiatives they periodically trot out at fancy conferences on the beach in Mauritius, Bali or the Seychelles. But right now, today, I'm willing to bet that they themselves don't have the relevant Lebanese Fiscal Agency Agreements.  At least the unnamed person from one of these institutions who just emailed me to ask whether my students had been able to dig up the Lebanese documents didn't have a clue as to how to find them. I was so very tempted to ask him, in response to his question, how his last transparency initiative conference on whatever beach had gone (he'd have likely responded: "Wonderfully! Pity you couldn't make it").

Aiyiyiyi

The Emperor's Old Bonds

posted by Mitu Gulati

Inspired by Tracy Alloway's recent piece on antique Chinese bonds (here), a group of my students has gone deep down the rabbit hole of the question of how one might recover on them (or, from the Chinese government’s perspective, how one would block recovery).  If I’m reading Michael, Charlie and Andres correctly, they think that the probability of recovery via litigation is near zero on almost all of the antique Chinese bonds.  All except one special bond issue that no one has brought litigation on yet.  I'm not saying that there is a real possibility of recovery here (if one is a legal realist, one would be deeply skeptical), but we are in the era of Trump.

I love their title, "The Emperor's Old Bonds".  But there is much more to this fun paper (here) than the title. The abstract is below:

Tracy Alloway’s recent article in Bloomberg has suggested that Trump’s trade war may finally provide relief to American holders of defaulted, pre-1950s Chinese bonds. Here, we examine the hurdles set before these bondholders, namely establishing jurisdiction over the People’s Republic of China as sovereign and the long-lapsed statute of limitations. We also evaluate the Chinese government’s possible recourse. 

The key takeaways from our investigation: To establish jurisdiction in the U.S., the bond must be denominated in U.S. Dollars or state a place of performance within the country. To overcome the long-expired statute of limitations, and win an equitable remedy, it must be shown that the PRC not only violated an absolute priority or pari passu clause, but also that they are a “uniquely recalcitrant” debtor. Finally, despite China’s commitment to the odious debt doctrine, the doctrine is unlikely to provide meaningful legal protection in the event of an otherwise successful suit. 

Overall, it is a difficult suit to bring, but through our investigations we have discovered one issue in particular which holds the greatest danger—or perhaps the greatest promise: the 1919 Gold Bond.

Venezuela, Lebanon, and Tools to De-Fang “Rush-In” Creditors

posted by Mark Weidemaier

A follow-up on my exchange with Mitu (parts 1, 2, 3, and 4) about whether a judgment-holder is bound by the terms of a restructuring accomplished via a sovereign bond’s collective action clause (CAC). The broader concern is that “rush-in” creditors—bondholders who file suit and obtain money judgments, thereby escaping the effect of any modification vote pursuant to the CAC—might jeopardize the prospects of a successful restructuring. Again, the subtext here is Venezuela, and perhaps Lebanon as well.

Note that, although my discussion with Mitu focused on CACs, one could have the same discussion about other bond provisions. Consider acceleration provisions. For example, what if 25% of bondholders vote to accelerate the bond, and a plaintiff subsequently gets a judgment for the full amount of accelerated principal, but then a majority of creditors vote to rescind the acceleration? The short answer to both questions is that the subsequent vote has no effect on the judgment holder. As I noted in my earlier posts, that’s not to say subsequent events like these can’t have an effect; it is just that they are not likely to have one in the ordinary course of events.*

The reason is quite simple. It is that the judgment is an entirely separate source of rights from the underlying legal claim that produced it. This is a practical consequence of the “merger” doctrine, which provides that a judgment extinguishes the plaintiff’s claim (not the contract, the claim). Thereafter, the plaintiff can’t bring another action on the same legal claim but can bring a subsequent action on the judgment. (Such an action differs from judgment enforcement proceedings such as attachment and execution, but we’ll set that detail to one side.)

