Boer Bonds and the Doctrine of War Debts

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).

ECB + CACs: Fig Leaf Aflutter

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?

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.

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

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

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

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.

Do Italian Sovereign Bonds Have an Implicit Force Majeure Clause?

"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.

The Choice of Advisers for the Lebanese Restructuring

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

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.

Paper Dragons

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?)

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.

Skeel on the Puerto Rico Oversight (NOT Control) Board

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?)

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?

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

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

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.

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

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!!!!

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.

Judgements, CACs and Civil Procedure Quicksand

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

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.

Do Judgements Trump CACs?

(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.

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

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

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

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

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.)

The "Necessity" Defense in Sovereign Debt Cases

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).

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

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].

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

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.

A Cautionary Tale: Argentina’s Pari Passu Debt Debacle

Mark Weidemaier & Mitu Gulati

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

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

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

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

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

Hinrichsen on Iraq’s Debt Restructuring

Iraq’s debt restructuring a decade and a half ago was one of the few things that went right with the US incursion into that country in 2003.  Thanks to a combination of an expensive war with Iran, mismanagement and corruption on the part of Saddam and his henchmen, and the debilitating effect of international sanctions on the economy, Iraq in 2003 found itself with one of the largest sovereign defaulted debt stocks in history.  Worse, thanks to the sanctions regime, much of the unpaid debt had, by the time of Saddam’s removal, matured into judgements and attachment orders.  That makes a debt restructurer's job much more difficult than in a normal sovereign restructuring.  And unlike other defaulting sovereigns in the past, who had precious few assets available for creditors in foreign jurisdictions to seize, the new Iraq had oil revenues that it desperately needed to use in order to try and get back to some semblance of normalcy and growth.

The fascinating story of how the debt was accumulated and then restructured has been told in bits and pieces.  But economic historian Simon Hinrichsen is the first, to my knowledge, to attempt to tell the full story. His draft article, “Tracing Iraqi Debt Through Defaults and Restructurings”, hot off the presses, is available on the LSE Econ History website here.  Among the most interesting aspects of the story are the use of UN Security Council Resolutions and US Executive Orders to immunize Iraqi oil assets (hence, neutralizing the risk of attacks by holdout creditors) and the attempted resuscitation of the ancient doctrine of Odious Debts. The former succeeded and the latter failed.  Many of these same issues are going to come up again when Venezuela embarks on its post-Maduro restructuring (see here and here).  I wonder how they will play out.

Simon's abstract is as follows:

In 1979 Iraq was a net creditor to the world, due to its large oil reserves and lack of external debt. Fifteen years later, its government debt-to-GDP was over 1,000%. At the time of the U.S. invasion in 2003, Iraq was saddled with around $130 billion in external debt that needed to be restructured. How does a country incur so much debt, so fast, and how does it get out of it? In answering this question, the paper makes two key contributions. First, I reconstruct the build-up of Iraqi debt through the 1980s and 1990s using mainly secondary sources. This paper is the first to create a debt series going back to 1979. The rise in Iraqi indebtedness was a consequence of global geopolitical trends in the 1980s where political lending trumped solvency concerns. Second, through primary sources and interviews with key actors involved, I use oral history to tell the story the Iraqi restructuring. It was one of the largest in history, yet no clear and detailed historical account exists. The restructuring was permeated by politics to inflict harsh terms on creditors at the Paris Club, at a time when creditor-friendly restructurings were the norm. In going for a politically expedient deal, however, the restructuring missed an opportunity to enshrine a doctrine of odious debt in international law

 

Yadav on Dodgy Debt Buybacks

I’ve long been fascinated by debt buybacks by issuers, in large part because they seemed to occupy a loophole in the securities disclosure laws.  A company could do a buyback of bonds and, because bondholders are not owed fiduciary duties by the company, there was no requirement for disclosure. That means that the company, to the extent it was in possession of secret information (the discovery of a gold mine, for example), could screw over the bondholders by buying back their securities before the news got out and the price went up.  Of course, the gold mine situation doesn’t occur all that often. But in the area that I do most of my research in, sovereign bonds, there are often large asymmetries of information between issuers and creditors. And yet, one rarely sees large scale buybacks of debt. (for the classic piece on sovereign buybacks, by Bulow and Rogoff, see here).

For years though, I’ve thought that this topic was of interest to no more than the three or four people in the legal academy who found bonds interesting (Marcel Kahan, Bill Bratton and a couple of others).  But just a few days ago I came across a wonderful new article by Yesha Yadav on precisely this topic. The draft article, “Debt Buybacks and the Myth of Creditor Power” is available here.  Yesha argues that the dramatic increase in corporate debt buybacks in recent years (apparently in the trillions of dollars) should be concerning not just because of the aforementioned disclosure loophole, but because these buybacks undermine corporate governance (when they are done in order to strip covenants) and allow shady behavior by banks seeking to increase the value of their loans at the expense of bondholders.

The story Yesha tells is more than plausible and she gives lots of vivid examples that support her arguments.  Since my particular interest is in flaws in the bond contract drafting process, the questions that her article raised for me have to do with why private contracting has not fixed the problem she identifies.  After all, the parties involved in these deals are super rich and sophisticated (with the fanciest of Wall Street law firms at their beck and call).

Sovereign Gold Bonds in 2019: Really?

Mark Weidemaier and Mitu Gulati

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

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

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

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

Mark Weidemaier & Mitu Gulati

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

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

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

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

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

Mark Weidemaier & Mitu Gulati

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

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

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

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

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

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

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

Mark Weidemaier & Mitu Gulati

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

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

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

Imagine Riding the Ceteris Pari-bus into the Sunset ... in Argentina

Imagine sovereign debt without Argentina -- no Paris Club, no pari passu, no CACs, no SDRM ... even sovereign immunity might look totally different. History teaches that whatever happens in Argentina's imminent bond restructuring (revisiting, reprofiling, rejiggering, revamping --the difference is overblown) is likely to have consequences beyond the long-suffering Republic. The fact that Argentina has an actual government with authority over the economy and some capacity to execute a restructuring (unlike, say, Venezuela) justifies wading into the small print of its bond disclosure--as Mark and Mitu have done. Their able interventions free me to focus on two under-covered points. Methinks that (1) the single-minded focus on voting thresholds is misguided, and that (2) it helps to think of "uniformly applicable" as the latest incarnation of pari passu, which goes to show that inter-creditor equity remains a perennial problem in sovereign debt.

Can Argentina Discriminate Against Bonds Issued Under Macri?

Mark Weidemaier and Mitu Gulati

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

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

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

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

Argentina’s [Insert Adjective Here] Debt Crisis

Mark Weidemaier & Mitu Gulati

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

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

Voluntary Reprofiling

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

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

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

Aurelius v. Puerto Rican Control Board (or "Do Activist Hedgies Add Value?")

This post draws considerably from research on Puerto Rico and its current constitutional status with Joseph Blocher (see here).

Tuesday was oral argument day at the Supreme Court in the battle between the Puerto Rican Control Board and a big bad hedge fund, Aurelius.  Aurelius, zealous defender of the constitution that it is, had brought a challenge to the constitutionality of the Control Board. The claim being that the failure of President Obama and the then Congress to follow the strictures of the Constitution for the appointment of principal officers of the federal government (nomination by the President, followed by Senate confirmation) made the Board and all its actions invalid.

I am not a constitutional scholar and don’t have any desire to be one.  Still, the basic issue here seems fairly simple:  Are the members of the Control Board principal federal officers?

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

Mark Weidemaier & Mitu Gulati

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

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

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

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

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

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

For a Caracas Chronicles piece on this, see here.

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

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

Can Creditors Seize CITGO? Enforcing the PDVSA 2020 Bond Collateral

Mark Weidemaier & Mitu Gulati

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

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

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

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

The Puzzling Pricing of Venezuelan Sovereign Bonds

by Mark Weidemaier & Mitu Gulati

Venezuela’s sovereign bonds differ in ways that should, in theory, be reflected in market prices. For example, depending on the bond, the vote required to modify payment terms through the collective action clause (CACs) varies from 100% (requiring each holder to assent), to 85%, to 75%. Bonds with higher voting thresholds are harder to restructure and one would think prices would reflect this. Two bonds issued by state oil company PDVSA also have legal features that one might expect to have pricing implications. One bond benefits from a pledge of collateral (the PDVSA 2020) and, in consequence, should be priced higher than otherwise-comparable bonds. A second was issued at a particularly large original issue discount (OID); this is a potential legal defect that should lower its price. This is the so-called “Hunger bond” (PDVSA 2022 —see here, here and here for more)).

Although these differences seem like they should matter, reports from the European markets (where the bonds can still be traded) indicate that bid prices for Venezuelan sovereign bonds range from around 13.0 to 13.5 cents on the dollar, while ask prices range from about 14.5 to 15.5. Moreover, prices on the bonds with different voting thresholds are identical. That is, the bonds that cannot be restructured except with each creditor’s assent are trading the same as bonds that allow a creditor majority of 85% or 75% to force restructuring terms on dissenters. But why? Venezuela is in full-fledged default, when legal protections should matter the most.  Shouldn’t these non-US investors (US investors can’t buy, given OFAC sanctions) be offering higher prices for bonds with better terms?