We can simplify--and avoid discussion of "merger" and associated legal doctrines--by focusing attention away from CACs and onto other bond provisions, which can more plausibly be modified in ways that will affect judgment holders. Consider the following sequence:

(1) The sovereign defaults and investors have a claim to bond principal (whether because the bond was accelerated or because the default was a failure to pay the principal when due);

(2) A plaintiff holding a minority in principal amount of the bonds sues and gets a money judgment for the full principal owed on those bonds;

(3) Thereafter, the issuer conducts a debt exchange in which participating bondholders vote to modify the exchanged bonds by removing the waiver of execution immunity.

Would this modification affect the judgment holder? Of course it would—at least, assuming courts do not reject this use of the exit amendment as unduly coercive.

Continue reading "Venezuela, Lebanon, and Tools to De-Fang “Rush-In” Creditors" »

Pre-1949 Chinese Bonds: How Much of a Litigation Threat Do They Pose?

posted by Mitu Gulati

As part of the international debt class that I'm teaching this term with Steve and Lee, we spent a couple of sessions discussing the various lawsuits that have been brought in US courts over China's defaulted pre-1949 debt.  The discussions have been a lot of fun because the students have had interesting perspectives on the question of whether the governments of mainland China and Taiwan need to continue to be concerned about these irritating lawsuits popping up (especially in the age of Trump, given that some of his ardent supporters in Tennessee appear to be big and vociferous holders of these antique debt instruments).

Among the interesting issues that were discussed were whether China's persistent refusal to even engage the debt holders amounted to the kind of "uniquely recalcitrant" debtor behavior that resulted in the New York granting an injunction against Argentina in the infamous NML litigation in 2011 and 2012. This is important because an NML type argument, via the priority clauses in a number of the old Chinese loans (particularly those that were issued in US dollars and via US banks), could be the key to resuscitating these old claims.

Reading cases such as Jackson v. PRC, and especially the US Statement of Interest that was filed there, are enough to convert even the most ardent legal formalists into realists. And, if so, the fact that the present inhabitant of the white house has (maybe, kinda . . .) shown more sympathy towards these holders of antique Chinese bonds than any prior US president in over a half century may be quite relevant.

I've asked our students, if they are willing, to post their views on these matters in the comments (and maybe even links to their papers).  They are quite interesting.

Judgments > CACs!!!!

posted by Mark Weidemaier

There is a subtext to my recent exchange with Mitu (here, here, and here) about whether a judgment-holder is bound by a subsequent vote to modify a bond’s payment terms, and it is of course Venezuela. U.S. sanctions prevent a restructuring of Venezuelan debt, and this long delay creates a window in which many creditors might obtain judgments. (It hasn’t happened but, you know, it’s a thing that could happen.) Mitu’s disarmingly “simple-minded” query in his most recent post is (of course) quite sophisticated. Might we view the CAC as an inter-creditor undertaking, such that, for example, after a successful restructuring vote participating bondholders could sue judgment-holders for a pro-rata share of any recovery the judgment-holder had managed to extract?

Before I go into a more detailed reply, a general comment. If one thinks that inter-creditor rivalry is a problem in sovereign debt restructuring—and a decision to litigate early is a form of inter-creditor rivalry, in the sense that a litigating creditor hopes to (i) avoid the effect of a restructuring and (ii) potentially earn a priority claim to the proceeds of any sale of attached sovereign assets—then one will want to find ways to limit inter-creditor rivalry. Perhaps the most elegant solution is to posit the existence of inter-creditor duties. I’m not entirely sure what Mitu has in mind when he posits a duty to “accept a supermajority [restructuring] decision.” (He’s raising this as a question, not necessarily insisting that the duty exists, but I’ll treat it as his proposal—hopefully that’s not too unfair.) Would the breach of that duty give rise to a cause of action for damages—measured, say, by any delay in resumption of payment caused by the lawsuit?* Would it require the judgment-holder to share with restructuring participants the proceeds of any recovery on the judgment, to the extent the recovery exceeded the NPV of the restructured bonds? I suspect this latter option is what Mitu has in mind, because it would eliminate incentives to litigate (or “rush-in,” as Steven Bodzin puts it). It would also be consistent with clever transaction structures that Mitu and Lee Buchheit have proposed elsewhere, which are designed to force holdouts to share any recovery with restructuring participants.

But here’s the thing. It might be a great idea to de-fang holdouts (or, in this context, rush-ins) like this. It would also be a great idea for every reader of this blog to send me $100. Alas, the modification provisions in sovereign bonds require neither thing.

Continue reading "Judgments > CACs!!!!" »

Judgements, CACs and Civil Procedure Quicksand

posted by Mitu Gulati

Mark's post below on whether obtaining a judgement is a clever way of getting around the threat of a cram down via a CAC is unsurprisingly superb.  Pharo's strategy, Mark says, is not at all crazy.  If he is right -- and I have learned over the years of working with Mark that he is almost always right -- then this strategy is going to be relevant not only in Venezuela, but in Argentina as well. It creates the problem, to quote Steven Bodzin of REDD Intelligence, of Rush-ins (as opposed to holdouts).

Interestingly, thanks to an old friend who has a doctorate in international civil procedure and follows these things, I discovered an old IMF paper where the IMF legal gurus (Thomas Laryea and Sean Hagan, most likely) had flagged this issue of judgements potentially undermining CACs for their board as far back as 2003--04. Paragraph 43 of the March 22 Report to the Board titled "Recent Developments in Sovereign Debt Litigation" basically supports Mark's view and warns the Board of precisely the complications we are discussing fifteen years later.  If one wants to go down the rabbit hole here, as I suspect the folks from Pharo have gone, the implications for the resuscitation of an Elliott-style pari passu attack via a judgement are significant. But I'm not wading into that quicksand now.

Now, to return to the question of whether Judgements do indeed quash CACs and to continue the discussion with Mark (with the caveat that he knows best), I have a simple minded query for those who are confident about that conclusion (I'm not confident either way). Take the following:

You and I enter into a contract to lend $100 to Mark. The contract also says that if Mark does not pay on the maturity date, you will refund $50 to me out of your own pocket.

Mark doesn't pay and you get a judgment against him.

Have you avoided paying me the $50?

Sharpened, the issue is whether a CAC is a form of intercreditor undertaking by which each holder promises to all the others that it will accept a supermajority decision about the treatment of the credit in a distressed situation.

After all, the clause does not say the modification "will be binding on all holders until the moment they receive a judgment". It says "binding on all holders".

And if Griesa/Baer are right that the bond continues to have legal vitality even after the awarding of a judgment, is this really so far-fetched?

Judgments > CACs

posted by Mark Weidemaier

Mitu’s post from two-days ago frames an important question. An investor holds a defaulted sovereign bond that includes a collective action clause, sues, and gets a final judgment for the full amount of the outstanding principal. Later, a majority of the remaining bondholders vote to restructure the bond’s payment terms—say, by accepting a 50% haircut. Is the judgment-holding investor somehow bound by this decision? If not, doesn’t this allow prospective holdout investors to circumvent the CAC by rushing to court to get a judgment? Let’s call this the judgment-trumps-CAC argument. Mitu’s post nicely highlights the importance of this question and some of the legal uncertainties. He also describes the judgment-trumps-CAC argument—tongue partially in cheek?—as “not crazy.”

Indeed, the judgment-trumps-CAC argument is not crazy. It is super-duper not-crazy, to the point of being unquestionably correct.* So it seems to me, anyway. Conceivably, a sovereign could use the bond’s subsequent modification as a basis for seeking relief from the judgment, though I wouldn’t fancy its odds of success. But absent such a development—which, importantly, requires judicial intervention—the judgment-holder can enforce the judgment.**

Without getting bogged down in detail, here are just a few reasons why.

Continue reading "Judgments > CACs" »

Do Judgements Trump CACs?

posted by Mitu Gulati

(Thanks to Steven Bodzin of REDD Intelligence for flagging this matter; he has an aptly titled piece on this out today “Venezuela Bondholders Seek Judgement Ahead of Collective Action Clause Activation”).