Enough With the Old Chinese Debt Already

Mark Weidemaier and Mitu Gulati

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

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

Trump Wants to Buy Greenland for the U.S. – But Who Is the Relevant Seller?

(This post draws from my prior work with Joseph Blocher and the many conversations we have had about this topic over the years; he bears no responsibility for errors and sarcasm)

According to a flurry of news reports from the WSJ, CNN, Bloomberg, the NYT and many more, our eminent chief executive has an interest in the possibility of buying Greenland.  Most reactions to this news of DJT’s latest whim have boiled down to incredulity, while also generating a fair amount of mirth (see here, here and here).  What has interested us the most, though, are the articles that have concluded that the U.S. cannot buy Greenland. Bloomberg’s Quick Take ran the title – “Can Trump Actually Buy Greenland – The Short Answer is No”. 

But is that really the case? The relevant international law seems to present no explicit barrier to nations buying and selling territory (here). Indeed, much of today’s United States was acquired through the purchase of territory.  The barrier that most commentators see as insurmountable is not legal, but rather the lack of a willing seller.  Maybe so.  But a handful of quotes from government officials and politicians in Denmark and a few from politicians in Greenland (see here and here) is not necessarily enough to conclude that this trade could never work.

Before jumping to the foregoing conclusion, one needs to first ask how such a sale would work.

Coyle on Studying the History of a Contract Provision

The way many of us teach interpretation in Contract Law, there is little role for history (admittedly, this is just based on casual observation). The meaning of a clause is a function of the words that make up that clause.  The parties to the transaction are assumed to have drafted it to document the key aspects of their transaction, to balance risks and rewards blah blah.  If a dispute arises, we might have an argument as to whether a strict textualist reading of the words accurately represent what the parties really meant by them or whether we need to also examine the context of the relationship. What we do not ever do, however, is to delve into the history of the clause from before these parties contemplated using it – that is, of what prior drafters of the original versions of this clause might have meant in using it.

The foregoing makes sense in a world in which the contracts for each deal are drafted from scratch. But does anyone draft contracts from scratch?  What if we live in a world where 99.9% of contracts are made up of provisions cut and paste from prior deals; provisions that are assumed to cover all the key contingencies, but not necessarily understood (or even read)? In this latter world, where there are lots of provisions that the parties to the transaction never fully focused on (let alone understood), might there be an argument – in cases where there are interpretive disputes -- for the use of a contract provision’s history? Might that history not sometimes be more relevant than the non-understandings of the parties as to what they did or did not understand they were contracting for? (Among the few pieces that wrestle with this question are these two gems: Lee Buchheit's Contract Paleontology here and Mark Weidemaier's Indiana Jones: Contract Originalist here)

I’m not sure what the answer to the foregoing question is. But it intrigues me.  And it connects to a wonderfully fresh new body of research in Contract Law where a number of scholars have been studying the production process for modern contracts.  The list of papers and scholars here is too long to do justice to and I’ll just end up making mistakes if I try to do a list.  But what unites this group of contract scholars is that for them it isn’t enough to assume that contracts show up fully formed at the time of a deal, purely the product of the brilliant minds of the deal makers who anticipate nearly every possible contingency at the start.  Instead, understanding what provisions show up in a contract, and in what formulation, requires understanding the contract production process. (Barak Richman's delightful "Contracts Meet Henry Ford" (here) is, to my mind, foundational).

It is perhaps too early to tell whether this research will catch on and revolutionize contract law. I hope it does, but I’m biased.

One of my favorite papers in this new body of contract scholarship showed up recently on ssrn. It is John Coyle’s “A History of the Choice-of-Law Clause” (here). I have rarely found a piece of legal scholarship so compelling.  The paper is not only a model of clarity in terms of the writing, but it is brave. It is completely unapologetic in not only taking on an entirely new mode of research (a painstaking documentation of the historical evolution of the most important terms in any and every contract), but in coming up with a cool and innovative research technique for unpacking that history (this project would have been impossible to do without that innovation).

Third Circuit Affirms Crystallex Attachment Order

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

India to Issue its First Foreign Currency Sovereign Bond?

Mitu Gulati & Mark Weidemaier

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

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

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

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

Mark Weidemaier & Mitu Gulati

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

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

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

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

Venezuelan Debt: Soft Power Matters

Mark Weidemaier and Mitu Gulati

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

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

Equal Treatment in Sovereign Restructurings

Mitu Gulati & Mark Weidemaier

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

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

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

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

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

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