A few weeks ago, I put up a post on the what I thought was an interesting and innovative set of arguments being raised by Juan Guaido’s team in the Casa Express/Pharo Gaia v. Venezuela litigation in New York (here).  I was especially interested in the argument that an obscure customary international law doctrine of necessity (i.e., things are really really bad in my country, so I can’t pay just yet) justified the court granting a stay in the litigation.  This argument was tried in a series of arbitral proceedings under bilateral investment treaties by Argentina in the wake of its 2001 crisis and it had mixed success.  But it has never before been raised in a New York court, under a garden variety New York law governed contract.  So, the judge will have to decide whether this international law defense is even admissible in this context or whether the only excuse defenses allowable are those from New York contract law (e.g., impracticability, duress, unconscionability, etc.). And then, assuming the judge rules in the affirmative, the question will be whether the necessity defense applies in this context. 

At the end of last week, the creditors submitted their counter arguments.  As expected, they expressed outrage and shock that the debtor would seek to bring in a defense from the outlandish world of customary international law into their precious New York law contract dispute arena.  But buried in between the outrage was a point that may well open pandora’s box. 

On page 5 of the creditor submission, in explaining why the grant of a stay would harm them and, therefore, should not be granted, the creditors say:

[The] threat [of prejudice to the creditors’ ability to recover] is magnified here by the collective-action-clauses in the 7.75% 2019 bonds which allow a supermajority to bind nonconsenting creditors to the terms of restructured bonds. . . . A judgment would protect the Pharo Plaintiffs who hold beneficial interests in the 7.75% 2019 bonds – from such compulsory restructuring of their debts. (emphasis mine).

The last sentence is worth reading again.

Continue reading "Do Judgements Trump CACs?" »

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

posted by Mitu Gulati

One of the more fun discussions we have had in my international debt class this term has been the question of whether a clever plaintiff's lawyer might be able to breathe life into defaulted Chinese bonds from the period 1911-1948. (Our thanks to Tracy Alloway's delightful piece in Bloomberg on this matter (here)).

Part of our inspiration for this discussion, however, was also reading an enormously fun 2008 Sixth Circuit opinion from Judge Jeff Sutton, in the 216 Jamaica Avenue case (here). The context of the case was the abrogation of gold clauses 1933 that we've discussed before on this site (here, here and here).  What we have not talked about, however, is what impact the removal of that 1933 prohibition on the use of gold clauses in 1977 had.  For long-term contracts that were written in the early 1900s that then had their gold clause index provisions abrogated in 1933, the 1977 law arguably re activated them.  Congress tried to stop most of the attempts at reactivation.  But for the cleverest of lawyers, there was always going to be a way.  For these contract arbitrageurs, scouring old contracts for lottery tickets through the re activation of these old clauses that everyone else has long forgotten is fun. It certainly was fun for us to read about (Congrats, Cooper & Kirk, who note their victory in this case on their website (here)).

As a general matter, courts don't tend to be very sympathetic to lawyers trying to reactivate old clauses to earn giant lottery payouts.  But in 216 Jamaica Avenue, that's precisely what happened. The opinion is an absolute delight, not only because of the wonderful facts and analysis of basic contract law matters such as "meeting of the minds" that befuddles most first-year students (and me), but also because it is written in a style that is reminiscent of the classic Richard Posner opinions; short, incisive and witty.   

I'm hoping that my students, if they find interesting ways in which to overcome the significant barriers to bringing suit on the antique Chinese bonds -- namely, the statute of limitations and jurisdictional hurdles -- will post about them in the comments.  The barrier is high though, despite Mr. Horatio Gadfly's optimism some years ago (here and here).

I do wonder though whether the Chinese (and Russian) governments will some day soon decide that they should just enter into global settlement with the owners of these antique bonds for pennies on the dollar and stop the periodic pesky lawsuits. Otherwise there will come a day where someone somewhere figures out a way to do a set off or restart the statute of limitations. 216 Jamaica Ave points in that direction.

Elliott Rocks (Strikes?) Again

posted by Mitu Gulati

Holdout hero Elliott Management, the king of holding out until it gets what it wants, scored itself a nice Christmas bonus. The hedge fund won a long game of chicken with Ireland’s government over junior bonds issued by Anglo Irish Bank by getting its money back in full. If you understand the law, it pays to be stubborn, writes the FT’s Rob Smith (here).

I have written critically about Elliott Associates and their creative use of the pari passu weapon against Argentina. But I cannot help but admire their skills.  Plus, from a long term perspective, maybe they do force us all to pay more attention to the terms in our contracts -- because, if we don't, they will eat our lunch. Everyone who took the deal offered by Allied Irish got 20 cents on the dollar.  According to Smith's piece, Elliott got 100 cents. Wow.

There is a lesson here for whoever is designing Argentina's latest restructuring.

The Bajan Debt Restructuring - 2018-19

posted by Mitu Gulati

Following in the footsteps of their mammoth restructuring of Greek Debt in March 2012, Andrew Shutter, Jim Ho, Lee Buchheit, and their team utilized the same "local law advantage" to design the restructuring of the Bajan debt in 2018-19.  Andrew, one of the gurus of the sovereign debt field, has just put up a super paper on this (here). The paper describes not only how the restructuring was engineered, but also the ways in which the strategy utilized was different from that used for Greece. There is also the use of an innovative "hurricane" clause in the new post-restructuring bonds that is worthy of a whole article in and of itself (some of the other Caribbean borrowers that Andrew and Lee worked with in recent years have also used this clause, but others could sure have used it as well -- and I'm thinking of Puerto Rico in particular here).

I'm particularly interested in how the holders of foreign-law bonds were induced to enter the deal, without significant holdout problems.  My guess is that they were paid a pretty penny.  But on that specific question, Andrew does not show all of his cards.

To this date, there has been precious little writing about this very cool operation in Barbados.  So, as someone who teaches in this area, I'm especially grateful to Andrew.  I'm also jealous that he probably got to go to Barbados a lot. 

 

 

Venezuela’s Weird (and Possibly Mythical?) Prescription Clause

posted by Mark Weidemaier

Mark Weidemaier & Mitu Gulati

Ben Bartenstein at Bloomberg has a provocative article on “prescription” clauses in Venezuela’s post-2005 sovereign bonds. As he explains, these clauses arguably modify the statute of limitations that would otherwise apply to bondholder claims, creating a “loophole” that might cost investors billions. Beginning in 2005, the Republic’s bond prospectuses began to include language like this (from a bond maturing in 2026):

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…

As Bartenstein notes, the meaning of the clause isn’t entirely clear. But he suggests that it might be interpreted to “let Venezuela off the hook on unpaid interest to any creditor after three years—provided the creditor doesn’t take legal action seeking repayment during that span.”

This is a great find by Bartenstein, and he’s right to highlight the risks associated with the clause. But we doubt the clauses have this effect. Actually, we’re not sure the clauses even exist. But first, some background. (Full disclosure: One of us (Mitu) talked to Ben about his find and was rather unhelpful to him; not even having been aware of these clauses prior to Ben flagging them.)

Continue reading "Venezuela’s Weird (and Possibly Mythical?) Prescription Clause" »

The "Necessity" Defense in Sovereign Debt Cases

posted by Mitu Gulati

My international debt class this week discussed the US Supreme Court’s gold clause decisions from 1935; and, in particular, US v. Perry. This is one of my favorite topics, in part because the events that occurred are so surprising to most students (as they were to me). Plus, there is some wonderful writing on the topic including a 2013 law review article by Indiana U Law School’s Gerard Magliocca (here) and a 2018 book by UCLA Economic Historian Sebastian Edwards (here).

For those who don’t know this case, basically the US imposed a massive haircut on its lenders by abrogating the gold clauses in its debt contracts via Congressional action in 1933.  Creditors yelled bloody murder and sued, and the case quickly made its way to SCOTUS.  There, the government, which didn’t have very many strong legal arguments on its side, threw itself at the court’s mercy and pled that the court deny the creditors’ claims on public policy grounds. That is, that the country was in such a deep crisis – arguably the worst it had ever seen – that extreme steps (such as the abrogation of a contract term) needed to be taken to improve general welfare.  It was a Hail Mary pass, and it worked even though the justices had to hold their noses and rule.  The Court ruled in a somewhat bizarre fashion, finding a constitutional violation but no damages.  The bottom line though was that the government won.  Better still, the US economy recovered and lenders became even more eager to lend to the US than they were before. (see here and here).

The question raised by Edwards and Magliocca though is whether we might see the use of this extreme necessity defense ever again.  And it turns out that there is a sovereign debt case going on right now, in January 2020, in a federal court in New York, where necessity is being raised as a defense. The country in question is Venezuela and the conditions surrounding Venezuela’s inability to pay are as extreme as they come (evil dictator, deep humanitarian crisis, broke government-in-exile stuck dealing with myriad lawsuits). The case is Casa Express Corp. v. Venezuela (Case 1:18-cv-11940-AT).  Question is whether, given that the crisis is occurring in a distant country as opposed to the US itself, the US federal court will find the appeal to “necessity” convincing in the same way that they did in 1935. (Venezuela is asking for a lot less relief in this case than the US was in 1935; Venezuela just wants a stay until Mr. Maduro can be induced to leave office and the IMF can help it prepare to deal with creditor claims).

Continue reading "The "Necessity" Defense in Sovereign Debt Cases" »

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

posted by Mitu Gulati

Argentina is on the brink of attempting a restructuring of its sovereign debt.  And, of course, that has attracted the birds of prey.  An article in Bloomberg a couple of days ago (here) reported that potential holdout creditors had hired expert lawyers to examine the fine print in Argentine contracts in the hope of finding a vehicle to support their litigation strategies.

Assuming that it is not going to be long before Argentina is in full restructuring mode, my question is whether an unusual clause in one of the Argentine bonds, combined with a recent case out of the Southern District of New York, might interfere with the Argentine government’s restructuring plans?

The clause is the Optional Redemption provision in the $2.75 bn hundred-year bond that Argentina issued in June 2017, with the hefty coupon of 7.125%.  Optional Redemption clauses, as my co authors (Amanda Dixon, Madison Whalen and Theresa Arnold) discovered in an analysis of over 500 recent sovereign and quasi sovereign issuances, are rare creatures in this market.  Fewer than 20% of all the sovereign issuers use them. Some, like Mexico, are frequent users. But others, such as Argentina, have used them only on rare occasion.

Oversimplifying, these provisions typically allow the issuer to call the bonds at a supra compensatory amount (somewhat misleadingly called the “make-whole” amount).  Our data suggests that such provisions were largely absent from the sovereign market in the period between the mid 1990s and 2010.  Somewhere around 2010 though, Issuer Call provisions with their “make-whole” premia began migrating into the sovereign world from the high-yield corporate bond market.  Precisely why the Issuer Call provisions are set at a supra compensatory amount is something of a mystery to me (Marcel Kahan and I discuss the mechanics of these clauses here).

What I’ve heard from lawyers and bankers in the interviews that Marcel and I did for our piece (here) is that high-yield corporates sometimes need to retire their old bonds to they can escape onerous covenants (for example, to engage in a lucrative merger).  And to do that they are willing to pay a high amount – that is, a supra compensatory “make-whole” premium. In the sovereign context though, not only is there not going to be any lucrative merger, but the covenants are not all that onerous such that issuers would want to pay a big premium to get out of them.  But maybe there are countries that think that their current borrowing costs are unduly high (e.g., the 7.125% coupon on Argentina’s 100-year bond) and that these costs will surely go down some day in the future.  That, in turn, will make the redemption option valuable to that optimistic issuer. And, maybe, like Argentina was in June 2017, the issuer will be willing to promise pay a high amount to creditors if conditions ever become so positive that it wants to retire substantial amounts of its high coupon debt. Alexander Hamilton certainly thought so in the Report on Public Credit in 1790 (here).  Things haven’t quite worked out for Argentina in the manner that they did for Hamilton and the US.  But a hundred years is a long time. 

Now, you might ask, why is an Optional Redemption clause relevant in the context of an attempted sovereign restructuring?  After all, an Issuer Call option and should only be relevant where the issuer chooses to exercise the option.  And Argentina is seeking to get creditors to take haircuts, rather than exercise its redemption option.  Remember, the redemption option typically requires the issuer to pay a supra compensatory amount (because it is intended to operate in a state of the world where things have improved so dramatically for that issuer that it wishes to retire the debt) – which is the opposite of the haircut that Argentina needs to impose currently (because things have turned terrible for Argentina).

The answer has to do with a New York case from late 2016, Cash America v. Wilmington Savings.  Drawing from a blog post that Marcel Kahan and I did for the Columbia Law School Blue Sky Blog a couple of days ago, here is the story of the case:

Bond indentures [for high-yield corporate issuers in the US] commonly contain what are called “make-whole” provisions that give the issuer of the bonds the option to redeem the bonds, at a premium over par. Bond indentures also contain an acceleration clause that gives bondholders the option, upon an Event of Default, to demand immediate payment of the principal amount and receive par. To reiterate, redemption is an option of the issuer while acceleration is an option for bondholders.

In Cash America [v. Wilmington Savings], the issuer was found to have violated a covenant in the bond indenture, thereby generating an Event of Default.  The court ruled that when the issuer engaged in a “voluntary” covenant breach, holders are entitled to receive as a remedy the amount they would have received upon redemption, that is a premium over the amount receivable under the acceleration clause.  [And that redemption amount was a supra compensatory “make-whole” amount].

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

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

posted by Mitu Gulati

The ideas in this post are drawn from work with Stephen Choi.  Errors are mine.

Last week was the first session in our International Debt Finance class, both at Duke and at NYU.  This is an exciting time to be teaching this material, given the many sovereign and quasi sovereign issuers that are struggling with over indebtedness.  Among them are Argentina, Lebanon, Venezuela, Italy (maybe) and, locally, Puerto Rico.

For day one, inspired by the provocative recent article by Julia Mahoney and Ed Kitch on the possible need to restructure the multi-trillion dollar US debt stock, we assigned both the Mahoney-Kitch (2019) piece (here) and Alexander Hamilton’s 1790 Report on Public Credit (here).

Hamilton’s Report on Public Credit is an astonishing document, since it is essentially a proposal to do a brutal debt restructuring (see here) for a new nation that, while significantly reducing the nation’s debt stock, would (hopefully) also serve as a building block for a solid reputation for this new debtor.  Somehow, it worked.  In what follows, we focus on only one aspect of Hamilton’s report: Hamilton’s views on the possibility of reducing the US debt stock--some of which was trading at pennies on the dollar--by doing a market buyback prior to the announcement of his plan.  In discussing possible strategies to reduce the public debt, he flags the possibility of doing a buyback of the debt at the current market prices.  Hamilton writes of this strategy:

Fourthly. To the purchase of the public debt at the price it shall bear in the market, while it continues below its true value. This measure, which would be, in the opinion of the Secretary [i.e., Hamilton, speaking of himself in the third person], highly dishonorable to the government, if it were to precede a provision for funding the debt, would become altogether unexceptionable, after that had been made. (emphasis added).

In other words, Hamilton says that doing a buyback before the government makes public its plan to fund the debt, would be wrong.  Why?  We don’t know exactly why.  But reading between the lines, AH would perhaps explain that the sovereign debtor should not be the beneficiary of its own misconduct (the default), particularly at the expense of its own citizens (the sellers of the paper at a discount). 

Question is, given that we have an additional 200 years plus of experience of sovereign restructurings since Hamilton, was he right to disfavor the buyback strategy? As a practical matter, in terms of the playbook of the modern sovereign debt restructurer, Hamilton’s admonition seems to have held sway. That is illustrated by this 2019 IMF publication on “How to Restructure Sovereign Debt: Lessons From Four Decades” which mentions buybacks only in a footnote (note 3, here) that suggests that prevailing economic wisdom is that they don’t work particularly well as a restructuring strategy.

Continue reading "Buybacks as a Sovereign Debt Restructuring Strategy: Why the Disfavor? " »

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